Microchip Technology Incorporated — Form 10-Q Summary
Business context and reporting period
Microchip designs, manufactures and sells embedded-control semiconductors, including microcontrollers, analog, interface, mixed-signal, timing and memory products, and licenses SuperFlash and other technologies. The report covers the quarter and six months ended September 30, 2016, the second quarter of fiscal 2017. Results include Atmel from its April 4, 2016 acquisition and Micrel from its August 3, 2015 acquisition.
Key financial metrics
| Metric | Three months ended September 30, 2016 | Three months ended September 30, 2015 | Six months ended September 30, 2016 | Six months ended September 30, 2015 |
|---|---|---|---|---|
| Net sales | $871.4 million | $541.4 million | $1.671 billion | $1.075 billion |
| Gross profit | $410.6 million | $301.0 million | $759.1 million | $610.0 million |
| Gross margin | 47.1% | 55.6% | 45.4% | 56.7% |
| Operating income | $62.8 million | $74.9 million | $3.7 million | $196.3 million |
| Net income (loss) attributable to Microchip | $33.9 million | $64.9 million | $(79.4) million | $195.6 million |
| Diluted EPS | $0.14 | $0.30 | $(0.37) | $0.90 |
| Operating cash flow | Not separately provided | Not separately provided | $446.1 million | $331.4 million |
Second-quarter sales increased 60.9% year over year and 9.0% sequentially from $799.4 million. Six-month sales increased 55.4% year over year. Management attributed growth primarily to the Atmel and Micrel acquisitions, market-share gains, new products and favorable general semiconductor and economic conditions. Semiconductor-product units increased approximately 61% in the quarter and 57% for the six-month period, while average selling prices increased approximately 1% and were approximately flat, respectively.
Gross margin declined primarily because of acquisition-related inventory fair-value step-up charges of approximately $84.3 million in the quarter and $174.8 million for the six-month period. Operating expenses also increased due to acquired businesses, higher amortization and acquisition-related costs. Six-month special charges were $31.6 million, including severance, office closures and other acquisition-related costs.
Balance sheet, cash flow, debt and liquidity
- Cash and cash equivalents were $490.0 million at September 30, 2016, compared with $2.093 billion at March 31, 2016. Cash, cash equivalents and investments totaled $490.8 million, down $2.074 billion.
- Operating cash flow was $446.1 million for the first six months, compared with $331.4 million in the prior-year period.
- Investing cash flow was $(2.316) billion, including $2.748 billion for the Atmel acquisition, net of cash acquired. Capital expenditures were $36.6 million, compared with $63.6 million.
- Financing cash flow was $267.8 million. The company borrowed $1.385 billion and repaid $951.5 million under its revolving credit facility, and paid $154.9 million in dividends.
- Revolving-credit borrowings were approximately $1.678 billion at September 30, 2016, versus $1.052 billion at March 31, 2016. The facility had total commitments of approximately $2.774 billion, with maturities in 2018 and 2020. The company was in compliance with its debt covenants.
- Senior and junior convertible-debt carrying amounts were $1.239 billion and $196.9 million, respectively. The junior debentures were convertible during the October–December 2016 period, and their if-converted value exceeded principal by $914.6 million.
- Inventory was $424.7 million, or 84 days, versus $306.8 million, or 110 days, at March 31, 2016. Management expected December-quarter inventory days to range from one day lower to 11 days higher than September levels, excluding acquired-inventory fair-value effects.
Material changes versus the prior comparable period
- The Atmel acquisition materially expanded sales, goodwill, intangible assets and debt. Total consideration was approximately $3.473 billion, funded with foreign cash, additional borrowings and 10.1 million Microchip shares.
- Atmel contributed approximately $274.1 million of quarterly sales and $493.1 million of six-month sales, but also contributed losses from continuing operations of $95.8 million and $259.4 million, respectively, including acquisition accounting effects.
- Goodwill increased to $2.385 billion from $1.013 billion, and net intangible assets increased to $2.323 billion from $606.3 million. Acquired-intangible amortization was $80.4 million in the quarter and $160.6 million for six months.
- Interest expense increased to $35.1 million in the quarter and $69.5 million for six months, compared with $25.6 million and $49.7 million, respectively, due primarily to higher borrowings.
- Technology-licensing revenue was $23.7 million in the quarter and $44.3 million for six months, compared with $23.2 million and $46.4 million, respectively; licensing represented a smaller percentage of total sales.
- The company recognized a six-month net loss from discontinued operations of $5.8 million related to Atmel’s mobile-touch business, with $14.1 million of assets classified as held for sale.
Guidance, outlook, commentary and risks
Management stated that existing liquidity, operating cash flow and borrowing capacity were expected to fund anticipated requirements for at least the next 12 months. The company planned approximately $120 million of capital expenditures over the next 12 months, primarily for equipment and facilities.
Management expected to continue investing in new products, process technologies and manufacturing capacity. It anticipated migrating some acquired assembly and test activities to internal facilities and planned to begin decommissioning the Micrel San Jose wafer fabrication facility in late fiscal 2017.
The Atmel mobile-touch business was classified as discontinued and held for sale because management determined it was not strategically aligned. On November 1, 2016, the company announced an agreement to sell related assets to Solomon Systech, expected to close in mid-November 2016 subject to customary conditions.
- Principal risks include integration of the large Atmel acquisition, realization of expected synergies, acquisition-related charges and potential impairment of substantial goodwill and intangible assets.
- Debt increased materially, creating refinancing, covenant and interest-rate risks. Convertible-debt conversion could dilute existing shareholders.
- Semiconductor demand, pricing, product mix, seasonality, manufacturing yields, capacity utilization and distributor inventory may cause significant quarterly volatility.
- The company relies on third-party wafer foundries, assembly and test providers, suppliers and distributors; approximately 41% of six-month sales came from products produced at outside wafer foundries.
- Approximately 85% of six-month sales were to foreign customers, with significant exposure to Asia, China, Thailand, the Philippines, Europe and potential Brexit-related disruption.
- Unrecognized tax benefits were $421.4 million, and the company was under IRS audit for fiscal 2011 and 2012. Possible but not probable legal and other contingency exposure was approximately $100 million above accrued amounts.
- The company disclosed pending Atmel-related product-liability and labor litigation, including a putative vehicle-airbag class action and more than 500 individual labor actions in France; management believed the matters were not expected to have a material adverse effect, but outcomes were uncertain.
- Revenue recognition for certain distributors and the effect of the future adoption of ASC 606 remain important estimates. The company expected to adopt the new revenue standard no later than April 1, 2018 and had not selected a transition method.
Facts investors should verify
- Whether Atmel integration produces the expected revenue growth, cost synergies and margin recovery after acquisition-related inventory step-up charges and restructuring costs subside.
- The company’s ability to reduce leverage while maintaining dividends, funding approximately $120 million of planned capital expenditures and supporting operations with reduced cash balances.
- The sustainability of reported sales growth excluding acquisition contributions and the effect of distributor sell-through, turns orders and inventory levels.
- Future gross margins after the acquired-inventory fair-value step-up is fully recognized, including the impact of product mix, pricing pressure and manufacturing costs.
- The outcome and timing of tax audits, uncertain tax positions, Atmel-related litigation and the mobile-touch divestiture.
- The effects of ASC 606 adoption on distributor revenue timing, deferred revenue and reported sales and margins.