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SigmaTel, LLC – ‘10-Q’ for 6/30/05

On:  Tuesday, 8/9/05, at 4:06pm ET   ·   For:  6/30/05   ·   Accession #:  1193125-5-162579   ·   File #:  0-50391

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2005

OR

For the Transition Period from              to             

Commission File Number: 000-50391

SIGMATEL, INC.

(Exact name of registrant as specified in its charter)

1601 S. MoPac Expressway

Suite 100

Austin, Texas 78746

(512) 381-3700

(Address and telephone number of principal executive offices)

Indicate by check mark whether 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  x    No  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  x    No  ¨

The number of shares outstanding of the Registrant’s Common Stock, $0.0001 par value, was 35,799,237 as of July 26, 2005.

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SIGMATEL, INC.

FORM 10-Q

TABLE OF CONTENTS

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PART I: FINANCIAL INFORMATION

Item 1. Financial Statements

SIGMATEL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

(unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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SIGMATEL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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SIGMATEL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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SigmaTel, Inc.

Notes to Condensed Consolidated Financial Statements

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of SigmaTel, Inc. and its wholly owned subsidiaries (the “Company”). The statements have been prepared in accordance with accounting principles generally accepted in the United States of America applicable to interim financial statements. Accordingly, they do not include all of the information and notes required for complete financial statements. Certain reclassifications have been made to all periods presented in the condensed consolidated financial statements to conform to the current year presentation. These reclassifications had no effect on the results of operations or stockholders’ equity. In the opinion of management, all adjustments and reclassifications considered necessary for a fair and comparable presentation have been included and are of a normal recurring nature. Operating results for the three and six month periods ended June 30, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005.

SigmaTel, Inc. was incorporated on December 28, 1993 and is a fabless designer of analog-intensive mixed-signal integrated circuits headquartered in Austin, Texas. SigmaTel Hong Kong, Limited was established and incorporated in Hong Kong in July 2004 and became a wholly owned subsidiary of SigmaTel, Inc. in August of 2004 for the purpose of providing engineering support to customers in Asia for their product development activities. In March 2005, the Company effected a name change of the Hong Kong subsidiary to SigmaTel Asia, Limited. In June 2005, SigmaTel Asia, Limited expanded its scope to include operational and other financial activities.

2. Significant Accounting Policies

For a description of what the Company believes to be the critical accounting policies that affect our more significant judgments and estimates used in the preparation of our financial statements, refer to our most recently filed Form 10-K with the Securities and Exchange Commission.

Consolidation and Foreign Currency Translation

The accompanying condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All material intercompany balances and transactions have been eliminated. The reporting currency of the Company’s foreign subsidiaries is the U.S. dollar. Assets and liabilities are translated at exchange rates in effect at the balance sheet date. Income and expense accounts are translated at the average monthly exchange rates for the periods. Resulting translation adjustments are recorded as a separate component of accumulated other comprehensive loss.

Accounting for Stock-Based Compensation

Employee stock awards under the Company’s compensation plans are accounted for in accordance with Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, Financial Accounting Standards Board Interpretation No. 44, Emerging Issues Task Force (“EITF”) Issue No. 00-23, and related interpretations. The Company accounts for equity awards issued to non-employees in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation, Transition and Disclosure, and EITF Issue No. 96-18, Accounting for Equity Instruments that are Issued to other than Employees for Acquiring, or in Conjunction with Selling Goods or Services and related interpretations. The following table illustrates the effect on net income as if the Company had applied the fair value recognition provisions of SFAS No. 123 (in thousands, except per share data):

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SigmaTel, Inc.

Notes to Condensed Consolidated Financial Statements Continued

Net Income per Share

Basic net income per share is computed by dividing net income by the weighted-average number of shares of common stock outstanding for the period. Diluted net income per share is computed giving effect to all potential dilutive common stock, including options, warrants, and common stock subject to repurchase.

A reconciliation of the numerator and denominator used in the calculation of basic and diluted net income per share is as follows (in thousands):

Weighted-average anti-dilutive potential shares have been excluded, as the exercise price of the underlying stock options exceeded the average market price of the stock during the respective periods. These excluded shares were approximately 1.6 million and 278,000 for the three months ended June 30, 2005 and 2004, respectively, and 1.1 million and 278,000 for the six months ended June 30, 2005 and 2004, respectively. The Company issued approximately 133,000 and 663,000 shares of common stock during the three and six months ended June 30, 2005, respectively.

