Cirrus Logic, Inc.: Form 10-Q for the period ended Sep 23, 2023

The following discussion should be read along with the unaudited consolidated condensed financial statements and notes thereto included in Item 1 of this Quarterly Report on Form 10-Q, as well as the audited consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations for the fiscal year ended March 25, 2023, contained in our fiscal year 2023 Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “Commission”) on May 19, 2023. We maintain a website at investor.cirrus.com, which makes available free of charge our most recent annual report and all other filings we have made with the Commission.

Special Note Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q including Management’s Discussion and Analysis of Financial Condition and Results of Operations and certain information incorporated herein by reference contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, (the "Exchange Act"). These forward-looking statements are based on expectations, estimates, forecasts and projections and the beliefs and assumptions of our management as of the filing of this Form 10-Q. In some cases, forward-looking statements are identified by words such as “expect,” “anticipate,” “target,” “project,” “believe,” “goals,” “estimates,” “intend,” and variations of these types of words and similar expressions which are intended to identify these forward-looking statements. In addition, any statements that refer to our plans, expectations, strategies or other characterizations of future events or circumstances are forward-looking statements. Readers are cautioned that these forward-looking statements are predictions and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements and readers should not place undue reliance on such statements. We undertake no obligation, and expressly disclaim any duty, to revise or update publicly any forward-looking statement for any reason.

For additional information regarding known material factors that could cause our actual results to differ from our projected results, please see “Item 1A - Risk Factors” in our 2023 Annual Report on Form 10-K filed with the Commission on May 19, 2023, and in "Part II, Item 1A - Risk Factors” within this Quarterly Report on Form 10-Q. Readers should carefully review these risk factors, as well as those identified in other documents filed by us with the Commission.

Overview

Cirrus Logic, Inc. (“Cirrus Logic,” “We,” “Us,” “Our,” or the “Company”) is a leader in low-power, high-precision mixed-signal processing solutions that create innovative user experiences for the world’s top mobile and consumer applications.

The Company remains committed to our three-pronged strategy for growing our business: first, maintaining our leadership position in smartphone audio; second, increasing HPMS content in smartphones; and third, leveraging our strength in audio and HPMS to expand into additional applications and markets with new and existing components.

During the second quarter of fiscal year 2024, the Company recorded the financial impact of the disposition of wafers associated with the new HPMS product previously scheduled for introduction in fall 2023, that did not come to market as anticipated. The disposition did not have a material financial impact. While this product was intended to be manufactured at GlobalFoundries as part of our Capacity Reservation Agreement, the agreement allows for wafer allocation flexibility within our product portfolio. As a result, these wafers are being reallocated to other products that utilize the same underlying technology, including amplifiers, haptic drivers, and battery and power integrated circuits (ICs). We continue to focus on our long-term strategy to drive content expansion with this customer as we pursue a variety of opportunities for both the next generation of our existing components as well as new products.

Critical Accounting Policies and Estimates

Our discussion and analysis of the Company’s financial condition and results of operations are based upon the unaudited consolidated condensed financial statements included in this report, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts. We evaluate the estimates on an on-going basis. We base these estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions and conditions.

There have been no significant changes during the three and six months ended September 23, 2023, to the information provided under the headings “Critical Accounting Estimates” and "Summary of Significant Accounting Policies" included in our fiscal year 2023 Annual Report on Form 10-K for the fiscal year ended March 25, 2023.

Recently Issued Accounting Pronouncements

For a discussion of recently issued accounting pronouncements, refer to Note 2 of the Notes to the Consolidated Condensed Financial Statements.

Results of Operations

Our fiscal year is the 52- or 53-week period ending on the last Saturday in March. Fiscal year 2024 is a 53-week fiscal year, including a 14-week fiscal third quarter. Fiscal year 2023 was a 52-week fiscal year.

The following table summarizes the results of our operations for the first three and six months of fiscal years 2024 and 2023, respectively, as a percentage of net sales. All percentage amounts were calculated using the underlying data in thousands, unaudited:

Net Sales

Net sales for the second quarter of fiscal year 2024 decreased $59.5 million, or 11 percent, to $481.1 million from $540.6 million in the second quarter of fiscal year 2023. Net sales from our audio products decreased $55.0 million, primarily driven by continued weakness in sales of general market products and a reduction in components shipping in smartphones. Net sales from HPMS products decreased $4.6 million for the quarter versus the second quarter of fiscal year 2023, primarily due to a decline in general market sales.

