Discussion and analysis by the management of SEMTECH CORP of the financial situation and operating results (Form 10-Q)


The following "Management's Discussion and Analysis of Financial Condition and
Results of Operations" should be read in conjunction with our interim unaudited
condensed consolidated financial statements and the accompanying notes included
in Part I, Item 1 of this Quarterly Report on Form 10-Q (this "Quarterly
Report"), and the "Special Note Regarding Forward-Looking and Cautionary
Statements" in this Quarterly Report.
Overview
Semtech Corporation (together with its consolidated subsidiaries, the "Company",
"we", "our", or "us") designs, develops, manufactures and markets
high-performance analog and mixed signal semiconductors and advanced algorithms.
We operate and account for results in one reportable segment through three
operating segments, comprised of our product lines: Signal Integrity, Wireless
and Sensing, and Protection.
Signal Integrity. We design, develop and market a portfolio of optical data
communications and video transport products used in a wide variety of
infrastructure and industrial applications. Our comprehensive portfolio of
integrated circuits ("ICs") for data centers, enterprise networks, passive
optical networks ("PON"), and wireless base station optical transceivers and
high-speed interfaces ranges from 100Mbps to 800Gbps and supports key industry
standards such as Fibre Channel, Infiniband, Ethernet, PON and synchronous
optical networks. Our video products offer advanced solutions for next
generation high-definition broadcast applications, as well as highly
differentiated video-over-IP technology for professional audio video
applications.
Wireless and Sensing. We design, develop and market a portfolio of specialized
radio frequency products used in a wide variety of industrial, medical and
communications applications, and specialized sensing products used in industrial
and consumer applications. Our wireless products, which include our LoRa®
devices and wireless radio frequency technology, feature industry leading and
longest range industrial, scientific and medical radio, enabling a lower total
cost of ownership and increased reliability in all environments. These features
make these products particularly suitable for machine to machine and
Internet-of-Things ("IoT") applications. Our unique sensing technology enables
proximity sensing and advanced user interface solutions for our mobile and
consumer products. Our wireless and sensing products can be found in a broad
range of applications in the industrial, medical, and consumer markets. We also
design, develop, and market power product devices that control, alter, regulate,
and condition the power within electronic systems focused on the LoRa and IoT
infrastructure segment. The highest volume product types within this category
are switching voltage regulators, combination switching and linear regulators,
smart regulators, isolated switches, and wireless charging.
Protection. We design, develop and market high-performance protection devices,
which are often referred to as transient voltage suppressors ("TVS"). TVS
devices provide protection for electronic systems where voltage spikes (called
transients), such as electrostatic discharge, electrical over stress or
secondary lightning surge energy, can permanently damage sensitive ICs. Our
portfolio of protection solutions include filter and termination devices that
are integrated with the TVS device. Our products provide robust protection while
preserving signal integrity in high-speed communications, networking and video
interfaces. These products also operate at very low voltage. Our protection
products can be found in a broad range of applications including smart phones,
LCD and organic light-emitting diode TVs and displays, set-top boxes, monitors
and displays, tablets, computers, notebooks, base stations, routers, automobile
and industrial instruments.
Our interim unaudited condensed consolidated balance sheets are referred to
herein as the "Balance Sheets" and interim unaudited condensed consolidated
statements of income are referred to herein as the "Statements of Income."
Our net sales by product line were as follows:
                                             Three Months Ended             

Nine months ended

                                              October 31,               October 25,         October 31,         October 25,
(in thousands)                                   2021                      2020                2021                2020
Signal Integrity                             $   75,405                $   61,553          $  215,187          $  193,127
Wireless and Sensing                             63,123                    51,145             184,223             122,933
Protection                                       56,404                    41,384             150,898             114,384
Total                                        $  194,932                $  154,082          $  550,308          $  430,444