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SigmaTel, Inc.

Notes to Condensed Consolidated Financial Statements Continued

3. Comprehensive Income

The components of comprehensive income are comprised of net income and foreign currency translation adjustments. Comprehensive income for the three and six months ended June 30, 2005 and 2004 was as follows (in thousands):

4. Short-term Investments

Short-term investments at June 30, 2005 and December 31, 2004, consisting of corporate, state and municipal securities, were acquired at an aggregate cost of $117.1 million and $114.8 million, respectively. The fair values of these instruments are based on market interest rates and other market information available to management as of each balance sheet date presented and were not materially different than the aggregate cost.

Short-term investments consist of the following (in thousands):

Management classifies investments in marketable securities at the time of purchase and reevaluates such classification at each balance sheet date. Securities classified as available-for-sale are stated at amortized cost, which is not materially different than market value as of June 30, 2005. $12.3 million of total liquid investments mature within three months, $9.8 million mature beyond three months but within one year and $94.9 million of investments have stated maturities beyond five years, but have interest rate maturities of less than thirty-five days.

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SigmaTel, Inc.

Notes to Condensed Consolidated Financial Statements Continued

5. Inventories

Inventories consist of the following (in thousands):

At June 30, 2005 and December 31, 2004, the Company’s reserve for slow-moving and obsolete inventory was approximately $2.4 million and $2.2 million, respectively. This increase resulted from additional reserve of $0.8 million for obsolescence offset by scrap and sales of items which had previously been reserved of $0.6 million.

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SigmaTel, Inc.

Notes to Condensed Consolidated Financial Statements Continued

6. Intangible Assets

Intangible assets subject to amortization expense primarily relate to licenses to use intellectual property in manufacturing and patents. Intangible assets consist of the following (in thousands):

Intangible asset amortization expense was $0.3 and $0.2 million for the three months ended June 30, 2005 and 2004, respectively, and was $0.6 and $0.5 million for the six months ended June 30, 2005 and 2004, respectively. Estimated aggregate intangible asset amortization expense is expected to be $1.3 million for each of the fiscal years 2005 through 2007, $1.1 million in 2008 and $0.3 million in 2009. The weighted average amortization period for intangible assets is five years.

7. Income Taxes

The provision for income taxes has been calculated based on the Company’s estimate of its effective tax rate for the full fiscal year. The Company’s effective tax rate was 37% and 2% for the three months ended June 30, 2005 and 2004, respectively, and 35% and 2% for the six months ended June 30, 2005 and 2004, respectively. The Company’s estimate of the effective tax rate for 2004 differed from the statutory rate primarily due to the Company’s anticipated reduction in its deferred tax asset valuation allowance attributable to the utilization of loss carryforwards.

The Company recognized certain tax benefits related to stock option plans in the amount of $1.0 million and $0 during the three months ended June 30, 2005 and 2004, respectively and $6.4 and $0 during the six months ended June 30, 2005 and 2004, respectively. These benefits were recorded as a reduction of income taxes payable and an increase in additional paid-in capital.

The determination of the provision for income taxes requires the Company to take positions on certain issues where there is uncertainty in the application of the tax law. The provision for income taxes includes amounts intended to satisfy unfavorable adjustments by the Internal Revenue Service and other tax authorities in an examination of the Company’s income tax returns. The ultimate resolution of these uncertainties may result in an assessment that is materially different from the current estimate of the liability and may result in income tax benefits or expenses being recognized in a future period.

8. Commitments and Contingencies

In December 2004, the Company abandoned a lease of office space in order to move its Austin, Texas operations to a larger location that would accommodate the Company’s rapidly growing staff of engineers as well as support staff. The total amount incurred in connection with the lease abandonment was approximately $2.0 million, which was expensed entirely in 2004. During the three and six months ended June 30, 2005, the Company adjusted the lease abandonment charge by $0 and $0.4 million due to additional subleases that were executed in the abandoned space during the period. The adjustment is reflected in the selling, general and administrative operating expense in the condensed consolidated statement of operations. At June 30, 2005, the liability is allocated between a current liability of approximately $0.7 million and a non-current liability of approximately $0.2 million. The Company does not expect any future charges related to this abandonment.

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SigmaTel, Inc.