Net sales for the first six months of fiscal year 2024 decreased $136.1 million, or 15 percent, to $798.1 million from $934.2 million for the first six months of fiscal year 2023. Net sales from our audio products decreased $113.6 million, primarily driven by continued weakness in general market sales and, to a lesser extent, a reduction in components shipping in smartphones. Net sales from HPMS products decreased $22.5 million for the year versus the first six months of fiscal year 2023, primarily due to a reduction in components shipping in smartphones.

International sales, including sales to U.S.-based end customers that manufacture products through contract manufacturers or plants located overseas, were approximately 99 percent and 98 percent of net sales for the second quarters of fiscal years 2024 and 2023, respectively, and 99 percent and 98 percent for the first six months of fiscal years 2024 and 2023, respectively. Our sales are denominated primarily in U.S. dollars.

Since the components we produce are largely proprietary, we consider our end customer to be the entity specifying the use of our component in their design. These end customers may purchase our products directly from us, through distributors, or third-party manufacturers contracted to produce their designs. For the second quarter of fiscal years 2024 and 2023, our ten largest end customers represented approximately 95 percent and 91 percent of our net sales, respectively, and 94 percent and 90 percent of our net sales for the first six months of fiscal years 2024 and 2023, respectively.

We had one end customer, Apple Inc., that purchased through multiple contract manufacturers and represented approximately 88 percent and 82 percent of the Company’s total net sales for the second quarter of fiscal years 2024 and 2023, respectively, and 86 percent and 81 percent for the first six months of fiscal years 2024 and 2023, respectively.

No other end customer or distributor represented more than 10 percent of net sales for the three and six months ended September 23, 2023 or September 24, 2022.

For more information, please see *"Part II, Item 1A - Risk Factors" — “*We depend on a limited number of customers and distributors for a substantial portion of our sales, and the loss of, or a significant reduction in orders from, or pricing on products sold to, any key customer or distributor could significantly reduce our sales and our profitability.”

Gross Margin

Gross margin was 51.3 percent in the second quarter of fiscal year 2024, up from 50.2 percent in the second quarter of fiscal year 2023. The increase was primarily due to reduced supply chain costs and inventory reserves, partially offset by a less favorable product mix.

Gross margin was 50.9 percent for the first six months of fiscal year 2024, up from 50.7 percent for the first six months of fiscal year 2023 due to reduced supply chain costs and the benefit of lower inventory reserves, mostly offset by a less favorable product mix.

Research and Development Expense

Research and development expense for the second quarter of fiscal year 2024 was $104.2 million, a decrease of $11.3 million, from $115.5 million in the second quarter of fiscal year 2023. Significant drivers of the decrease included reduced amortization of acquisition intangibles expense, increased R&D incentives, lower variable compensation costs, reduced acquisition-related and product development costs, partially offset by higher employee-related and stock-based compensation expenses for the quarter.

Research and development expense for the first six months of fiscal year 2024 was $210.4 million, a decrease of $14.8 million, from $225.2 million for the first six months of fiscal year 2023 primarily due to reduced amortization of acquisition intangibles expense, increased R&D incentives, lower variable compensation costs, reduced product development and acquisition-related costs, partially offset by higher employee-related and stock-based compensation expenses for the period.

Selling, General and Administrative Expense

Selling, general and administrative expense for the second quarter of fiscal year 2024 was $34.3 million, a decrease of $5.3 million, from $39.6 million in the second quarter of fiscal year 2023, primarily due to lower variable compensation costs and employee-related expenses.

Selling, general and administrative expense for the first six months of fiscal year 2024 was $69.7 million, a decrease of $8.5 million, from $78.2 million for the first six months of fiscal year 2023, primarily due to lower variable compensation costs and employee-related expenses for the period.

Restructuring and Related Costs

Restructuring costs for the second quarter and first six months of fiscal year 2024 were $2.3 million. These costs were primarily related to workforce reduction actions previously disclosed. See Note 10 - Restructuring and Related Costs for additional information.

Interest Income

The Company reported interest income of $4.0 million and $8.8 million, for the three and six months ended September 23, 2023, respectively and $1.5 million and $2.1 million for the three and six months ended September 24, 2022, respectively. Interest income increased in the current period due to higher yields on combined average cash, cash equivalents and marketable securities balances, compared to the prior period.

Interest Expense

The Company reported interest expense of $0.2 million and $0.5 million for the three and six months ended September 23, 2023, respectively and $0.2 million and $0.5 million for the three and six months ended September 24, 2022, respectively. Interest expense consists primarily of commitment fees associated with the Company's Revolving Credit Facility (see Note 8 - Revolving Credit Facility).

