Microchip Technology Incorporated — Q1 FY2018 Form 10-Q Summary
Business context and reporting period
Microchip designs, manufactures and sells embedded-control semiconductor products, including microcontrollers, analog, interface, mixed-signal, timing and memory products, and licenses SuperFlash and other technologies. The report covers the three months ended June 30, 2017, compared primarily with the three months ended June 30, 2016. The filing was signed August 4, 2017.
Reportable segments were semiconductor products and technology licensing. Semiconductor products generated $947.1 million of sales and technology licensing generated $25.0 million.
Key financial metrics
| Metric | Q1 FY2018 | Q1 FY2017 | Change |
|---|---|---|---|
| Net sales | $972.1 million | $799.4 million | Up 21.6% |
| Gross profit | $584.4 million | $348.5 million | Up 67.7% |
| Gross margin | 60.1% | 43.6% | Up 16.5 percentage points |
| Operating income | $221.6 million | $(59.1) million | Turned profitable |
| Net income from continuing operations | $170.6 million | $(109.2) million | Turned profitable |
| Net income | $170.6 million | $(113.4) million | Turned profitable |
| Diluted EPS | $0.70 | $(0.53) | Improved $1.23 |
| Operating cash flow | $345.0 million | $224.0 million | Up $121.0 million |
| Capital expenditures | $22.1 million | $18.5 million | Up $3.6 million |
Product-line sales were $635.5 million for microcontrollers, $239.1 million for analog, interface, mixed-signal and timing products, $49.5 million for memory products, $25.0 million for technology licensing and $23.1 million for multi-market and other products. Foreign customers represented approximately 85% of sales, with Asia representing 58.0% of total sales.
At June 30, 2017, cash and cash equivalents were $773.0 million, short-term investments were $457.2 million and long-term investments were $420.5 million, totaling $1.65 billion in cash, cash equivalents and investments. Accounts receivable were $529.0 million and inventories were $426.8 million.
Principal debt outstanding was $4.51 billion, with net debt reported on the balance sheet of $3.00 billion, including $11.3 million classified as current. No borrowings were outstanding under the $2.774 billion revolving credit facility. The company was in compliance with its debt covenants at June 30, 2017.
The quarterly dividend paid was $0.3615 per share, totaling $82.9 million. A $0.362 per-share dividend was declared for payment in September 2017. No shares were repurchased during the quarter.
Material changes versus the prior comparable period
- Sales increased 21.6%, driven primarily by broader business growth, market-share gains, semiconductor industry conditions and approximately 19% growth in product units sold. Microcontroller sales increased 27.5% and analog, interface, mixed-signal and timing sales increased 12.6%.
- Gross margin increased to 60.1%, principally because Q1 FY2017 included approximately $90.5 million of acquired-inventory fair-value charges related to the Atmel and other acquisitions.
- Research and development expense declined 11.8% to $130.5 million, and selling, general and administrative expense declined 27.4% to $114.3 million, reflecting acquisition synergies and lower prior-year accelerated vesting and share-based compensation costs.
- Amortization of acquired intangible assets increased to $120.8 million from $80.2 million, primarily because Atmel in-process research and development assets began amortizing.
- Special charges changed from $22.0 million of expense to $2.8 million of net income, primarily reflecting a gain on the sale of a decommissioned Micrel facility partly offset by restructuring costs.
- Interest expense increased to $49.5 million from $34.4 million following the issuance of new 2017 senior and junior convertible debt. The company also recorded a $13.8 million loss on settlement of convertible debt.
- Q1 FY2017 included a $4.1 million net loss from discontinued mobile-touch operations; there were no discontinued-operation results in Q1 FY2018 following the November 2016 sale.
- Cash flow from investing activities improved substantially because Q1 FY2017 included $2.75 billion used for the Atmel acquisition. Q1 FY2018 investing cash outflow was $391.3 million, largely reflecting purchases of available-for-sale investments.
Guidance, outlook, commentary and risks
- Management expected September 2017-quarter inventory days to remain approximately flat with the June level of 100 days and believed current inventory supported competitive lead times and delivery performance.
- Management planned approximately $190.0 million of capital expenditures over the following 12 months, funded through cash balances and operating cash flow, to expand production capacity and bring more assembly and testing in-house.
- Management believed existing liquidity, operating cash flow and available credit were sufficient for anticipated requirements for at least the next 12 months.
- Gross margins are expected to fluctuate with product mix, capacity utilization, manufacturing yields, fixed-cost absorption, competitive pricing and economic conditions.
- Revenue recognition will change upon adoption of ASC 606, expected no later than April 1, 2018. Distributor revenue currently deferred until resale to end customers will generally be recognized upon shipment to distributors, subject to estimated returns and allowances. The company expected to use the full-retrospective method but had not completed its assessment.
- Deferred income on distributor shipments was $308.8 million at June 30, 2017, representing approximately $435.7 million of deferred revenue less $126.9 million of deferred cost of sales. Future price concessions may reduce the amount ultimately recognized.
- Key risks include semiconductor cyclicality, pricing pressure, customer and distributor inventory patterns, limited order visibility, reliance on external wafer foundries and Asian assembly and test contractors, manufacturing capacity and yield risks, foreign operations, tax audits, acquisition integration, substantial debt and potential impairment of $2.30 billion of goodwill and $2.03 billion of net intangible assets.
- Continental Automotive alleged approximately $61.6 million of costs and damages in an ICC arbitration concerning airbag-control-unit recalls. The company intends to defend the matter. Aggregate potential liability from contingencies considered possible but not probable was estimated at approximately $100 million above accrued amounts.
- The company also disclosed approximately $151.5 million of potential payments under technology-license indemnifications with specified limits, although no related liability was recorded and management did not expect a material adverse effect.
Most important facts for investors to verify
- Whether the strong sales growth and 60.1% gross margin are sustainable after the prior-year Atmel acquisition accounting effects have fully rolled off.
- The effect of ASC 606 adoption on deferred distributor revenue, reported sales, gross margin and comparative periods.
- Progress in integrating Atmel and realizing cost synergies, while monitoring continuing amortization and impairment exposure.
- Debt service requirements, convertible-debt conversion and dilution potential, and compliance with leverage and interest-coverage covenants.
- Whether operating cash flow can support approximately $190 million of planned capital expenditures, quarterly dividends and other corporate needs.
- Demand, pricing and inventory trends across microcontrollers, analog products and memory products, including distributor inventory days and sell-through.
- Potential exposure from the Continental arbitration, other product-liability and intellectual-property claims, tax examinations and foreign operations.