Description
Intersil Corporation. Director DONALD MACLEOD bought 50,000 shares on 11-01-2012 at $ 7.27
BUSINESS OVERVIEW
Company Overview
We design, develop, manufacture and market high-performance analog and mixed-signal integrated circuits (“ICs”). We believe our product portfolio addresses some of the largest opportunities within the industrial, computing, consumer and communications markets.
Our mission is to provide differentiated, high-performance analog and mixed-signal ICs that meet our customers’ needs and exceed their expectations. Our objective is to grow our business faster than our peers. We were formed in August 1999 when we acquired the semiconductor business of Harris Corporation (“Harris”) and began operating as Intersil. We began our transformation into a high-performance analog and mixed-signal company in 2002 with the acquisition of Elantec Semiconductor, Inc. (“Elantec”), the divestiture of our wireless networking business in 2003, the 2004 acquisition of Xicor, Inc. (“Xicor”) and the 2007 acquisition of Planet ATE, Inc.. We acquired D2Audio Corporation, Kenet, Inc. and Zilker Labs, Inc. (“Zilker”) in 2008 and Quellan Inc. (“Quellan”) in 2009. During 2010, we acquired the business of Rock Semiconductor and also acquired Techwell, Inc. (“Techwell”), expanding our leadership in specific high-growth industrial markets.
Our internet address is www.intersil.com . We post the following filings free of charge on our website: our annual reports on
Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K, the filings of our officers and directors pursuant to Section 16(a) of the Securities Exchange Act of 1934 (the “Exchange Act”), our proxy statements on Schedule 14A related to our annual shareholders’ meeting and any amendments to these reports or statements filed or furnished pursuant to Section 13(a) or 15(d) of the Act.
We have adopted a Corporate Code of Ethics, which is applicable to our Senior Financial Officers, including our Chief Executive Officer (“CEO”), Chief Financial Officer (“CFO”), Treasurer and other financial professionals. A complimentary copy of the Code of Ethics is available on our website or upon request. The content on any website referred to in this filing is not incorporated by reference into this filing unless expressly noted otherwise.
The Securities and Exchange Commission (“SEC”) maintains an internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov . You may read and copy any materials filed by us with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549 and may obtain information on the operation of the Public Reference Room by calling the SEC at (202) 551-8090.
Products and Technology
Our product strategy is focused on broadening our portfolio of Application-Specific Standard Products and General Purpose Proprietary Products which are targeted within the industrial, computing, consumer and communications markets.
Industrial
Our industrial products include our operational amplifiers, bridge drivers, isolated and non-isolated power management products, switches and multiplexers, video decoders, and other standard analog and power management products. These products target end markets including medical imaging, energy management, automotive, military, instrumentation, security surveillance and factory automation. The industrial category, which has grown substantially as a result of our acquisition of Techwell, represented 29% of our sales in 2011.
Computing
Our computing products include desktop, server, notebook and network attached storage power management, including core power devices and other power management products for peripheral devices as well as lithium ion battery chargers. The computing category represented 27% of our sales in 2011.
Consumer
Our consumer products include our handheld, display, gaming, light sensor and Class-D audio amplifier products. These products target high-growth applications such as smartphones, LCD televisions, tablet computers, electronic game systems, set top boxes, MP3 players, GPS systems, AV receivers and home audio systems. The consumer category represented 22% of our sales in 2011.
Communications
Our communications products include our line drivers, isolated and non-isolated power management, radiation-hardened products, Zilker Labs digital power management products, broadband and hot plug power management products and high-speed data converters. These products target applications in markets such as DSL, home gateway, satellite, networking, cellular base station and networking/switching equipment. The communications category represented 22% of our sales in 2011.
Glossary
Analog integrated circuits —circuits that operate with voltage and current varying in a continuous fashion; in contrast, digital chips only use and create voltages or currents at discrete levels, with no intermediate values. Some examples of analog ICs are operational amplifiers, voltage references, and comparators.
Bridge driver power management —a device that supplies or accepts power in the form of voltage and current into a circuit that consists of a load connecting two or more switching elements. An example of a bridge driver is a device that opens and closes switches arranged to cause a motor to start, control speed, stop, and reverse direction. Power management to and from those devices is an element of the technology.
Broadband power management —broadband is a term which refers to a signaling method which includes or handles a relatively wide range of frequencies which may be divided into channels. Power management from/to those devices is an element of the technology.
Cellular Base Station —consists of transmission and reception equipment, including the base station antenna, which connects a cellular phone to the network.
Global Positioning System (“GPS”) —devices that use the Global Navigation Satellite System, which is comprised of more than two dozen GPS satellites in medium Earth orbit, transmitting signals allowing GPS receivers to determine the receiver’s location, speed and direction.
Hot plug power management —hot plugging, also known as hot swapping, is the ability to remove and replace components of a machine, usually a computer, while it is operating. A well-known example of this functionality is the universal serial bus (USB) that allows users to add or remove peripheral components. Power management from/to those devices is an element of the technology.
Line driver —an amplifier used to improve the transmission reliability of a digital signal over a metallic transmission line, to longer physical distances, by driving the input to the line with a higher than normal signal level.
Mixed-signal integrated circuits —any IC that has both analog circuits and digital circuits on a single semiconductor die. Examples of mixed-signal ICs include analog-to-digital/digital -to-analog converters, digitally controlled potentiometers, and real time clocks.
MP3 players —devices that play digital audio in the MPEG-1 Audio Layer 3 format, more commonly referred to as MP3, which is an encoding and compression format designed to greatly reduce the amount of data required to represent the audio content.
Multiplexer —also known as ‘mux’, a multiplexer is a device that combines several input signals into a single output signal in such a manner that each of the input signals subsequently can be recovered.
Operational amplifiers —usually referred to as an ‘op-amp,’ captures weak signals from various inputs and amplifies them for processing. Op-amps are among the most widely used electronic devices today, being utilized in a vast array of consumer, industrial, and scientific devices.
Power converters —a circuit which converts a source of direct current from one voltage to another. Converters are important in portable electronic devices such as cellular phones and laptop computers, which are supplied with power from batteries. Such electronic devices often contain several sub-circuits, with each sub-circuit requiring a unique voltage level different than that supplied by the battery.
Smartphones —a cell phone that also adds features that one might find on a computer, such as the ability to access the internet, send and receive e-mail and edit documents.
Sales, Marketing and Distribution
In 2011, we derived approximately 47% of our revenues from original equipment manufacturer (“OEM”) customers, original design manufacturer (“ODM”) customers, and contract manufacturers. We derived approximately 53% of our revenues through distributors and value-added resellers.
Our sales organization is supported by customer service and logistics organizations throughout the world. Product orders flow to our fabrication facility or to foundries where the semiconductor wafers are made. Most of our semiconductors are assembled and tested at the facilities of independent subcontractors. Finished products are then shipped to customers either indirectly via third parties or directly via company-managed warehouses.
To serve our customer base, we maintain a highly focused sales team, which focuses on those major accounts that are strategic to our marketing and product strategies. Our direct geographical sales organizations sell products in regions throughout the world. The geographical sales force works closely with a network of distributors and manufacturers’ representatives, creating a worldwide selling network. Dedicated direct sales organizations operate in the North American, European, Japanese and Asia/Pacific markets. We strategically locate sales offices near major OEM and ODM customers throughout the world. The technical applications organization is deployed alongside the direct sales force, ensuring both applications and product/customer focus. Our dedicated marketing organization supports field sales and is aligned by specific product group.
Manufacturers’ representatives generally do not offer products that compete directly with our products, but may offer complementary items manufactured by others. Manufacturers’ representatives do not maintain product inventory; instead, customers place large quantity orders either directly with us or through these manufacturers’ representatives. Smaller quantity orders are typically placed through distributors.
Distributors and value-added resellers handle a wide variety of products, including products sold by other companies that compete with our products. Most of our sales to distributors include agreements allowing for market price fluctuations and/or the right to return some unsold products. Some of our distribution agreements contain an industry standard stock rotation provision allowing for minimum levels of inventory returns or scrap. In our experience, these inventory returns can usually be resold. We recognize revenue shipped to North American distributors when the distributor sells the product. We generally recognize sales made to international distributors when product is shipped to the international distributors and provisions are recorded on those sales for expected price fluctuations and returns.
Research and Development
We believe that the continued introduction of new products in our target markets is essential to our growth. We incurred costs of $185.5 million, $183.3 million and $145.1 million on research and development projects in 2011, 2010 and 2009, respectively, including equity-based employee compensation. We believe that we must continue to innovate, enhance and expand our products and services to maintain our leadership position, and we intend to achieve this through in-house research and development and, occasionally, selective acquisitions. As of December 30, 2011, we had more than 700 employees engaged in research and development. We introduce hundreds of new products each year over many different product families that serve many different markets.