Other Income (Expense)

For the three and six months ended September 23, 2023, the Company reported other expense of $0.1 million and other income of $0.3 million, respectively, and $0.3 million and $0.8 million in other income for the three and six months ended

September 24, 2022, respectively. This activity primarily related to remeasurement on foreign currency denominated monetary assets and liabilities.

Income Taxes

Our provision for income taxes is based on estimated effective tax rates derived from an estimate of annual consolidated earnings before taxes, adjusted for nondeductible expenses, other permanent items and any applicable credits.

The following table presents the provision for income taxes (in thousands) and the effective tax rates:

Our income tax expense for the second quarter of fiscal year 2024 was $34.0 million compared to $30.6 million for the second quarter of fiscal year 2023, resulting in effective tax rates of 31.1 percent and 26.0 percent, respectively. Our income tax expense was $41.2 million and $46.0 million for the first six months of fiscal years 2024 and 2023, respectively, resulting in effective tax rates of 31.1 percent and 26.6 percent, respectively. Our effective tax rates for the second quarters and first six months of fiscal year 2024 and 2023 were higher than the federal statutory rate primarily due to a provision in the Tax Cuts and Jobs Act of 2017 that requires R&D expenditures incurred in tax years beginning after December 31, 2021 to be capitalized and amortized ratably over five or fifteen years depending on the location in which the research activities are conducted, resulting in higher global intangible low-taxed income ("GILTI"), which is treated as a period cost. In addition, our effective tax rates for both periods presented were unfavorably impacted by U.S. tax rules related to refundable tax credits, including R&D expenditure credits available to us in the United Kingdom, that reduce the amount of foreign tax credits available to offset GILTI.

Liquidity and Capital Resources

We require cash to fund our operating expenses and working capital requirements, including outlays for inventory, capital expenditures, share repurchases, and strategic acquisitions. Our principal sources of liquidity are cash on hand, cash generated from operations, cash generated from the sale and maturity of marketable securities, and available borrowings under our $300 million Revolving Credit Facility.

Cash used in or generated from our operating activities is net income adjusted for certain non-cash items and changes in working capital. Cash used in operations was $62.5 million for the first six months of fiscal year 2024 versus $110.4 million generated for the corresponding period of fiscal year 2023. The cash flow used in operations during the first six months of fiscal year 2024 was related to the cash components of our net income and a $216.5 million unfavorable change in working capital, primarily as a result of an increase in accounts receivables (see Note 6) and inventory and a decrease in acquisition-related liabilities, partially offset by prepaid wafer usage (related to the Capacity Reservation Agreement) beginning in the second quarter of fiscal year 2024. The Company anticipates inventory to remain at increased levels during fiscal year 2024 as we balance product demand and wafer purchase commitments. The cash flow from operations during the corresponding period of fiscal year 2023 was related to the cash components of our net income and a $84.9 million unfavorable change in working capital, primarily as a result of an increase in accounts receivables and inventory for the period.

Net cash used in investing activities was $23.8 million during the first six months of fiscal year 2024 versus $16.9 million during the first six months of fiscal year 2023. The cash used in investing activities in the first six months of fiscal year 2024 was related to capital expenditures of $20.8 million and net purchases of marketable securities of $2.9 million. The cash used in investing activities in the corresponding period in fiscal year 2023 was related to capital expenditures and technology investments of $17.5 million, partially offset by net sales of marketable securities of $0.6 million.

Net cash used in financing activities was $81.6 million during the first six months of fiscal year 2024 and was primarily associated with stock repurchases for the period of $79.1 million. The cash used in financing activities during the first six months of fiscal year 2023 of $108.3 million was primarily associated with stock repurchases during the period of $106.4 million.

Our future capital requirements will depend on many factors, including the rate of sales growth, market acceptance of our products, the timing and extent of research and development projects, potential future acquisitions of companies or technologies, inventory build, and commitments under the Capacity Reservation Agreement with GlobalFoundries (discussed further in Note 13 - Commitments and Contingencies of the Notes to the Consolidated Condensed Financial Statements). We believe our expected future cash earnings, existing cash, cash equivalents, investment balances, and available borrowings under our Revolving Credit Facility will be sufficient to meet our capital requirements both domestically and internationally, in the short-term (i.e. the next 12 months) and in the long-term, although we could be required, or could elect, to seek additional funding prior to that time.

