Microchip Technology Incorporated — Form 10-Q Summary
Reporting period: Three months ended June 30, 2014, the first quarter of fiscal 2015. The filing was signed August 11, 2014. Microchip designs, manufactures and licenses embedded-control semiconductor products, including microcontrollers, analog and mixed-signal devices, memory, connectivity and related technologies.
Financial performance and liquidity
| Metric | Q1 FY2015 | Q1 FY2014 | Change |
|---|---|---|---|
| Net sales | $528.9 million | $462.8 million | Up 14.3% |
| Gross profit | $306.5 million | $266.6 million | Up 15.0% |
| Gross margin | 58.0% | 57.6% | Up 40 basis points |
| Operating income | $115.9 million | $98.4 million | Up 17.8% |
| Operating margin | 21.9% | 21.3% | Up 60 basis points |
| Net income | $89.9 million | $78.6 million | Up 14.4% |
| Diluted EPS | $0.40 | $0.37 | Up 8.1% |
| Operating cash flow | $165.8 million | $167.4 million | Down $1.6 million |
Cash and cash equivalents were $617.8 million at June 30, 2014, compared with $466.6 million at March 31, 2014. Cash, cash equivalents and investments totaled $2.287 billion, up $143.9 million from the prior quarter. The company paid $71.2 million in dividends and declared a subsequent quarterly dividend of $0.356 per share.
Debt included $980.0 million outstanding under the credit agreement, $374.2 million carrying value of junior subordinated convertible debentures, $327.1 million of long-term borrowings and $17.5 million of short-term borrowings. The company was in compliance with its credit-facility covenants. Management stated that existing liquidity, operating cash flow and available borrowings should cover anticipated requirements for at least the next 12 months.
Capital expenditures were $44.6 million, compared with $27.8 million in the prior-year quarter. Management expects approximately $135 million of capital expenditures over the next 12 months, funded primarily through cash balances and operating cash flow.
Material changes versus the prior comparable period
- Sales growth reflected market-share gains, industry conditions and the April 1, 2014 acquisition of Supertex, which contributed $17.8 million of sales.
- Semiconductor product sales increased to $508.4 million from $440.3 million; technology licensing revenue declined to $20.4 million from $22.5 million.
- Microcontroller sales rose 14.5%; analog, interface and mixed-signal sales rose 21.5%; memory sales declined 1.8%; and technology licensing sales declined 9.2%.
- Unit volume for semiconductor products increased approximately 12.9%, while average selling prices increased approximately 1.6%.
- Gross margin improved despite approximately $7.8 million of acquired-inventory fair-value charges. Excess-capacity charges declined to approximately $0.8 million from $10.4 million.
- Research and development expense increased 15.4% to $84.4 million, primarily due to Supertex-related costs and higher headcount.
- Amortization of acquired intangible assets increased to $36.6 million from $27.7 million, mainly because of Supertex and prior acquisitions.
- Interest expense increased to $13.7 million from $11.9 million because of higher borrowings used to finance Supertex.
- The effective tax rate increased to 16.0% from 13.0%, partly because of tax expenses associated with Supertex.
Acquisitions, outlook and management commentary
Supertex was acquired for approximately $391.8 million on April 1, 2014. The preliminary purchase-price allocation included $133.7 million of goodwill and $89.6 million of acquired intangible assets. The allocation remained subject to revision. Supertex contributed $17.8 million of sales and a reported $17.7 million net loss for the quarter, including acquisition-related effects.
Management expected inventory levels in the September 2014 quarter to be flat to modestly lower than June levels, excluding inventory from the subsequent ISSC acquisition, and expected to operate at normal capacity levels. The filing does not provide a clear numerical revenue or earnings guidance range for the September quarter.
On July 14, 2014, Microchip completed a tender offer for approximately 83.46% of ISSC Technologies for approximately $328.5 million of total equity value. ISSC provides low-power Bluetooth and wireless solutions and was expected to be consolidated beginning in the quarter ending September 30, 2014.
Risks, contingencies and unusual items
- Semiconductor demand, pricing, product mix, capacity utilization, manufacturing yields, turns orders and distributor inventory can cause significant quarterly volatility.
- Approximately 52% of sales came through distributors, generally without long-term agreements. Deferred income on distributor shipments was $146.6 million at June 30, 2014.
- Approximately 84% of sales were to foreign customers, and substantially all foreign sales were denominated in U.S. dollars. Thailand operations face political and natural-disaster risks, including flooding.
- The company relies on outside wafer foundries and Asian assembly and test contractors; supply, capacity, yield or quality disruptions could materially affect results.
- Unrecognized tax benefits were $196.4 million. The IRS was auditing Microchip and SMSC for fiscal 2011 and 2012 and Supertex for fiscal 2011 through 2013.
- The company recorded a $5.7 million contingent liability related to the 2010 acquisition of Silicon Storage Technology. Technology-license indemnification obligations could reach approximately $132 million where limits are specified; no related liability was recorded.
- Available-for-sale investments included $9.8 million of auction-rate securities valued using Level 3 inputs. Unrealized investment losses totaled $1.5 million, which management did not consider other-than-temporary.
- The convertible debentures were convertible during July through September 2014 because the stock-price trigger was met. Their conversion price was approximately $25.67 per share, and potential dilution was reflected in diluted EPS.
- Special charges were $0.3 million, compared with $1.7 million in the prior-year quarter. The company recognized $0.4 million of intangible-asset impairment.
- Legal and intellectual-property claims are possible in the ordinary course of business, although management did not expect pending matters to have a material adverse effect.
Investor verification checklist
- Verify the final purchase-price allocation, integration costs and operating contribution of Supertex.
- Assess the cash, debt and liquidity impact of the ISSC acquisition and subsequent consolidation.
- Monitor gross margin for acquired-inventory charges, capacity utilization, product mix and manufacturing yields.
- Review distributor sell-through, deferred distributor income and inventory days for signs of channel-related revenue risk.
- Track tax-audit developments, unrecognized tax benefits and the sustainability of the 16.0% effective tax rate.
- Evaluate potential dilution or cash requirements associated with the convertible debentures.
- Confirm capital expenditures, dividend policy and the availability of cash held by foreign subsidiaries.
- Review exposure to foundry and subcontractor disruptions, Thailand operating risks, intellectual-property claims and acquisition execution risk.