Microchip Technology Incorporated: Q3 FY2011 Form 10-Q Summary
Reporting period: Quarterly period ended December 31, 2010; fiscal year ending March 31, 2011. The filing compares three- and nine-month results with the periods ended December 31, 2009. Microchip designs, manufactures and markets embedded-control semiconductors and, following its acquisition of Silicon Storage Technology, Inc. (SST), licenses Flash intellectual property.
Financial performance and position
| Metric | Three months ended Dec. 31, 2010 | Three months ended Dec. 31, 2009 | Nine months ended Dec. 31, 2010 | Nine months ended Dec. 31, 2009 |
|---|---|---|---|---|
| Net sales | $367.8 million | $250.1 million | $1,107.2 million | $669.7 million |
| Gross profit | $216.4 million | $146.0 million | $648.8 million | $365.8 million |
| Gross margin | 58.8% | 58.4% | 58.6% | 54.6% |
| Operating income | $117.5 million | $72.6 million | $349.8 million | $156.5 million |
| Net income | $100.8 million | $69.4 million | $293.4 million | $141.3 million |
| Diluted EPS | $0.51 | $0.37 | $1.53 | $0.76 |
- Third-quarter sales increased 47.1% year over year but declined 3.8% from the preceding quarter's $382.3 million, primarily due to general semiconductor industry conditions.
- Nine-month operating margin was 31.6%, compared with 23.4% in the prior-year period. Third-quarter operating margin was 31.9%, compared with 29.0%.
- Operating cash flow for the nine months was $430.1 million, versus $344.0 million in the prior-year period.
- Capital expenditures were $100.1 million, versus $28.4 million in the prior-year period. Management expects approximately $100 million of capital expenditures during the next 12 months.
- Cash and cash equivalents were $500.6 million at December 31, 2010. Short- and long-term investments totaled $1.072 billion, producing total cash, cash equivalents and investments of approximately $1.573 billion.
- Total assets were $2.829 billion, compared with $2.516 billion at March 31, 2010. Inventory increased to $177.7 million from $116.6 million, or 107 days from 97 days.
- Junior subordinated convertible debentures had a $345.6 million carrying value and $1.15 billion principal amount. Their estimated fair value was $1.419 billion. The debentures carry a 2.125% coupon and mature in 2037.
- Cash dividends paid during the first nine months totaled $256.8 million. The company paid $0.344 per share on December 2, 2010 and accelerated a second $0.345 per-share dividend to December 27, 2010.
Material changes versus the prior comparable period
- Sales growth reflected improving semiconductor conditions, market-share gains in microcontroller and analog products, and the SST acquisition. Silicon product unit volume rose approximately 34% in the quarter and 66% for the nine months; average selling prices rose approximately 4% in the quarter but declined approximately 3% for the nine months.
- Gross margin improved mainly because production operated at or above normal capacity in fiscal 2011, whereas under-absorption charges affected fiscal 2010. The company recorded no comparable under-absorption charges in the first nine months of fiscal 2011 versus $22.3 million in the prior-year period.
- Research and development expense increased 39.1% in the quarter and 44.5% for the nine months, while SG&A increased 30.2% and 41.8%, respectively. In both cases, increases reflected restored compensation programs and SST-related costs, although expenses declined as a percentage of sales.
- Interest income decreased because of lower short-term investment rates. Nine-month other income declined primarily because the prior-year period included a $7.5 million gain on trading securities.
- The effective tax rate from continuing operations was 10.9% for the quarter and 12.4% for the nine months, versus 0.7% and 8.2%, respectively, in the prior-year periods. The prior year benefited from an IRS tax settlement; the current quarter benefited from reinstatement of the R&D tax credit.
Acquisition, discontinued operations and unusual items
- Microchip acquired SST on April 8, 2010 for total consideration of $353.8 million, including $295.4 million of cash. The preliminary purchase price allocation included $50.9 million of purchased intangible assets and $9.0 million of goodwill; the allocation remained subject to revision.
- SST contributed $56.8 million of continuing revenue in the quarter and $171.7 million from April 9 through December 31, 2010. SST operations were fully integrated beginning October 1, 2010.
- Technology licensing generated $19.1 million of quarterly revenue and $51.7 million for the nine-month period. Semiconductor products generated $348.8 million and $1.056 billion, respectively.
- Selected SST businesses were sold, licensed or classified as discontinued operations. Discontinued operations generated a net loss of $1.2 million in the quarter and $5.1 million for the nine months, including inventory write-downs of approximately $1.3 million and $3.6 million, respectively. Remaining assets held for sale totaled $1.1 million.
- Special charges were $0.6 million for the quarter and $1.7 million for the nine months, primarily severance and office-closing costs related to SST.
Guidance, outlook, commentary and risks
- Management expects to increase inventory in the March 2011 quarter to shorten lead times and improve delivery performance. It expects existing liquidity and operating cash flow to fund anticipated requirements for at least the next 12 months.
- Management expects gross margins to fluctuate with capacity utilization, product mix, yields, fixed-cost absorption, competitive pricing and economic conditions.
- Key risks include semiconductor cyclicality, short order visibility and dependence on turns orders, competitive price pressure, product demand and mix, inventory obsolescence, manufacturing yields, third-party foundry and assembly capacity, and supply disruptions.
- Approximately 80% of sales were to foreign customers, with Asia representing 57.1% of quarterly sales. Substantially all foreign sales were denominated in U.S. dollars; geopolitical, infrastructure, export-control, tax and economic risks remain material.
- Distributors represented approximately 54% of quarterly sales and 56% of nine-month sales. Distributor inventory was 39 days at December 31, 2010. Revenue is generally recognized upon distributor sell-through, and deferred income on distributor shipments was $142.7 million.
- Auction-rate securities of $12.9 million continued to experience failed auctions and were valued using Level 3 estimates. The company recorded impairment charges of $0.4 million in the quarter and $1.3 million for the nine months and warned that additional impairments are possible.
- The company is subject to IRS audits for fiscal 2006 through 2008. Unrecognized tax benefits increased by approximately $50.5 million from March 31, 2010, primarily due to SST-related positions, ongoing accruals and interest.
- Legal proceedings and intellectual-property claims are considered unlikely to have a material adverse effect based on current information, but outcomes are uncertain. Technology-license indemnification obligations with specified limits could reach approximately $85 million; no liability was recorded for these obligations.
- Management reported effective disclosure controls. During the quarter, essentially all SST processes were transitioned to Microchip's internal control environment.
Most important facts for investors to verify
- Whether the SST purchase price allocation, goodwill allocation and contingent liabilities change upon final valuation.
- Whether the acquisition's revenue and margin contribution is sustainable after full integration and divestiture of nonstrategic product lines.
- March 2011 quarter sales, inventory growth and the effect of higher inventory on cash conversion and gross margin.
- The company's ability to sustain approximately 59% gross margins amid semiconductor pricing pressure and changing product mix.
- Liquidity and valuation risk associated with the $12.9 million of failed auction-rate securities and the broader investment portfolio.
- Potential cash requirements, dilution and refinancing considerations related to the $1.15 billion convertible debentures.
- Outcomes of IRS audits, uncertain tax positions and any changes in tax legislation affecting foreign earnings.
- Exposure to distributor concentration, third-party manufacturing capacity, foreign operations and intellectual-property litigation.