Business Context and Reporting Period
Microchip Technology Incorporated designs, manufactures and sells embedded-control semiconductor products and licenses SuperFlash and other technologies. Reportable segments are semiconductor products and technology licensing. This unaudited Form 10-Q covers the three and six months ended September 30, 2020, the second quarter and first six months of fiscal 2021.
Operations remained fully operational at the quarter end, although COVID-19, economic uncertainty, trade restrictions and customer demand fluctuations affected markets and supply chains. Semiconductor products represented $1,286.2 million, or approximately 98%, of quarterly sales; technology licensing represented $23.3 million.
Financial Performance and Key Metrics
| Metric | Q2 FY2021 | Q2 FY2020 | Six Months FY2021 | Six Months FY2020 |
|---|---|---|---|---|
| Net sales | $1,309.5 million | $1,337.8 million | $2,619.2 million | $2,660.4 million |
| Gross profit | $807.9 million | $827.5 million | $1,606.2 million | $1,642.7 million |
| Gross margin | 61.7% | 61.9% | 61.3% | 61.7% |
| Operating income | $226.2 million | $183.6 million | $444.5 million | $355.2 million |
| Operating margin | 17.3% | 13.7% | 17.0% | 13.4% |
| Net income | $73.6 million | $108.9 million | $197.2 million | $159.6 million |
| Diluted EPS | $0.27 | $0.43 | $0.75 | $0.63 |
Quarterly sales declined 2.1% year over year and six-month sales declined 1.5%. Microcontroller sales increased 0.8% in the quarter and 1.0% for the six months; analog sales decreased 8.2% and 6.2%, respectively; FPGA sales increased 16.3% and 6.0%; and LMO sales decreased 10.9% and 5.9%.
Six-month operating cash flow was $957.6 million versus $776.6 million in the prior-year period. Capital expenditures were $15.8 million versus $41.6 million, implying operating cash flow less capital expenditures of approximately $941.8 million. Financing cash flow was negative $931.7 million, primarily reflecting debt settlements, debt repayments and dividends.
At September 30, 2020, cash and cash equivalents were $368.3 million and short-term investments were $2.0 million. Inventories were $661.4 million, or approximately 120 days of inventory, compared with $685.7 million and 122 days at March 31, 2020.
Material Changes Versus Prior Comparable Period
- Revenue declined primarily because of weaker demand in consumer, automotive and industrial markets and the continuing effects of COVID-19. Excluding distributor inventory changes, management estimated demand declined 4.4% in the quarter and 4.3% for the six months.
- Demand was relatively stronger in computing and communications. Asia sales increased as demand in China and Taiwan recovered, while Europe weakened, particularly in automotive and industrial markets.
- Gross margin decreased modestly because of lower sales and increased unabsorbed capacity charges, partly offset by product mix. Unabsorbed capacity charges were $12.2 million in the quarter and $26.1 million for the six months.
- Operating margin improved because research and development and selling, general and administrative expenses declined 9.1% and 16.0%, respectively, in the quarter, reflecting discretionary spending controls, lower headcount costs and reduced travel.
- Quarterly net income fell despite higher operating income because the company recorded a $45.1 million loss on debt settlements, compared with $0.1 million in the prior-year quarter. For the six months, net income increased partly because of a $60.9 million nonrecurring tax benefit related to an intra-group intellectual-property transfer and despite a $25.2 million cumulative tax expense associated with the Altera litigation.
- Interest expense declined to $93.3 million in the quarter and $192.4 million for the six months, compared with $129.6 million and $262.2 million, respectively, due to debt paydown and lower variable interest rates.
Debt, Liquidity and Capital Allocation
Principal debt outstanding was $9.87 billion at September 30, 2020, with net debt carrying value of $9.18 billion. Current maturities were $996.1 million, consisting of the 3.922% 2021 Notes due June 1, 2021. The company had $1.92 billion outstanding under its $3.57 billion revolving facility and $1.71 billion under its term loan facility. Variable-rate debt was approximately $3.63 billion; management estimated that a 50-basis-point rate increase would increase annual interest expense by approximately $18.1 million.
In May 2020, the company issued $1.0 billion of 2.670% 2023 Notes and $1.2 billion of 4.250% 2025 Notes. Proceeds were used to settle convertible debt, repay the $615.0 million bridge loan and reduce revolving debt. During the quarter, the company settled additional convertible debt using revolving-facility borrowings.
The company paid $185.7 million in dividends during the six months. A quarterly dividend of $0.3685 per share was declared on November 5, 2020, with an expected aggregate payment of approximately $96.0 million. No common-stock repurchases occurred during the period.
Management expects capital expenditures of $120 million to $180 million over the next twelve months and believes existing cash, operating cash flow and revolving-facility availability will meet anticipated requirements for at least twelve months.
Guidance, Outlook, Risks and Unusual Items
- Management expects December 2020 inventory days to be between four days below and four days above September levels.
- The company expects to incur less than $4.0 million of additional costs in the second half of fiscal 2021 related to repurposing Fab 5; $4.0 million was incurred in the first six months.
- COVID-19 cases, government restrictions, customer cancellations, supply-chain interruptions and logistics constraints could adversely affect production, shipments and demand in future periods.
- U.S.-China trade restrictions and the Huawei ban reduced analog demand and may continue to affect sales, costs and customer relationships. Approximately 76% of first-half sales were to foreign customers, including approximately 22% to China and 16% to Taiwan.
- Approximately 61% of sales came from products manufactured at outside wafer foundries, and third-party contractors performed approximately 53% of assembly and 45% of test requirements during the first six months.
- Material legal and regulatory matters include shareholder litigation related to the Microsemi acquisition, government investigations by the Department of Justice and SEC, and a Continental arbitration claim alleging approximately $218.3 million of damages. The company estimated possible but not probable aggregate liabilities of approximately $100 million above accrued amounts.
- Technology license agreements contain indemnification provisions with specified potential exposure of approximately $168.1 million; no related liability was recorded.
- Goodwill was $6.66 billion and net intangible assets were $5.26 billion. No goodwill or intangible-asset impairment charges were recorded in the first six months of fiscal 2021.
- Disclosure controls and procedures were effective at September 30, 2020, and no material change in internal control over financial reporting was identified during the quarter.
Important Facts for Investors to Verify
- Whether COVID-19-related demand recovery in automotive, industrial and consumer markets offsets continued economic, trade and supply-chain risks.
- The company’s ability to refinance or repay the $996.1 million of current debt maturities and manage total principal debt of $9.87 billion.
- Future gross-margin effects from capacity utilization, product mix, foundry dependence and Fab 5 restructuring.
- The sustainability of operating cash flow and the planned $120 million to $180 million of capital expenditures while continuing quarterly dividends.
- The financial and operational outcomes of the pending legal proceedings, government investigations and Continental arbitration.
- The extent to which nonrecurring tax items affected the six-month earnings increase and whether future effective tax rates remain comparable.
- Potential dilution and cash requirements from the remaining convertible debt, including the 2015 Senior Convertible Debt, which was convertible during the fourth calendar quarter of 2020.