We design, develop and market a wide range of products for commercial
applications, the majority of which are sold into the infrastructure, high-end
consumer and industrial end markets.
Infrastructure: data centers, PON, base stations, optical networks, servers,
carrier networks, switches and routers, cable modems, wireless local area
network ("LAN") and other communication infrastructure equipment.
High-End Consumer: smartphones, tablets, wearables, desktops, notebooks, and
other handheld products, wireless charging, set-top boxes, digital televisions,
monitors and displays, digital video recorders and other consumer equipment.
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Industrial: IoT applications, analog and digital video broadcast equipment,
video-over-IP solutions, automated meter reading, smart grid, wireless charging,
military and aerospace, medical, security systems, automotive, industrial and
home automation and other industrial equipment.
Our end customers are primarily original equipment manufacturers that produce
and sell electronics.
Impact of COVID-19
The COVID-19 pandemic has significantly affected health and economic conditions
throughout the United States ("U.S.") and the rest of the world including Asia,
where a significant percentage of our customers, suppliers, third party
foundries and subcontractors are located. As a result of the pandemic, certain
of our facilities and the third-party foundries and assembly and test
contractors to which we outsource our manufacturing functions, have had to
periodically reduce or suspend operations. The disruption experienced during
such closures has resulted in reduced production of our products, delays for
delivery of our products to our customers, and reduced ability to receive
supplies, which have had and may continue to have, individually and in the
aggregate, an adverse effect on our results.
Currently, customer demand remains strong and supply tight, with many of our
suppliers running at or near capacity and our customers competing for the
limited supply. While we have increased our inventory levels to prepare for our
strong backlog of orders, we cannot provide assurance that we will have
sufficient inventory if this high level of demand is sustained over the longer
term. In addition, the prices to obtain raw materials and convert them into the
necessary inventory have increased in certain cases, and may continue to
increase. While we have been largely successful with passing on selective price
increases to our customers, we cannot assure you that all future potential price
increases can be absorbed through increased pricing to our customers.
We believe we have good visibility going into the fourth quarter of fiscal year
2022; however, it is unknown how much of the increased demand reflects real end
market strength. We believe the general supply chain constraints in the industry
may be motivating certain customers to increase their orders and inventory
levels to protect against supply risk. To the extent that this cautionary
purchasing is occurring, we could experience a decrease in future demand as
potential excess inventory is worked down.
Factors Affecting Our Performance
Most of our sales to customers are made on the basis of individual customer
purchase orders. Many customers include cancellation provisions in their
purchase orders. Trends within the industry toward shorter lead-times and
"just-in-time" deliveries have reduced our ability to predict future shipments.
As a result, we generally rely on orders received and shipped within the same
quarter for a significant portion of our sales. As a result of current macro
conditions where demand is exceeding supply and we are seeing global shortages,
lead times may continue to expand resulting in fewer orders being shipped and
received in the same quarter. Orders received and shipped in the third quarters
of fiscal years 2022 and 2021 represented 3% and 26% of net sales, respectively.
Sales made directly to customers during the third quarters of fiscal years 2022
and 2021 were 12% and 18% of net sales, respectively. The remaining sales were
made through independent distributors. The decline in direct sales is due to
customers electing to leverage the value of distribution to better manage their
supply chain.
Our business relies on foreign-based entities. Many of our third-party
subcontractors and suppliers, including third-party foundries that supply
silicon wafers, are located in foreign countries including Taiwan and China.
Foreign sales constituted approximately 90% and 90% of our net sales during the
third quarters of fiscal years 2022 and 2021, respectively. Approximately 78%
and 80% of our sales during the third quarters of fiscal years 2022 and 2021,
respectively, were to customers located in the Asia-Pacific region. The
remaining foreign sales were primarily to customers in Europe, Canada and
Mexico. Doing business in foreign locations also subjects us to export
restrictions and trade laws, which may limit our ability to sell to certain
customers.
We use several metrics as indicators of future potential growth. The indicators
that we believe best correlate to potential future sales growth are design wins
and new product releases. There are many factors that may cause a design win or
new product release not to result in sales, including a customer's decision not
to go to system production, a change in a customer's perspective regarding a
product's value or a customer's product failing in the end market. As a result,
although a design win or new product introduction is an important step towards
generating future sales, it does not inevitably result in us being awarded
business or receiving a purchase commitment.
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Results of Operations
The following table sets forth, for the periods indicated, our interim unaudited
condensed consolidated statements of income expressed as a percentage of net
sales.
                                                                  Three Months Ended                                    Nine Months Ended
                                                       October 31, 2021             October 25, 2020        October 31, 2021        October 25, 2020
Net sales                                                            100.0  %                100.0  %                100.0  %                100.0  %
Cost of sales                                                         36.5  %                 39.0  %                 37.5  %                 38.9  %
Gross profit                                                          63.5  %                 61.0  %                 62.5  %                 61.1  %
Operating costs and expenses:
Selling, general and administrative                                   24.4  %                 27.8  %                 23.3  %                 26.9  %
Product development and engineering                                   19.2  %                 18.1  %                 19.9  %                 19.7  %
Intangible amortization                                                0.7  %                  1.2  %                  0.7  %                  1.5  %

Total operating costs and expenses                                    44.3  %                 47.1  %                 44.0  %                 48.1  %
Operating income                                                      19.2  %                 13.9  %                 18.5  %                 13.0  %
Interest expense                                                      (0.6) %                 (0.7) %                 (0.7) %                 (0.9) %
Non-operating income (expense), net                                    0.1  %                 (0.2) %                  0.1  %                    -  %
Investment impairments and credit loss reserves                       (0.1) %                 (0.2) %                 (0.2) %                 (1.3) %
Income before taxes and equity in net gains of
equity method investments                                             18.5  %                 12.9  %                 17.8  %                 10.9  %
Provision for income taxes                                             1.5  %                  1.0  %                  1.7  %                  0.6  %
Net income before equity in net gains of equity
method investments                                                    17.0  %                 11.9  %                 16.1  %                 10.3  %
Equity in net gains of equity method investments                       0.7  %                  0.1  %                  0.4  %                    -  %
Net income                                                            17.7  %                 12.0  %                 16.5  %                 10.3  %
Net loss attributable to noncontrolling interest                         -  %                    -  %                    -  %                    -  %
Net income attributable to common stockholders                        17.7  %                 12.0  %                 16.5  %                 10.3  %
Percentages may not add precisely due to
rounding.