Manufacturing
Our products utilize silicon wafers containing ICs. Our business is dependent upon reliable fabrication, packaging and testing of these wafers. We fabricate wafers of ICs in our Florida manufacturing facility. We also have wafers of ICs manufactured by leading foundry suppliers such as IBM Microelectronics, Taiwan Semiconductor Manufacturing Company and United Microelectronics Corporation. We believe that our strategy of employing internal and foundry suppliers provides an increased level of flexibility and capacity to meet production demand. In addition, this strategy significantly reduces the ongoing capital investment required to maintain our production capabilities. During 2011, we internally produced approximately 15% of our wafers and outsourced the remaining 85% from foundry partners.
Following fabrication, wafers are subject to packaging and testing processes. The majority of these processes are performed by independent subcontractors located in Malaysia, Taiwan, China and Singapore. However, we maintain internal assembly and test capabilities for certain products in Florida and California.
In 2011, we did not experience delays in obtaining raw materials. However, our reliance on foundry partners for silicon wafers, the building block of our products, is critical and the relative importance of this part of the supply chain continues to increase, increasing our risk of incurring a production-limiting shortfall. As is typical in the industry, we must allow for significant lead times in delivery of certain materials. The production of ICs, from wafer fabrication through packaging and final testing, may take from eight to sixteen weeks. We manufacture thousands of product types and our customers often require delivery within a short period of time following their order. To consistently meet these requirements, we maintain a substantial work-in-process and finished goods inventory. Manufacture, assembly and testing of ICs is a complex process. Normal risks include errors and interruptions in the production process, defects and shortages in raw materials, disruptions at supplier locations, unexpected demand, as well as other risks, all of which can have an unfavorable impact to production costs, gross margins and our ability to meet customer demand.
Backlog
Our product sales are made pursuant to purchase orders that are generally booked up to six months in advance of delivery. Our standard terms and conditions of sale provide that these orders may not be cancelled or rescheduled thirty days prior to the most current customer request date (“CRD”) for standard products and ninety days prior to CRD for semi-custom and custom products. Backlog is influenced by several factors, including end market demand, pricing and customer order patterns in reaction to product lead times. Additionally, we believe backlog can fall faster than consumption rates in periods of weak end market demand since production lead times can be shorter. Conversely, we believe backlog can grow faster than consumption in periods of strong end market demand as production and delivery times increase and some customers may increase orders in excess of their current consumption to reduce their own risk of production disruptions.
Our six-month backlog as of December 30, 2011 was $134.8 million compared to the six-month backlog as of December 31, 2010 of $166.3 million. Although not always the case, as discussed in the foregoing paragraph, backlog can be a leading indicator of near-term revenue performance.
See Business Outlook elsewhere in the accompanying Management’s Discussion and Analysis of Financial Condition and Results of Operations relating to expected revenues in the near-term.
Seasonality
The consumer and computing markets have historically experienced weaker demand in the first half of the year than in the second half of the year in the semiconductor industry. However, economic events, acquisitions and the cyclical nature of the industry have had a greater impact on quarterly fluctuations in recent years.
Competition
The high-performance analog and mixed-signal market is extremely competitive. We compete in our target markets with many companies that may have significantly greater financial, technical, manufacturing and marketing resources than us, including but not limited to Texas Instruments, Analog Devices, Linear Technology, ON Semiconductor and Maxim Integrated Products. We compete on the basis of technical performance, product features, customized design, price, availability, quality, reliability, sales and technical support. Our ability to compete successfully depends on elements both within and outside of our control, including successful and timely development of new products and manufacturing processes, product performance and quality, manufacturing yields, product availability, intellectual property protection obtained by us and our competitors, customer service, pricing, industry trends and general economic trends.
Trademarks and Patents
We own rights to a number of trademarks and patents that are important to our business. Our trademarks do not expire as long as we continue to use them in our business. We have registered some of our trademarks with the U.S. Patent and Trademark Office and other foreign governmental trademark authorities. These registrations provide rights in addition to basic trademark rights. As long as we comply with renewal and other procedures specified by the applicable trademark laws, these additional rights will not expire. Our corporate policy is to protect proprietary products by obtaining patents for these products when practicable. We currently possess over 1,200 U.S. and foreign patents and have approximately 1,150 U.S. and foreign patents pending. The expiration dates of these patents range from 2012 to 2030.
Employees
Our worldwide workforce consisted of 1,643 employees (full and part-time) as of December 30, 2011. None of our employees are subject to a collective bargaining agreement.
Environmental Matters
We believe that our operations are substantially in compliance with applicable environmental requirements. Our costs and capital expenditures to comply with environmental regulations have been immaterial during the last three years. However, we are subject to numerous federal, state and international environmental laws and regulatory requirements. From time to time, we become involved in investigations or litigations of various potential environmental issues concerning activities at our facilities or former facilities or remediation as a result of past activities (including past activities of companies we have acquired). Further, we may receive notices from the U.S. Environmental Protection Agency or equivalent state or international environmental agencies that we are a potentially responsible party under the Comprehensive Environmental Response, Compensation and Liability Act (commonly known as the “Superfund Act”) and/or equivalent laws. Such notices assert potential liability for cleanup costs at various sites, which may include sites owned by us, sites we previously owned and treatment or disposal sites not owned by us, allegedly containing hazardous substances attributable to us from past operations. While it is not feasible to predict the outcome of many of these proceedings, in the opinion of our management, any payments we may be required to make as a result of such claims in existence will not have a material adverse effect on our financial condition, results of operations or cash flows. To the extent any known contamination was caused prior to August 1999, Intersil is indemnified against any associated environmental liabilities. This indemnification does not expire, nor does it have a maximum amount.
CEO BACKGROUND
David B. Bell, CEO, President, and Director. Mr. Bell, age 55, has served as our CEO, President and Director since February 13, 2008 . Prior to this, Mr. Bell served as President, Chief Operating Officer, and Director of Intersil from April 2, 2007 to February 12, 2008. Prior to joining Intersil, Mr. Bell was employed for 12 years with Linear Technology Corporation (“LTC”), most recently, from June 2003 to January 2007, as its President. Prior to becoming President of LTC, from January 2002 to June 2003, Mr. Bell served as LTC’s Vice President and General Manager of Power Products and, from February 1999 to January 2002, as LTC’s General Manager of Power Products. From June 1994 to January 1999, he held the position of LTC’s Manager of Strategic Product Development. Mr. Bell has served on the Board of Directors of the Semiconductor Industry Association since March 2008, the Board of Open-Silicon, Inc., a semiconductor design and manufacturing company since March 2010, and the Board of the Global Semiconductor Alliance since November 2011. Mr. Bell joined the Board of the Silicon Valley Leadership Group in September 2011. Mr. Bell’s qualifications to serve as a Director include his more than 30 years of management experience at analog companies in positions including CEO, President, Chief Operating Officer and Research and Development Manager.
Robert W. Conn, Director. Dr. Conn, age 69, has been a Director since April 2000. Dr. Conn was appointed President and director of the Kavli Foundation, a philanthropic organization, in April 2009. Dr. Conn has been President of Conn Engineering & Consulting, Inc. since 2002. In addition, he has been a Professor and Dean of Engineering, Emeritus, at the University of California, San Diego since 2004. From 2002 to 2008, Dr. Conn was Managing Director of Enterprise Partners Venture Capital. From 1994 to July 2002, Dr. Conn was the Dean of the Jacobs School of Engineering, University of California, San Diego, and the Walter J. Zable Endowed Chair in Engineering. Dr. Conn served on the Board of Directors of ChipPAC, Inc. from 2002 through 2004, and on the Board of Directors of STATS ChipPAC, Inc. from 2004 through 2007. Presently, he is a member of the National Academy of Engineering. Dr. Conn has previously served on the Board of Directors of several privately-held companies. Dr. Conn’s qualifications to serve as a Director include his academic experience as Professor of Engineering and Dean of a major university engineering department and his experience as a venture capitalist specializing in technology companies.
