Microchip Technology Incorporated — Form 10-Q Summary
Business context and reporting period
This unaudited Form 10-Q covers the quarter and nine months ended December 31, 2017, the third quarter of fiscal 2018. Microchip designs, manufactures and sells embedded-control semiconductors, including microcontrollers, analog, interface, mixed-signal, timing and memory products, and licenses SuperFlash and other technologies. Semiconductor products generated $966.7 million of quarterly sales and technology licensing generated $27.5 million.
Financial performance and position
| Metric | Three months ended Dec. 31, 2017 | Prior-year period | Nine months ended Dec. 31, 2017 | Prior-year period |
|---|---|---|---|---|
| Net sales | $994.2 million | $834.4 million | $2,978.5 million | $2,505.1 million |
| Gross profit / margin | $607.1 million / 61.1% | $465.3 million / 55.8% | $1,805.6 million / 60.6% | $1,224.4 million / 48.9% |
| Operating income / margin | $245.2 million / 24.7% | $118.1 million / 14.2% | $692.2 million / 23.2% | $121.7 million / 4.9% |
| Net income (loss) | $(251.1) million | $107.2 million | $108.7 million | $27.7 million |
| Diluted EPS | $(1.07) | $0.46 | $0.44 | $0.14 |
- Quarterly sales increased 19.2% year over year and declined 1.8% sequentially from $1,012.1 million, primarily because of seasonality. Excluding specified Atmel-related revenue-recognition effects, management reported year-over-year growth of 12.8% for the quarter and 15.0% for the nine-month period.
- Microcontrollers represented 66.5% of quarterly sales and increased 27.9% year over year. Analog, interface, mixed-signal and timing sales increased 4.7%; memory sales increased 4.2%; and technology licensing sales increased 15.5%.
- The quarterly net loss resulted principally from a $447.7 million income-tax provision, including provisional effects of the Tax Cuts and Jobs Act. The company recorded a provisional tax impact of $443.2 million, reducing diluted nine-month EPS by $1.79. The provisional one-time transition tax was $627.7 million, partially offset by a $142.6 million deferred-tax remeasurement benefit and a $36.4 million foreign-tax-credit valuation-allowance release.
- Research and development expense was $131.6 million for the quarter and $395.7 million for nine months. Selling, general and administrative expense was $109.1 million and $337.6 million, respectively. Acquired-intangible amortization was $121.0 million and $362.8 million, respectively.
- Cash provided by operating activities was $1,060.1 million for the nine months, compared with $736.9 million in the prior-year period. Capital expenditures were $148.4 million, compared with $52.3 million.
- Cash, cash equivalents and investments totaled $1,985.0 million at December 31, 2017, up $574.8 million from March 31, 2017. Cash and cash equivalents were $672.1 million.
- Outstanding debt had $4,481.3 million of principal and $3,039.6 million of net carrying value, excluding the undrawn revolving facility. The company had no borrowings under its $3,122.3 million credit facility and was in compliance with its covenants.
- Inventory was $487.1 million, or 115 days, versus $417.2 million, or 103 days, at March 31, 2017. Deferred income on distributor shipments was $335.7 million.
Material changes versus the prior comparable period
- Gross margin improved substantially, partly because the prior-year periods included $12.0 million of quarterly and $186.7 million of nine-month acquired-inventory fair-value charges associated with acquisitions, as well as higher prior-year inventory write-down effects.
- Operating performance benefited from Atmel integration synergies, favorable semiconductor-market conditions, market-share gains, product mix and manufacturing efficiencies. R&D and SG&A declined year over year for the nine-month period, primarily from acquisition-related synergies and lower share-based compensation.
- Interest expense increased to $49.7 million for the quarter and $148.7 million for nine months, primarily because of the 2017 senior and junior convertible debt issuances. The company also recognized a $2.1 million quarterly and $16.0 million nine-month loss on settlement of convertible debt.
- Special charges declined to $0.2 million for the quarter and $17.3 million for nine months, versus $20.9 million and $52.5 million, respectively, in the prior-year periods. The current-year nine-month amount primarily included a $19.5 million Oregon utility-transition charge.
- The 2007 Junior Debt was fully settled by December 31, 2017. The 2015 Senior Debt was convertible during January 1 through March 31, 2018, with an above-par conversion value of $1,108.8 million at December 31, 2017.
Guidance, outlook, commentary and risks
- Management expected inventory days to increase modestly in the March 2018 quarter and believed existing inventory supported competitive lead times and delivery performance.
- The company intended to spend approximately $190.0 million on equipment and facilities during the following 12 months, funded through cash balances and operating cash flow.
- A quarterly dividend of $0.3630 per share was declared for payment in March 2018. The board may change or suspend future dividends.
- Beginning April 1, 2018, the company planned to adopt ASC 606 under the modified retrospective method. Revenue for distributor sales will generally be recognized upon shipment rather than when distributors sell to end customers, subject to estimated returns and allowances. Distributor inventory levels and pricing variability may materially affect future reported sales.
- The company expects to pay the provisional transition tax over eight years, although the amount remains subject to measurement-period adjustments under SAB 118. Future tax expense may also be affected by new taxes on foreign earnings and tax audits.
- Key risks include semiconductor cyclicality and seasonality, competitive pricing pressure, limited order visibility, distributor concentration, inventory obsolescence, reliance on third-party foundries and assembly/test contractors, manufacturing-yield and capacity risks, foreign operations, currency fluctuations, acquisition integration, substantial debt, tax uncertainty, intellectual-property claims, cybersecurity and business interruptions.
- Continental alleged that Atmel components contributed to airbag-control-unit recall costs of approximately $69.7 million, subject to increase. The company estimated possible-but-not-probable liabilities of approximately $100 million above accrued amounts and disclosed potential indemnification obligations of approximately $159.0 million under agreements with specified limits.
Most important facts for investors to verify
- Whether the provisional Tax Cuts and Jobs Act accounting, including the $627.7 million transition-tax estimate and $443.2 million total provisional impact, changes materially during the SAB 118 measurement period.
- The effect of ASC 606 adoption on revenue, gross margin, deferred distributor income and period-to-period comparability beginning April 1, 2018.
- Debt-service requirements, convertible-debt dilution or cash-settlement exposure, and compliance with the credit facility’s leverage and interest-coverage covenants.
- Whether inventory growth, distributor inventory of 34 days, and the planned March-quarter increase lead to excess inventory, price concessions or margin pressure.
- The outcome and potential exposure from the Continental arbitration, other Atmel-related claims, tax audits and intellectual-property matters.
- Whether sales growth, gross-margin improvement and Atmel integration synergies continue after adjusting for prior-year acquisition accounting effects and favorable semiconductor-market conditions.