Revolving Credit Facility

On July 8, 2021, the Company entered into a second amended and restated credit agreement (the “Second Amended Credit Agreement”) with Wells Fargo Bank, National Association, as administrative agent, and the lenders party thereto. The Second Amended Credit Agreement provides for a $300 million senior secured revolving credit facility (the “Revolving Credit Facility”). The Revolving Credit Facility matures on July 8, 2026 (the “Maturity Date”). The Revolving Credit Facility is required to be guaranteed by all of Cirrus Logic’s material domestic subsidiaries ("Subsidiary Guarantors"). The Revolving Credit Facility is secured by substantially all the assets of Cirrus Logic and any Subsidiary Guarantors, except for certain excluded assets.

On March 20, 2023, the Company, entered into the First Amendment (the "Amendment") to its Second Amended Credit Agreement, with the lending institutions party thereto and Wells Fargo Bank, National Association, as administrative agent. The Amendment updates the benchmark interest rate provisions to replace the London interbank offered rate ("LIBOR") with the forward-looking secured overnight financing rate ("Term SOFR"), for the purposes of calculating interest under the terms of the Second Amended Credit Agreement.

As of September 23, 2023, the Company had no amounts outstanding under the Revolving Credit Facility and was in compliance with all covenants under the Second Amended Credit Agreement.

See Note 8 — Revolving Credit Facility for additional information including material terms and related covenants.

We are exposed to market risks associated with interest rates on our debt securities, currency movements on non-functional currency assets and liabilities, and the effect of market factors on the value of our marketable securities. We assess these risks on a regular basis and have established policies that are designed to protect against the adverse effects of these and other potential exposures. We use forward contracts to manage exposure to foreign currency exchange risk attributable to certain non-U.S. dollar balance sheet exposures. Gains and losses from these foreign currency forward contracts are recognized currently in earnings along with the gains and losses resulting from remeasuring the underlying exposures. For further description of our market risks, see “Part II – Item 7A – Quantitative and Qualitative Disclosures about Market Risk” in our fiscal year 2023 Annual Report on Form 10-K filed with the Commission on May 19, 2023. For related financial statement impact see Note 5 - Derivative Financial Instruments.

Evaluation of disclosure controls and procedures

As required by Rule 13a-15(b) of the Exchange Act, we have evaluated, under the supervision and with the participation of our management, including our chief executive officer (CEO) and chief financial officer (CFO), the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q. Our disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed by us in reports that we file or submit under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the Commission rules and forms and (ii) accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure.

Based upon the evaluation, our management, including our CEO and CFO, has concluded that our disclosure controls and procedures were effective as of September 23, 2023.

Changes in control over financial reporting

There has been no change in the Company’s internal control over financial reporting during the quarter ended September 23, 2023, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

In evaluating all forward-looking statements, you should specifically consider risk factors that may cause actual results to vary from those contained in the forward-looking statements. Various risk factors associated with our business are included in our Annual Report on Form 10-K for the year ended March 25, 2023, as filed with the Commission on May 19, 2023, and available at www.sec.gov (http://www.sec.gov). Other than as set forth below, there have been no material changes to those risk factors previously disclosed in our Annual Report on Form 10-K for the fiscal year ended March 25, 2023.

We depend on a limited number of customers and distributors for a substantial portion of our sales, and the loss of, or a significant reduction in orders from, or pricing on products sold to, any key customer or distributor could significantly reduce our sales and our profitability.

While we generate sales from a broad base of customers worldwide, the loss of any of our key customers, or a significant reduction in sales or selling prices to any key customer, or reductions in selling prices made to retain key customer relationships, would significantly reduce our revenue, margins and earnings and adversely affect our business. For the second quarter of fiscal years 2024 and 2023, our ten largest end customers represented approximately 95 percent and 91 percent of our net sales, respectively. For the first six month periods of fiscal years 2024 and 2023, our ten largest end customers represented approximately 94 percent and 90 percent of our net sales, respectively. We had one end customer, Apple Inc., that purchased through multiple contract manufacturers and represented approximately 88 percent and 82 percent of the Company’s total net sales for the second quarter of fiscal years 2024 and 2023, respectively and 86 percent and 81 percent for the first six months of fiscal years 2024 and 2023, respectively. No other end customer or distributor represented more than 10 percent of net sales for the three and six months ended September 23, 2023, or September 24, 2022.