James V. Diller, Director . Mr. Diller, age 76, has been a Director since May 2002. Mr. Diller is a retired Chairman of the Board of Elantec Semiconductor, Inc., a post he held from 1997 to May 2002. Mr. Diller served as a Director of Elantec Semiconductor, Inc. from 1986 to May 2002 when Elantec was acquired by Intersil. From November 1998 to July 2000, he served as Elantec’s President and CEO. Mr. Diller is a founder of PMC-Sierra, Inc., a company that engages in the design, development, marketing, and support of communications semiconductors, storage semiconductors, and microprocessors and was its President and CEO from 1983 to 1997; he is currently Vice Chairman of the Board of Directors. In addition, Mr. Diller became Chairman of the Board of Avago Technologies Limited, a leading global manufacturer of optoelectronics and analog interface components, in January 2010 and previously served on the Board of Avago since December 2005. He was a Director of Sierra Wireless, Inc. from 1993 through 2003. Mr. Diller also serves on the Board of Directors of a privately-held company. Mr. Diller’s qualifications to serve as a Director include his extensive analog IC company management experience in positions such as Chairman of the Board, CEO, President and General Manager, and his experience as a product development engineer.
Gary E. Gist, Director . Mr. Gist, age 65, has been Chairman of the Board since May 2005. Prior to this, Mr. Gist served as a Director since our inception in August 1999. Mr. Gist has served as vice president of Palomar Display Products, a privately held company that engages in the development and integration of displays and computer systems for demanding applications used in harsh environments, since January 2009. He has also served as a member of the Board of Directors of Palomar Display Products since May 2009. From 1995 to 2008, Mr. Gist served as the President and CEO of Palomar Technological Companies. Mr. Gist also serves on the Board of Directors of a privately-held company. Mr. Gist’s qualifications to serve as a Director include his management experience as Director, CEO and President of a technology company providing products to the semiconductor industry and his financial experience as a CPA with a prominent public accounting firm.
Mercedes Johnson, Director. Ms. Johnson, age 58, has been a Director since August 2005. Ms. Johnson was previously the Senior Vice President of Finance and Chief Financial Officer (“CFO”) at Avago Technologies from November 2005 until her retirement in August 2008. Prior to her employment with Avago, Ms. Johnson worked for Lam Research Corporation, serving as its Senior Vice President of Finance from June 2004 to January 2005, and as its CFO from April 1997 to May 2004. Ms. Johnson has served as a member of the Board of Directors of Micron Technology, Inc. since June 2005 and has served as a member of the Board of Directors of Juniper Networks since May 2011. She also served on the Board of Directors for Storage Technology Corporation from January 2004 to August 2005. Ms. Johnson’s qualifications to serve as a Director include her experience as a senior financial executive at semiconductor and semiconductor equipment companies, and as a board member of a publicly-traded semiconductor company.
Gregory Lang, Director . Mr. Lang, age 48, has been a Director since February 2006. Mr. Lang has served as President, CEO and Director of PMC-Sierra, Inc., a company that engages in the design, development, market and support of semiconductor solutions for storage, mobile and optical networks, since May 2008. In March 2008, Mr. Lang resigned his position as President, CEO and Director of Integrated Device Technology Inc. (“IDT”). Mr. Lang joined IDT as President in October 2001, was appointed CEO in January 2003 and elected to the IDT Board of Directors in September 2003. Prior to joining IDT, Mr. Lang held the position of Vice President and General Manager of Intel’s platform networking group. Previously he managed Intel’s Ethernet, storage I/O processing, home networking and broadband businesses. Mr. Lang’s qualifications to serve as a Director include his 25 years of experience in the semiconductor industry in positions including CEO, President and Vice President and General Manager.
Jan Peeters, Director. Mr. Peeters, age 60, has been a Director since April 2000. Mr. Peeters is Chairman and CEO of Olameter Inc., a meter asset and data management company, which he formed in 1998. He presently serves, since 1998, as Chairman of Cogeco Inc. and Cogeco Cable Inc., publicly-traded Canadian companies in the areas of broadcasting and cable. In addition, Mr. Peeters serves as Chairman, since 2009, on the Board of GFFI, a small-cap financing company. Mr. Peeters served as Chairman on the Board of iNovia Capital, a venture capital company from 1999 to 2011. He also served as Governor of McGill University from 1999 to 2009 and he served on the Board of Directors of Call-Net, a publicly-traded Canadian telecommunications company, from 1999 to 2002. He was previously founder, vice-chairman, president and CEO of Fonorola Inc., a facilities-based long-distance telephone company from 1988 to 1998, at which time it was acquired by Call-Net Enterprises Inc. Mr. Peeters’ qualifications to serve as a Director include his senior executive experience at public and private companies in positions such as Chairman, Director and CEO.
Robert N. Pokelwaldt, Director. Mr. Pokelwaldt, age 75, has been a Director since April 2000. Mr. Pokelwaldt was previously Chairman and CEO of YORK International Corporation, a manufacturer of air conditioning and cooling systems from January 1993 until his retirement in October 1999. While at YORK International Corporation, he also served as President, CEO and Director from June 1991 to January 1993 and was President and Chief Operating Officer from January 1990 to June 1991. Mr. Pokelwaldt retired from the Board of Directors of Carpenter Tech in May 2004 and he retired from the Board of Directors of Mohawk Industries, Inc. in May 2011. Mr. Pokelwaldt’s qualifications to serve as a Director include his senior executive experience at public and private companies in positions such as Chairman, Director and CEO.
James A. Urry, Director. Mr. Urry, age 58, has been a Director since our inception in August 1999. Mr. Urry has served as Chief Investment Officer and Managing Partner at Augusta Columbia Capital Group LLC since May 2011. Prior to this, Mr. Urry was a Partner at Court Square Capital Partners, a private equity firm from July 2007 to May 2011. Court Square Capital Partners was established as a result of a spin-off from Citigroup Venture Capital Ltd. in 2007. Previous to this, Mr. Urry was a Partner at Citigroup Venture Capital Ltd. from 1989 to June 2007. Mr. Urry served on the Board of Directors of Lyris, Inc. from June 2007 to August 2011 He also served as a Director of AMI Semiconductor prior to the merger of AMI and ON Semiconductor on March 12, 2008. Mr. Urry’s qualifications to serve as a Director include his experience as a senior executive at private equity firms, and as a Director at a public semiconductor firm.
MANAGEMENT DISCUSSION FROM LATEST 10K
Overview
We focus our design, development, manufacturing and marketing efforts on the high-performance analog and mixed-signal segment of the semiconductor market. Digital and analog semiconductor components are the basic ingredient in today’s electronic devices. In contrast to the binary nature of digital components, analog components monitor, evaluate and modify electrical signals and strengths allowing them to deal with basic and essential properties such as heat, touch, light and sound. The high-performance analog and mixed-signal segment is distinguished by its highly differentiated and technologically advanced products which can be building blocks for more complex circuits or highly integrated for specific applications. Historically, the high-performance analog and mixed-signal segment has yielded higher gross margins and suffers less competition than the digital and broader analog segments of the semiconductor market. The high-performance analog and mixed-signal segment requires uniquely talented and experienced designers, engineers and specialized selling and marketing efforts to address the myriad of challenges associated with today’s complex applications.
We began our transformation into a high-performance analog and mixed-signal company with the acquisition of Elantec in 2002 and the divestiture of our wireless networking business in 2003. We further strengthened the transformation with the 2004 acquisition of Xicor. Our transformation has required us to report our financial performance with restructurings, impairments, discontinued operations and write-offs attendant to our acquisitions. Our first full year as a pure high-performance analog and mixed-signal company was 2004. Since then, our focus has resulted in revenue growth that has been very broad-based across our many analog and mixed-signal products. We have introduced hundreds of new products in each of the last few years including several new product families that have significantly expanded our served available market. In April 2010, we completed the acquisition of Techwell, bringing unique capabilities which complement our industrial video businesses and making industrial our largest end market. Our investments to expand our product portfolio to over 60 product families appear to be successful, which will enable us to reach our primary management goals of revenue growth with higher margins, growing operating income and increasing cash flow generation measured against the investment in the company.
Operating Expenses
Research and Development (“R&D”)
R&D expenses consist primarily of salaries and expenses of employees engaged in product/process research, design and development activities, as well as related subcontracting activities, prototype development, cost of design tools and technology license agreement expenses.
Our R&D expenses increased by 1% or $2.1 million to $185.5 million in 2011 compared to $183.3 million for 2010. While we continue to invest in R&D to persue future growth, we implemented cost saving initiatives in the third and fourth quarters of 2011 to optimize and integrate acquired organizations and to maintain R&D spending at approximately 2010 levels. We realigned our resources to focus on our primary future growth drivers while continuing to invest in products aimed at the broad industrial market.
Our R&D expenses increased by 26% or $38.3 million to $183.3 million in 2010 compared to $145.1 million for 2009. We grew our R&D spending primarily through additional employees gained in acquisitions in order to invest in future products and technology essential for long-term growth.