Notes to Condensed Consolidated Financial Statements Continued

In the normal course of its business, the Company enters into contracts that contain a variety of representations and warranties and which provide general indemnifications. The Company’s exposure under these arrangements is unknown as this would involve future claims that might be made against the Company that have not yet occurred. However, based on experience, the Company expects the risk of any loss to be remote.

9. Related Party Transactions

Revenues from a significant stockholder were approximately $2.9 million and $5.9 million for the three months ended June 30, 2005 and 2004, respectively, and $22.9 million and $9.1 million for the six months ended June 30, 2005 and 2004, respectively.

Accounts receivable from sales to a significant stockholder were approximately $3.5 million and $7.0 million as of June 30, 2005 and December 31, 2004, respectively.

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SigmaTel, Inc.

Notes to Condensed Consolidated Financial Statements Continued

10. Operating Segments and Geographic Information

The Company operates as a single segment. The Company’s chief operating decision maker is considered to be the Chief Executive Officer. The chief operating decision maker allocates resources and assesses performance of the business at the entity-wide level to manage the business.

The following table summarizes the percentages of revenues by geographic region:

The table below summarizes the percentage of long-lived assets by geographic region:

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SigmaTel, Inc.

Notes to Condensed Consolidated Financial Statements Continued

11. Recent Accounting Pronouncements

In November 2004, the FASB issued SFAS 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4. The standard requires that abnormal amounts of idle capacity and spoilage costs should be excluded from the cost of inventory and expensed when incurred. The provision is effective for fiscal periods beginning after June 15, 2005. The Company does not expect the adoption of this standard to have a material effect on its financial position, results of operations or cash flows.

In December 2004, the FASB issued SFAS 153, Exchanges of Nonmonetary Assets, an amendment of APB No. 29, Accounting for Nonmonetary Transactions. SFAS 153 requires exchanges of productive assets to be accounted for at fair value, rather than at carryover basis, unless (1) neither the asset received nor the asset surrendered has a fair value that is determinable within reasonable limits or (2) the transactions lack commercial substance. SFAS 153 is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The Company does not expect the adoption of this standard to have a material effect on its financial position, results of operations or cash flows.

In December 2004, the FASB released its final revised standard, SFAS No. 123R, Share-Based Payment. SFAS 123R requires that a public entity measure the cost of equity based service awards based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award or the vesting period. No compensation cost is recognized for equity instruments for which employees do not render the requisite service. A public entity will initially measure the cost of liability based service awards based on its current fair value; the fair value of that award will be remeasured subsequently at each reporting date through the settlement date. Changes in fair value during the requisite service period will be recognized as compensation cost over that period. Adoption of SFAS 123R is required for annual periods beginning after June 15, 2005. The Company is evaluating SFAS 123R and believes it will have a material adverse effect on its financial position, results of operations and cash flows.

In March 2005, the FASB issued FASB Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations (FIN 47). FIN 47 clarifies that an entity must record a liability for a “conditional” asset retirement obligation if the fair value of the obligation can be reasonably estimated. The provision is effective for no later than the end of fiscal year ending December 15, 2005. The Company does not expect the adoption of this standard to have a material effect on its financial position, results of operations or cash flows.

In May 2005, the FASB issued SFAS 154, Accounting Changes and Error Corrections – A Replacement of APB Opinion No. 20 and FASB Statement No. 3. SFAS 154 changes the requirements for the accounting for and reporting of a change in accounting principle. This statement requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. This statement redefines restatements as the revising of previously issued financial statements to reflect the correction of an error. SFAS 154 requires that retrospective application of a change in accounting principle be limited to the direct effects of the change. This statement also requires that a change in depreciation, amortization, or depletion method for long-lived, non-financial assets be accounted for as a change in accounting estimate affected by a change in accounting principle. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company does not expect the adoption of this standard to have a material effect on its financial position, results of operations or cash flows.

12. Subsequent Events

In July 2005, the Company announced that it had signed a definitive agreement to acquire Protocom Corporation, a provider of semiconductors to the multi-function imaging market. In connection with the acquisition, the Company expects to pay $28.2 million in the form of approximately 1,437,000 shares of its common stock issued or reserved for future issuance and make a cash payment of $18.8 million, in exchange for all outstanding shares of capital stock of Protocom. A portion of the consideration payable to the shareholders will be placed into escrow pursuant to the terms of the acquisition agreement. The Company will also assume all unvested employee stock options of Protocom, which will entitle the holders to receive up to approximately 185,000 shares of the Company’s common stock upon exercise and vesting. The Company may record a one-time charge for purchased in-process research and development expenses related to the acquisition in its third fiscal quarter. The amount of that charge, if any, has not yet been determined.

