Attached files
| file | filename |
|---|---|
| EXCEL - IDEA: XBRL DOCUMENT - INTEGRATED SILICON SOLUTION INC | Financial_Report.xls |
| EX-31.2 - CERTIFICATION OF CFO PURSUANT TO SECTION 302 - INTEGRATED SILICON SOLUTION INC | issi-06302014xex312.htm |
| EX-3.1 - RESTATED CERTIFICATE OF INCORPORATION, AS AMENDED - INTEGRATED SILICON SOLUTION INC | issi-6302014xex31.htm |
| EX-31.1 - CERTIFICATION OF CEO PURSUANT TO SECTION 302 - INTEGRATED SILICON SOLUTION INC | issi-06302014xex311.htm |
| EX-32 - CERTIFICATION OF CEO AND CFO PURSUANT TO SECTION 906 - INTEGRATED SILICON SOLUTION INC | issi-06302014xex32.htm |
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 June 30, 2014
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 000-23084
__________________________________________
Integrated Silicon Solution, Inc.
(Exact name of registrant as specified in its charter)
___________________________________________
Delaware | 77-0199971 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
1623 Buckeye Drive, Milpitas, California | 95035 | |
(Address of principal executive offices) | (Zip Code) | |
(408) 969-6600
(Registrant’s telephone number, including area code)
______________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 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. Yes ý 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). Yes ý No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer | ¨ | Accelerated filer | ý |
Non-accelerated filer | ¨ | Smaller reporting company | ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ý
The number of outstanding shares of the registrant’s Common Stock as of August 1, 2014 was 30,710,313.
TABLE OF CONTENTS
PART I | Financial Information | |
References in this Quarterly Report on Form 10-Q to “we,” “us,” “our” and “ISSI” mean Integrated Silicon Solution, Inc. and all entities controlled by Integrated Silicon Solution, Inc.
Part I. FINANCIAL INFORMATION
Item 1. | Financial Statements |
Integrated Silicon Solution, Inc.
Condensed Consolidated Statements of Income
(Unaudited)
(In thousands, except per share data)
Three Months Ended June 30, | Nine Months Ended June 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Net sales | $ | 84,834 | $ | 77,788 | $ | 244,825 | $ | 229,178 | ||||||||
Cost of sales | 55,538 | 51,741 | 162,250 | 153,651 | ||||||||||||
Gross profit | 29,296 | 26,047 | 82,575 | 75,527 | ||||||||||||
Operating expenses: | ||||||||||||||||
Research and development | 10,978 | 10,583 | 32,363 | 30,914 | ||||||||||||
Selling, general and administrative | 11,942 | 10,829 | 34,845 | 32,648 | ||||||||||||
Total operating expenses | 22,920 | 21,412 | 67,208 | 63,562 | ||||||||||||
Operating income | 6,376 | 4,635 | 15,367 | 11,965 | ||||||||||||
Interest and other income (expense), net | 99 | 546 | 905 | 1,329 | ||||||||||||
Gain on sale of investments | 2,140 | 7,280 | 11,300 | 9,339 | ||||||||||||
Income before income taxes | 8,615 | 12,461 | 27,572 | 22,633 | ||||||||||||
Provision for income taxes | 2,388 | 5,215 | 6,941 | 9,619 | ||||||||||||
Consolidated net income | 6,227 | 7,246 | 20,631 | 13,014 | ||||||||||||
Net income attributable to noncontrolling interests | (41 | ) | (182 | ) | (198 | ) | (164 | ) | ||||||||
Net income attributable to ISSI | $ | 6,186 | $ | 7,064 | $ | 20,433 | $ | 12,850 | ||||||||
Basic net income per share | $ | 0.20 | $ | 0.25 | $ | 0.69 | $ | 0.46 | ||||||||
Shares used in basic per share calculation | 30,312 | 28,293 | 29,816 | 27,988 | ||||||||||||
Diluted net income per share | $ | 0.19 | $ | 0.24 | $ | 0.65 | $ | 0.44 | ||||||||
Shares used in diluted per share calculation | 31,963 | 29,755 | 31,337 | 29,427 | ||||||||||||
See accompanying notes to condensed consolidated financial statements.
1
Integrated Silicon Solution, Inc.
Condensed Consolidated Statements of Comprehensive Income
(Unaudited)
(In thousands)
Three Months Ended June 30, | Nine Months Ended June 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Consolidated net income | $ | 6,227 | $ | 7,246 | $ | 20,631 | $ | 13,014 | ||||||||
Other comprehensive income, net of tax: | ||||||||||||||||
Change in unrealized gain (loss) on investments: | ||||||||||||||||
Changes arising during current period, net of tax benefit (expense) of $0, ($2,750), $251 and ($9,774), respectively | — | 7,231 | (349 | ) | 17,166 | |||||||||||
Reclassification for gain included in net income, net of tax expense of $592, $2,057, $3,589 and $2,193, respectively | (1,024 | ) | (2,371 | ) | (6,029 | ) | (3,039 | ) | ||||||||
(1,024 | ) | 4,860 | (6,378 | ) | 14,127 | |||||||||||
Change in cumulative translation adjustment: | ||||||||||||||||
Changes arising during current period | 2,989 | (1,018 | ) | (1,020 | ) | (3,357 | ) | |||||||||
Change in retirement plan actuarial losses: | ||||||||||||||||
Reclassification for gain included in net income, net of tax expense (benefit) of $0 for the three and nine months ended June 30, 2014 and 2013 | 27 | 168 | 82 | 218 | ||||||||||||
Change in retirement plan transition obligation: | ||||||||||||||||
Reclassification for gain included in net income, net of tax expense (benefit) of $0 for the three and nine months ended June 30, 2014 and 2013 | (15 | ) | (67 | ) | (45 | ) | (97 | ) | ||||||||
Other comprehensive income (loss) | 1,977 | 3,943 | (7,361 | ) | 10,891 | |||||||||||
Comprehensive income | 8,204 | 11,189 | 13,270 | 23,905 | ||||||||||||
Comprehensive income attributable to noncontrolling interest | (41 | ) | (182 | ) | (198 | ) | (164 | ) | ||||||||
Comprehensive income attributable to ISSI | $ | 8,163 | $ | 11,007 | $ | 13,072 | $ | 23,741 | ||||||||
See accompanying notes to condensed consolidated financial statements.
2
Integrated Silicon Solution, Inc.
Condensed Consolidated Balance Sheets
(In thousands)
June 30, 2014 | September 30, 2013 | |||||||
(unaudited) | (1) | |||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 139,469 | $ | 119,997 | ||||
Restricted cash | 1,000 | — | ||||||
Short-term investments | 1,746 | 21,558 | ||||||
Accounts receivable, net | 50,329 | 46,088 | ||||||
Inventories | 80,097 | 68,469 | ||||||
Deferred tax assets | 2,840 | 2,326 | ||||||
Other current assets | 15,745 | 14,602 | ||||||
Total current assets | 291,226 | 273,040 | ||||||
Property, equipment and leasehold improvements, net | 50,221 | 46,504 | ||||||
Purchased intangible assets, net | 5,440 | 6,626 | ||||||
Goodwill | 9,178 | 9,178 | ||||||
Deferred tax assets | 10,338 | 9,942 | ||||||
Other assets | 23,446 | 16,579 | ||||||
Total assets | $ | 389,849 | $ | 361,869 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 46,982 | $ | 50,229 | ||||
Accrued compensation and benefits | 10,155 | 8,072 | ||||||
Accrued expenses | 10,834 | 7,357 | ||||||
Current portion of long-term debt | 195 | 195 | ||||||
Total current liabilities | 68,166 | 65,853 | ||||||
Long-term debt | 4,388 | 4,534 | ||||||
Other long-term liabilities | 5,083 | 8,712 | ||||||
Total liabilities | 77,637 | 79,099 | ||||||
Commitments and contingencies | ||||||||
Stockholders’ equity: | ||||||||
Common stock | 3 | 3 | ||||||
Additional paid-in capital | 360,293 | 343,947 | ||||||
Accumulated deficit | (52,065 | ) | (72,498 | ) | ||||
Accumulated other comprehensive income | 1,760 | 9,121 | ||||||
Total ISSI stockholders’ equity | 309,991 | 280,573 | ||||||
Noncontrolling interest | 2,221 | 2,197 | ||||||
Total stockholders’ equity | 312,212 | 282,770 | ||||||
Total liabilities and stockholders’ equity | $ | 389,849 | $ | 361,869 | ||||
(1) | Derived from audited financial statements. |
See accompanying notes to condensed consolidated financial statements.
3
Integrated Silicon Solution, Inc.
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(In thousands)
Nine Months Ended June 30, | ||||||||
2014 | 2013 | |||||||
Cash flows from operating activities | ||||||||
Consolidated net income | $ | 20,631 | $ | 13,014 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 5,885 | 4,152 | ||||||
Stock-based compensation | 4,585 | 4,373 | ||||||
Excess tax benefits from share-based compensation | (2,567 | ) | — | |||||
Amortization of intangibles | 1,186 | 1,191 | ||||||
Gain on sale of investments | (11,300 | ) | (9,339 | ) | ||||
Equity in net loss of affiliate | 215 | 222 | ||||||
Net foreign currency transaction gains | (405 | ) | (538 | ) | ||||
Deferred tax assets | 1,736 | 7,197 | ||||||
Other non-cash items | (35 | ) | 56 | |||||
Net effect of changes in current and other assets and current liabilities | (14,231 | ) | 1,582 | |||||
Net cash provided by operating activities | 5,700 | 21,910 | ||||||
Cash flows from investing activities | ||||||||
Acquisition of property and equipment | (9,928 | ) | (17,883 | ) | ||||
Acquisition of noncontrolling interest in consolidated subsidiary | (199 | ) | (1,614 | ) | ||||
Payment of license fees | (7,098 | ) | — | |||||
Payment of holdback related to Si En acquisition | — | (4,200 | ) | |||||
Proceeds from sale of investments | — | 4,256 | ||||||
Increase in restricted cash | (1,000 | ) | — | |||||
Purchases of available-for-sale securities | (1,316 | ) | (4,330 | ) | ||||
Sales of available-for-sale securities | 22,143 | 22,637 | ||||||
Cash provided by (used in) investing activities | 2,602 | (1,134 | ) | |||||
Cash flows from financing activities | ||||||||
Repurchases and retirement of common stock | (350 | ) | (547 | ) | ||||
Proceeds from issuance of stock through compensation plans | 9,569 | 5,338 | ||||||
Excess tax benefit from share-based compensation | 2,567 | — | ||||||
Proceeds from borrowings | — | 4,875 | ||||||
Principal payments of long-term obligations | (146 | ) | (97 | ) | ||||
Proceeds from borrowings under short-term lines of credit | — | 4,069 | ||||||
Principal payments of short-term lines of credit | — | (4,069 | ) | |||||
Cash provided by financing activities | 11,640 | 9,569 | ||||||
Effect of exchange rate changes on cash and cash equivalents | (470 | ) | (616 | ) | ||||
Net increase in cash and cash equivalents | 19,472 | 29,729 | ||||||
Cash and cash equivalents at beginning of period | 119,997 | 75,497 | ||||||
Cash and cash equivalents at end of period | $ | 139,469 | $ | 105,226 | ||||
See accompanying notes to condensed consolidated financial statements.
4
INTEGRATED SILICON SOLUTION, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. | Basis of Presentation |
The accompanying unaudited condensed consolidated financial statements include the accounts of Integrated Silicon Solution, Inc. (the Company or ISSI) and its consolidated majority owned subsidiaries, after elimination of all significant intercompany accounts and transactions. These financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) for interim financial information and with Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (which are of a normal, recurring nature) considered necessary for fair presentation have been included.
On September 14, 2012, the Company acquired approximately 94.1% of the outstanding shares of Chingis Technology Corporation (Chingis) and the Company’s financial results reflect accounting for Chingis on a consolidated basis from the date of acquisition. In May 2013, the Company acquired an additional 4.8% of Chingis for approximately $1.6 million. In October 2013, the Company acquired an additional 0.5% of Chingis for approximately $0.2 million. At June 30, 2014, the Company owned approximately 99.4% of the outstanding shares of Chingis.
The Company’s operating results for the nine months ended June 30, 2014 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2014 or for any other period. The financial statements included herein should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2013.
Certain reclassifications have been made to prior year balances in order to conform to the current year's presentation.
2. | Use of Estimates |
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported amounts of revenues and expenses during the reporting period. Such estimates include the useful lives of fixed assets, allowances for doubtful accounts and customer returns, valuation allowances for deferred tax assets, inventory write-downs, potential reserves relating to litigation matters, accrued liabilities, and other reserves. The Company bases its estimates and judgments on its historical experience, knowledge of current conditions and its beliefs of what could occur in the future, given available information. Actual results may differ from those estimates, and such differences may be material to the financial statements.
3. | Impact of Recently Issued Accounting Pronouncements and Standards |
The following issued accounting pronouncements are not yet effective for the Company as of June 30, 2014.
Liabilities
In February 2013, the Financial Accounting Standards Board (FASB) issued guidance for the recognition, measurement and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of the guidance is fixed at the reporting date. Examples of obligations include debt arrangements, other contractual obligations, and settled litigation and judicial rulings. The guidance requires an entity to measure such obligations as the sum of the amount that the reporting entity agreed to pay on the basis of its arrangement among its co-obligors in addition to amounts the reporting entity expects to pay on behalf of its co-obligors. The guidance becomes effective for the Company beginning in the first quarter of fiscal 2015 and is not expected to have a material impact on the Company's consolidated financial statements.
Foreign Currency Matters
In March 2013, FASB issued guidance on when foreign currency translation adjustments should be released to net income. When a parent entity ceases to have a controlling financial interest in a subsidiary or group of assets that is a business within a foreign entity, the parent is required to release any related cumulative translation adjustment into net income. Accordingly, the cumulative translation adjustment should be released into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. The guidance becomes effective for the Company beginning in the first quarter of fiscal 2015 and is not expected to have a material impact on the Company's consolidated financial statements.
5
INTEGRATED SILICON SOLUTION, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
Revenue from Contracts with Customers
In May 2014, FASB amended the existing accounting standards for revenue recognition. The new guidance establishes principles for recognizing revenue upon the transfer of promised goods or services to customers, in an amount that reflects the expected consideration received in exchange for those goods or services. The guidance becomes effective for the Company beginning in the first quarter of fiscal 2018. Early adoption is not permitted. The new revenue standard may be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized as of the date of adoption. The Company has not yet selected a transition method nor has the Company determined the impact of adopting the new revenue standard on its consolidated financial statements.