Selling, General and Administrative (“SG&A”)
SG&A expenses consist primarily of salaries and expenses of employees engaged in selling and marketing our products as well as the salaries and expenses required to perform our human resources, finance, information systems, legal, executive and other administrative functions.
Our SG&A expenses increased by 2% or $2.6 million to $140.0 million for 2011 compared to $137.5 million for 2010. The increase in 2011 was primarily due to higher labor costs and supplies from additional employees gained in acquisitions during 2010 and increased sales and incentives during the first quarter of 2011.
Our SG&A expenses increased by 14% or $17.0 million to $137.5 million for 2010 compared to $120.5 million for 2009. The increase in 2010 was primarily driven by increased sales commissions, compensation expense and increased incentives as sales increased.
Amortization of Purchased Intangibles
Amortization of purchased intangibles was $26.8 million in 2011, $27.7 million in 2010 and $12.7 million in 2009. The decrease in 2011 was primarily due to intangibles that became fully amortized during 2011. The increase in 2010 was primarily due to purchased intangibles from the acquisition of Techwell in the second quarter of 2010. Our purchased intangibles, which are definite-lived assets, are amortized over their useful lives ranging from 3 to 11 years.
Restructuring
Restructuring costs were $4.1 million in 2011, minimal in 2010 and $2.1 million in 2009. The 2011 restructuring was part of our ongoing efforts to optimize operations and conclude the integrations of acquired organizations. It included workforce reductions of approximately 5% and an anticipated reduction in annual operating expenses of approximately $13 million. Restructuring expenses in 2009 related to our fab consolidation efforts announced in 2008.
Acquisition-related Costs
Acquisition-related costs were $0.3 million in 2011, $8.0 million in 2010 and $0.9 million in 2009. Acquisition-related costs in 2011 and 2010 were primarily due to the acquisition of Techwell in the second quarter of 2010. Acquisition-related costs in 2009 were primarily related to the Quellan acquisition in the third quarter of 2009.
Other Income and Expenses
Interest Income
Our interest income decreased 14% to $2.7 million in 2011 compared to $3.1 million in 2010 and $5.4 million in 2009. Interest income decreased in 2011 and 2010 due to decreased average cash and investment balances and continued low interest rates.
Interest Expense and Fees
Our interest expense and fees increased to $14.5 million in 2011 from $12.9 million in 2010 and $0.6 million in 2009. The increase was due to interest and fees on the long-term debt agreement entered into during 2010 to facilitate the acquisition of Techwell.
Loss on Extinguishment of Debt
During the year ended December 30, 2011, we extinguished our previous term-loan agreement and wrote-off $8.4 million in unamortized loan fees.
(Loss) Gain on Deferred Compensation Investments
We have a liability for a non-qualified deferred compensation plan. We maintain a portfolio of approximately $11.2 million in mutual fund investments and corporate owned life insurance under the plan. Changes in the fair value of the asset are recorded as a (loss) gain on deferred compensation investments and changes in the fair value of the liability are recorded as a component of compensation expense. In general, the compensation (benefit) expense is substantially offset by the gains and losses on the investment. During 2011, we recorded a loss on deferred compensation investments of $0.5 million and a decrease in compensation expense of $0.1 million. During 2010, we recorded a gain on deferred compensation investments of $0.9 million and an increase in compensation expense of $1.1 million.
Loss on Sale of Investments
During 2011, we sold our entire remaining portfolio of auction rate securities (“ARS”) for a net loss of $6.5 million, before taxes. During 2010, we recorded a $0.1 million loss on the sale of certain investments, before taxes. There were no losses on the sale of investments in 2009.
Other-Than-Temporary Impairment Losses
During 2010 and 2009, we recorded impairment charges of $1.1 million and $14.3 million, respectively, before taxes, on certain ARS whose decline in fair value was determined to be other-than-temporary. The impairments were recorded due to credit rating downgrades on specific investments in the ARS portfolio. We did not record any other than temporary impairments in 2011.
Income Tax (Benefit) Expense
Our income tax benefit was $13.7 million for 2011 compared to tax expense of $85.4 million for 2010. Income tax for 2011 included a benefit of $10.9 million related to the re-measurement of our unrecognized tax benefits (“UTBs”). We re-measured certain of our UTBs as we approach closure on our IRS audit for tax years 2005 through 2007 which is currently in the appeals process and as we progress through the audit for tax years 2008 and 2009 which is currently under examination. Also as a result of our progress in appeals, we included a benefit of $9.7 million related to incremental prior year federal and state R&D credits net of a valuation allowance on the state portion of these credits. Income tax expense for 2010 included a $68.8 million charge due primarily to a provision established upon the completion of fieldwork on a multi-year IRS examination, offset by a tax benefit of $4.5 million resulting from the donation of a portion of our facilities in Palm Bay.
Our income tax expense was $85.4 million for 2010 compared to tax expense of $7.6 million for 2009. Income tax expense for 2010 included a $68.8 million charge due primarily to a provision established upon the completion of fieldwork on a multi-year IRS examination, offset by a tax benefit of $4.5 million resulting from the donation of a portion of our facilities in Palm Bay. Income tax expense for 2009 included a $5.2 million benefit related to a reversal of the valuation allowance associated with previously recorded impairments on ARS, partially offset by a $3.4 million charge related to the move of our international headquarters.
In determining net income, we estimate and exercise judgment in the calculation of tax expense and tax liabilities, and in assessing the recoverability of deferred tax assets that arise from temporary differences between the tax and financial statement recognition of assets and liabilities.
In the ordinary course of business, the ultimate tax outcome of many transactions and calculations is uncertain, as the calculation of tax liabilities involves the application of complex tax laws in the United States and other jurisdictions. We recognize liabilities for additional taxes that may be due on tax audit issues based on an estimate of the ultimate resolution of those issues. Although we believe the estimates are reasonable, the final outcome may be different than amounts we estimate. Such determinations could have a material impact on the income tax provision, effective tax rate and operating results in the period they occur. In addition, the effective tax rate reflected in our forward-looking statements is based on current enacted tax law. Significant changes in enacted tax law could materially impact our estimates.
Backlog
Our sales are made pursuant to purchase orders that are generally booked up to six months in advance of delivery. Our standard terms and conditions of sale provide that these orders may not be cancelled or rescheduled thirty days prior to the most current CRD for standard products and ninety days prior to the customer request date for semi-custom and custom products. Backlog is influenced by several factors, including end market demand, pricing and customer order patterns in reaction to product lead times. Additionally, we believe backlog can fall faster than consumption rates in periods of weak end market demand since production lead times can be shorter. Conversely, we believe backlog can grow faster than consumption in periods of strong end market demand as production and delivery times increase and some customers may increase orders in excess of their current consumption to reduce their own risk of production disruptions.
Our six-month backlog was $134.8 million as of December 30, 2011 compared to $166.3 million as of December 31, 2010 and $157.4 million as of January 1, 2010. Although not always the case, we believe backlog can be an indicator of performance in the near future.
Business Outlook
When we announced via our Fourth Quarter 2011 Earnings press release (filed with our Current Report on Form 8-K on February 1, 2012), we anticipated revenues for the first quarter of 2012 to be in the range of $152 to $160 million. Based on this outlook, we expected first quarter 2012 earnings (loss) per diluted share between ($0.03) and $0.00.
Impact of Inflation and Changing Prices
The semiconductor industry has, for several decades, experienced a phenomenon of continual decline in sales prices per unit. This phenomenon brings unique challenges to managing our business. In order to increase revenues, we must continually introduce new products that support higher sales prices or increase the units of product sold. This leads to capacity and production management issues and requires a large investment in research and development to regularly introduce new products that are differentiated based on qualities other than price and enable us to increase our average unit selling prices. At the same time we are faced with many fixed costs in our business that increase at the same rate of general inflation in the economy and must be managed carefully and aggressively in order to maintain operating margins. These characteristics of revenue pressure from selling price, the need to invest heavily in research and development and inflation-prone fixed costs means that earning a reasonable return for our shareholders is challenging.
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; revenue growth or decline; and potential acquisitions. We believe that we have the financial resources necessary to meet business requirements for the next 12 months, including our dividend program, the requisite capital expenditures for the maintenance of worldwide manufacturing capacity, working capital requirements and potential future acquisitions or strategic investments. As of December 30, 2011, our total shareholders’ equity was $1,080.7 million and we had $383.7 million in cash and cash equivalents. We had $26.5 million in short-term investments and $4.8 million in long-term investments, both primarily bank time deposits, as of December 30, 2011. In addition, as of December 30, 2011, we had $200.0 million in long-term debt outstanding (see Note 11 in the accompanying consolidated financial statements).