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SigmaTel, Inc.

Notes to Condensed Consolidated Financial Statements Continued

Also, in July 2005, the Company closed its acquisition of the software, patents and engineering resources associated with the Rio^® portable audio product line from D&M Holdings, Inc. In connection with the acquisition, the Company made a cash payment of $9.5 million, and $0.5 million will be held in escrow pursuant to the terms of the acquisition agreement. The Company may record a one-time charge for purchased in-process research and development expenses related to the acquisition in its third fiscal quarter. The amount of that charge, if any, has not yet been determined.

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

Forward-looking Statements

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such statements are based upon current expectations that involve risks and uncertainties. Any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. For example, the words “believes”, “anticipates”, “plans”, “expects”, “intends” and similar expressions are intended to identify forward-looking statements. Our actual results and the timing of certain events may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such a discrepancy include, but are not limited to, those discussed in “Overview”, “Results of Operations”, “Liquidity and Capital Resources” and “Risks That May Affect Future Results” below. All forward-looking statements in this document are based on information available to us as of the date hereof and we assume no obligation to update any such forward-looking statements. The following discussion should be read in conjunction with our condensed consolidated financial statements and the accompanying notes contained in this quarterly report. Unless expressly stated or the context otherwise requires, the terms “we”, “our”, “us” and “SigmaTel” refer to SigmaTel, Inc. and its consolidated subsidiaries.

Overview

We are a fabless semiconductor company that designs, develops, and markets proprietary, analog-intensive, mixed-signal integrated circuits, or ICs. We were founded in 1993 with an initial focus on providing semiconductor design services on a contract basis. We began to develop our first IC product, an AC97 audio codec for PC sound cards, in 1995 and began shipping this product in 1997. From 1997 to 2000, our annual revenues grew rapidly from $1.2 million to $47.4 million. During that time, we began to develop an asymmetric digital subscriber line, or ADSL system on a chip, or SoC and a portable audio SoC. Neither of these products generated revenues, which led to significant operating losses in 2000 and 2001. During 2000 and 2001, the PC audio market transitioned from sound cards to host audio solutions, which are integrated on desktop PC motherboards and in notebook PCs. As sound cards began to lose market share, we experienced a significant loss in market share and a revenue decline from 2000 to 2001.

In early 2001, we hired our current Chief Executive Officer, Ronald Edgerton, and established a new management team. This new management team stopped development of our ADSL SoC, reduced headcount, and redirected our development efforts towards host audio codecs and portable audio SoCs. From 2002 to 2004, our annual revenues grew substantially from $30.9 million to $194.8 million due primarily to increased sales of our portable audio SoCs. Our operating results improved from an operating loss of $5.6 million to operating income of $53.1 million from 2002 to 2004. Revenues and operating results continue to improve during 2005. Revenue increased from $68.1 million to $168.9 million for the six months ended June 30, 2004 and 2005, respectively. Our operating results improved from an operating income of $15.4 million to $54.0 million for the six months ended June 30, 2004 and 2005, respectively.

In the third quarter of 2004, we established an international subsidiary and opened an office in Hong Kong. In March and June of 2005, we opened branch or liaison offices of our Hong Kong subsidiary in Taipei, Taiwan and Shenzhen, China, respectively. We also recently established international subsidiaries and opened offices in Singapore and Seoul, South Korea.

We currently offer products that serve four markets: portable compressed audio players, notebook and desktop PC audio, consumer audio, and USB peripherals. We made our first commercial shipments of PC audio codecs during 1997. We made our first commercial shipments of USB peripheral ICs in 2000, primarily targeting USB-to-Infrared wireless connectivity applications. We made our first commercial shipments of portable audio SoCs in 2001. The primary market for these products is the portable compressed audio player market. During 2001, we also began to sell our audio codecs into the consumer electronics market for products such as DVD players and set top boxes.