We may not be able to maintain or increase sales to certain of our key customers for a variety of reasons, including:

- most of our customers can stop incorporating our products into their own products with limited notice to us and suffer little or no penalty;

- our agreements with our customers typically do not require them to purchase a minimum quantity of our products;

- many of our customers have pre-existing or concurrent relationships with our current or potential competitors that may affect the customers’ decisions to purchase our products;

- many of our customers have sufficient resources to internally develop technology solutions and semiconductor components that could replace the products that we currently supply in our customers’ end products;

- our customers face intense competition from other manufacturers that do not use our products;

- our customers regularly evaluate alternative sources of supply in order to diversify their supplier base, which increases their negotiating leverage with us and their ability to either obtain or dual-source components from other suppliers; and

- our current customers may be hesitant in some cases to award new business to us based on their desire to manage their supply chain risks around any potential over-dependence on a supplier or supply chain.

In addition, our dependence on a limited number of key customers may make it easier for them to pressure us on price reductions or to not accept price increases resulting from unexpected or additional cost increases or fees associated with our suppliers. We have experienced pricing pressure from certain key customers, and we expect that the average selling prices ("ASPs") for certain of our products will decline from time to time, potentially reducing our revenue, margins, and earnings.

Our key customer relationships often require us to develop new products that may involve significant technological challenges. Our customers frequently place considerable pressure on us to meet tight development schedules. In addition, we have entered, and may again enter in the future, into customer agreements providing for exclusivity periods during which we may only sell specified products or technology to a specific customer. Even without exclusivity periods, the products that we develop are often specific to our customer's system architecture and frequently cannot be sold to other customers. Accordingly, we have in the past and may in the future devote a substantial amount of resources to strategic relationships, which could detract from or delay our completion of other important development projects or the development of next-generation products and technologies, and notwithstanding our efforts, our customers may not be obligated to purchase new products that we develop for them, which could impact our operating results, financial condition, and cash flows. For example, in April 2023, we were informed that a new product that we had developed for a key customer for introduction in the fall of calendar 2023 was no longer expected to come to market as planned.

Our reliance on certain customers may continue to increase, which could heighten the risks associated with having key customers, including making us more vulnerable to significant reductions in revenue, margins, and earnings; pricing pressure; and other adverse effects on our business.

Because we depend on subcontractors internationally to perform key manufacturing functions for us, we are subject to political, economic, climate and natural disaster risks that could disrupt the fabrication, assembly, packaging, or testing of our products.

We depend on third-party subcontractors, primarily in Asia, for the fabrication, assembly, packaging, and testing of most of our products. International operations may be subject to a variety of risks, including political instability, global health conditions, currency controls, exchange rate fluctuations, changes in import/export regulations, tariff and freight rates, as well as the risks of natural disasters such as earthquakes, tsunamis, and floods. The potential physical impacts of climate change, including high heat events, power or water shortages, fires, rising sea levels, changes in storm patterns or intensities, or other extreme weather conditions, are uncertain and could impact operations at our subcontractors. Any disruption to our manufacturing cycle could adversely affect our operations and financial results.

Although we seek to reduce our dependence on any one subcontractor, the substantial majority of our semiconductor wafers are manufactured by TSMC at fabs in Taiwan, and GlobalFoundries in Singapore and Germany. This concentration of subcontractors and manufacturing operations, subjects us to the risks of conducting business internationally, including associated political and economic conditions. If we experience manufacturing problems at a particular location, or a supplier is unable to continue operating due to financial difficulties, natural disasters, political or economic turmoil or conflict, or other reasons, we would be required to transfer manufacturing to a backup supplier. Transferring from a primary supplier to another facility would likely result in increased production costs and a delay in production. Further, such a transition may not be possible, particularly in a supply constrained environment. There are only a few foundries that are currently available for certain advanced processing technologies that we utilize or may utilize. As a result, delays in our production or shipping by the parties to whom we outsource these functions could reduce our sales, damage our customer relationships, and damage our reputation in the marketplace, any of which could harm our business, results of operations, and financial condition.

For example, we rely on several third-party suppliers located in Taiwan. Any deterioration in the social, political, or economic conditions in Taiwan, particularly as it relates to China-Taiwan relations, may disrupt our business operations and materially and adversely affect our results of operations. Similarly, our operations also could be harmed, and our costs could increase, if Russia’s invasion of Ukraine results in a shortage of materials that our suppliers require to manufacture our products.

In addition, we are currently working with a supplier that is headquartered in Israel on the development of additional manufacturing alternatives. The recent declaration of war by Israel against Hamas, and the resulting actions that may be taken by governments in response to the war, could potentially impact or delay the supplier's ability to provide timely engineering support that may be required to advance our efforts to develop future manufacturing alternatives.