As of December 30, 2011, approximately $320.3 million of our cash and cash equivalents, short-term investments and long-term investments was held by our foreign subsidiaries. This amount would be subject to federal and state taxation at approximately 37.5% upon repatriation. We currently do not intend nor foresee a need to repatriate these funds. As of December 30, 2011, all of our short and long-term investments were held by our foreign subsidiaries and were all denominated in U.S. dollars.
On September 1, 2011, we established a new five-year, $325.0 million revolving credit facility (the “Facility”). This Facility replaced our previous $300.0 million term-loan facility and $75.0 million revolving credit facility. As of December 30, 2011, the outstanding principal balance on the Facility was $200.0 million, resulting in $125.0 million of borrowing capacity. The Facility matures on September 1, 2016 and is payable in full upon maturity. Under the Facility, $25.0 million is available for the issuance of standby letters of credit, $10.0 million is available as swing line loans and $50.0 million is available for multicurrency borrowings. Amounts repaid under the Facility may be reborrowed. The Facility currently bears interest at 2.25% over one-month LIBOR but is variable based on our leverage ratio as described in the Credit Agreement in Exhibit 10.1. As of December 30, 2011, we were in compliance with all applicable covenants of the Credit Agreement.
Distributor, OEM and warranty allowances, or “Other Allowances”
Allowances for various customer credits are shown in the table above as “Other allowances.” This is a combination of distributor, OEM and warranty allowances.
Sales to international distributors are made under agreements which provide the distributors certain price protection on a percentage of unsold inventories they hold. Accordingly, distributor allowances are estimates of the amount of price adjustments that will be encountered in the future on inventory held by international distributors as of the balance sheet date. We rely primarily on historical international distributor transactions to estimate these adjustments. The international distributor allowances are comprised of two components that are reasonably estimable. The first component is the price protection allowance, which protects the distributors’ gross margins in the event of falling prices (which are common in semiconductors and other electronic components). This allowance is based on the relationship of historical credits issued to distributors in relation to historical inventory levels and the price paid by the distributor as applied to current inventory levels. The second component is a stock rotation allowance, which is based on the percentage of sales made to limited international distributors whereby the distributors can periodically receive a credit for unsold inventory they hold. Distributor allowances were $12.4 million as of December 30, 2011 and $3.1 million as of December 31, 2010. In 2011, we entered into price protection agreements with additional international distributors to solidify our relationship and stabilize prices across geographic regions.
Allowances for our OEM customers totaled $1.8 million as of December 30, 2011. Warranty allowances, returns for which there are product performance claims, totaled $0.3 million as of December 30, 2011.
Allowances for excess or obsolete inventory, or “Inventory Allowances”
We record our inventories at the lower of cost or market as described in Note 2 to the accompanying consolidated financial statements. As the ultimate market value that we will realize through sales on our inventory cannot be known with exact certainty, we rely on past sales experience and future sales forecasts to project it. In analyzing our inventory levels, we classify certain inventory as either excess or obsolete. These classifications are maintained for all classes of inventory, although raw materials are seldom deemed excess or obsolete. We classify inventory as obsolete if we have withdrawn it from the marketplace or if we have had no sales of the product for the past 18 months and no sales forecasted for the next 24 months. We provide an allowance for 100% of the standard cost of obsolete inventory. It is our policy to scrap obsolete inventory. We conduct reviews of excess inventory on a quarterly basis and reserve a significant portion of the standard cost of excess inventory. We classify inventory as excess if we have quantities of product greater than the amounts we have sold in the past 18 months or have forecasted to sell in the next 24 months. We typically retain excess inventory until the inventory is sold or reclassified as obsolete.
For all items identified as excess or obsolete, management reviews the individual facts and circumstances, i.e.: competitive landscape, industry economic conditions, product lifecycles and product cannibalization, specific to that inventory. Inventory allowances totaled approximately $37.4 million on gross inventory of $135.3 million as of December 30, 2011 and $45.6 million on gross inventory of $147.6 million as of December 31, 2010.
Product demand estimates are a key element in determining inventory allowances. Our estimate of product demand requires significant judgment and is based in part on historical revenue. Historical sales may not accurately predict future demand. If future demand is ultimately lower than our estimate, we could incur significant additional expenses to provide allowances for and scrap obsolete inventory.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Overview
We design, develop, manufacture and market high-performance analog, mixed-signal and power integrated circuits (“ICs”). We believe our product portfolio addresses some of the fastest growing applications within the Industrial & Infrastructure, Consumer, and Personal Computing markets.
Critical Accounting Policies
You should refer to the disclosures regarding critical accounting policies in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the fiscal year ended December 30, 2011.
Operating Costs and Expenses
Research and Development (“R&D”)
R&D expenses consist primarily of salaries and expenses of employees engaged in product/process research, design and development activities, as well as related subcontracting activities, prototype development, cost of design tools and technology license agreement expenses.
R&D expenses decreased $1.6 million or 3.3% to $46.2 million during the quarter ended June 29, 2012 from $47.8 million during the quarter ended July 1, 2011. We reduced our R&D spending primarily through lower incentive compensation due to lower operating income and cost reduction initiatives.
R&D expenses decreased $6.9 million or 7.1% to $90.6 million during the two quarters ended June 29, 2012 from $97.5 million during the two quarters ended July 1, 2011. We reduced our R&D spending primarily through lower incentive compensation due to lower operating income and cost reduction initiatives.
Selling, General and Administrative (“SG&A”)
SG&A expenses consist primarily of salaries and expenses of employees engaged in selling and marketing our products as well as the salaries and expenses required to perform our human resources, finance, information systems, legal, executive and other administrative functions.
SG&A costs increased by $0.1 million or 0.4% to $36.4 million during the quarter ended June 29, 2012 from $36.2 million during the quarter ended July 1, 2011. The increase was driven primarily by increased legal and other professional fees, offset by cost reduction initiatives and lower incentive compensation due to lower operating income.
SG&A costs decreased by $0.6 million or 0.9% to $70.6 million during the two quarters ended June 29, 2012 from $71.2 million during the two quarters ended July 1, 2011. The decrease was driven by decreased sales incentives, compensation expense and other incentive compensation offset by increased legal and other professional fees.
Amortization of Purchased Intangible Assets
Amortization of purchased intangible assets increased $0.5 million or 7.2% to $7.2 million in the quarter ended June 29, 2012 from $6.7 million in the quarter ended July 1, 2011. Amortization of purchased intangible assets increased $0.8 million or 6.1% to $14.4 million in the two quarters ended June 29, 2012 from $13.6 million in the two quarters ended July 1, 2011. The increase related to additional amortization on in-process research and development projects acquired from Techwell, Inc. and completed during the quarter ended March 30, 2012.
Restructuring
Restructuring costs were $8.3 million in the quarter ended June 29, 2012 and $0.1 million in the quarter ended July 1, 2011. Restructuring costs were $9.8 million in the two quarters ended June 29, 2012 and $2.4 million in the two quarters ended July 1, 2011. The restructurings were part of our ongoing efforts to optimize operations. It included a workforce reduction of approximately 11% and an ongoing reduction in annual operating expenses of approximately $40.0 million.
Other Income and Expenses
Interest Income
Interest income decreased to $0.1 million during the quarter ended June 29, 2012 from $0.7 million during the quarter ended July 1, 2011. Interest income decreased to $0.3 million during the two quarters ended June 29, 2012 from $1.5 million during the two quarters ended July 1, 2011. The decrease was due primarily to the sale of our remaining auction rate securities in the fourth quarter of 2011.
Interest Expense and Fees
Interest expense and fees decreased to $1.8 million during the quarter ended June 29, 2012 from $4.2 million during the quarter ended July 1, 2011. Interest expense decreased to $3.8 million during the two quarters ended June 29, 2012 from $8.7 million during the two quarters ended July 1, 2011. The decrease was due to the replacement of our previous long-term debt agreement with a new revolving loan facility with a lower interest rate and repayments of our debt.
(Loss) Gain on Deferred Compensation Investments, Net
We have a liability for a non-qualified deferred compensation plan. We maintain a portfolio of approximately $11.0 million in mutual fund investments and corporate owned life insurance under the plan. Changes in the fair value of the asset are recorded as a gain or loss on deferred compensation investments and changes in the fair value of the liability are recorded as a component of compensation expense. In general, the compensation expense or benefit is substantially offset by the gains and losses on the investment. During the quarter ended June 29, 2012, we recorded a loss of $0.5 million on deferred compensation investments and a decrease in compensation expense of $0.5 million. During the two quarters ended June 29, 2012, we recorded a gain on deferred compensation investments of $0.2 million and a $0.3 million increase in compensation expense.
Income Tax Expense
Income tax expense for the quarter ended June 29, 2012 was $3.1 million compared with $5.7 million for the quarter ended July 1, 2011. The quarter ended June 29, 2012 included $8.6 million of income tax benefit offset by an $11.7 million discrete tax charge related to a tax election on transfer pricing in connection with the resolution of the IRS audit of tax years 2005-2007. Excluding discrete items, the effective tax rate for the quarter ended June 29, 2012 was higher than the same quarter last year due to a greater portion of income in higher tax jurisdictions and the expiration of the research and development credit.
Income tax expense for the two quarters ended June 29, 2012 was $3.1 million compared with $8.8 million for the two quarters ended July 1, 2011. The effective tax rate for the two quarters ended June 29, 2012, excluding discrete items, was higher than the prior year due to a greater portion of income in higher tax jurisdictions and the expiration of the research and development credit.
In determining net income, we estimate and exercise judgment in the determination of tax expense and tax liabilities and in assessing the recoverability of deferred tax assets that arise from temporary differences between the tax and financial statement recognition of assets and liabilities.
In the ordinary course of business, the ultimate tax outcome of many transactions and calculations is uncertain, as the calculation of tax liabilities involves the application of complex tax laws in the United States and other jurisdictions. We recognize liabilities for additional taxes that may be due on tax audit issues based on an estimate of the ultimate resolution of those issues. Although we believe the estimates are reasonable, the final outcome may be different than amounts we estimate. Such determinations could have a material impact on the income tax provision, effective tax rate and operating results in the period they occur. In addition, the effective tax rate reflected in our forward-looking statements is based on current enacted tax law. Significant changes in enacted tax law could materially affect our estimates.
Backlog
Our sales are made pursuant to purchase orders that are generally booked up to six months in advance of delivery. Our standard terms and conditions of sale provide that these orders may not be cancelled or rescheduled thirty days prior to the most current customer request date (“CRD”) for standard products and ninety days prior to the CRD for semi-custom and custom products. Backlog is influenced by several factors, including end market demand, pricing and customer order patterns in reaction to product lead times. Additionally, we believe backlog can decline faster than consumption rates in periods of weak end market demand since production lead times can be shorter. Conversely, we believe backlog can grow faster than consumption in periods of strong end market demand as production and delivery times increase and some customers may increase orders in excess of their current consumption to reduce their own risk of production disruptions.
Our six-month backlog was $127.4 million as of June 29, 2012 compared to $134.8 million as of December 30, 2011 and $174.8 million as of July 1, 2011. Although not always the case, we believe backlog can be an indicator of performance in the near future.
Business Outlook
In our second quarter 2012 earnings release, furnished as an exhibit to the Form 8-K we filed with the Securities and Exchange Commission (“SEC”) on July 25, 2012, we announced anticipated revenues for the third quarter of 2012 to be in the range of $156 million to $163 million. Based on this outlook, we stated that we expect third quarter 2012 earnings per diluted share to be between $0.02 and $0.04.
Contractual Obligations and Off-Balance Sheet Arrangements
Our contractual obligations and off-balance sheet arrangements have not changed significantly from December 30, 2011. As of June 29, 2012, we had $24.4 million of open purchase orders for inventory from suppliers.
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; revenue growth or decline; and potential acquisitions. As of June 29, 2012, our total shareholders’ equity was $1,046.2 million and we had $314.1 million in cash and cash equivalents. We had $2.0 million in short-term investments and $2.8 million in long-term investments, consisting of bank time deposits, as of June 29, 2012. In addition, as of June 29, 2012, we had $150.0 million in long-term debt outstanding (see Note 9 in the accompanying consolidated financial statements).
As of June 29, 2012, approximately $291.0 million of our cash and cash equivalents and short-term investments was held by our foreign subsidiaries. In connection with the settlement of the IRS audit for tax years 2005-2007, based on the agreed upon transfer pricing adjustments, approximately $162 million of cash in our foreign subsidiaries will be repatriated in our third quarter of 2012 without further taxation. The remaining funds would be subject to federal and state taxation at approximately 37.5% upon repatriation, net of any foreign tax credits that might be available. We currently do not intend nor foresee a need to repatriate any additional funds. As of June 29, 2012, all of our long-term investments were held domestically.
Capital Expenditures
Capital expenditures, net of sales proceeds, were $4.6 million for the two quarters ended June 29, 2012 and $5.3 million for the two quarters ended July 1, 2011. Capital expenditures have been focused primarily on electronic equipment, mostly for R&D, the expansion of test capacity to support continuing unit volume growth and IT related equipment. We anticipate capital expenditures will remain at current levels in the near term.
Cash flow from exercises and vesting of stock awards and our Employee Stock Purchase Plan (“ESPP”)
Cash flows from stock plans (including exercises of stock options (“Options”), tax payments on vesting restricted and deferred stock awards (“Awards”) and sales under our ESPP) were $1.1 million in the two quarters ended June 29, 2012, compared to $1.3 million received in the two quarters ended July 1, 2011.
We have changed the mix of new share-based incentive grants to a larger proportion of Awards than Options. Awards do not yield cash proceeds from an exercise event as do Options, but may result in tax payments on shares withheld. Additionally, exercises are decisions of grantees and are influenced by the level of our stock price and by other considerations of grantees. The recent decline in stock price has resulted in many of our options being “underwater” with exercise prices in excess of the current stock price. While the level of cash inflow from stock plans is difficult to forecast or control, we believe it will remain a secondary source of cash.
Dividends on Common Stock
In April 2012, our Board of Directors declared a quarterly dividend of $0.12 per share of common stock. We paid dividends of $15.3 million on May 25, 2012 to shareholders of record as of the close of business on May 15, 2012. In July 2012, our Board of Directors declared a quarterly dividend of $0.12 per share of common stock. The dividend will be paid on August 24, 2012 to shareholders of record as of the close of business on August 14, 2012.
CONF CALL
Brendan Lahiff
Thank you, Derek. Good afternoon, and thank you for joining us today for Intersil's Third Quarter 2012 Earnings Results Conference Call. Today with me is Dave Bell, Intersil's President and Chief Executive Officer; and Jonathan Kennedy, Intersil's Senior Vice President and Chief Financial Officer.
Today, we will deliver remarks on the third quarter 2012 and provide a summary of our fourth quarter 2012 business outlook. After our prepared comments, we will open the line for questions.
We completed our third quarter on September 28, 2012. An earnings press release was issued today at approximately 1:05 PM Pacific Time. A copy of the press release and supplementary slides to accompany the earnings conference call are available on the Investor Relations section of our website at ir.intersil.com. A copy of the prepared remarks has also been made available on the Investor Relations website prior to the conference call.
As always, this call is being webcast live over the Internet and may be accessed via the Investor Relations section of our website. A telephonic replay of the conference call and webcast will be available for 2 weeks through November 7.
Please note that some comments made during this conference may contain forward-looking statements. I'd like to remind you, while these statements reflect our current best judgment, they are subject to risks and uncertainties that could cause our actual results to vary. These risk factors are discussed in detail on our filings with the Securities and Exchange Commission.
In addition, during this call, we may refer to financial measures that are not prepared according to Generally Accepted Accounting Principles. We sometimes use these measures, because we believe they provide useful information about the performance of our business and should be considered by investors in conjunction with the GAAP measures reported.
Our agenda for the call today is as follows: Dave Bell will discuss key highlights from the quarter, and Jonathan Kennedy will review the quarter from a financial perspective. and Dave will follow with additional commentary on our -- each of our 3 key markets, as well as forward-looking guidance. A Q&A session will follow.
I'd now like to turn the call over to Dave Bell, President and CEO of Intersil.
David B. Bell - Chief Executive Officer, President and Director
Thanks, Brendan. Good afternoon, and thank you for joining us today for Intersil's Third Quarter 2012 Earnings Conference Call.
During the third quarter, we saw significantly softening business conditions in all markets and geographies, but the weakness was most pronounced in the PC market. From a top-level perspective, there appear to be haves and have nots in the semiconductor business. Those companies with significant sales into smartphones and tablets are probably experiencing growth. However, those that are reliant on a very weak PC market are seeing sales go backwards.
Today, Intersil still derives roughly 22% of its sales from PCs and very little from smartphones and tablets, however, that picture is already beginning to change with significant sales growth expected from handheld products in 2013.
Despite these near-term challenges, here is the question savvy investors should be asking, how will Intersil provide sustainable growth in the years to come in this hyper competitive environment? And how is Intersil adapting to changing market conditions and aligning resources with the most promising opportunities?