4. | Fair Value Measurements |
Under FASB guidance, fair value is defined as the price expected to be received from the sale of an asset or paid to transfer a liability in a transaction between market participants at the measurement date. In determining fair value, the Company uses various valuation approaches, including quoted market prices and discounted cash flows. The FASB guidance also establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that the market participants would use in pricing the asset or liability developed based on market data obtained from independent sources. Unobservable inputs are inputs that reflect a company’s judgment concerning the assumptions that market participants would use in pricing the asset or liability developed based on the best information available at that time. The fair value hierarchy is broken down into the following three levels based on the reliability of inputs:
• | Level 1 – Valuations based on quoted prices in active markets for identical instruments that the Company is able to access. Since valuations are based on quoted prices which are readily and regularly available in an active market, valuation of these products can be done without a significant degree of judgment. |
• | Level 2 – Valuations based on quoted prices in active markets for instruments that are similar, or quoted prices in markets that are not active for identical or similar instruments and model-derived valuations in which all significant inputs and significant value drives are observable in active markets. |
• | Level 3 – Valuations based on inputs that are unobservable and significant to the overall fair value measurement. These values are generally determined using pricing models for which the assumptions utilize management’s estimates of market participant assumptions. |
As of June 30, 2014 and September 30, 2013, all of the Company’s financial assets utilize Level 1 inputs. The Company did not have any financial assets utilizing Level 2 or Level 3 inputs at June 30, 2014 or September 30, 2013.
The following table represents the Company’s fair value hierarchy for financial assets measured at fair value on a recurring basis:
June 30, 2014 | September 30, 2013 | |||||||
(Level 1) | (Level 1) | |||||||
(In thousands) | ||||||||
Money market instruments (1) | $ | 19,321 | $ | 19,318 | ||||
Semiconductor Manufacturing International Corp. | ||||||||
(SMIC) common stock (2) | — | 1,793 | ||||||
Nanya Technology Corporation (Nanya) common stock (2) | — | 16,624 | ||||||
$ | 19,321 | $ | 37,735 | |||||
(1) | Included in cash and cash equivalents |
(2) | Included in short-term investments |
There were no transfers in or out of Level 1 assets during the three months ended June 30, 2014.
As of June 30, 2014, the Company did not have any liabilities or non-financial assets that are measured at fair value on a recurring basis.
6
INTEGRATED SILICON SOLUTION, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
Available-for-sale marketable securities consisted of the following:
June 30, 2014 | Amortized Cost | Gross Unrealized Holding Gains | Gross Unrealized Holding Losses | Fair Value | ||||||||||||
(In thousands) | ||||||||||||||||
Money market instruments | $ | 19,321 | $ | — | $ | — | $ | 19,321 | ||||||||
Certificates of deposit | 21,266 | — | — | 21,266 | ||||||||||||
Nanya common stock | — | — | — | — | ||||||||||||
Total | 40,587 | — | — | 40,587 | ||||||||||||
Less: Amounts included in cash, cash | ||||||||||||||||
equivalents and restricted cash | (38,841 | ) | — | — | (38,841 | ) | ||||||||||
$ | 1,746 | $ | — | $ | — | $ | 1,746 | |||||||||
September 30, 2013 | Amortized Cost | Gross Unrealized Holding Gains | Gross Unrealized Holding Losses | Fair Value | ||||||||||||
(In thousands) | ||||||||||||||||
Money market instruments | $ | 19,318 | $ | — | $ | — | $ | 19,318 | ||||||||
Certificates of deposit | 15,595 | — | — | 15,595 | ||||||||||||
SMIC common stock | 1,099 | 694 | — | 1,793 | ||||||||||||
Nanya common stock | 7,100 | 9,524 | — | 16,624 | ||||||||||||
Total | 43,112 | 10,218 | — | 53,330 | ||||||||||||
Less: Amounts included in cash and cash | ||||||||||||||||
equivalents | (31,772 | ) | — | — | (31,772 | ) | ||||||||||
$ | 11,340 | $ | 10,218 | $ | — | $ | 21,558 | |||||||||
During the three months ended June 30, 2014, the Company sold its approximately 23.2 million remaining shares of freely- tradeable Nanya common stock for approximately $3.6 million which resulted in a pre-tax gain of approximately $2.1 million. During the nine months ended June 30, 2014, the Company sold approximately 109.6 million shares of Nanya common stock for approximately $16.2 million which resulted in a pre-tax gain of approximately $9.2 million. See Note 8 for further information regarding our Nanya share ownership.
During the nine months ended June 30, 2014, the Company sold all of its approximately 29.9 million remaining shares of SMIC common stock for approximately $3.2 million which resulted in a pre-tax gain of approximately $2.1 million.
As of June 30, 2014 and September 30, 2013, the Company had cash, cash equivalents, restricted cash and short-term investments in foreign financial institutions of $70.2 million ($2.0 million of which was in China and subject to exchange control regulations) and $71.2 million, respectively.
7
INTEGRATED SILICON SOLUTION, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
5. | Stock-based Compensation |
Stock-Based Benefit Plans
The Company grants stock-based compensation awards under its 2007 Incentive Compensation Plan (the 2007 Plan) which permits the grant of stock options, stock appreciation rights (SARs), restricted stock awards, restricted stock units (RSUs), performance shares and performance units. The Company has outstanding grants under its 2012 Inducement Option Plan (the Inducement Plan) and under prior plans, though no further grants can be made under these plans. At June 30, 2014, 1,811,000 shares were available for future grant under the 2007 Plan. Options generally vest ratably over a four-year period with a 6-month or 1-year cliff vest and then vesting ratably over the remaining period. Options granted prior to October 1, 2005 expire ten years after the date of grant; options granted after October 1, 2005 expire seven years after the date of the grant. RSUs generally vest annually over periods ranging from two years to four years based upon continued employment with the Company.
The Company began granting cash-settled SARs in the first quarter of fiscal 2014. The SARs vest ratably over a four-year period with a 6-month or 1-year cliff vest and then vest ratably each month over the remaining period based upon continued employment with the Company. The SARs expire seven years after the date of grant. These SARs allow the holder to receive in cash the difference between the SARs' exercise price (which is the closing market price of the Company's common stock on the grant date) and the closing market price of the Company's common stock on the date the holder exercises the SAR. The SARs are recorded as a liability in accrued compensation and benefits in the Company's balance sheet.
The Company has an Employee Stock Purchase Plan (ESPP) which permits eligible employees to purchase shares of the Company’s common stock through payroll deductions. As approved by the Board of Directors, effective August 1, 2010, shares under the ESPP are purchased at a price equal to 85% of the lesser of the fair market value of the Company’s common stock as of the first day or the last day of each six-month offering period. The offering periods under the ESPP commence on approximately February 1 and August 1 of each year. At June 30, 2014, 453,000 shares were available for future issuance under the ESPP.
Stock-Based Compensation
The following table outlines the effects of total stock-based compensation including expense related to SARs.
Three Months Ended June 30, | Nine Months Ended June 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
(In thousands) | ||||||||||||||||
Stock-based compensation | ||||||||||||||||
Cost of sales | $ | 50 | $ | 46 | $ | 154 | $ | 133 | ||||||||
Research and development | 694 | 566 | 2,119 | 1,665 | ||||||||||||
Selling, general and administrative | 1,017 | 852 | 3,156 | 2,575 | ||||||||||||
Total stock-based compensation | 1,761 | 1,464 | 5,429 | 4,373 | ||||||||||||
Tax effect on stock-based compensation | (330 | ) | — | (1,018 | ) | — | ||||||||||
Net effect on net income | $ | 1,431 | $ | 1,464 | $ | 4,411 | $ | 4,373 | ||||||||
Compensation related to SARs included in total stock-based compensation | $ | 222 | $ | — | $ | 844 | $ | — | ||||||||
As of June 30, 2014, there was approximately $9.4 million of total unrecognized stock-based compensation expense related to options and awards under the Company’s stock-based benefit plans that will be recognized over a weighted-average period of approximately 2.23 years. Future stock option and award grants will add to this total whereas quarterly amortization and the vesting of the existing stock option and award grants will reduce this total. In addition, as of June 30, 2014, there was approximately $54,000 of total unrecognized stock-based compensation expense under the Company’s ESPP that will be recognized over a weighted-average period of approximately one month. As of June 30, 2014, there was approximately $4.4 million of total unrecognized stock-based compensation expense related to SARs that will be recognized over a weighted-average period of approximately 3.36 years. Future SAR grants will add to this total whereas quarterly amortization and the vesting of the SARs will reduce this total. In addition, because the SARs are settled with cash, the fair value of the SARs must be revalued on a quarterly basis which will likely impact the amount of expense in future periods.
8
INTEGRATED SILICON SOLUTION, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
The Company uses the Black-Scholes option pricing model to estimate the fair value of the options and SARS granted and rights to acquire stock granted under the ESPP. The weighted average estimated fair values of stock option grants and rights granted under the ESPP, as well as the weighted average assumptions used in calculating these values during the three and nine month periods ended June 30, 2014 and 2013 were based on estimates at the date of grant as follows:
Three Months Ended June 30, | Nine Months Ended June 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Options | ||||||||||||||||
Weighted-average fair value of grants | $ | 6.13 | $ | 4.31 | $ | 4.70 | $ | 4.31 | ||||||||
Expected term in years | 4.42 | 4.45 | 4.42 | 4.45 | ||||||||||||
Estimated volatility | 51 | % | 55 | % | 51 | % | 59 | % | ||||||||
Risk-free interest rate | 1.21 | % | 0.62 | % | 1.04 | % | 0.53 | % | ||||||||
Dividend yield | — | % | — | % | — | % | — | % | ||||||||
ESPP | ||||||||||||||||
Weighted-average fair value of grants | $ | — | $ | — | $ | 2.66 | $ | 2.30 | ||||||||
Expected term in years | — | — | 0.49 | 0.49 | ||||||||||||
Estimated volatility | — | % | — | % | 27 | % | 32 | % | ||||||||
Risk-free interest rate | — | % | — | % | 0.41 | % | 0.11 | % | ||||||||
Dividend yield | — | % | — | % | — | % | — | % | ||||||||
The Company issues RSUs from time to time. The estimated fair value of RSU awards is calculated based on the market price of the Company’s common stock on the date of grant. The weighted average grant date fair value of RSUs granted in the three month period ended June 30, 2014 was $14.45 per share. The weighted average grant date fair value of RSUs granted in the nine month periods ended June 30, 2014 and June 30, 2013, was $11.62 per share and $9.14 per share, respectively.
A summary of the Company’s stock option activity and related information for the nine months ended June 30, 2014 follows (number of shares and aggregate intrinsic value are presented in thousands):
Number of Shares | Weighted-Average Exercise Price | Weighted-Average Remaining Contractual Term in Years | Aggregate Intrinsic Value | ||||||||||
Outstanding at September 30, 2013 | 5,351 | $ | 7.51 | ||||||||||
Granted | 468 | $ | 11.22 | ||||||||||
Exercised | (1,239 | ) | $ | 6.77 | $ | 7,632 | |||||||
Cancelled/Expired | (121 | ) | $ | 10.18 | |||||||||
Outstanding at June 30, 2014 | 4,459 | $ | 8.03 | 3.94 | $ | 30,036 | |||||||
Exercisable at June 30, 2014 | 2,759 | $ | 6.87 | 3.13 | $ | 21,800 | |||||||
Vested and expected to vest after June 30, 2014 | 4,384 | $ | 8.00 | 3.91 | $ | 29,689 | |||||||
A summary of the Company’s RSU activity and related information for the nine months ended June 30, 2014 under the 2007 Plan follows (number of shares and aggregate intrinsic value are presented in thousands):
Number of Shares | Weighted-Average Grant Date Fair Value | Aggregate Intrinsic Value | |||||||||
Outstanding at September 30, 2013 | 269 | $ | 9.02 | ||||||||
Granted | 88 | $ | 11.62 | ||||||||
Vested | (92 | ) | $ | 8.91 | $ | 1,062 | |||||
Forfeited | (1 | ) | $ | 10.64 | |||||||
Outstanding at June 30, 2014 | 264 | $ | 9.92 | $ | 3,899 | ||||||
9
INTEGRATED SILICON SOLUTION, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
A summary of the Company’s SAR activity and related information for the nine months ended June 30, 2014 under the 2007 Plan follows (number of shares and aggregate intrinsic value are presented in thousands):
Number of Shares | Weighted-Average Exercise Price | Weighted-Average Remaining Contractual Term in Years | Aggregate Intrinsic Value | ||||||||||
Outstanding at September 30, 2013 | — | $ | — | ||||||||||
Granted | 779 | $ | 10.96 | ||||||||||
Exercised | (3 | ) | $ | 10.96 | |||||||||
Cancelled/Expired | (18 | ) | $ | 10.96 | |||||||||
Outstanding at June 30, 2014 | 758 | $ | 10.96 | 6.32 | $ | 2,889 | |||||||
Exercisable at June 30, 2014 | 62 | $ | 10.96 | 6.28 | $ | 237 | |||||||
6. | Concentrations |
In the three and nine months ended June 30, 2014, revenue from the Company's largest distributor accounted for approximately 20% and 18%, respectively, of the Company's total net sales. In the three and nine months ended June 30, 2014, revenue from the Company's second largest distributor accounted for approximately 12% and 13%, respectively, of the Company's total net sales. In the three and nine months ended June 30, 2013, revenue from the Company's largest distributor accounted for approximately 13% and 14%, respectively, of the Company's total net sales. In the three and nine months ended June 30, 2013, revenue from the Company's second largest distributor accounted for approximately 10% and 11%, respectively, of the Company's total net sales.
7. | Inventories |
The following is a summary of inventories by major category:
June 30, 2014 | September 30, 2013 | |||||||
(In thousands) | ||||||||
Purchased components | $ | 18,193 | $ | 14,039 | ||||
Work-in-process | 27,570 | 20,960 | ||||||
Finished goods | 34,334 | 33,470 | ||||||
$ | 80,097 | $ | 68,469 | |||||
During the three and nine months ended June 30, 2014, the Company recorded inventory write-downs of $2.1 million and $4.3 million, respectively. During the three and nine months ended June 30, 2013, the Company recorded inventory write-downs of $1.2 million and $3.5 million, respectively. The inventory write-downs were predominantly for excess and obsolescence and lower of cost or market issues on certain of the Company's products.