Our regional breakdown of profit (loss) from continuing operations before tax and equity in net gains (losses) from equity-accounted investments was as follows:

                                                            Three Months Ended                          Nine Months Ended
                                                                             October 25,         October 31,         October 25,
(in thousands)                                     October 31, 2021             2020                2021                2020
Domestic                                         $          (5,358)         $   (2,054)         $  (17,466)         $  (19,065)
Foreign                                                     41,438              21,957             115,384              65,813
Total                                            $          36,080          $   19,903          $   97,918          $   46,748

The domestic performance of continuing operations includes higher levels of stock-based compensation compared to foreign operations. Comparison of the three completed months October 31, 2021 and 25 october 2020
The following table summarizes our net sales by major end market:

                                                            Three Months 

Ended

(in thousands, except percentages)           October 31, 2021                October 25, 2020
Infrastructure                         $        66,804        34  %    $        58,916        39  %
High-End Consumer                               60,309        31  %             45,321        29  %
Industrial                                      67,819        35  %             49,845        32  %
Total                                  $       194,932       100  %    $       154,082       100  %


Net Sales
Net sales for the third quarter of fiscal year 2022 were $194.9 million, an
increase of 26.5% compared to $154.1 million for the third quarter of fiscal
year 2021. Our industrial end market increased $18.0 million versus the prior
year primarily due to an
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approximately $10 million increase in LoRa-enabled product sales, as we gained
traction in the expanding range of IoT applications, an approximately $7 million
increase in broadcast product sales and an approximately $5 million increase in
broad-based industrial sales, partially offset by declining sales from our
legacy Power and High Reliability business. Net sales from our high-end consumer
end market increased $15.0 million primarily driven by an approximately $6
million increase in our TVS consumer products including smartphones and an
approximately $5 million increase in our proximity sensing products. We
experienced an increase of $7.9 million in net sales from our infrastructure end
market, primarily driven by an approximately $13 million increase in 10G PON
sales, partially offset by an approximately $5 million decline in data center
demand.
Based on booking trends and our backlog entering the quarter, we estimate net
sales for the fourth quarter of fiscal year 2022 to be between $184.0 million
and $194.0 million. The range of guidance reflects continued uncertainty
regarding macro-related events and those associated with the COVID-19 pandemic
discussed above.
Gross Profit
For the third quarter of fiscal year 2022, gross profit increased to $123.7
million from $94.1 million for the third quarter of fiscal year 2021 as a result
of higher sales. Gross margins were 63.5% for the third quarter of fiscal year
2022 compared to 61.0% for the third quarter of fiscal year 2021, reflecting a
more favorable product mix. For the fourth quarter of fiscal year 2022, we
expect our gross margins to be in the range of 63.1% to 64.1%.
Operating Costs and Expenses
                                                                     Three Months Ended
(in thousands, except percentages)                  October 31, 2021                    October 25, 2020                 Change
Selling, general and administrative           $  47,621               55  %       $  42,891               59  %               11  %
Product development and engineering              37,346               43  %          27,890               38  %               34  %
Intangible amortization                           1,298                2  %           1,798                3  %              (28) %

Total operating costs and expenses            $  86,265              100  %       $  72,579              100  %               19  %


Selling, General and Administrative Expenses
Selling, general and administrative ("SG&A") expenses increased $4.7 million in
the third quarter of fiscal year 2022 compared to the third quarter of fiscal
year 2021 primarily as a result of an approximately $3 million increase in
share-based compensation expense driven by remeasurement of the cash-settled
awards liability.
Product Development and Engineering Expenses
Product development and engineering expenses increased $9.5 million in the third
quarter of fiscal year 2022 compared to the third quarter of fiscal year 2021 as
a result of an approximately $5 million increase in staffing-related costs,
including performance-based compensation, and an approximately $4 million
increase in operating supplies and contracted research, as well as fluctuations
in the timing of development activities. The levels of product development and
engineering expenses reported in a fiscal period can be significantly impacted,
and therefore experience period over period volatility, by the number of new
product tape-outs and by the timing of recoveries from non-recurring engineering
services, which are typically recorded as a reduction to product development and
engineering expense.
Intangible Amortization
Intangible amortization was $1.3 million and $1.8 million for the third quarters
of fiscal years 2022 and 2021, respectively. This decrease was primarily due to
certain finite-lived intangible assets associated with the acquisition of Gennum
Corporation, which became fully amortized during fiscal year 2021.
Interest Expense
Interest expense, including amortization of debt discounts and issuance costs,
was $1.2 million and $1.0 million for the third quarters of fiscal years 2022
and 2021, respectively. This increase was primarily due to a $20.0 million draw
on the Credit Facility during the third quarter of 2022, which was repaid during
the same quarter.
Investment Impairments and Credit Loss Reserves
During the third quarter of fiscal year 2022, investment impairments and credit
loss reserves totaled a loss of $0.2 million due to adjustments to our reserve
for current expected credit losses. During the third quarter of fiscal year
2021, investment impairments and credit loss reserves totaled a loss of $0.3
million and primarily reflected adjustments to our reserve for current expected
credit losses.
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Provision for Income Taxes
The effective tax rates for the third quarters of fiscal years 2022 and 2021
were provision rates of 8.4% and 7.9%, respectively. In the third quarter of
fiscal year 2022, we recorded income tax expense of $3.0 million, compared to
$1.6 million in the third quarter of fiscal year 2021. The effective tax rates
in the third quarters of fiscal years 2022 and 2021 differ from the statutory
federal income tax rate of 21% primarily due to a regional mix of income, excess
tax benefits from share-based compensation, withholding taxes on certain foreign
earnings and research and development tax credits.
As a global organization, we are subject to audit by taxing authorities in
various jurisdictions. To the extent that an audit, or the closure of a statute
of limitations, results in adjusting our reserves for uncertain tax positions,
our effective tax rate could experience extreme volatility since any adjustment
would be recorded as a discrete item in the period of adjustment.
Comparison of the Nine Months Ended October 31, 2021 and October 25, 2020
The following table summarizes our net sales by major end market:
                                                            Nine Months 

Ended

(in thousands, except percentages)           October 31, 2021                October 25, 2020
Infrastructure                         $       195,737        36  %    $       185,083        43  %
High-End Consumer                              173,337        31  %            112,507        26  %
Industrial                                     181,234        33  %            132,854        31  %
Total                                  $       550,308       100  %    $       430,444       100  %


Net Sales
Net sales for the first nine months of fiscal year 2022 were $550.3 million, an
increase of 27.8% compared to $430.4 million for the first nine months of fiscal
year 2021. During the first nine months of fiscal year 2022, we experienced
strong demand across all three of our end markets compared to the prior year
when our net sales were adversely impacted by delays in certain shipments of our
products due to COVID-19 related shutdowns, including certain subcontractors in
Malaysia. Net sales from our high-end consumer end market increased $60.8
million primarily driven by an approximately $32 million increase in our
proximity sensing products and an approximately $23 million increase in our TVS
consumer products, including smartphones. Net sales from our industrial end
market increased $48.4 million versus the prior year primarily due to an
approximately $31 million increase in LoRa-enabled product sales, as we gained
traction in the expanding range of IoT applications, and an approximately $12
million increase in broadcast product sales and an approximately $8 million
increase in broad-based industrial sales, partially offset by declining sales
from our legacy Power and High Reliability business. Net sales from our
infrastructure end market increased $10.7 million driven by an approximately $23
million increase in 10G PON sales, and an approximately $6 million increase in
broad-based Protection sales, partially offset by an approximately $17 million
decline in data center demand.
Gross Profit
For the first nine months of fiscal year 2022, gross profit increased to $344.0
million from $263.1 million for the first nine months of fiscal year 2021 as a
result of higher sales. Gross margins were 62.5% for the first nine months of
fiscal year 2022 compared to 61.1% for the first nine months of fiscal year
2021, reflecting a more favorable product mix.
Operating Costs and Expenses
                                                                            Nine Months Ended
(in thousands, except percentages)                     October 31, 2021                          October 25, 2020                    Change
Selling, general and administrative           $       128,402               53  %       $       115,746               56  %               11  %
Product development and engineering                   109,633               45  %                84,696               41  %               29  %
Intangible amortization                                 3,894                2  %                 6,658                3  %              (42) %
Changes in the fair value of contingent
earn-out obligations                                        -                -  %                   (33)               -  %              100  %
Total operating costs and expenses            $       241,929              100  %       $       207,067              100  %               17  %


Selling, General and Administrative Expenses
SG&A expenses increased $12.7 million for the first nine months of fiscal year
2022 compared to the first nine months of fiscal year 2021 primarily as a result
of an approximately $11 million increase in staffing-related costs, including
performance-based compensation.
Product Development and Engineering Expenses
Product development and engineering expenses increased $24.9 million in the
first nine months of fiscal year 2022 compared to
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the first nine months of fiscal year 2021 as a result of an approximately $10
million increase in staffing-related costs, including performance-based
compensation, and an approximately $10 million increase in operating supplies
and contracted research, as well as fluctuations in the timing of development
activities. The levels of product development and engineering expenses reported
in a fiscal period can be significantly impacted, and therefore experience
period-over-period volatility, by the number of new product tape-outs and by the
timing of recoveries from non-recurring engineering services, which are
typically recorded as a reduction to product development and engineering
expense.
Intangible Amortization
Intangible amortization was $3.9 million and $6.7 million for the first nine
months of fiscal years 2022 and 2021, respectively. This decrease was primarily
due to certain finite-lived intangible assets associated with the acquisitions
of Gennum Corporation, Triune Systems, LLC, and AptoVision Technologies, Inc.,
which became fully amortized during fiscal year 2021.
Changes in the Fair Value of Contingent Earn-out Obligations
The change in the fair value of contingent earn-out obligations for the first
nine months of fiscal year 2021 reflects the difference between the final
earn-out targets achieved for Cycleo SAS in fiscal year 2021 and the forecasted
achievement level at the end of fiscal year 2020.
Interest Expense
Interest expense, including amortization of debt discounts and issuance costs,
was $3.6 million and $3.8 million for the first nine months of fiscal years 2022
and 2021, respectively. This decrease was primarily due to lower overall debt
levels.
Investment Impairments and Credit Loss Reserves
During the first nine months of fiscal year 2022, investment impairments and
credit loss reserves totaled a loss of $0.9 million due to adjustments to our
reserve for current expected credit losses. During the first nine months of
fiscal year 2021, investment impairments and credit loss reserves totaled a loss
of $5.5 million, which reflects $2.7 million of adjustments to our reserve for
current expected credit losses, which were, in-part, due to the impact of the
COVID-19 pandemic on early-stage development companies. The remaining loss
relates to other-than-temporary impairment on three of our equity investments.
Provision for Income Taxes
The effective tax rates for the first nine months of fiscal years 2022 and 2021
were provision rates of 9.4% and 5.4%, respectively. In the first nine months of
fiscal year 2022, we recorded income tax expense of $9.2 million, compared to
$2.5 million in the first nine months of fiscal year 2021. The effective tax
rates in the first nine months of fiscal years 2022 and 2021 differ from the
statutory federal income tax rate of 21% primarily due to regional mix of
income, excess tax benefits from share-based compensation, return-to-provision
adjustments, withholding taxes on certain foreign earnings and research and
development tax credits.
Liquidity and Capital Resources
Our capital requirements depend on a variety of factors including, but not
limited to, the rate of increase or decrease in our existing business base; the
success, timing and amount of investment required to bring new products to
market; sales growth or decline; potential acquisitions; the general economic
environment in which we operate; and our ability to generate cash flow from
operations, which are more uncertain as a result of the COVID-19 pandemic and
its impact on the general economy. Our liquidity needs during this uncertain
time will depend on multiple factors, including our ability to continue
operations and production of our products, given the global supply constraints,
the COVID-19 pandemic's effect on our customers, the availability of sufficient
amounts of financing and our operating performance.
We believe that our cash on hand, cash available from future operations and
available borrowing capacity under our Credit Facility (as defined below) are
sufficient to meet liquidity requirements for at least the next 12 months,
including funds needed for our material cash requirements. As of October 31,
2021, we had $276.6 million in cash and cash equivalents and $423.0 million of
undrawn capacity on our Credit Facility. Over the longer-term, we believe our
strong cash-generating business model will continue to provide adequate
liquidity to fund our normal operations, which have minimal capital intensity.
To the extent that we enter into acquisitions or strategic partnerships, we may
be required to raise additional capital through debt issuances or equity
offerings. In addition, we expect to refinance our Credit Facility ahead of its
maturity in November 2024. While we have not had issues securing favorable
financing historically, there is no assurance that we will be able to refinance
or secure additional capital at favorable terms, or at all in the future.
A meaningful portion of our capital resources, and the liquidity they represent,
are held by our foreign subsidiaries. As of October 31, 2021, our foreign
subsidiaries held approximately $227.8 million of cash and cash equivalents,
compared to $182.9 million at January 31, 2021.
We expect our future cash uses will be for capital expenditures, repurchases of
our common stock and, potentially, acquisitions and other investments that
support achievement of our business strategies. We expect to fund those cash
requirements through our cash from operations and borrowings against our Credit
Facility.
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Credit Facility
On November 7, 2019, we, with certain of our domestic subsidiaries as
guarantors, entered into an amended and restated credit agreement (the "Credit
Agreement") with the lenders party thereto and HSBC Bank USA, National
Association, as administrative agent, swing line lender and letter of credit
issuer. The Credit Agreement provides $600.0 million in borrowing capacity of
revolving loans under the senior secured first lien credit facility (the "Credit
Facility"). The Credit Facility matures on November 7, 2024.
In the first nine months of fiscal year 2022, we borrowed $20.0 million against
our Credit Facility and made payments on our Credit Facility that totaled $24.0
million. In the first nine months of fiscal year 2021, we made payments on our
Credit Facility that totaled $12.0 million. As of October 31, 2021, we had
$177.0 million of outstanding borrowings against our Credit Facility, which had
$423.0 million of undrawn capacity.
The Credit Agreement provides that, subject to certain customary conditions,
including obtaining commitments with respect thereto, we may request the
establishment of one or more term loan facilities and/or increases to the
revolving loans in a principal amount not to exceed (a) $300.0 million, plus (b)
an unlimited amount, so long as our consolidated leverage ratio, determined on a
pro forma basis, does not exceed 3.00 to 1.00. However, the lenders are not
required to provide such increase upon our request.
Interest on loans made under the Credit Facility in U.S. Dollars accrues, at our
option, at a rate per annum equal to (1) the Base Rate (as defined below) plus a
margin ranging from 0.25% to 1.25% depending upon our consolidated leverage
ratio or (2) LIBOR (determined with respect to deposits in U.S. Dollars) for an
interest period to be selected by us plus a margin ranging from 1.25% to 2.25%
depending upon our consolidated leverage ratio (such margin, the "Applicable
Margin"). The "Base Rate" is equal to a fluctuating rate equal to the highest of
(a) the prime rate of the Administrative Agent, (b) 0.50% above the federal
funds effective rate published by the Federal Reserve Bank of New York and (c)
one-month LIBOR (determined with respect to deposits in U.S. Dollars), plus
1.00%. Interest on loans made under the Credit Facility in Alternative
Currencies (as defined in the Credit Agreement) accrues at a rate per annum
equal to LIBOR (determined with respect to deposits in the applicable
Alternative Currency) (other than loans made in Canadian Dollars, for which a
special reference rate for Canadian Dollars applies) for an interest period to
be selected by us plus the Applicable Margin.
In the first quarter of fiscal year 2021, we entered into an interest rate swap
agreement with a three-year term to hedge the variability of interest payments
on the first $150.0 million of debt outstanding under our Credit Facility. Based
on our current leverage ratio as of October 31, 2021, interest payments on the
first $150.0 million of debt outstanding under our Credit Facility are fixed at
1.9775%.
All our obligations under the Credit Agreement are unconditionally guaranteed by
all of our direct and indirect domestic subsidiaries, other than certain
excluded subsidiaries, including, but not limited to, any domestic subsidiary
the primary assets of which consist of equity or debt of non-U.S. subsidiaries,
certain immaterial non-wholly-owned domestic subsidiaries and subsidiaries that
are prohibited from providing a guarantee under applicable law or that would
require governmental approval to provide such guarantee. The Company and the
guarantors have also pledged substantially all of their assets to secure their
obligations under the Credit Agreement.
No amortization is required with respect to the revolving loans and we may
voluntarily prepay borrowings at any time and from time to time, without premium
or penalty, other than customary "breakage costs" and fees for LIBOR-based
loans.
The Credit Agreement contains customary covenants, including limitations on our
ability to, among other things, incur indebtedness, create liens on assets,
engage in certain fundamental corporate changes, make investments, repurchase
stock, pay dividends or make similar distributions, engage in certain affiliate
transactions, or enter into agreements that restrict our ability to create
liens, pay dividends or make loan repayments. In addition, we must comply with
financial covenants, including maintaining a maximum consolidated leverage
ratio, determined as of the last day of each fiscal quarter, of 3.50 to 1.00 or
less, provided that, such maximum consolidated leverage ratio may be increased
to 4.00 to 1.00 for the four consecutive fiscal quarters ending on or after the
date of consummation of a permitted acquisition that constitutes a "Material
Acquisition" under the Credit Agreement, subject to the satisfaction of certain
conditions. As of October 31, 2021, we were in compliance with the covenants in
our Credit Agreement.
The Credit Agreement also contains customary provisions pertaining to events of
default. If any event of default occurs, the obligations under the Credit
Agreement may be declared due and payable, terminated upon written notice to us
and existing letters of credit may be required to be cash collateralized. On
August 11, 2021, we entered into an amendment to the Credit Agreement in order
to, among other things, (i) provide for contractual fallback language for LIBOR
replacement to reflect the Alternative Reference Rates Committee hardwired
approach and (ii) incorporate certain provisions that clarify the rights of the
administrative agent to recover from lenders or other secured parties erroneous
payments made to such lenders or secured parties.
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Capital Expenditures and Research and Development
We incur significant expenditures in order to fund the development, design and
manufacture of new products. We intend to continue to focus on those areas that
have shown potential for viable and profitable market opportunities, which may
require additional investment in equipment and the hiring of additional design
and application engineers aimed at developing new products. Certain of these
expenditures, particularly the addition of design engineers, do not generate
significant payback in the short-term. We plan to finance these expenditures
with cash generated by our operations and our existing cash balances.
Purchases under our Stock Repurchase Program
We currently have in effect a stock repurchase program that was initially
approved by our Board of Directors in March 2008. On March 11, 2021, the
Company's Board of Directors approved the expansion of the stock repurchase
program by an additional $350.0 million. This program represents one of our
principal efforts to return value to our stockholders. We repurchased 1,387,624
shares under this program in the first nine months of fiscal year 2022 for $97.0
million. In the first nine months of fiscal year 2021, we repurchased 1,527,834
shares under this program for $66.4 million. As of October 31, 2021, the
remaining authorization under this program was $292.2 million. We intend to fund
repurchases under the program from cash on hand. We have no obligation to
repurchase any shares under the program and may suspend or discontinue it at any
time.
Working Capital
Working capital, defined as total current assets less total current liabilities,
fluctuates depending on end-market demand and our effective management of
certain items such as receivables, inventory and payables. In times of
escalating demand, our working capital requirements may increase as we purchase
additional manufacturing materials and increase production. In addition, our
working capital may be affected by potential acquisitions and transactions
involving our debt instruments. Although investments made to fund working
capital will reduce our cash balances, these investments are necessary to
support business and operating initiatives. Our working capital, excluding cash
and cash equivalents, was $95.8 million and $96.3 million as of October 31, 2021
and January 31, 2021, respectively. Our working capital, including cash and cash
equivalents, was $372.4 million and $365.2 million as of October 31, 2021 and
January 31, 2021, respectively.
Cash Flows
One of our primary goals is to continually improve the cash flows from our
existing operating activities. Additionally, we will continue to seek to
maintain and improve our existing business performance with capital expenditures
and, potentially, acquisitions and other investments that support achievement of
our business strategies. Acquisitions may be made for either cash or stock
consideration, or a combination of both.
In summary, our cash flows for each period were as follows:
                                                                          Nine Months Ended
                                                                  October 31,          October 25,
(in thousands)                                                        2021                 2020
Net cash provided by operating activities                        $   152,137          $    91,676
Net cash used in investing activities                                (29,831)             (32,399)
Net cash used in financing activities                               (114,598)             (90,330)
Net increase (decrease) in cash and cash equivalents             $     

7,708 (31,053) $


Operating Activities
Net cash provided by operating activities is driven by net income adjusted for
non-cash items and fluctuations in operating assets and liabilities.
Operating cash flows for the first nine months of fiscal year 2022 compared to
the first nine months of fiscal year 2021 were favorably impacted by a 27.8%
increase in net sales and unfavorably impacted by a $12.3 million incremental
increase in inventory spend, a $24.9 million increase in product development and
engineering expenses due to higher staffing-related costs, increases in
operating supplies and contracted research, and fluctuations in the timing of
development activities, and a $12.7 million increase in SG&A expenses due to
higher staffing-related costs.
Investing Activities
Net cash used in investing activities was primarily attributable to capital
expenditures, premiums paid for corporate-owned life insurance and purchases of
investments.
Capital expenditures were $18.1 million for the first nine months of fiscal year
2022, compared to $21.8 million for the first nine months of fiscal year 2021.
In the first nine months of fiscal years 2022 and 2021, we made significant
investments to update and expand our production capabilities.
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In the first nine months of fiscal year 2022, we paid $5.8 million for strategic
investments, including investments in companies that are enabling the LoRa and
LoRaWAN®-based ecosystem, compared to $10.9 million of investments in the first
nine months of fiscal year 2021.
In the first nine months of fiscal year 2022, we paid $6.0 million for premiums
on corporate-owned life insurance in order to provide substantive coverage for
our deferred compensation liability.
Financing Activities
Net cash used in financing activities is primarily attributable to repurchases
of outstanding common stock, payments related to employee share-based
compensation payroll taxes and payments on our Credit Facility, offset by
proceeds on our Credit Facility and proceeds from stock option exercises.
In the first nine months of fiscal year 2022, we paid $17.9 million for employee
share-based compensation payroll taxes and received $4.3 million in proceeds
from the exercise of stock options, compared to payments of $17.0 million for
employee share-based compensation payroll taxes and proceeds of $5.1 million
from the exercise of stock options in the first nine months of fiscal year 2021.
We do not directly control the timing of the exercise of stock options. Such
exercises are independent decisions made by grantees and are influenced most
directly by the stock price and the expiration dates of stock option awards.
Such proceeds are difficult to forecast, resulting from several factors that are
outside our control. We believe that such proceeds will remain a nominal source
of cash in the future.
Critical Accounting Estimates
Our critical accounting estimates are disclosed in "Management's Discussion and
Analysis of Financial Condition and Results of Operations" included in Item 7 of
our Annual Report on Form 10-K. There have been no significant changes to our
policies during the nine months ended October 31, 2021. For a discussion of
recent accounting pronouncements, see Note 1 to our interim unaudited condensed
consolidated financial statements.
Available Information
General information about us can be found on our website at www.semtech.com. The
information on our website is for informational purposes only and should not be
relied on for investment purposes. The information on our website is not
incorporated by reference into this Quarterly Report and should not be
considered part of this or any other report filed with the SEC.
We make available free of charge, either by direct access on our website or by a
link to the SEC website, our Annual Report on Form 10-K, Quarterly Reports on
Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or
furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of
1934, as amended (the "Exchange Act"), or as soon as reasonably practicable
after such reports are electronically filed with, or furnished to, the SEC. Our
reports filed with, or furnished to, the SEC are also available directly at the
SEC's website at www.sec.gov.
ITEM 3.Quantitative and Qualitative Disclosures About Market Risk
We are subject to a variety of market risks, including commodity risk and the
risks related to foreign currency, interest rates and market performance that
are discussed in Item 7A of our Annual Report. Many of the factors that can have
an impact on our market risk are external to us, and so we are unable to fully
predict them.
We considered the historical trends in foreign currency exchange rates and
determined that it is reasonably possible that adverse changes in foreign
exchange rates of 10% for all currencies could be experienced in the near-term.
These reasonably possible adverse changes were applied to our total monetary
assets and liabilities denominated in currencies other than our functional
currency as of the end of our third quarter of fiscal year 2022. The adverse
impact these changes would have had (after taking into account balance sheet
hedges only) would not have had a material impact on our income before taxes.
We are subject to interest rate risk in connection with the portion of the
outstanding debt under our Credit Facility that bears interest at a variable
rate as of October 31, 2021. During fiscal year 2021, we entered into an
interest rate swap agreement with a three-year term to hedge the variability of
interest payments on the first $150.0 million of debt outstanding under our
Credit Facility. Based on our current leverage ratio as of October 31, 2021,
interest payments on the first $150.0 million of our debt outstanding under our
Credit Facility are fixed at 1.9775%. See above under "Liquidity and Capital
Resources - Credit Facility" for the interest rates applicable to U.S. and
Alternative Currencies borrowings under our Credit Facility in excess of $150.0
million. Based upon the amount of our outstanding indebtedness as of October 31,
2021, a one percentage point increase in LIBOR would not have a material impact
on our interest expense as only $27.0 million of our outstanding debt balance
remains subject to a floating rate.
The Chief Executive of the U.K. Financial Conduct Authority (the "FCA"), which
regulates LIBOR, has announced that the FCA will no longer persuade or compel
banks to submit rates for the calculation of LIBOR after 2021. For U.S. dollar
LIBOR,
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publication of the one-week and two-month LIBOR settings will cease after
December 31, 2021, and publication of the overnight and 12-month LIBOR settings
will cease after June 30, 2023. Immediately after June 30, 2023, the one-month,
three-month and six-month U.S. dollar LIBOR settings will no longer be
representative. Given these changes, the LIBOR administrator has advised that no
new contracts using U.S. dollar LIBOR should be entered into after December 31,
2021. It is also possible that U.S. LIBOR will be discontinued or modified prior
to June 30, 2023.
Our Credit Facility provides that, if it is publicly announced that the
administrator of LIBOR has ceased or will cease to provide LIBOR, if it is
publicly announced by the applicable regulatory supervisor that LIBOR is no
longer representative, or if either the administrative agent or lenders holding
50% of the aggregate principal amount of our revolving commitments and term
loans elect, we and the administrative agent may amend our Credit Agreement to
replace LIBOR with an alternate benchmark rate. This alternative benchmark rate
may include a forward-looking term rate that is based on the secured overnight
financing rate, also known as SOFR, published by the Federal Reserve Bank of New
York.
Interest rates also affect our return on excess cash and investments. As of
October 31, 2021, we had $276.6 million of cash and cash equivalents. A majority
of our cash and cash equivalents generate interest income based on prevailing
interest rates. Interest income, net of reserves, generated by our investments
and cash and cash equivalents was not material in the third quarter of fiscal
year 2022. A significant change in interest rates would impact the amount of
interest income generated from our cash and investments. It would also impact
the market value of our investments.
Our investments are primarily subject to credit risk. Our investment guidelines
prescribe credit quality, permissible investments, diversification, and duration
restrictions. These restrictions are intended to limit risk by restricting our
investments to high quality debt instruments with relatively short-term
durations. Our investment strategy limits investment of new funds and maturing
securities to U.S. Treasury, Federal agency securities, high quality money
market funds and time deposits with our principal commercial banks. Outside of
these investment guidelines, we also invest in a limited amount of debt
securities in privately held companies that we view as strategic to our
business. For example, many of these investments are in companies that are
enabling the LoRa and LoRaWAN®-based ecosystem. We evaluate the credit risk of
these investments on a quarterly basis and increased our current credit loss and
reserves by $0.9 million during the nine months ended October 31, 2021, related
to the credit risk on our debt securities investments, resulting in a current
expected credit loss reserve balance on our available-for-sale and
held-to-maturity debt securities of $4.3 million as of October 31, 2021.
ITEM 4.Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e)
and 15d-15(e) under the Exchange Act), which are designed to ensure that
information required to be disclosed in the reports we file or submit under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the SEC's rules and forms, and that such information is
accumulated and communicated to our management, including our Chief Executive
Officer ("CEO") and Chief Financial Officer ("CFO"), as appropriate to allow
timely decisions regarding required disclosure. Our management, with the
participation of our CEO and CFO, evaluated the effectiveness of the design and
operation of our disclosure controls and procedures as of the end of the period
covered by this Quarterly Report. Based on that evaluation, our CEO and CFO
concluded that, our disclosure controls and procedures were effective as of
October 31, 2021.
Changes in Internal Controls
As of October 31, 2021, there were no changes to our internal control over
financial reporting that occurred during the fiscal quarter then ended that have
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.
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