We are committed to building a great, enduring company, and despite the present challenges, we're making excellent progress in transforming our business. I'll explain later how our top 10 growth drivers are creating a very bright future.
I'd like to briefly address an issue that emerged during the last few weeks -- concern over Intersil's dividend. That issue was recently raised by a few analyst reports. Let me be clear, Intersil's strong balance sheet and cash flow can continue to support the current dividend policy, even through cyclical industry downturns. Even after paying our dividend, our cash and short-term investment balance increased during the third quarter, now sitting at $322 million. Intersil's dividend policy is to pay the dividend using excess free cash flow, with our strong cash balance acting as a backstop in the rare occasion that free cash flow doesn't cover the dividend payment.
Intersil's Board of Directors just authorized this quarter's dividend of $0.12 per share of common stock, marking the ninth consecutive year of paying quarterly dividend through numerous semiconductor cycles, returning a total of $432 million to shareholders. And at our present stock-price, Intersil's dividend yield is an extraordinary 7%.
Also during the third quarter, Intersil's Board of Directors authorized the repurchase of $50 million of Intersil stock over the next 12 months. We began purchasing shares in September, and to date, we have purchased over 1.5 million shares under the plan. We expect to continue purchasing shares over the next 3 quarters, which we believe will boost future EPS.
Recognizing the challenging business environment, we made the decision to significantly reduce operating expenses during the second quarter. This restructuring was performed to target a new operating model of non-GAAP operating profit margin of 24% at a $200 million per quarter revenue rate.
The third quarter non-GAAP operating expenses realized the full benefit of our restructuring, and our operating expense have fallen by over $11 million or 16% over the second quarter, significantly boosting our profitability despite lower revenue. This restructuring also focused nearly all of our development resources on our top 10 growth drivers. These are the carefully chosen product areas, where we're confident that Intersil has the technology, the talent and the customer relationships to beat much larger rivals.
I'd now like to talk briefly about the business conditions in the third quarter. Bookings were stable through most of the quarter, however, bookings weakened again during September. As a result, we closed the third quarter with a book-to-bill ratio of slightly less than 1.
We reported third quarter revenues of $151.4 million, an 18.9% decrease from $186.8 million in the third quarter of 2011 and a 7.1% decrease from $163 million in the second quarter of 2012. The revenue reduction was primarily driven by an unexpectedly weak PC market. Intersil also recorded one time income from an IP agreement resolving a dispute with another semiconductor company, which added another $13.4 million to operating income and boosted GAAP operating profit margin to 12.7%.
At this time, I'd like to turn the call over to Jonathan Kennedy for a financial summary of the third quarter. I'll then discuss results from each of our end markets in more detail, and finally, provide comments on our fourth quarter 2012 outlook. Jonathan?
Jonathan A. Kennedy - Chief Financial Officer, Senior Vice President and Principal Accounting Officer
Thank you, Dave. I'd like to reiterate Dave's comments regarding our dividends. Our policy is based on free cash flow and is backstopped by cash on hand. Free cash flow for the quarter was $21.7 million, and our cash and short-term investments were $321.9 million. Our ongoing quarterly dividend payment is approximately $15 million.
Now on to the third quarter income statement. We reported $151.4 million of revenue for the third quarter, an 18.9% decrease from the third quarter last year and a 7.1% sequential decrease in the second quarter of 2012. Revenue increased sequentially in the consumer market, where new handset parts begin ramping, and seasonal strength in gaming provided much of the increase. And this was offset by weaker-than-expected conditions in the computing market where PC sales continued to be weak.
Our lead times remained normal throughout the quarter, with no significant supply constraints. Our internal utilization was approximately 79% as production continued just below consumption, and inventory levels were reduced. Third quarter turns were 35%, and we are expecting Q4 turns to be about the same at the midpoint of our guidance.
Gross margin was 54.1% in Q3, 40 basis points below the previous quarter, driven primarily by an increase in excess inventory reserves. Looking to Q4, we expect gross margin to decline slightly on lower utilization.
R&D expense was $38.7 million or 26% of revenue, and SG&A expense were $30.2 million or 20% of revenue. During Q4, we expect R&D expenses of about $38 million and SG&A expenses of approximately $30 million, as we realize the benefit of lower labor hours from year-end holidays in the fourth quarter.
Amortization of intangibles was $7.1 million during the quarter and Q4 amortization is expected to be lower at $6.7 million. Our Q3 GAAP operating margin was 12.7%. We incurred a gain on our deferred compensation investments of $0.7 million during this quarter, which was offset by a similar expense in SG&A.
Operating income included a $13.4 million benefit from the completion of a non-recurring onetime agreement, resolving a patent and trade secret dispute with another semiconductor company.
Interest income was $0.1 million for the third quarter, and interest expense was $2 million. And we expect Q4 interest income and expense to be approximately flat to Q3.
Our Q3 GAAP tax rate was 89% due to certain discrete tax expense items, as well as the effects of declining foreign income relative to our expectations earlier in the year. We expect our Q4 tax expense to be about $10 million, as we realize the effects of minimal foreign income and true up for the full year. This estimate does not include any benefit from the R&D tax credit. Our GAAP tax rates should revert back to a more normal level in 2013.
Equity compensation was $5.3 million for the third quarter. Q4 equity compensation is expected to be flat at about $5.3 million. And by classification, equity compensation is expected to be approximately $0.4 million in cost of sales, $2.3 million in R&D and about $2.6 million in SG&A. On a GAAP basis, we recorded net income of $2 million or $0.02 per diluted share.
Now on a non-GAAP basis. We present non-GAAP measures, because we believe they add additional analysis that when considered with GAAP information can help investors more thoroughly understand the results of our normal ongoing operations. Our Q3 non-GAAP results exclude equity compensation, intangible amortization, the related impact of income tax expense on these items, onetime items and certain discrete tax items.
Non-GAAP operating income was $18.9 million, and our non-GAAP operating margin was 12.5%. Our non-GAAP tax rate was 23%, and non-GAAP net income was $13.1 million or $0.10 per diluted share for the third quarter. We expect our non-GAAP tax rate to be approximately 25% for the fourth quarter. A reconciliation between GAAP and non-GAAP measures can be found on Page 8 in today's press release.
Now for the balance sheet and cash flow. Free cash flow during the quarter was $21.7 million. Dividend payments were $15.4 million. Long-term debt was unchanged in the third quarter at $150 million. As Dave mentioned, we repurchased 690,500 shares during the third quarter. And as of today, we repurchased approximately 1.5 million shares since we announced the repurchase program on August 6. Our balance sheet continued to be very strong with $321.9 million in cash and $150 million in long-term debt. More than half of our cash is now onshore and available with no further tax liabilities.
Days of sales outstanding increased slightly to 38 days for the quarter. Soft demand during the third quarter led us to continue our inventory reduction. Net inventory decreased $3.8 million or 4.7% from the second quarter to $81.6 million, and days of inventory increased by 1 day to 109. Looking ahead, we expect inventory dollars to be down another $4 million to $6 million, and inventory day to decrease to about 105 days. Our Q3 ending worldwide distributor inventory was flat in dollars compared to Q2, but up 6 days to 70.
Looking ahead to the fourth quarter, we expect to reduce channel inventory by $3 million to $5 million to align with the weaker demand. Our Q3 depreciation was $4.8 million, flat compared to the second quarter, and CapEx was sharply lower at $0.9 million.
We expect Q4 CapEx to increase to approximately $10 million to $12 million as we upgrade our internal production capability to achieve lower internal production costs. We expect capital expenditure rates to be at this level for the next 2 quarters as we complete the project.
Our weighted average diluted share count was 127.6 million shares in the third quarter. And we expect fourth quarter weighted average diluted shares to be slightly lower, as we continue to execute our stock repurchase program.
Now back to Dave.
David B. Bell - Chief Executive Officer, President and Director
Thanks, Jonathan. I'll now address our business in each of our 3 end markets, beginning with industrial and infrastructure. During today's commentary, as well as in the coming quarters, I will be aligning the end market discussions around our top 10 growth drivers. As you all know by now, our top 10 growth drivers are the carefully chosen areas where we have what it takes to gain market share in this hyper-competitive environment.
At our Analyst Day on May 8, I claimed that several of our growth drivers would begin to contribute by the beginning of 2013. We're on track for that to happen, and several growth drivers are already beginning to move the needle in the fourth quarter. In the following commentary, my primary focus will be on those growth drivers that are expected to contribute significant revenue growth during 2013.