10
INTEGRATED SILICON SOLUTION, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
8. | Other Assets |
Other assets consisted of the following:
June 30, 2014 | September 30, 2013 | |||||||
(In thousands) | ||||||||
Restricted assets | $ | 508 | $ | 811 | ||||
Other investment | 1,469 | 1,684 | ||||||
Nanya private placement shares | 10,831 | 10,920 | ||||||
Technology licenses, net | 9,456 | 2,002 | ||||||
Other | 1,182 | 1,162 | ||||||
$ | 23,446 | $ | 16,579 | |||||
The Company has various deposits including deposits with suppliers for purchase guarantees and for customs clearance. These deposits are included in restricted assets.
In September 2012, the Company invested approximately $27.1 million in Nanya, which was comprised of common shares which are classified as available-for-sale securities and private placement shares which are accounted for on the cost-basis. The Company accounts for the private placement shares it acquired in Nanya on the cost-basis as these securities are restricted and the restrictions do not terminate within one year of the reporting date. In addition, as of June 30, 2014, the Company had pledged $5.3 million of its Nanya private placement shares as collateral for the Company's accounts payable.
From time-to-time, the Company licenses patents or other intellectual property rights from third parties. The technology licenses are being amortized over their estimated useful lives ranging from three to ten years.
In March 2012, the Company made an equity investment of $2.0 million in a private technology company headquartered in Hong Kong. At June 30, 2014, the Company's ownership interest in such company was approximately 31%. This investment is accounted for under the equity method and the Company's results include its percentage share of such company's results of operations in interest and other income, net.
9. | Purchased Intangible Assets |
The following tables present details of the Company’s total purchased intangible assets:
Gross | Accumulated Amortization | Net | ||||||||||
(In thousands) | ||||||||||||
June 30, 2014 | ||||||||||||
Developed technology | $ | 5,330 | $ | 2,414 | $ | 2,916 | ||||||
Customer relationships | 3,340 | 997 | 2,343 | |||||||||
Other | 450 | 269 | 181 | |||||||||
Total | $ | 9,120 | $ | 3,680 | $ | 5,440 | ||||||
September 30, 2013 | ||||||||||||
Developed technology | $ | 5,330 | $ | 1,758 | $ | 3,572 | ||||||
Customer relationships | 3,340 | 580 | 2,760 | |||||||||
Other | 450 | 156 | 294 | |||||||||
Total | $ | 9,120 | $ | 2,494 | $ | 6,626 | ||||||
11
INTEGRATED SILICON SOLUTION, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
The following table presents details of the amortization expense of purchased intangible assets as reported in the consolidated statements of income:
Three Months Ended June 30, | Nine Months Ended June 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
(In thousands) | ||||||||||||||||
Reported as: | ||||||||||||||||
Cost of sales | $ | 191 | $ | 222 | $ | 656 | $ | 647 | ||||||||
Operating expenses | 177 | 176 | 530 | 544 | ||||||||||||
Total | $ | 368 | $ | 398 | $ | 1,186 | $ | 1,191 | ||||||||
The following table presents the estimated future amortization expense of the Company’s purchased intangible assets at June 30, 2014 (in thousands). The weighted-average remaining amortization period for developed technology, customer relationships and other intangibles is 4.29 years, 4.21 years and 1.21 years, respectively. If the Company acquires additional purchased intangible assets in the future, its future amortization may be increased by those assets.
Fiscal year | |||
Remainder of 2014 | $ | 347 | |
2015 | 1,382 | ||
2016 | 1,238 | ||
2017 | 1,239 | ||
2018 | 1,195 | ||
Thereafter | 39 | ||
Total | $ | 5,440 | |
10. | Borrowings |
In December 2012, the Company obtained a bank loan in the amount of $4.9 million (the Loan), to partially finance the $6.5 million purchase price of approximately 2.85 acres of land and a 55,612 square foot building located at 1623 Buckeye Drive, Milpitas, California for its corporate headquarters. The Loan has a maturity date of November 30, 2017 and is secured by the property and an assignment of all leases and rents relating to the property. The Loan is subject to customary events of default, including defaults in the payment of principal and interest. The Loan bears an interest rate of one percent above LIBOR adjusted on a monthly basis. Principal payments due under the Loan are as follows (in thousands):
Fiscal year | |||
Remainder of 2014 | $ | 49 | |
2015 | 195 | ||
2016 | 195 | ||
2017 | 195 | ||
2018 | 195 | ||
Thereafter | 3,754 | ||
Total | $ | 4,583 | |
12
INTEGRATED SILICON SOLUTION, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
11. | Accumulated Other Comprehensive Income |
The components of accumulated other comprehensive income, net of tax, were as follows:
June 30, 2014 | September 30, 2013 | |||||||
(In thousands) | ||||||||
Accumulated foreign currency translation adjustments | $ | 3,767 | $ | 4,787 | ||||
Accumulated net unrealized gain on SMIC (net of tax of $0 and $275, respectively) | — | 419 | ||||||
Accumulated net unrealized gain on Nanya (net of tax of $0 and $3,565, respectively) | — | 5,959 | ||||||
Accumulated net retirement plan transition asset (net of tax of $148 and $148, respectively) | 2 | 47 | ||||||
Accumulated net retirement plan actuarial losses (net of tax of $470 and $470, respectively) | (2,009 | ) | (2,091 | ) | ||||
Total accumulated other comprehensive income | $ | 1,760 | $ | 9,121 | ||||
The significant amounts reclassified out of accumulated other comprehensive income into the consolidated condensed statements of income, with presentation location, during the three and nine months ended June 30, 2014 and June 30, 2013 were as follows:
Three Months Ended June 30, | Nine Months Ended June 30, | |||||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||||
(In thousands) | ||||||||||||||||||
Comprehensive Income Components | Amount Reclassified from Accumulated Other Comprehensive Income | Amount Reclassified from Accumulated Other Comprehensive Income | Location | |||||||||||||||
Unrealized holding gains (losses) on available-for -sale investments | ||||||||||||||||||
$ | 1,616 | $ | 4,428 | $ | 9,618 | $ | 5,232 | Gain on the sale of investments | ||||||||||
(592 | ) | (2,057 | ) | (3,589 | ) | (2,193 | ) | Provision for income taxes | ||||||||||
$ | 1,024 | $ | 2,371 | $ | 6,029 | $ | 3,039 | |||||||||||
12. | Income Taxes |
The income tax provision includes U.S. federal, state and local, and foreign income taxes and is based on the application of a forecasted annual income tax rate applied to the current quarter's year-to-date pre-tax income for fiscal 2014. In determining the estimated annual effective income tax rate, the Company analyzes various factors, including projections of the Company's annual earnings, taxing jurisdictions in which the earnings will be generated, the impact of state and local income taxes, the Company's ability to use tax credits and net operating loss carryforwards, and available tax planning alternatives. Discrete items, including the effect of changes in tax laws, tax rates, and certain circumstances with respect to valuation allowances or other unusual or non-recurring tax adjustments are reflected in the period in which they occur as an addition to, or reduction from, the income tax provision, rather than being included in the estimated annual effective income tax rate.
For the three and nine months ended June 30, 2014, the Company recorded income tax expense of $2.4 million and $6.9 million, respectively, that represents an effective tax rate of approximately 28% and 25%, respectively. The differences between the recorded provision for income taxes and the tax provision, based on the federal statutory rate of 35%, were primarily attributable to the differential in foreign tax rates, non-deductible stock-based compensation expense and certain foreign losses not benefited.
For the three months and nine months ended June 30, 2013, the Company recorded income tax expense of $5.2 million and $9.6 million, respectively, that represents an effective tax rate of approximately 42% and 42%, respectively. Discrete items were recorded in the three months and nine months ended June 30, 2013 related to a decrease in the valuation allowance of approximately $1.3 million for foreign tax credit carryforwards based on the Company's estimated ability to use these carryforwards in the future as a result of a change in its legal structure and an increase in the valuation allowance for research and development credits of $0.5 million in certain foreign jurisdictions based on the Company's estimated inability to use these credits in the future. The nine
13
INTEGRATED SILICON SOLUTION, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
months ended June 30, 2013 includes an additional discrete item related to an increase in the valuation allowance of approximately $1.5 million for California net operating loss carryforwards based on the Company's estimated inability to use these carryforwards in the future as a result of a change in the Company's legal structure. The difference between the recorded provision for income taxes and the tax provision, based on the federal statutory rate of 35%, was primarily attributable to the impact of these discrete items, the differential in foreign tax rates, significant foreign inclusions and non-deductible stock-based compensation expense.
As of June 30, 2014, the Company had unrecognized tax positions that would impact its effective tax rate, if realized.
13. | Per Share Data |
The following table sets forth the computation of basic and diluted net income per share (in thousands, except per share amounts):
Three Months Ended June 30, | Nine Months Ended June 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Numerator for basic and diluted net income per share: | ||||||||||||||||
Net income attributable to ISSI | $ | 6,186 | $ | 7,064 | $ | 20,433 | $ | 12,850 | ||||||||
Denominator for basic net income per share: | ||||||||||||||||
Weighted average common shares outstanding | 30,312 | 28,293 | 29,816 | 27,988 | ||||||||||||
Dilutive stock options and awards | 1,651 | 1,462 | 1,521 | 1,439 | ||||||||||||
Denominator for diluted net income per share | 31,963 | 29,755 | 31,337 | 29,427 | ||||||||||||
Basic net income per share | $ | 0.20 | $ | 0.25 | $ | 0.69 | $ | 0.46 | ||||||||
Diluted net income per share | $ | 0.19 | $ | 0.24 | $ | 0.65 | $ | 0.44 | ||||||||
For the three months and nine months ended June 30, 2014, stock options and awards for 686,000 shares and 1,070,000 shares, respectively, were excluded from diluted earnings per share by the application of the treasury stock method. For the three months and nine months ended June 30, 2013, stock options and awards for 2,864,000 shares and 2,849,000 shares, respectively, were excluded from diluted earnings per share by the application of the treasury stock method.
14. | Common Stock Repurchase Program |
In the nine month period ended June 30, 2014, the Company did not repurchase any shares of its common stock in the open market. As of June 30, 2014, the Company had repurchased and retired an aggregate of 14,179,711 shares of common stock at a cost of approximately $88.5 million since September 2007. As of June 30, 2014, $19.8 million remained available under the Company's existing share repurchase authorization.
The Company issues RSUs as part of its equity incentive plan. For a portion of the RSUs granted, the number of shares issued on the date the RSUs vest is net of the statutory withholding requirements that the Company pays on behalf of its employees. During the nine months ended June 30, 2014, the Company withheld 30,323 shares to satisfy approximately $0.4 million of employee tax obligations. Although the shares withheld are not issued, they are treated as common stock repurchases for accounting purposes, as they reduce the number of shares that would have been issued upon vesting.
15. | Commitments and Contingencies |
Legal Matters
In the semiconductor industry, it is not unusual for companies to receive notices alleging infringement of patents or other intellectual property rights of others. The Company has been, and from time-to-time expects to be, notified of claims that it may be infringing patents, maskwork rights or copyrights owned by third parties. If it appears necessary or desirable, the Company may seek licenses under patents that it is alleged to be infringing. Although patent holders commonly offer such licenses, licenses may not be offered and the terms of any offered licenses may not be acceptable to the Company. The failure to obtain a license under a key patent or intellectual property right from a third party for technology used by the Company could cause it to incur substantial liabilities and to suspend the manufacture of the products utilizing the invention or to attempt to develop non-infringing products, any of which could materially and adversely affect the Company’s business and operating results. Furthermore, there can be no assurance that the Company will not become involved in protracted litigation regarding its alleged infringement of third
14
INTEGRATED SILICON SOLUTION, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
party intellectual property rights or litigation to assert and protect its patents or other intellectual property rights. Any litigation relating to patent infringement or other intellectual property matters could result in substantial cost and diversion of the Company’s resources.
GSI Technology Inc. v. Integrated Silicon Solution, Inc., et al.
On October 2, 2013, GSI Technology Inc. (GSI) filed a Second Amended Complaint in a lawsuit filed earlier in 2013 solely against defendant United Memories, Inc. in the United States District Court for the Northern District of California. GSI named the Company as a new, second defendant in the Second Amended Complaint. On April 18, 2014, the Court granted the Company's motion to dismiss that complaint in part, leaving claims against the Company for Unfair Competition under California Business & Professions Code 17200, misappropriation of trade secrets, and intentional interference with prospective economic advantage. In the remaining portion of the complaint, GSI alleges that the Company acted together with United Memories, Inc. to harm GSI in connection with a bid from Cisco Systems, Inc. and misappropriated alleged GSI trade secrets. GSI seeks damages and injunctive relief. The Company filed an answer on June 2, 2014 and asserted a declaratory relief counterclaim against GSI. Before the Company was named as a defendant, the Court denied motions by GSI against United Memories, Inc. for temporary and preliminary injunctive relief. The Court issued a case management order on June 13, 2014 with a scheduled trial date of July 13, 2015. The Company believes it has meritorious defenses to the claims alleged by GSI and intends to defend this suit vigorously. However, there can be no assurance as to the outcome of this matter or any future litigation.
Other Legal Proceedings
In the ordinary course of its business, the Company has been involved in a limited number of other legal actions, both as plaintiff and defendant, and could incur uninsured liability in any one or more of them. Although the outcome of these actions is not presently determinable, the Company believes that the ultimate resolution of these matters will not have a material adverse effect on its financial position, cash flows or results of operations. However, no assurances can be given with respect to the extent or outcome of any such litigation in the future.
Commitments to Wafer Fabrication Facilities and Contract Manufacturers
The Company issues purchase orders for wafers to various wafer foundries. These purchase orders are generally considered to be cancelable. However, to the degree that the wafers have entered into work-in-process at the foundry, as a matter of practice, it becomes increasingly difficult to cancel the purchase order. As of June 30, 2014, the Company had approximately $26.6 million of purchase orders for which the related wafers had been entered into wafer work-in-process (i.e., manufacturing had begun).
16. | Geographic and Segment Information |
The Company has one operating segment, which is to design, develop, and market high-performance SRAM, DRAM, and other semiconductor products. The following table summarizes the Company’s operations in different geographic areas:
Three Months Ended June 30, | Nine Months Ended June 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
(In thousands) | ||||||||||||||||
Net sales | ||||||||||||||||
United States | $ | 9,571 | $ | 9,517 | $ | 28,449 | $ | 27,731 | ||||||||
China | 9,838 | 10,477 | 32,689 | 20,579 | ||||||||||||
Hong Kong | 16,456 | 13,638 | 45,499 | 50,532 | ||||||||||||
Japan | 5,916 | 8,194 | 16,569 | 23,241 | ||||||||||||
Korea | 4,000 | 3,311 | 10,544 | 10,064 | ||||||||||||
Taiwan | 12,344 | 11,230 | 35,099 | 30,447 | ||||||||||||
Other Asia Pacific countries | 6,435 | 5,880 | 18,390 | 18,374 | ||||||||||||
Europe | 19,587 | 14,797 | 56,207 | 46,681 | ||||||||||||
Other | 687 | 744 | 1,379 | 1,529 | ||||||||||||
Total net sales | $ | 84,834 | $ | 77,788 | $ | 244,825 | $ | 229,178 | ||||||||
15
INTEGRATED SILICON SOLUTION, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
June 30, 2014 | September 30, 2013 | |||||||
(In thousands) | ||||||||
Long-lived assets | ||||||||
United States | $ | 10,943 | $ | 9,696 | ||||
Hong Kong | 16 | 7 | ||||||
China | 3,955 | 3,424 | ||||||
Taiwan | 35,307 | 33,377 | ||||||
$ | 50,221 | $ | 46,504 | |||||
Revenues are attributed to countries based on the customers' ship-to location.
Long-lived assets by geographic area are those assets used in the Company’s operations in each area.
17. | Related Party Transactions |
The Company sells semiconductor products to Chrontel International Ltd. (Chrontel). Jimmy S.M. Lee, the Company’s Executive Chairman, has been a director of Chrontel since July 1995. Sales to Chrontel were $80,000 and $162,000 during the three months and nine months ending June 30, 2014, respectively. Sales to Chrontel were $104,000 and $294,000 during the three months and nine months ending June 30, 2013, respectively. Accounts receivable from Chrontel was approximately $26,000 and $65,000 at June 30, 2014 and September 30, 2013, respectively.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
We have made forward-looking statements in this report that are subject to risks and uncertainties. Forward-looking statements include information concerning possible or assumed future results of our operations. Also, when we use words such as “believes,” “expects,” “anticipates” or similar expressions, we are making forward-looking statements. You should note that an investment in our securities involves certain risks and uncertainties that could affect our future financial results. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth in “Risk Factors” and elsewhere in this report.
We believe it is important to communicate our expectations to our investors. However, there may be events in the future that we are not able to predict accurately or over which we have no control. The risks described in “Risk Factors” included in this report, as well as any other cautionary language in this report, provide examples of risks, uncertainties and events that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements. Before you invest in our common stock, you should be aware that the occurrence of the events described in “Risk Factors” and elsewhere in this report could harm our business and adversely affect our results.
All forward-looking statements made by us or persons acting on our behalf are expressly qualified in their entirety by the "Risk Factors" and other cautionary statements set forth in this report. Except as required by federal securities laws, we are under no obligation to update any forward-looking statement, whether as a result of new information, future events, or otherwise.
Overview
We are a fabless semiconductor company that designs and markets high performance integrated circuits for the following key markets: (i) automotive, (ii) communications, (iii) industrial, medical and military (IMM), and (iv) digital consumer. Our primary products are low and medium density DRAM, high speed and low power SRAM, serial and parallel NOR flash products and a variety of mixed signal and analog products. In the first nine months of fiscal 2014 and in fiscal 2013, approximately 89% and 88%, respectively, of our revenue was derived from our DRAM and SRAM products. Sales of our DRAM products have represented a majority of our revenue in each year since fiscal 2003.
On September 14, 2012, we acquired approximately 94.1% of the outstanding shares of Chingis Technology Corporation (Chingis) for approximately $32 million, or $13 million net of the approximately $19 million in cash and cash equivalents on Chingis' balance sheet at closing. In May 2013 and October 2013, we acquired additional shares of Chingis. At June 30, 2014, we owned approximately 99.4% of the outstanding shares of Chingis. Founded in 1995, Chingis provides a variety of NOR flash memory technologies used in standalone and embedded applications. Chingis is headquartered in HsinChu, Taiwan and has offices in Taiwan, Korea, China and the U.S. Our financial results reflect accounting for Chingis on a consolidated basis beginning on September 14, 2012.
On January 31, 2011, we acquired Si En Integration Holdings Limited (Si En), a privately held fabless provider of high performance analog and mixed signal integrated circuits headquartered in Xiamen, China. Si En targets the mobile communications, digital consumer, networking, and automotive markets. Si En’s current products include audio power amplifiers, LED drivers, power management and temperature sensors.
In order to control our operating expenses, for the past several years we have limited our headcount in the U.S. and maintained much of our operations in Taiwan and China. We believe this strategy has enabled us to limit our operating expenses while simultaneously locating these operations closer to our manufacturing partners and our customers. As a result of these efforts, we currently have significantly more employees in Asia than we do in the U.S. We intend to continue these strategies going forward.
As a fabless semiconductor company, our business model is less capital intensive because we rely on third parties to manufacture, assemble and test our products. Because of our dependence on third-party wafer foundries, our ability to increase our unit sales volumes depends on our ability to increase our wafer capacity allocation from current foundries, add additional foundries and improve yields of good die per wafer. In recent years, it has become more difficult for us to secure long-term foundry capacity (particularly for our DRAM products) due to industry consolidation affecting foundries and adverse financial conditions at foundries. In this regard, in September 2012, we invested approximately $27.1 million in Nanya and entered into an agreement with Nanya to provide us with access to leading edge process technologies and certain wafer volume guarantees. In addition, certain of our foundries have decided from time to time not to produce the type of wafers that we need (especially certain types of DRAM wafers) so we have been forced to rely on alternative sources of supply and to place large last time buy orders which expose us to the risk of inventory obsolescence. Once a product is in production at a particular foundry, it is time consuming and costly to have such product manufactured at a different foundry. Although such matters have not had a material adverse impact
16
on our business or financial results in recent periods, there can be no assurance as to the future impact that such matters will have on our business, customer relationships or results of operations.
The average selling prices of our DRAM and SRAM products are sensitive to supply and demand conditions in our target markets and have generally declined over time. We experienced declines in the average selling prices for certain of our products in the first nine months of fiscal 2014 and in fiscal 2013. We expect average selling prices for our products to decline in the future, principally due to market demand, market competition and the supply of competitive products in the market. Any future decreases in our average selling prices could have an adverse impact on our revenue, gross margins and operating margins. Our ability to maintain or increase revenues will be highly dependent upon our ability to increase unit sales volumes of existing products and to introduce and sell new products in quantities sufficient to compensate for the anticipated declines in average selling prices of existing products. Declining average selling prices will adversely affect our gross margins unless we are able to offset such declines with commensurate reductions in per unit costs or changes in product mix in favor of higher margin products.
Revenue from product sales to our direct customers is recognized upon shipment provided that persuasive evidence of a sales arrangement exists, the price is fixed or determinable, title has transferred, collection of resulting receivables is reasonably assured, there are no customer acceptance requirements and there are no remaining significant obligations. A portion of our sales is made to distributors under agreements that provide for the possibility of certain sales price rebates and limited product return privileges. Given the uncertainties associated with credits that will be issued to these distributors, we defer recognition of such sales until our products are sold by the distributors to their end customers. Revenue from sales to distributors who do not have sales price rebates or product return privileges is recognized at the time our products are sold by us to the distributors.
We market and sell our products in Asia, the U.S., Europe and other locations through our direct sales force, distributors and sales representatives. The percentage of our sales shipped outside the U.S. was approximately 89% in the three months ended June 30, 2014, approximately 88% in the three months ended June 30, 2013, and approximately 88% in each of the nine months ended June 30, 2014 and June 30, 2013. We measure sales location by the shipping destination. We anticipate that sales to international customers will continue to represent a significant percentage of our net sales. The percentages of our net sales by region are set forth in the following table:
Three Months Ended June 30, | Nine Months Ended June 30, | |||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||
Asia | 65 | % | 68 | % | 65 | % | 67 | % | ||||
Europe | 23 | 19 | 23 | 20 | ||||||||
U.S. | 11 | 12 | 12 | 12 | ||||||||
Other | 1 | 1 | — | 1 | ||||||||
Total | 100 | % | 100 | % | 100 | % | 100 | % | ||||
Our sales are generally made by purchase orders. Because industry practice allows customers to reschedule or cancel orders on relatively short notice, backlog may not be a good indicator of our future sales. Cancellations of customer orders or changes in product specifications could result in the loss of anticipated sales without allowing us sufficient time to reduce our inventory and operating expenses.
Due to the complex nature of the markets we serve and the broad fluctuations in economic conditions in the U.S. and other countries, it is difficult for us to assess the impact of seasonal factors on our business.
We are subject to the risks of conducting business internationally, including economic conditions in Asia, particularly Taiwan and China, changes in trade policy and regulatory requirements, duties, tariffs and other trade barriers and restrictions, the burdens of complying with foreign laws and, possibly, political instability. Most of our foundries and all of our assembly and test subcontractors are located in Asia. Although our international sales are largely denominated in U.S. dollars, we do have sales transactions in New Taiwan dollars, in Hong Kong dollars and in Chinese renminbi. In addition, we have foreign operations where expenses are generally denominated in the local currency. Such transactions expose us to the risk of exchange rate fluctuations. We monitor our exposure to foreign currency fluctuations, but have not adopted any hedging strategies to date. There can be no assurance that exchange rate fluctuations will not harm our business and operating results in the future.
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Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make difficult and subjective estimates, judgments and assumptions. These estimates, judgments and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenue and expenses during the reporting period. The estimates and judgments that we use in applying our accounting policies have a significant impact on the results we report in our financial statements. We base our estimates and judgments on our historical experience combined with knowledge of current conditions and our beliefs of what could occur in the future, considering the information available at the time. Actual results could differ from those estimates and such differences may be material to our financial statements. We reevaluate our estimates and judgments on an ongoing basis.
Our critical accounting policies which are impacted by our estimates are: (i) the valuation of our inventory, which impacts cost of goods sold and gross profit; (ii) the valuation of our allowance for sales returns and allowances, which impacts net sales; (iii) the valuation of our allowance for doubtful accounts, which impacts general and administrative expense; (iv) accounting for acquisitions and goodwill, which impacts cost of goods sold and operating expense when we record impairments; (v) accounting for stock-based compensation which impacts costs of goods sold, research and development expense and selling, general and administrative expense and (vi) accounting for income taxes. Each of these policies is described in more detail below. We also have other key accounting policies that may not require us to make estimates and judgments that are as subjective or difficult. For instance, our policies with regard to revenue recognition, including the deferral of revenues on sales to distributors with sales price rebates and product return privileges. These policies are described in the notes to our financial statements contained in our Annual Report on Form 10-K for the fiscal year ended September 30, 2013.
Valuation of inventory. Our inventories are stated at the lower of cost or market value. Determining the market value of inventories on hand and at distributors as of the balance sheet date involves numerous judgments, including projecting average selling prices and sales volumes for future periods and costs to complete products in work in process inventories. When market values are below our costs, we record a charge to cost of goods sold to write down our inventories to their estimated market value in advance of when the inventories are actually sold. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required that may adversely affect our operating results. If actual market conditions are more favorable, we may have higher gross margins when the written down products are sold. In addition to lower of cost or market write-downs, we also analyze inventory to determine whether any of it is excess, obsolete or defective. We write down to zero dollars (which is a charge to cost of goods sold) the carrying value of inventory on hand that has aged over one year (two years for wafer and die bank) to cover estimated excess and obsolete exposures, unless adjustments are made based on management’s judgments for newer products, end of life products, planned inventory increases or strategic customer supply. In making such judgments to write down inventory, we take into account the product life cycles which can range from six to 30 months, the stage in the life cycle of the product, and the impact of competitors’ announcements and product introductions on our products. Once established, these write-downs are considered permanent.
Valuation of allowance for sales returns and allowances. Net sales consist principally of total product sales less estimated sales returns and allowances. To estimate sales returns and allowances, we analyze potential customer specific product application issues, potential quality and reliability issues and historical returns. We evaluate quarterly the adequacy of the allowance for sales returns and allowances. This allowance is reflected as a reduction to accounts receivable in our consolidated balance sheets. Increases to the allowance are recorded as a reduction to net sales. Because the allowance for sales returns and allowances is based on our judgments and estimates, particularly as to product application, quality and reliability issues, our allowances may not be adequate to cover actual sales returns and other allowances. If our allowances are not adequate, our net sales could be adversely affected.
Valuation of allowance for doubtful accounts. We maintain an allowance for doubtful accounts for losses that we estimate will arise from our customers’ inability to make required payments for goods and services purchased from us. We make our estimates of the uncollectibility of our accounts receivable by analyzing historical bad debts, specific customer creditworthiness and current economic trends. Once an account is deemed unlikely to be fully collected, we write down the carrying value of the receivable to the estimated recoverable value, which results in a charge to general and administrative expense, which decreases our profitability.
Accounting for acquisitions and goodwill. We account for acquisitions using the purchase accounting method. Under this method, the total consideration paid is allocated over the fair value of the net assets acquired, including in-process research and development, with any excess allocated to goodwill. Goodwill is defined as the excess of the purchase price over the fair value allocated to the net assets. Our judgments as to the fair value of the assets will, therefore, affect the amount of goodwill that we record. Management is responsible for the valuation of tangible and intangible assets. For tangible assets acquired in any acquisition, such as plant and equipment, the useful lives are estimated by considering comparable lives of similar assets, past history, the intended use of the assets and their condition. In estimating the useful life of the acquired intangible assets with definite lives, we
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consider the industry environment and unique factors relating to each product relative to our business strategy and the likelihood of technological obsolescence. Acquired intangible assets primarily include developed and in-process technology (IPR&D), customer relationships, trade names and non-compete agreements. The amounts allocated to IPR&D projects are not expensed until technological feasibility is reached for each project. Upon completion of development for each project, the acquired IPR&D will be amortized over its useful life. We are currently amortizing our acquired intangible assets with definite lives over periods generally ranging from three to six years.
We perform goodwill impairment tests on an annual basis and between annual tests in certain circumstances where indicators of impairment may exist. For instance, in response to changes in industry and market conditions, we could be required to strategically realign our resources and consider restructuring, disposing of, or otherwise exiting businesses, which could result in an impairment of tangible and intangible assets, including goodwill. In this regard, in fiscal 2012, we recorded impairment charges of $13.1 million for intangible assets and goodwill from our acquisition of Si En and $1.2 million for the impairment of certain tangible assets.
Accounting for stock-based compensation. Stock option fair value is calculated on the date of grant using the Black-Scholes valuation model. The compensation cost is then recognized on a straight-line basis over the requisite service period of the option, which is generally the option vesting term of four years. The Black-Scholes valuation model requires us to estimate key assumptions such as expected term, volatility, dividend yield and risk-free interest rates that determine the stock option fair value. In addition, we estimate forfeitures at the time of grant. In subsequent periods, if actual forfeitures differ from the estimate, the forfeiture rate may be revised. We estimate our expected forfeitures rate based on our historical activity and judgment regarding trends. We estimate the expected term for option grants based upon historical exercise data. If we determined that another method used to estimate expected life was more reasonable than our current method, or if another method for calculating these input assumptions was prescribed by authoritative guidance, the fair value calculated could change materially. We also use the Black-Scholes method to estimate the value of cash-settled stock appreciation rights (SARs). The fair value of the SARs must be revalued on a quarterly basis which will likely impact the amount of our expense in future periods. Upon the exercise of a SAR, the expense recognized is adjusted to reflect the difference between the exercise price of the SAR and the closing market price of our common stock on the date of exercise.
Accounting for income taxes. We account for income taxes under the asset and liability approach. We record a valuation allowance to reduce our net deferred tax assets to the amount that we believe is more likely than not to be realized. In assessing the need for a valuation allowance, we consider historical levels of income, projections of future income, expectations and risks associated with estimates of future taxable income, and ongoing prudent and practical tax planning strategies. To the extent we believe it is more likely than not that some portion of our deferred tax assets will not be realized, we would increase the valuation allowance against the deferred tax assets. Realization of our deferred tax assets is dependent primarily upon future U.S. and foreign taxable income. Our judgments regarding future profitability may change due to future market conditions, changes in U.S. or international tax laws and other factors. These changes, if any, may require possible material adjustments to these deferred tax assets, resulting in a reduction in net income or an increase in net loss in the period when such determinations are made.
We are subject to income taxes in the U.S. and foreign countries, and we are subject to routine corporate income tax audits in certain of these jurisdictions. We believe that our tax return positions are fully supported, but tax authorities may challenge certain positions, which may not be fully sustained. Our income tax expense includes amounts intended to satisfy income tax assessments that result from these challenges. Determining the income tax expense for these potential assessments and recording the related assets and liabilities requires management judgment and estimates. We evaluate our uncertain tax positions and believe that our provision for uncertain tax positions, including related interest and penalties, is adequate based on information currently available to us. However, the amount ultimately paid upon resolution of audits could be materially different from the amounts previously included in income tax expense and therefore could have a material impact on our tax provision, net income and cash flows. Our overall tax provision requirement could change due to the issuance of new regulations or new case law, management's judgments on undistributed foreign earnings including judgments about and intentions concerning our future operations, negotiations with tax authorities, resolution with respect to individual audit issues, or the entire audit, or the expiration of statutes of limitations.
Accounting Changes and Recent Accounting Pronouncements
For a description of accounting changes and recent accounting pronouncements, including the expected dates of adoption and estimated effects, if any, on our consolidated condensed financial statements, see “Note 3: Impact of Recently Issued Accounting Pronouncements and Standards” in the Notes to Condensed Consolidated Financial Statements of this Form 10-Q.
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Results of Operations
Three Months Ended June 30, 2014 Compared to Three Months Ended June 30, 2013
Net Sales. Net sales consist principally of total product sales less estimated sales returns. Net sales increased to $84.8 million in the three months ended June 30, 2014 from $77.8 million in the three months ended June 30, 2013. The increase of $7.0 million was primarily the result of a $8.3 million increase in our DRAM and SRAM revenue in the three months ended June 30, 2014 compared to the three months ended June 30, 2013. The increase in our DRAM revenue can be attributed to an increase in unit shipments along with an increase in average selling prices due to a change in product mix to higher density products. The increase in our SRAM revenue can be attributed to an increase in unit shipments. However, our flash revenue decreased by $1.4 million in the three months ended June 30, 2014 compared to the three months ended June 30, 2013 as a result of a decrease in unit shipments. Our analog revenue increased by $0.1 million in the three months ended June 30, 2014 compared to the three months ended June 30, 2013. We anticipate that the average selling prices of our existing products will generally decline over time, although the rate of decline may fluctuate for certain products. There can be no assurance that any future price declines will be offset by higher volumes or by higher prices on newer products.
In the three months ended June 30, 2014, revenue from our largest and second largest distributor accounted for approximately 20% and 12%, respectively, of our total net sales. In the three months ended June 30, 2013, revenue from our largest and second largest distributor accounted for approximately 13% and 10%, respectively, of our total net sales.
Gross profit. Cost of sales includes die cost from wafers acquired from foundries, subcontracted package, assembly and test costs, costs associated with in-house product testing, quality assurance and import duties. Gross profit increased by $3.3 million to $29.3 million in the three months ended June 30, 2014 from $26.0 million in the three months ended June 30, 2013 primarily as a result of an increase in DRAM and SRAM shipments. Our gross margin was 34.5% in the three months ended June 30, 2014 compared to 33.5% in the three months ended June 30, 2013. The increase in gross margin in the three months ended June 30, 2014 compared to the three months ended June 30, 2013 can be attributed to a change in product mix for our DRAM and SRAM products. In addition, we achieved cost reductions for assembly and test charges for certain products which benefited our gross margin. We believe that the average selling prices of our products will decline over time and, unless we are able to reduce our cost per unit to the extent necessary to offset such declines, the decline in average selling prices could result in a material decline in our gross margin. In addition, our product costs could increase if our suppliers raise prices, which could result in a material decline in our gross margin. Although we have product cost reduction programs in place that involve efforts to reduce internal costs and supplier costs, there can be no assurance that product costs will be reduced or that such reductions will be sufficient to offset the expected declines in average selling prices. We do not believe that such cost reduction efforts are likely to have a material adverse impact on the quality of our products or the level of service provided by us.
Research and Development. Research and development expenses increased by 4% to $11.0 million in the three months ended June 30, 2014 from $10.6 million in the three months ended June 30, 2013. As a percentage of net sales, research and development expenses decreased to 12.9% in the three months ended June 30, 2014 from 13.6% in the three months ended June 30, 2013. The increase in research and development expenses of $0.4 million was primarily the result of an increase in headcount related expenses partially offset by a decrease in product development costs. We expect the dollar amount of our research and development expenses to increase in the September 2014 quarter and expect such expenses to fluctuate as a percentage of net sales depending on our overall level of sales.
Selling, General and Administrative. Selling, general and administrative expenses increased by 10% to $11.9 million in the three months ended June 30, 2014 from $10.8 million in the three months ended June 30, 2013. As a percentage of net sales, selling, general and administrative expenses increased to 14.1% in the three months ended June 30, 2014 from 13.9% in the three months ended June 30, 2013. The increase in selling, general and administrative expenses of $1.1 million was primarily the result of an increase in headcount related expenses, expenses related to our world-wide sales conference, sales commissions and legal fees related to ongoing litigation. We expect the dollar amount of our selling, general and administrative expenses to increase in the September 2014 quarter and expect such expenses to fluctuate as a percentage of net sales depending on our overall level of sales.
Interest and other income, net. Interest and other income, net was $0.1 million in the three months ended June 30, 2014 compared to $0.5 million in the three months ended June 30, 2013. The $0.1 million of interest and other income in the three months ended June 30, 2014 is comprised primarily of $0.2 million in rental income from the lease of excess space in our Taiwan facility and an exchange loss of $0.1 million as a result of the depreciation of the U.S. dollar compared to the New Taiwan dollar. The $0.5 million of interest and other income in the three months ended June 30, 2013 is comprised primarily of $0.3 million in rental income from the lease of excess space in our Taiwan facility and an exchange gain of $0.3 million as a result of the appreciation of the U.S. dollar compared to the New Taiwan dollar partially offset by other items.
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Gain on the sale of investments. Gain on the sale of investments was $2.1 million in the three months ended June 30, 2014 compared to $7.2 million in the three months ended June 30, 2013. In the three months ended June 30, 2014, we sold our approximately 23.2 million remaining salable shares of Nanya common stock for approximately $3.6 million which resulted in a pre-tax gain of approximately $2.1 million. In the three months ended June 30, 2013, we sold approximately 69.0 million shares of Nanya common stock for approximately $11.5 million which resulted in a pre-tax gain of approximately $7.0 million, and we sold our investment in Giantec for approximately $4.3 million which resulted in a pre-tax gain of approximately $0.2 million.
Provision for income taxes. For the three months ended June 30, 2014, we recorded income tax expense of $2.4 million that represents an effective tax rate of approximately 28%. The difference between the recorded provision for income taxes and the tax provision, based on the federal statutory rate of 35%, was primarily attributable to the differential in foreign tax rates, non-deductible stock-based compensation expense and certain foreign losses not benefited. For the three months ended June 30, 2013, we recorded income tax expense of $5.2 million that represents an effective tax rate of approximately 42%. In the three months June 30, 2013, we recorded a decrease in the valuation allowance of approximately $1.3 million for foreign tax credit carryforwards based on our estimated ability to use these carryforwards in the future as a result of a change in our legal structure and an increase in the valuation allowance for research and development credits of $0.5 million in certain foreign jurisdictions based on our estimated inability to use these credits in the future. The difference between the recorded provision for income taxes and the tax provision, based on the federal statutory rate of 35%, was primarily attributable to the impact of such items, the differential in foreign tax rates, significant foreign inclusions and non-deductible stock-based compensation expense.
Net (income) loss attributable to noncontrolling interests. The net income attributable to noncontrolling interests was $41,000 in the three months ended June 30, 2014 compared to $182,000 in the three months ended June 30, 2013.
Nine Months Ended June 30, 2014 Compared to Nine Months Ended June 30, 2013
Net Sales. Net sales increased to $244.8 million in the nine months ended June 30, 2014 from $229.2 million in the nine months ended June 30, 2013. The increase of $15.6 million was primarily the result of a $18.6 million increase in our DRAM and SRAM revenue in the nine months ended June 30, 2014 compared to the nine months ended June 30, 2013. The increase in our DRAM revenue can be attributed to an increase in unit shipments along with and increase in average selling prices due to a change in product mix to higher density products. The increase in our SRAM revenue can be attributed to an increase in unit shipments. However, our flash revenue decreased by $3.3 million in the nine months ended June 30, 2014 compared to the nine months ended June 30, 2013 as a result of a decrease in unit shipments. Our analog revenue increased by $0.3 million in the nine months ended June 30, 2014 compared to the nine months ended June 30, 2013.
In the nine months ended June 30, 2014, revenue from our largest and second largest distributor accounted for approximately 18% and 13%, respectively, of our total net sales. In the nine months ended June 30, 2013, revenue from our largest and second largest distributor accounted for approximately 14% and 11%, respectively, of our total net sales.
Gross profit. Gross profit increased by $7.1 million to $82.6 million in the nine months ended June 30, 2014 from $75.5 million in the nine months ended June 30, 2013 primarily as a result of an increase in DRAM and SRAM shipments. Our gross margin was 33.7% in the nine months ended June 30, 2014 compared to 33.0% in the nine months ended June 30, 2013. The increase in gross margin in the nine months ended June 30, 2014 compared to the nine months ended June 30, 2013 can be attributed to a change in product mix for our DRAM and SRAM products. In addition, we achieved cost reductions for assembly and test charges for certain products which benefited our gross margin.
Research and development. Research and development expenses increased by 5% to $32.4 million in the nine months ended June 30, 2014 from $30.9 million in the nine months ended June 30, 2013. As a percentage of net sales, research and development expenses decreased to 13.2% in the nine months ended June 30, 2014 from 13.5% in the nine months ended June 30, 2013. The increase in research and development expenses of $1.5 million was primarily the result of an increase in headcount related expenses partially offset by a decrease in product development costs.
Selling, general and administrative. Selling, general and administrative expenses increased by 7% to $34.8 million in the nine months ended June 30, 2014 from $32.6 million in the nine months ended June 30, 2013. As a percentage of net sales, selling, general and administrative expenses were 14.2% in each of the nine months ended June 30, 2014 and the nine months ended June 30, 2013. The increase in selling, general and administrative expenses of $2.2 million was primarily the result of an increase in headcount related expenses, sales commissions, expenses related to our world-wide sales conference and legal fees related to ongoing litigation.
Interest and other income, net. Interest and other income, net was $0.9 million in the nine months ended June 30, 2014 compared to $1.3 million in the nine months ended June 30, 2013. The $0.9 million of interest and other income in the nine months ended June 30, 2014 is comprised primarily of $0.7 million in rental income from the lease of excess space in our Taiwan facility and an exchange gain of $0.4 million as a result of the appreciation of the U.S. dollar compared to the New Taiwan dollar partially
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offset by $0.2 million of other items. The $1.3 million of interest and other income in the nine months ended June 30, 2013 is comprised primarily of $0.9 million in rental income from the lease of excess space in our Taiwan facility and an exchange gain of $0.5 million as a result of the appreciation of the U.S. dollar compared to the New Taiwan dollar partially offset by other items.
Gain on the sale of investments. Gain on the sale of investments was $11.3 million in the nine months ended June 30, 2014 compared to $9.3 million in the nine months ended June 30, 2013. In the nine months ended June 30, 2014, we sold approximately 109.6 million shares of Nanya common stock for approximately $16.2 million which resulted in a pre-tax gain of approximately $9.2 million. In addition, we sold our remaining shares of SMIC for approximately $3.2 million which resulted in a pre-tax gain of approximately $2.1 million. In the nine months ended June 30, 2013, we sold approximately 109.5 million shares of Nanya common stock for approximately $16.1 million which resulted in a pre-tax gain of approximately $9.1 million. In addition, we sold our investment in Giantec for approximately $4.3 million which resulted in a pre-tax gain of approximately $0.2 million.
Provision for income taxes. For the nine months ended June 30, 2014, we recorded income tax expense of $6.9 million that represents an effective tax rate of approximately 25%. The difference between the recorded provision for income taxes and the tax provision, based on the federal statutory rate of 35%, was primarily attributable to the differential in foreign tax rates and non-deductible stock-based compensation expense. For the nine months ended June 30, 2013, we recorded income tax expense of $9.6 million that represents an effective tax rate of approximately 42%. In the nine months ended June 30, 2013, we recorded an increase in the valuation allowance of approximately $1.5 million for California net operating loss carryforwards and a decrease in the valuation allowance of approximately $1.3 million for foreign tax credit carryforwards based on our estimated ability to use these carryforwards in the future as a result of a change in our legal structure. In addition, we recorded an increase in the valuation allowance for research and development credits of $0.5 million in certain foreign jurisdictions based on our estimated inability to use these credits in the future. The difference between the recorded provision for income taxes and the tax provision, based on the federal statutory rate of 35%, was primarily attributable to the impact of such items, the differential in foreign tax rates, significant foreign inclusions and non-deductible stock-based compensation expense.
Net income attributable to noncontrolling interests. The net income attributable to noncontrolling interests was $198,000 in the nine months ended June 30, 2014 compared to $164,000 in the nine months ended June 30, 2013.
Liquidity and Capital Resources
As of June 30, 2014, our principal sources of liquidity included cash, cash equivalents, restricted cash and short-term investments of approximately $142.2 million. During the nine months ended June 30, 2014, we generated $5.7 million from operating activities compared to $21.9 million generated in the nine months ended June 30, 2013. The cash provided by operations in the nine months ended June 30, 2014 was primarily due to our net income of $20.6 million adjusted for non-cash items of $0.7 million and increases in accrued liabilities of $5.8 million. This was partially offset by increases in accounts receivable of $4.3 million, increases in inventories of $11.5 million, increases in other assets of $1.3 million and decreases in accounts payable of $2.9 million. The cash provided by operations in the nine months ended June 30, 2013 was primarily due to our net income of $13.0 million adjusted for non-cash items of $7.3 million, increases in accounts payable of $2.2 million, decreases in inventories of $0.9 million and decreases in other assets of $0.7 million. This was partially offset by decreases in accrued liabilities of $1.5 million and increases in accounts receivable of $0.7 million.
In the nine months ended June 30, 2014, we generated $2.6 million from investing activities compared to $1.1 million used in the nine months ended June 30, 2013. The cash generated in the nine months ended June 30, 2014 included $16.2 million from the sale of our remaining approximately 109.6 million freely-tradeable shares of Nanya common stock, $3.2 million from the sale of our remaining shares of SMIC common stock and $1.4 million from net sales of other available-for-sale securities. In the nine months ended June 30, 2014, we used $9.9 million for the acquisition of property and equipment, $7.1 million for the payment of license fees, $1.0 million to collateralize accounts payable to a supplier and $0.2 million to acquire additional shares of our Chingis subsidiary. The cash used in the nine months ended June 30, 2013 included $17.9 million for the acquisition of property, equipment and building improvements including $9.1 million for our new corporate headquarters and $2.4 million for office space in Suzhou, China, $4.2 million for the payment of a holdback related to our acquisition of Si En and $1.6 million to acquire an additional 4.8% of the noncontrolling interest in our Chingis subsidiary. In the nine months ended June 30, 2013, we generated $16.1 million from the sale of approximately 109.5 million shares of Nanya common stock, $4.3 million from the sale of our investment in Giantec and $2.2 million from net sales of available-for-sale securities.
In the nine months ended June 30, 2014, we made capital expenditures of approximately $9.9 million for test equipment, engineering tools, computer hardware and software. On June 25, 2014, we entered into an agreement to purchase an approximately 30,908 square foot building located in Zhangjiang Hi-tech Park, Shanghai, China. We will relocate our Shanghai operations to this location upon completion of the building improvements which is expected in mid-2015. The purchase price is approximately $8.4 million which will be paid from our existing cash and cash equivalent balances. We expect to spend approximately $22.0
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million to $27.0 million to purchase property, building improvements and capital equipment during the next twelve months, including approximately $10 million for the purchase of the Shanghai building and related improvements and the remaining balance for additional test equipment, design and engineering tools, and computer hardware and software. We expect to fund our capital expenditures from our existing cash and cash equivalent balances.
We generated $11.6 million from financing activities during the nine months ended June 30, 2014 compared to $9.6 million during the nine months ended June 30, 2013. Our sources of financing for the nine months ended June 30, 2014 were proceeds from the issuance of common stock of $9.6 million from stock option exercises and sales under our employee stock purchase plan and $2.6 million excess tax benefits from share-based compensation. In the nine months ended June 30, 2014, we used $0.4 million to settle shares withheld for statutory withholding requirements upon the vesting of RSUs and $0.2 million for the repayment of long-term borrowings. Our sources of financing for the nine months ended June 30, 2013 were borrowings of $4.9 million to purchase our new corporate headquarters in Milpitas, California, borrowing of $4.1 million under short-term lines of credit and proceeds from the issuance of common stock of $5.3 million from stock option exercises and sales under our employee stock purchase plan. In the nine months ended June 30, 2013, we used $4.2 million for the repayment of short-term and long-term borrowings and $0.5 million to settle shares withheld for statutory withholding requirements upon the vesting of RSUs.
At June 30, 2014, we had $17.4 million in borrowings available through a number of short-term lines of credit with various financial institutions in Taiwan. These lines of credit expire at various times through March 2015. As of June 30, 2014, we had no outstanding borrowings under these short-term lines of credit.
On December 4, 2012, we purchased a building in Milpitas, California consisting of 55,612 square feet on approximately 2.85 acres for $6.5 million. We relocated our headquarters to this location in June 2013. We financed a portion of the purchase price for our new headquarters with a loan for approximately $4.9 million. In Taiwan, we own and occupy our building and the land upon which our building is situated is leased under an operating lease that expires in March 2016. We have operations in leased sites in the U.S., China and Hong Kong. In addition to these sites, we lease sales offices in the U.S., Europe and Asia. These leases expire at various dates through 2019. Our outstanding commitments under these leases were approximately $2.3 million at June 30, 2014.
We generally warrant our products against defects in materials and workmanship for a period of 12 months. Liability for a stated warranty period is usually limited to the replacement of defective items or return of amounts paid. Warranty expense has historically been immaterial to our financial statements.
Our contractual cash obligations at June 30, 2014 are outlined in the table below:
Payments Due by Period | |||||||||||||||||||
Contractual Obligations | Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | ||||||||||||||
(In thousands) | |||||||||||||||||||
Operating leases | $ | 2,296 | $ | 308 | $ | 1,711 | $ | 227 | $ | 50 | |||||||||
Borrowings | 4,583 | 49 | 390 | 4,144 | — | ||||||||||||||
Purchase of Shanghai building | 8,407 | 8,407 | — | — | — | ||||||||||||||
Purchase obligations with wafer foundries | 26,607 | 26,607 | — | — | — | ||||||||||||||
Total contractual cash obligations | $ | 41,893 | $ | 35,371 | $ | 2,101 | $ | 4,371 | $ | 50 | |||||||||
At June 30, 2014, we had outstanding authorization from our Board to purchase up to $19.8 million of our common stock from time to time.
We believe our existing funds will satisfy our anticipated working capital and other cash requirements through at least the next 12 months. We may from time to time take actions to further increase our cash position through equity or debt financings, sales of shares of investments, additional bank borrowings, or the disposition of certain assets. From time to time, we may also commit to acquisitions or equity investments, including strategic investments in or prepayments to wafer fabrication foundries or assembly and test subcontractors. To the extent we enter into such transactions, any such transaction could require us to seek additional equity or debt financing to fund such activities. There can be no assurance that any such additional financing could be obtained on terms acceptable to us, if at all.
Off-Balance Sheet Arrangements
We may be obligated to indemnify certain customers, distributors, suppliers, and subcontractors for attorney fees and damages and costs awarded against these parties in certain circumstances in which our products are alleged to infringe third party intellectual property rights, including patents, registered trademarks, or copyrights. In certain cases, there are limits on and exceptions to our
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potential liability for indemnification relating to intellectual property infringement claims. In addition, we have entered into indemnification agreements with our officers and directors, and the Company’s bylaws provide that indemnification may be provided to our agents. We have directors’ and officers’ insurance pursuant to which we may be reimbursed for certain indemnity expenses, subject to the terms of the insurance policy. We cannot estimate the amount of potential future indemnity expenses that we may be required to make. The amount of available directors’ and officers’ insurance may not be sufficient to cover our indemnity obligations, which may have a material adverse effect on our results of operations in future periods.
Other than as set forth above, we are not currently party to any off-balance sheet arrangements as defined in Item 303 (a)(4)(ii) of SEC Regulation S-K.
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Item 3.Quantitative and Qualitative Disclosures about Market Risk
Foreign Currency Exchange Risk. We anticipate that international sales will continue to account for a significant portion of our consolidated revenue. Our international sales are largely denominated in U.S. dollars and therefore are not subject to material foreign currency exchange risk. However, we have operations in China, Europe, Taiwan, Hong Kong, India, Japan, Korea and Singapore where our expenses are denominated in each country’s local currency and are subject to some foreign currency exchange risk. In the nine months ended June 30, 2014 and in fiscal 2013, we recorded exchange gains of approximately $0.4 million and $0.2 million, respectively. We do not currently engage in any hedging activities. In the future, if we feel our foreign currency exposure has significantly increased, we may consider entering into hedging transactions to help mitigate that risk.
Interest Rate Risk. We had cash, cash equivalents, restricted cash and short-term investments of $142.2 million at June 30, 2014. These funds were primarily invested in money market funds and certificates of deposit. Due to the relatively short-term nature of our investment portfolio, we believe that we do not have any material exposure to changes in the fair value of our investment portfolio as a result of changes in interest rates. We believe a hypothetical 100 basis point increase in interest rates would not materially affect the fair value of our interest-sensitive financial instruments. Since we believe we have the ability to liquidate this portfolio, we do not expect our operating results or cash flows to be materially affected to any significant degree by a sudden change in market interest rates on our investment portfolio.
Investments in Publicly Traded Companies. We own approximately $10.8 million of private placement shares in Nanya which are accounted for on the cost-basis. We account for such shares on the cost-basis as these securities are restricted and the restrictions do not terminate within one year of the reporting date. In the event a decline in the market value of our Nanya shares below our cost basis is determined to be other-than-temporary, we would be required to recognize a loss on our investment through our operating results.
Item 4.Controls and Procedures
Our Chief Executive Officer and our Chief Financial Officer, based on the evaluation of our disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended) required by paragraph (b) of Rule 13a-15 or Rule 15d-15, have concluded that, as of June 30, 2014, our disclosure controls and procedures were effective to ensure that the information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 (i) is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
During the three months ended June 30, 2014, there were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Securities Exchange Act Rules 13a-15 or 15d-15 that was conducted during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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Part II. OTHER INFORMATION
Item 1.Legal Proceedings
GSI Technology Inc. v. Integrated Silicon Solution, Inc., et al.
On October 2, 2013, GSI Technology Inc. (GSI) filed a Second Amended Complaint in a lawsuit filed earlier in 2013 solely against defendant United Memories, Inc. in the United States District Court for the Northern District of California. GSI named us as a new, second defendant in the Second Amended Complaint. On April 18, 2014, the Court granted our motion to dismiss that complaint in part, leaving claims against us for Unfair Competition under California Business & Professions Code 17200, misappropriation of trade secrets, and intentional interference with prospective economic advantage. In the remaining portion of the complaint, GSI alleges that we acted together with United Memories, Inc. to harm GSI in connection with a bid from Cisco Systems, Inc. and misappropriated alleged GSI trade secrets. GSI seeks damages and injunctive relief. We filed an answer on June 2, 2014 and asserted a declaratory relief counterclaim against GSI. Before we were named as a defendant, the Court denied motions by GSI against United Memories, Inc. for temporary and preliminary injunctive relief. The Court issued a case management order on June 13, 2014 with a scheduled trial date of July 13, 2015. We believe we have meritorious defenses to the claims alleged by GSI and intend to defend this suit vigorously. However, there can be no assurance as to the outcome of this matter or any future litigation.
Other Legal Proceedings
In the ordinary course of our business, as is common in the semiconductor industry, we have been involved in a limited number of other legal actions, both as plaintiff and defendant, and could incur uninsured liability in any one or more of them. Although the outcome of these actions is not presently determinable, we believe that the ultimate resolution of these matters will not have a material adverse effect on our financial position, cash flows or results of operations. However, no assurances can be given with respect to the extent or outcome of any such litigation in the future.
Item 1A. Risk Factors
Uncertain economic conditions and any future downturn in the automotive market or other markets we serve are expected to adversely affect our business and financial results.
Substantially all of our products are incorporated into products for the automotive, communications, IMM, and digital consumer markets. In particular, in both the nine months ended June 30, 2014 and in fiscal 2013, approximately 46% of our sales were to the automotive market and any future downturn in this market would have a material adverse effect on our revenue and profitability. Historically, the automotive, communications, IMM, and digital consumer markets have experienced cyclical depressed business conditions, often in connection with, or in anticipation of, a decline in general economic conditions, or due to adverse supply and demand conditions in such markets. Industry downturns have resulted in reduced demand and declining average selling prices for our products which adversely affected our business. During uncertain economic conditions, our current or potential customers may delay or reduce purchases of our products which would adversely affect our revenues and harm our business and financial results. In addition, any uncertainty in the economy may negatively impact the spending patterns of businesses including our current and potential customers. We expect our business to be adversely impacted by any further downturn in the U.S. or global economies.
Our sales depend on DRAM and SRAM products and reduced demand for these products or a decline in average selling prices could harm our business.
In the first nine months of fiscal 2014 and in fiscal 2013, approximately 89% and 88%, respectively, of our net sales were derived from the sale of DRAM and SRAM products, which are subject to unit volume fluctuations and declines in average selling prices that could harm our business. While our total revenue increased in the December 2012 quarter, our DRAM and SRAM revenue declined 4.9% in the December 2012 quarter from the September 2012 quarter due to weakness in the communications market. We also experienced a sequential decline in revenue from $66.2 million in the December 2011 quarter to $62.5 million in the March 2012 quarter primarily as a result of a decrease in unit shipments of our DRAM products. We experienced a sequential decline in revenue from $71.3 million in our September 2011 quarter to $66.2 million in our December 2011 quarter partially as a result of a decrease in unit shipments of our SRAM products. We may not be able to offset any future price declines for our products by higher volumes or by higher prices on newer products. While we experienced increases in the average selling prices for certain of our products in fiscal 2013 and the first nine months of fiscal 2014, historically, average selling prices for semiconductor memory products have declined, and we expect that average selling prices for our products will decline in the future. Although we entered the NOR Flash market with our acquisition of Chingis in September 2012, our NOR Flash business is generally subject to the same types of unit volume fluctuations and declines in average selling prices as our DRAM and SRAM businesses. Our
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ability to maintain or increase revenues will depend upon our ability to increase unit sales volume of existing products and introduce and sell new products that compensate for the anticipated declines in the average selling prices of our existing products.
If we are unable to obtain an adequate supply of wafers due to industry consolidation involving foundries, financial difficulties at foundries or other reasons, our business will be harmed unless we are able to secure alternative capacity in a timely manner and on reasonable terms.
If we are unable to obtain an adequate supply of wafers from our current suppliers or any alternative sources in a timely manner and on reasonable terms, our business will be severely harmed. For example, our revenue in the March 2013 quarter was adversely affected as we were unable to secure an adequate supply of NOR flash wafers. Our principal manufacturing relationships are with GlobalFoundries, Hynix, Nanya, Powerchip, SMIC, TSMC, UMC and Vanguard. Each of our wafer foundries also supplies wafers to other semiconductor companies, including certain of our competitors or for their own account. Although we are allocated wafer capacity from our key suppliers, we may not be able to obtain such capacity in periods of tight supply. If any of our suppliers experience manufacturing failures or yield shortfalls, severe financial or operational difficulties, choose to prioritize capacity for other uses, or reduce or eliminate deliveries to us for any other reason, we may not be able to obtain enough wafers to meet the market demand for our products which would adversely affect our revenues. In recent years, it has been more difficult for us to secure long-term foundry capacity (particularly for our DRAM products) due to industry consolidation affecting foundries and adverse financial conditions at foundries. From time to time, certain of our wafer foundries have announced that they will no longer produce a specific type of wafer we may need (especially certain types of DRAM wafers). In such event, we have had to and expect in the future to have to place large last time buy orders which expose us to the risk of inventory obsolescence. Once a product is in production at a particular foundry, it is time consuming and costly to have such product manufactured at a different foundry. In addition, we may not be able to qualify additional manufacturing sources for existing or new products in a timely manner and we cannot be certain that other manufacturing sources would be able to deliver an adequate supply of wafers to us or at the same cost.
Foundry capacity can be limited, resulting in higher wafer prices, and we have had to enter into special arrangements to secure foundry capacity.
If we are not able to obtain sufficient foundry capacity as required, our relationships with our customers would be harmed and our future sales would be adversely impacted. In order to secure foundry capacity, we have entered into in the past, and will likely enter into in the future, various arrangements with suppliers, which could include:
• | option payments or other prepayments to foundries; |
• | increased prices for wafers; |
• | purchases of equity or debt securities in foundries; |
• | nonrefundable deposits with, or loans to, foundries in exchange for capacity commitments; |
• | contracts that commit us to purchase specified quantities of wafers over extended periods: |
• | process development relationships with foundries; and |
• | joint ventures. |
In this regard, in September 2012, we invested approximately $27.1 million in Nanya and entered into an agreement with Nanya to provide us with access to leading edge process technologies and certain wafer volume guarantees.
In the future, we may not be able to make arrangements for needed foundry capacity in a timely fashion or at all, and such arrangements, if any, may not be on terms favorable to us. Once we make commitments to secure foundry capacity, we may incur significant financial penalties if we subsequently determine that we are not able to utilize all of that capacity. Such penalties may be substantial and could harm our financial results. In addition, we must be able to secure sufficient assembly and test capacity from third-party contractors. In order to secure such capacity, we are exposed to many of the same risks we face when securing foundry capacity. In the past, we have purchased testing equipment for use by our contractors to satisfy a portion of our capacity needs. If we are not able to secure required assembly and test capacity, our business and customer relationships would be harmed.
We rely on third-party contractors to fabricate, assemble and test our products. Our business is highly dependent on the continued operations of such contractors and our failure to successfully manage our relationships with these contractors could damage our relationships with our customers, decrease our sales and limit our growth.
We rely on third-party contractors located in Asia to fabricate, assemble and test our products. Any uncertain economic conditions or uncertainty in the U.S. and global credit markets could materially impact the financial condition or operations of our third-party contractors such as our wafer foundries, test contractors and assembly contractors. Our business is highly dependent on the continued operations of such contractors. Any deterioration in the financial condition of our contractors or any disruption in the operations of our contractors could adversely impact the flow of our products to our end customers and materially adversely
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impact our business and results of operation. In recent years, several foundries (including foundries that we relied on for wafers)experienced financial difficulties and filed for bankruptcy protection, substantially reduced their operations or were acquired by competing companies. There are significant risks associated with our reliance on these third-party contractors, including:
• | potential price increases; |
• | possible capacity shortages; |
• | foundries ceasing production of wafer types that we need; |
• | financial viability of our foundries or other contractors; |
• | reduced control over product quality; |
• | reduced control over delivery schedules; |
• | their inability to increase production and achieve acceptable yields on a timely basis; |
• | absence of long-term agreements; |
• | limited warranties on products supplied to us; |
• | impact of foreign exchange rates on our product costs; and |
• | general risks related to conducting business internationally. |
If any of these risks are realized, our business and results of operations could be adversely affected until our subcontractor is able to remedy the problem or until we are able to secure an alternative subcontractor.
Potential intellectual property claims and litigation could subject us to significant liability for damages and could invalidate our proprietary rights.
In the semiconductor industry, it is not unusual for companies to receive notices alleging infringement of patents or other intellectual property rights. We have been, and from time-to-time expect to be, notified of claims that we may be infringing patents, maskwork rights or copyrights owned by third-parties. If it appears necessary or desirable, we may seek licenses under patents that we are alleged to be infringing. However, licenses may not be offered and the terms of any offered licenses may not be acceptable to us.
The failure to obtain a license under a key patent or intellectual property right from a third party for technology used by us could cause us to incur substantial liabilities and to suspend the manufacture of the products utilizing the invention or to attempt to develop non-infringing products, any of which could harm our business. Furthermore, we may become involved in protracted litigation regarding the alleged infringement by us of third-party intellectual property rights or litigation to assert and protect our patents or other intellectual property rights. Any litigation relating to patent infringement or other intellectual property matters could result in substantial costs and diversion of our resources, which could harm our business. In this regard, please refer to "Part II, Item 1. Legal Proceedings" for discussion of our pending litigation with GSI.
Our foundries may experience lower than expected yields which could adversely affect our business.
The manufacture of integrated circuits is a highly complex and technically demanding process. Production yields and device reliability can be affected by a large number of factors. As is typical in the semiconductor industry, our foundries have from time to time experienced lower than anticipated manufacturing yields and device reliability problems, particularly in connection with the introduction of new products and changes in such foundry’s processing steps. There can be no assurance that our foundries will not experience lower than expected manufacturing yields or device reliability problems in the future, which could materially and adversely affect our business and operating results.
Our operating results are expected to continue to fluctuate and may not meet our financial guidance or published analyst forecasts. This may cause the price of our common stock to decline significantly.
Our future quarterly and annual operating results are subject to fluctuations due to a wide variety of factors, including:
• | changes in the global economy; |
• | changes in business conditions in our key markets especially the automotive market; |
• | shortages in foundry, assembly or test capacity; |
• | the cyclicality of the semiconductor industry; |
• | declines in average selling prices of our products; |
• | changes in our product mix which could reduce our gross margins; |
• | a failure to introduce new products and to implement technologies on a timely basis; |
• | disruption in the supply of wafers, assembly or test services; |
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• | changes in the pricing for wafers or assembly or test services; |
• | oversupply of memory or analog products in the market; |
• | inventory write-downs for lower of cost or market or excess and obsolete products; |
• | cancellation of existing orders or the failure to secure new orders; |
• | a failure to deliver products to customers on a timely basis; |
• | excess inventory levels at our customers; |
• | decreases in the demand for our memory or analog products; |
• | our ability to control or reduce our operating expenses; |
• | the costs and outcome of any pending or future litigation including our litigation with GSI; |
• | fluctuations in foreign currencies relative to the U.S. dollar; |
• | increased expenses associated with new product introductions, masks or process changes; |
• | the ability of customers to make payments to us; |
• | market acceptance of ours and our customers’ products; |
• | a failure to anticipate changing customer product requirements; |
• | fluctuations in manufacturing yields at our suppliers; |
• | fluctuations in product quality resulting in rework, replacement, or loss due to damages; |
• | the timing of significant orders; and |
• | the commencement of any future litigation or antidumping proceedings. |
Shifts in industry-wide capacity may cause our results to fluctuate. These shifts may occur quickly with little or no advance notice. Such shifts have historically resulted in significant inventory write-downs.
The semiconductor industry is highly cyclical and is subject to significant downturns resulting from excess capacity, overproduction, reduced demand or technological obsolescence. Shifts in industry-wide capacity from shortages to oversupply or from oversupply to shortages may result in significant fluctuations in our quarterly or annual operating results. These shifts in industry conditions can occur quickly with little or no advance notice to us. Adverse changes in industry conditions are likely to result in a decline in average selling prices and the stated value of our inventory. In the first nine months of fiscal 2014, in fiscal 2013, and in fiscal 2012, we recorded inventory write-downs of $4.3 million, $4.6 million, and $5.7 million, respectively. These inventory write-downs related to adjusting our inventory valuation for certain excess and obsolete products, and valuing our inventory at the lower-of-cost-or-market.
Differences in forecasted average selling prices used in calculating lower of cost or market adjustments can result in significant changes in the estimated net realizable value of inventory and accordingly the amount of write-down recorded. If the estimated market value of products in inventory at quarter-end is below the manufacturing cost of these products, we will recognize charges to write down the carrying value of our inventories to market value. In addition, we write down to zero dollars the carrying value of inventory on hand that has aged over one year (two years for wafer and die bank) to cover estimated excess and obsolete exposures, unless adjustments are made based on management’s judgments for newer products, end of life products, planned inventory increases or strategic customer supply. In making such judgments to write down inventory, management takes into account the product life cycles which can range from six to 30 months, the stage in the life cycle of the product, the impact of competitors’ announcements and product introductions on our products. Future additional inventory write-downs may occur due to lower of cost or market accounting, excess inventory or inventory obsolescence.
Strong competition in the semiconductor market may harm our business.
The semiconductor market is intensely competitive and has been characterized by an oversupply of product, price erosion, rapid technological change, short product life cycles, cyclical market patterns, and heightened foreign and domestic competition. Many of our competitors offer broader product lines and have greater financial, technical, marketing, distribution and other resources than us. We may not be able to compete successfully against any of these competitors. Our ability to compete successfully in our markets depends on factors both within and outside of our control, including:
• | the pricing of our products; |
• | the supply and cost of wafers; |
• | product design, functionality, performance and reliability; |
• | successful and timely product development; |
• | the performance of our competitors and their pricing policies; |
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• | wafer manufacturing over or under capacity; |
• | real or perceived imbalances in supply and demand for our products; |
• | the rate at which OEM customers incorporate our products into their systems; |
• | the gain or loss of significant customers; |
• | the success of our customers’ products and end-user demand; |
• | access to advanced process technologies at competitive prices; |
• | achievement of acceptable yields of functional die; |
• | the capacity of our third-party contractors to assemble and test our products; |
• | the nature and success of our competitors; |
• | our financial strength and the financial strength of our competitors; and |
• | general economic conditions. |
In addition, we are vulnerable to technology advances utilized by competitors to manufacture higher performance or lower cost products. We may not be able to compete successfully in the future as to any of these factors. Our failure to compete successfully in these or other areas could harm our business and financial results.
Our revenues and business would be harmed if we are not able to successfully develop, introduce and sell new products and develop and implement new manufacturing technologies in a timely manner. Our research and development expenses could increase and our business could be harmed if the implementation of these new manufacturing technologies is unsuccessful.
We operate in highly competitive, quickly changing markets which are characterized by rapid obsolescence of existing products. As a result, our future success depends on our ability to develop and introduce new products that our customers choose to buy in significant quantities. If we fail to introduce new products in a timely manner or if our customers’ products do not achieve commercial success, our business and results of operations could be seriously harmed. The design and introduction of new products is challenging as such products typically incorporate more functions and operate at faster speeds than prior products. Increasing complexity generally requires smaller features on a chip. This makes developing new generations of products substantially more difficult than prior generations. The cost to develop products utilizing these new technologies is expensive and requires significant research and development spending and, as a result, our research and development expenses could increase in the future. Further, new products may not work properly in our customers’ applications. If we are unable to design, introduce, manufacture, market and sell new products successfully, our business and financial results would be seriously harmed.
We may encounter difficulties in effectively integrating newly acquired businesses.
From time to time, we have acquired and expect in the future to acquire other companies or assets that we believe to be complementary to our business. In this regard, in September 2012, we acquired Chingis, a provider of NOR flash memory technologies used in standalone and embedded applications headquartered in Taiwan. In addition, in January 2011, we acquired Si En, a privately held fabless provider of high performance analog and mixed signal integrated circuits headquartered in Xiamen, China. Acquisitions may result in the use of our cash resources, potentially dilutive issuances of equity securities, incurrence of debt and contingent liabilities, amortization expenses related to intangible assets, and the possible impairment of goodwill, which could harm our profitability. In addition, acquisitions involve numerous risks, including:
• | lower than expected sales of any acquired products; |
• | the risk that the markets for acquired products do not develop as expected; |
• | difficulties in continuing to develop new technologies and deliver products to market on time; |
• | the potential loss of key employees and customers as a result of the acquisition; |
• | difficulties in successfully assimilating the operations, technologies and personnel of the acquired company; |
• | diversion of management’s attention from other business concerns; |
• | risks of entering markets in which we have no, or limited, direct prior experience; and |
• | higher than estimated acquisition expenses. |
There is no assurance that any of our recent or future acquisitions will contribute positively to our business or operating results.
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The loss of a significant customer or a reduction in orders from one or more large customers could adversely affect our operating results.
