Microchip Technology Incorporated — Q1 FY2017 Form 10-Q Summary
Reporting period: Three months ended June 30, 2016; filed August 9, 2016. The quarter includes Atmel results from its April 4, 2016 acquisition date. Microchip designs, manufactures and licenses embedded-control semiconductor products, including microcontrollers, analog, mixed-signal, memory, connectivity and related technologies.
Financial Performance and Position
| Metric | Q1 FY2017 | Q1 FY2016 | Change |
|---|---|---|---|
| Net sales | $799.4 million | $534.0 million | +49.7% |
| Gross profit | $348.5 million | $309.0 million | +12.8% |
| Gross margin | 43.6% | 57.9% | Down 14.3 points |
| Operating income (loss) | $(59.1) million | $121.3 million | Declined materially |
| Net income (loss) from continuing operations | $(109.2) million | $130.5 million | Declined materially |
| Net income (loss) | $(113.4) million | $130.5 million | Declined materially |
| Diluted EPS | $(0.53) | $0.60 | Declined materially |
| Cash flow from operations | $224.0 million | $181.5 million | +23.4% |
| Capital expenditures | $18.5 million | $33.6 million | Decreased |
Gross margin was reduced principally by approximately $91.5 million of acquired-inventory fair-value step-up charges from acquisitions, along with product mix and inventory-related effects. Operating expenses increased substantially, including research and development of $147.9 million, selling, general and administrative expense of $157.5 million, acquired-intangible amortization of $80.2 million and special charges of $22.0 million.
- Product mix: Microcontrollers generated $498.3 million of sales, analog/interface/mixed-signal/timing products $212.3 million, memory products $45.9 million and technology licensing $20.6 million.
- Units and pricing: Semiconductor units sold increased approximately 53% year over year, while average selling prices declined approximately 1%.
- Liquidity: Cash, cash equivalents and investments totaled approximately $601.8 million at June 30, 2016, versus $2.56 billion at March 31, 2016.
- Working capital: Accounts receivable was $435.5 million and inventory was $518.4 million at quarter-end. Balance-sheet inventory represented approximately 105 days, compared with 110 days at March 31, 2016.
- Debt: Carrying amounts included $1.914 billion under the revolving credit facility, $1.227 billion of senior convertible debentures and $195.3 million of junior convertible debentures. Total carrying debt represented by these items was approximately $3.34 billion.
- Dividends: The company paid $77.2 million, or $0.3595 per share, during the quarter and declared a subsequent quarterly dividend of $0.3600 per share.
Material Changes Versus the Prior Comparable Period
- Revenue increased primarily because of the Atmel acquisition, the prior-year Micrel acquisition and growth in the historical business.
- Atmel contributed approximately $219.0 million of continuing net sales and a $163.6 million net loss during the post-acquisition period included in the quarter.
- Gross margin fell from 57.9% to 43.6%, primarily because of acquired-inventory fair-value adjustments and higher acquisition-related manufacturing costs.
- Research and development expense increased 74.6%, and selling, general and administrative expense increased 135.6%, primarily because of the acquired businesses and related integration costs.
- Interest expense increased to $34.4 million from $24.1 million because of higher borrowings used to finance acquisitions. Other income declined to $2.0 million from $16.9 million, as the prior-year period included significant investment-sale gains.
- The company reported $4.1 million of loss from discontinued operations related to Atmel’s mobile touch business, which was classified as held for sale.
- Cash used in investing activities was $2.30 billion, including $2.75 billion for the Atmel acquisition, net of cash acquired. Financing activities provided $580.0 million, including $1.28 billion of new revolving borrowings, partially offset by $602.0 million of repayments.
Acquisition, Outlook, Risks and Unusual Items
Atmel acquisition and integration
Atmel was acquired for approximately $3.47 billion of total consideration, including cash, 10.1 million Microchip shares and assumed equity awards. The preliminary purchase-price allocation included $1.38 billion of goodwill and $1.88 billion of purchased intangible assets. The allocation remained subject to revision, including valuations of inventory, intangible assets, taxes and liabilities. Management identified integration complexity, potential employee and customer attrition, additional charges and the ability to realize expected synergies as significant risks.
Guidance and management outlook
- Management expected September-quarter inventory days to be flat to down four days from June levels, excluding the effect of selling through acquired inventory fair-value markups.
- Management planned approximately $120 million of capital expenditures over the following twelve months, funded through cash balances and operating cash flow.
- Management stated that existing liquidity, operating cash flow and available credit were expected to meet anticipated cash requirements for at least the next twelve months.
- The company expected to continue quarterly dividends, but emphasized that the Board may change or suspend them based on results, liquidity, requirements and market conditions.
Key risks and contingencies
- Debt increased materially following the Atmel acquisition. The revolving facility had $1.922 billion outstanding against total commitments of approximately $2.774 billion; the company was in compliance with its debt covenants at June 30, 2016.
- Atmel’s mobile touch business was marketed for sale and had $18.4 million of assets held for sale at quarter-end.
- Potential liabilities that were possible but not probable were estimated at approximately $100 million above accrued amounts. Technology-license indemnification exposure with specified limits was approximately $147 million, with no related liability recorded.
- The company was involved in Atmel-related litigation, including automotive airbag product-liability claims and more than 500 individual labor actions involving former employees of an Atmel-related French facility.
- Unrecognized tax benefits increased to $420.9 million, including $193.9 million related to the Atmel acquisition. The IRS was auditing fiscal 2011 and 2012 tax years.
- Approximately 85% of sales were to foreign customers, and approximately 56% of sales were through distributors. Risks include semiconductor cyclicality, pricing pressure, customer and distributor inventory levels, outsourced manufacturing, supply disruptions, foreign operations, Brexit-related logistics and tax changes.
- The company had adopted new stock-compensation guidance and recorded cumulative-effect adjustments to retained earnings, including $47.2 million for previously unrecognized excess tax benefits. Revenue-recognition guidance was not yet adopted; the future change is expected to require revenue recognition upon distributor shipment rather than end-customer sell-through.
Investor Verification Checklist
- Verify the final Atmel purchase-price allocation and the amount and duration of acquired-intangible amortization.
- Assess whether gross-margin pressure from acquired-inventory fair-value adjustments was temporary and whether integration synergies were realized.
- Monitor debt reduction, leverage-ratio compliance, refinancing needs and the cash interest burden.
- Reconcile operating cash flow with reported losses, including the effects of depreciation, amortization, share-based compensation and working-capital changes.
- Evaluate inventory levels, distributor sell-through, deferred distributor revenue and the risk of future price concessions or inventory write-downs.
- Track the mobile touch divestiture, Atmel-related litigation and the potential resolution of tax audits and uncertain tax positions.
- Review the company’s subsequent revenue-recognition adoption disclosures and the effect on reported revenue, margins and comparability.