Revenue in the industrial and infrastructure market represented approximately 57% of third quarter revenue, an 11% decrease from the second quarter. While most product lines in our general-purpose product portfolios saw a slight-to-moderate decreases due to macro-economic conditions, we saw several positive developments in our I&I top 10 growth drivers.
In cloud infrastructure, our Zilker Labs digital power controllers continued to accumulate design wins both in controller and module configurations. During the third quarter, sales of Zilker Labs' digital controllers increased almost 30%, as customer shipments continued to accelerate. We're now sampling our new third-generation digital controller, which delivers transient response far better than any other digital controller. This new controller will be released to production in the second half of 2013 in both controller and module configurations.
We previously talked about a $15 million per year digital module design win at a major infrastructure customer, and that program is on track for a production ramp in Q4. In fact, orders are already booked in the backlog for that program. In addition, we continue to expand our family of digital power modules and released 3 additional modules to production in September.
In the dense power conversion arena, we're sampling our new ISL8225, a dual output module capable of delivering 100 watts of power from a 17-millimeter square PCB footprint. No other module today even comes close to that level of power density. We already have numerous customers that are anxious to ramp production with this module by the end of this year.
A couple of major hand-held power tool makers are designing in Intersil products for both battery charging and motor drive. Our lead customer in this new market is expected to drive several million dollars of sales in 2013 and is expected to grow further as other design wins go to production.
Security surveillance products continue to accumulate design wins because of our investment in SAM-expanding products, diversifying our business away from the price-challenged video coder market. We recently started delivering customers complete digital video recorder reference designs, including software development kits with Intersil's supplying every IC in the DVR except for memory. This drives the average DVR dollar content from around $4 today to approximately $40, obviously, creating huge potential for revenue growth in 2013 and beyond. In the 2.5 years since we acquired Techwell, this product line has been transformed from a business entirely dependent on video decoders to one where we can supply nearly every piece of silicon in the DVR.
Looking at the automotive market, we expect that in December, the National Transportation Safety Board will make a decision regarding the implementation of the Kids Transportation Safety Act. Once this issue has been resolved, we expect to see increased demand for our automotive LCD drivers for rear camera applications. In addition, the Pico projector product line has secured its first design win from a major auto manufacturer for heads-up display.
We expect continued softness in nearly all product lines and territories in the industrial and infrastructure market as the fourth quarter progresses. Consequently, we expect sales into the I&I market to be flat to slightly down in the fourth quarter.
Now let's look at the personal computing market. Revenue in the PC market represented 22% of third quarter revenue and decreased 17% sequentially from the prior quarter. The PC market was surprisingly weak during the third quarter, with forecast eroding as the quarter progressed. We believe this was due to a combination of 3 factors: a weak worldwide economy, competition from tablets and pent-up demand for Windows 8, since most ODMs want to enter the holiday season with the latest hardware and operating system.
But something more significant is happening here. I believe we're also seeing the beginning of the end for the traditional notebook computer. The spectrum of products from smartphones to tablets to Ultrabooks is the future of portable computing, and the traditional notebook will continue to decline. We share Intel's view on the dominant position that Ultrabooks will take in the notebook space in the coming years. A couple of years from now, anyone carrying a full-sized notebook computer will look like a dinosaur.
Because of this shift, we're investing heavily in new power management chipset for Ultrabooks. But at the same time, we're maintaining our leadership, market share and VCORE power for traditional notebooks. Unfortunately, that market leadership position did not translate into sales growth in the third quarter for the reasons mentioned earlier. Both notebook and desktop demand were lower, and the product mix was approximately 78% notebook and 22% desktop.
Design activity on the next-generation Haswell notebook and Ultrabook platforms remains strong. We're confident that we're maintaining a somewhat smaller, yet leading market share in the Ivy Bridge platform. We're also promoting an integrated power management chipset for the Haswell Ultrabook platform that drives a higher dollar content than an Ivy Bridge in previous notebook platforms. We believe our design ins will enter into production in early 2013, when Intel's Haswell platform is planned to begin production. Looking at the fourth quarter, we expect PC sales to continue declining due to worldwide economic headwinds and uncertainty about how much sales will be accelerated with the release of Windows 8.
Now let's look at the consumer market. Revenue in the consumer market represented approximately 21% of third quarter revenue and increased 20% from the second quarter. I'll start with gaming, which we're including in the handheld device's top 10 growth driver. Our tethered gaming business provided strong revenue growth in a seasonally strongest quarter. During the quarter, we landed a couple of new laser diode driver design wins that will result in significant sales beginning in the middle of next year. We're already supporting prototype builds for one of these customers, and we forecast these wins will add approximately $25 million per year of additional gaming revenue, beginning in the middle of 2013.
During last quarter's conference call, we discussed the ISL9110 buck-boost regulator design wins for accessory products related to a major smartphone watch. We said repeatedly that our emphasis on the handheld devices category will provide the nearest term evidence that our strategy was beginning to deliver.
Chip Works just released a tear down report showing its regulator inside Apple's new Lightning to 30-pin adapter. The ramp of that and other design wins is translating into revenue, and we shipped roughly $4 million of this product in the third quarter. This buck-boost regulator is also gaining traction with other customers and has now gained a win with a major tablet provider. Other design wins in the tablet space include LCD back light design wins, with 2 additional major suppliers in the tablet market.
Also, in the handheld devices category, we're pleased to report that we're on track with the industry-first all-in-one display IC. We discussed this device at our Analyst Day in May, and we're on schedule to deliver first samples during Q4, just as we said. This level of integration has not been achieved any other supplier. And numerous OEM and LCD panel customers are anxiously awaiting samples. We expect this new product to be designed into many tablets and Ultrabooks in 2013 with revenue beginning by the end of next year.
In optical sensors, we began to fill in the revenue hole created by a major smartphone customer earlier this year. We now have numerous new customers ramping smartphones and tablets incorporating our ambient Light and Proximity Sensors. We're also on track to sample our new long-range proximity sensor in this quarter. Many customers feel this unique, new sensor will allow them to embed innovative new features into future handheld and PC products.
Active cables is becoming a very exciting category, with the growth in Thunderbolt-enabled products. We've already received first production orders for our 40-nanometer Thunderbolt chipset, and we continue to sample to most major cable manufacturers. We expect to ship over 100,000 chipsets in Q4, and this is just the very beginning of what we're confident will become a major revenue driver in 2013.
And finally, I'd like to address Pico projectors. During the third quarter, we signed a partnership agreement with Microvision to develop Pico projectors designed specifically for handheld devices. We believe that within 2 years, major smartphone, tablet and Ultrabook makers will be shipping products that embed HD Pico projectors, and Intersil will be capable of supplying all of the silicon surrounding the projector light engine. And as previously mentioned, later this quarter, we will be shipping first prototypes of a heads-up display Pico projector system for a major automotive customer.
Looking ahead to the fourth quarter, we expect sales into the consumer market to be down slightly based on gaming seasonally ramping down, but somewhat offset by contributions from other growth drivers.
Now let's turn to our outlook for the fourth quarter. As mentioned during my introduction, demand was soft in the third quarter, and the PC market grew weaker as the quarter progressed. The quarterly book-to-bill ratio ended at slightly less than one. However, inventories throughout the channel remain at reasonably low levels, and any uptick in demand will click the result in growing short lead time orders.
Because of the continued softness, we are forecasting fourth quarter revenue to be in the range of $135 million to $141 million. Gross margin is expected to be flat to slightly down. On a GAAP basis, we expect fourth quarter earnings per share to be approximately minus $0.09. We expect non-GAAP earnings per share to be approximately $0.06.
This has been a frustrating quarter for both Intersil and our investors, with concerns over the macro economy, the PC market and even Intersil's dividend. It's going to continue being a bumpy ride for those investors that are shortsighted in gambling at where stocks will be during the next quarter. Fortunately, our sights are set a bit further out. We are passionate about building a great and enduring company that will provide outstanding return to our investors, but accomplishing this goal has required a complete transformation of our business, and executing such a transformation during these economic conditions is not for the faint of heart.
We've been tirelessly working on this transformation, focusing on our top 10 growth drivers, and we're just beginning to see the results of these investments. Based on my earlier commentary, you should now understand how several of these growth divers will create significant growth in 2013, decoupling Intersil from the stagnant semiconductor market.
Right now, investors have the unique opportunity to invest in Intersil at a ridiculously low valuation and earn a 7% dividend yield, while they watch our top 10 growth drivers begin to deliver. But they won't need to wait much longer since nearly all of our expected growth in 2013 is based on design wins that have already been secured.
With that, I would now like to open the call to questions for either Jonathan or me. Operator?
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Fund Letters