As sales to our customers are executed pursuant to purchase orders and no purchasing contracts typically exist, our customers can cease doing business with us at any time. We may not be able to retain our key customers, such customers may cancel or reschedule orders, and in the event of canceled orders, such orders may not be replaced by other sales. In addition, sales to any particular customer may fluctuate significantly from quarter to quarter, and such fluctuating sales could harm our business and financial results.
We have significant international sales and operations and risks related to our international activities could harm our operating results.
In the nine months ended June 30, 2014, approximately 12% of our net sales was attributable to customers located in the U.S., 23% was attributable to customers located in Europe and 65% was attributable to customers located in Asia. In fiscal 2013, approximately 12% of our net sales was attributable to customers located in the U.S., 20% was attributable to customers located in Europe and 67% was attributable to customers located in Asia. In fiscal 2012, approximately 16% of our net sales was attributable to customers located in the U.S., 21% was attributable to customers located in Europe and 62% was attributable to customers located in Asia. We anticipate that sales to international sites will continue to represent a significant percentage of our net sales. Although our international sales are largely denominated in U.S. dollars, we do have sales transactions in New Taiwan dollars, in Hong Kong dollars and in Chinese renminbi. In addition, our wafer foundries and assembly and test subcontractors are primarily located in Taiwan and China and, while our wafer purchases are denominated in U.S. dollars, most of our assembly and test costs are denominated in New Taiwan dollars. A substantial majority of our employees are located outside of the U.S and the expenses for our foreign operations are generally denominated in local currency. As a result, a devaluation of the U.S. dollar compared to the New Taiwan dollar or Chinese renminbi could substantially increase the cost of our products and our operations in Taiwan or China.
We are subject to the risks of conducting business internationally, including:
• | global economic conditions, particularly in Taiwan and China; |
• | difficulties in hiring and retaining experienced engineers in countries such as China and Taiwan; |
• | foreign currency fluctuations; |
• | duties, tariffs and other trade barriers and restrictions; |
• | changes in trade policy and regulatory requirements; |
• | transportation delays; |
• | the burdens of complying with foreign laws; |
• | imposition of foreign currency controls; |
• | language barriers; |
• | difficulties in collecting foreign accounts receivable; |
• | difficulties in protecting our intellectual property rights; |
• | political instability, including any changes in relations between China and Taiwan; |
• | public health outbreaks such as SARS, ebola or avian flu; and |
• | earthquakes and other natural disasters. |
We depend on our ability to attract and retain our key technical and management personnel.
Our success depends upon the continued service of our key technical and management personnel. Several of our important manufacturing and other subcontractor relationships are based on personal relationships between our senior executive officers and such parties. In particular, our Executive Chairman has long-term relationships with our key foundries. If we were to lose the services of any key executives, it may negatively impact the related business relationships since we typically have no long-term contractual agreements with such parties. Our success also depends on our ability to continue to attract, retain and motivate qualified technical personnel, particularly experienced circuit designers and process engineers. The competition for such employees depends on general economic and industry conditions but such competition has been intense in recent periods. We have no employment contracts or key person life insurance policies with or for any of our employees. The loss of the service of one or more of our key personnel could harm our business.
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Our products are complex and could contain defects, which could reduce sales of those products or result in claims against us.
We develop complex and evolving products. Despite testing by us and our customers, errors may be found in existing or new products. This could result in a delay in recognition or loss of revenues, loss of market share or failure to achieve market acceptance. The occurrence of defects could also cause us to incur significant warranty, support and repair costs, could divert the attention of our engineering personnel from our product development efforts, and could harm our relationships with our customers. The occurrence of these problems could also result in the delay or loss of market acceptance of our products and would likely harm our business. Defects, integration issues or other performance problems in our products could result in financial or other damages to our customers. Our customers could also seek and obtain damages from us for their losses. From time to time, we have been involved in disputes regarding product warranty issues. Although we seek to limit our liability, a product liability claim brought against us, even if unsuccessful, would likely be time consuming and could be costly to defend.
We may be unable to effectively protect our intellectual property, which would negatively impact our ability to compete.
We believe that the protection of our intellectual proprietary rights will continue to be important to the success of our business. We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights. We also enter into confidentiality or license agreements with our employees, consultants and business partners, and take actions to control access to and distribution of our documentation and other proprietary information. Despite these efforts, unauthorized parties may attempt to copy or otherwise obtain and use our proprietary technology. Monitoring unauthorized use of our technology is difficult, and we cannot be certain that the steps we have taken will prevent unauthorized use of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as do the laws of the U.S. Many U.S. companies have encountered substantial infringement problems in foreign countries, including countries in which we design and sell our products. We cannot be certain that patents will be issued as a result of our pending applications nor can we be certain that any issued patents would protect or benefit us or give us adequate protection from competing products. For example, issued patents may be circumvented or challenged and declared invalid or unenforceable. We also cannot be certain that others will not develop similar technology or develop competing technologies on their own.
Our results of operations could vary as a result of the methods, estimates, and judgments we use in applying our accounting policies.
The methods, estimates, and judgments we use in applying our accounting policies have a significant impact on our results of operations (see “Critical Accounting Policies” in Part I, Item 2 of this Form 10-Q). Such methods, estimates, and judgments are, by their nature, subject to substantial risks, uncertainties, and assumptions, and factors may arise over time that lead us to change our methods, estimates, and judgments and such changes could significantly affect our results of operations. In particular, the calculation of share-based compensation expense requires us to use valuation methodologies (which were not developed for use in valuing employee stock awards) and a number of assumptions, estimates, and conclusions regarding matters such as expected forfeitures, expected volatility of our share price, the expected dividend rate with respect to our common stock, and the equity award exercise behavior of our employees. Furthermore, there are no means, under applicable accounting principles, to compare and adjust our expense if and when we learn about additional information that may affect the estimates that we previously made, with the exception of changes in expected forfeitures of share-based awards. In the future, factors may arise that lead us to change our estimates and assumptions with respect to future share-based compensation arrangements, resulting in variability in our share-based compensation expense over time. Changes in forecasted share-based compensation expense could impact our gross margin percentage, research and development expenses, and selling, general and administrative expenses.
Our stock price is expected to continue to be volatile.
The trading price of our common stock has been and is expected to be subject to wide fluctuations in response to:
• | quarter-to-quarter variations in our operating results; |
• | general conditions or cyclicality in the semiconductor industry or the end markets that we serve; |
• | new or revised earnings estimates or guidance by us or industry analysts; |
• | comments or recommendations issued by analysts who follow us, our competitors or the semiconductor industry; |
• | aggregate valuations and movement of stocks in the broader semiconductor industry; |
• | announcements of new products, strategic relationships or acquisitions by us or our competitors; |
• | increases or decreases in available wafer capacity; |
• | governmental regulations, trade laws and import duties; |
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• | announcements related to future or existing litigation involving us or any of our competitors; |
• | announcements of technological innovations by us or our competitors; |
• | announcements regarding our cash dividend program, including the timing and amount of any future dividends; |
• | announcements regarding our share repurchase program and the timing and amount of shares we purchase under such program; |
• | additions or departures of senior management; and |
• | other events or factors, many of which are beyond our control. |
In addition, stock markets have from time to time experienced extreme price and trading volume volatility. This volatility has had a substantial effect on the market prices of securities of many companies for reasons frequently unrelated to the operating performance of the specific companies. These broad market fluctuations have adversely affected the market price of our common stock in the past and are likely to continue to do so in the future.
We have incurred significant losses in certain recent periods, and there can be no assurance that we will be able to sustain profitability in the future.
Though we had been profitable for twelve consecutive quarters beginning with the September 2009 quarter through the June 2012 quarter, we incurred a loss of $13.2 million in the September 2012 quarter and a loss of $2.7 million for fiscal 2012, which included a $14.3 million write-down for certain tangible and intangible net assets related to our acquisition of Si En and a charge of $2.3 million to write-down our investment in SMIC due to the decline in fair market value of such shares being considered other than temporary. There can be no assurance that we will maintain profitability in future periods. Our ability to maintain profitability on a quarterly or fiscal year basis in the future will depend on a variety of factors, including the need for future inventory write-downs, our ability to increase net sales, maintain or expand gross margins, introduce new products on a timely basis, secure sufficient wafer fabrication and assembly and test capacity and control operating expenses, including stock-based compensation. Adverse developments with respect to these or other factors could result in quarterly or annual operating losses in the future.
Adverse changes in our effective tax rate will harm our results of operations.
A number of factors may increase our future effective tax rates, including:
• | changes in the valuation of our deferred tax assets and liabilities, and changes in deferred tax valuation allowances; |
• | exhaustion of our existing federal and foreign net operating loss carryforwards and credits; |
• | our decision to repatriate non-U.S. earnings for which we have not previously provided for U.S. taxes; |
• | increases in expenses not deductible for tax purposes, including impairments of goodwill in connection with acquisitions; |
• | the jurisdictions in which our profits are determined to be earned and taxed; |
• | limitations on the utilization of federal net operating loss carryforwards and credits; |
• | the resolution of issues arising from tax audits with various tax authorities; |
• | adjustments to income taxes upon finalization of various tax returns; |
• | changes in available tax credits; |
• | changes in tax laws or the interpretation of such tax laws; and |
• | changes in U.S. generally accepted accounting principles. |
Any significant increase in our future effective tax rates will reduce our net income for future periods.
We have used and may in the future use a significant amount of our cash resources to repurchase shares of our common stock and such repurchases present potential risks and disadvantages to us and our continuing stockholders.
While we have not repurchased any shares since fiscal 2011, from September 2007 through September 2011, we repurchased and retired an aggregate of 14,179,711 shares of our common stock in the open market under Rule 10b-18 and pursuant to our tender offers at a cost of approximately $88.5 million. At June 30, 2014, we had outstanding authorization from our Board to purchase up to an additional $19.8 million of our common stock from time to time. Although our Board of Directors has determined that these repurchase programs are in the best interests of our stockholders, these repurchases expose us to a number of risks including:
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• | the use of a substantial portion of our cash reserves, which may reduce our ability to engage in significant cash acquisitions or to pursue other business opportunities that could create significant value to our stockholders; |
• | the risk that we would not be able to replenish our cash reserves by raising debt or equity financing in the future on terms acceptable to us, or at all; |
• | the risk that these repurchases have reduced our “public float,” which is the number of our shares owned by non-affiliate stockholders and available for trading in the securities markets, and likely reduced the number of our stockholders, which may reduce the volume of trading in our shares and may result in lower stock prices and reduced liquidity in the trading of our shares; and |
• | the risk that our stock price could decline and that we would be able to repurchase shares of our common stock at a lower price per share than the prices we pay in our repurchase programs. |
Business disruptions could seriously harm our future revenue and financial condition and increase our costs and expenses.
Our worldwide operations, including the operations of our foundries and other suppliers, could be subject to natural disasters and other business disruptions, which could seriously harm our revenue and financial condition and increase our costs and expenses. Our corporate headquarters, and a portion of our research and development activities, are located in Milpitas, California, and our other critical business operations and many of our suppliers are located in Asia, near major earthquake faults. The ultimate impact on us, our significant suppliers and our general infrastructure of being located near major earthquake faults is unknown, but our revenue, profitability and financial condition could suffer in the event of a major earthquake or other natural disaster. Losses and interruptions could also be caused by earthquakes, power shortages, telecommunications failures, water shortages, tsunamis, floods, typhoons, volcanic eruptions, fires, extreme weather conditions, medical epidemics such as a flu or ebola outbreak and other natural or manmade disasters.
Our operations involve the use of hazardous and toxic materials, and we must comply with environmental laws and regulations, which can be expensive, and may adversely affect our business and operating results.
We are subject to federal, state and local regulations relating to the use, handling, storage, disposal and human exposure to hazardous and toxic materials. If we were to violate or become liable under environmental laws in the future as a result of our inability to obtain permits, human error, accident, equipment failure or other causes, we could be subject to fines, costs, or civil or criminal sanctions, face property damage or personal injury claims or be required to incur substantial investigation or remediation costs or experience disruptions in our operations, any of which could have a material adverse effect on our business. In addition, environmental laws could become more stringent over time, imposing greater compliance costs and increasing the risks and penalties associated with violations, which could harm our business.
We also face increasing complexity in our product design as we adjust to new and future requirements relating to the materials composition of our products, including the restrictions on lead and other hazardous substances applicable to specified electronic products placed on the market in the European Union (Restriction on the Use of Hazardous Substances Directive 2002/95/EC, also known as the RoHS Directive). We expect that our operations will be affected by other new environmental laws and regulations on an ongoing basis. Although we cannot predict the ultimate impact of any such new laws and regulations, they will likely result in additional costs, and could require that we change the design or manufacturing of our products, any of which could have a material adverse effect on our business.
We may experience difficulties in complying with Sarbanes-Oxley Section 404 in future periods.
We concluded that our internal control over financial reporting was effective at September 30, 2013. If, in the future, we are unable to conclude that our internal control over financial reporting is effective or we are unable to conclude that our disclosure controls and procedures are effective, we could lose investor confidence in the accuracy and completeness of our financial reports, which could have an adverse effect on our stock price.
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Item 6. Exhibits
(a) The following exhibits are filed as a part of this report.
Exhibit 3.1 | Restated Certificate of Incorporation, as amended (including Certificate of Designation of Series 1 Redeemable Preferred Stock). | |
Exhibit 31.1 | Certification Pursuant to SEC Release No. 33-8238, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
Exhibit 31.2 | Certification Pursuant to SEC Release No. 33-8238, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
Exhibit 32 | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
Exhibit 101.INS | ** | XBRL Instance Document |
Exhibit 101.SCH | ** | XBRL Taxonomy Extension Schema Document |
Exhibit 101.CAL | ** | XBRL Taxonomy Extension Calculation Linkbase Document |
Exhibit 101.DEF | ** | XBRL Taxonomy Extension Definition Linkbase Document |
Exhibit 101.LAB | ** | XBRL Taxonomy Extension Label Linkbase Document |
Exhibit 101.PRE | ** | XBRL Taxonomy Extension Presentation Linkbase Document |
** | XBRL (Extensible Business Reporting Language) information is furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, and is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Integrated Silicon Solution, Inc. | ||||
(Registrant) | ||||
Dated: | August 7, 2014 | /s/ John M. Cobb | ||
John M. Cobb | ||||
Vice President and Chief Financial Officer | ||||
(Principal Financial and | ||||
Accounting Officer) | ||||
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