As a fabless semiconductor company, our business model is less capital intensive because we rely on third parties to manufacture, assemble, and test our ICs. We also utilize distributors to sell our products. Our sales through

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distributors result in lower gross margins, but also lower selling expenses than are associated with direct sales to end customers. A few customers account for a substantial portion of our sales. The following table sets forth our customers that represented 10% or more of our revenues for the periods indicated:

The percentage of our revenues from customers located outside the U.S. was 94.3% and 99.8% for the three months ended June 30, 2005 and 2004, respectively, and 97.6% and 99.8% for the six months ended June 30, 2005 and 2004, respectively. Most of the products that use our ICs are manufactured outside of the U.S. As a result, we believe that a substantial majority of our revenues will continue to come from customers located outside of the U.S. All of our revenues to date have been denominated in U.S. dollars.

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The percentages of our revenues by country are set forth in the following table:

Our sales cycles can take up to 12 months to complete and volume production of products that use our ICs can take an additional 3 to 6 months to be achieved, if at all. The lengthy sales cycles of our products make forecasting the volume and timing of orders difficult. In addition, the delays inherent in lengthy sales cycles increase the risk that customers may seek to cancel or modify their orders. Our sales are made by purchase orders. Because industry practice allows customers to reschedule or cancel orders on relatively short notice, and order lead times can vary period to period, backlog is not 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.

Because many of our ICs are designed for use in consumer electronic products, such as portable compressed audio players, PCs, and DVD players, we expect our business to be subject to seasonality, with increased revenues in the third and fourth quarters of each year, when customers place orders to meet year-end holiday demand, and lower revenues in the first and second quarters of each year. However, our recent rapid revenue growth makes it difficult for us to assess the impact of seasonal factors on our business. In particular, strong sales of our portable audio SoCs resulted in increased revenues during the first quarter of 2005 compared to the fourth quarter of 2004, offsetting seasonal demand factors. Seasonal demand factors normalized in the second quarter; however, specific demand for our products was affected by the price volatility in other components used to build our customer’s devices, specifically NAND Flash, as well as high inventory levels of our products at specific customers at the end of the first quarter.

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The following describes certain line items in our condensed consolidated statements of operations:

Revenues. Revenues consist primarily of sales of our ICs, net of sales discounts or incentives. We recognize revenues on direct sales at the time of shipment to our customers. We defer revenues on sales through distributors with rights of return or price protection until products are resold by such distributors to their customers.

Cost of Goods Sold. Cost of goods sold consists primarily of the costs of purchasing silicon wafers, and also includes costs associated with assembly, test and shipping of our ICs, costs of personnel and equipment associated with manufacturing support and quality assurance, and occupancy costs. Because we do not have long-term, fixed-price supply contracts, our wafer costs are subject to the cyclical demand for semiconductors.

Research and Development. Research and development expense consists primarily of employee, contractor, and related costs, expenses for development testing, evaluation, masking costs, occupancy costs, and depreciation on research and development equipment. All research and development costs are expensed as incurred. We plan to continue to invest a significant amount in research and development activities to develop new products. We expect research and development expenses to increase in absolute dollars.

Selling, General and Administrative. Selling, general and administrative expense consists primarily of employee, contractor, and related costs, occupancy costs, sales commissions to independent sales representatives, professional services, and promotional and marketing expenses. We expect selling expenses will fluctuate with changes in revenues, and we expect that general and administrative expenses will increase to support our future operations.

Amortization of Deferred Stock-Based Compensation. In connection with grants of stock options and the issuance of warrants as a private company between 2000 and 2003, we recorded an aggregate of $7.5 million in deferred stock-based compensation. These options and warrants are considered compensatory because the fair value of our stock determined for financial reporting purposes was greater than the fair value determined by our board of directors on the date of grant or issuance. We have also recorded deferred stock-based compensation due to the conversion of certain contractors to employees. As of June 30, 2005, we had an aggregate of $0.9 million of deferred stock-based compensation remaining to be amortized. We are amortizing deferred stock-based compensation over the vesting period of the related options and warrants, which is generally four or five years. This deferred stock-based compensation balance is expected to be amortized as follows: $0.4 million during 2005 and $0.5 million during 2006 and beyond.

Provision for Income Taxes. We accrue federal, state, and foreign income taxes at the applicable statutory rates adjusted for certain items including non-deductible expenses, research and development tax credits, interest income from tax advantaged investments, as well as changes in our deferred tax asset valuation allowance.

Results of Operations

The following table sets forth our condensed consolidated statements of operations as a percentage of revenues for the periods indicated: