Microchip Technology Incorporated — Q3 FY2015 Form 10-Q Summary
Reporting period: Quarterly period ended December 31, 2014; fiscal year ending March 31. Results are unaudited and should be read with the FY2014 Form 10-K.
Business Context
Microchip designs, manufactures and sells embedded-control semiconductor products, including microcontrollers, analog, interface, mixed-signal and memory products, and licenses SuperFlash and other technologies. Principal markets include consumer, automotive, industrial, office automation and telecommunications. Approximately 84% of sales were to foreign customers, and Asia represented approximately 60% of sales in the quarter.
Fiscal 2015 results include Supertex from April 1, 2014 and a controlling interest in ISSC from July 17, 2014. ISSC provides low-power Bluetooth and wireless solutions for the Internet of Things market; Supertex provides high-voltage analog and mixed-signal technologies.
Financial Performance and Key Metrics
| Metric | Q3 FY2015 | Q3 FY2014 | 9M FY2015 | 9M FY2014 |
|---|---|---|---|---|
| Net sales | $528.7 million | $482.4 million | $1.604 billion | $1.438 billion |
| Gross profit | $302.0 million | $282.7 million | $915.9 million | $838.2 million |
| Gross margin | 57.1% | 58.6% | 57.1% | 58.3% |
| Operating income | $98.0 million | $116.9 million | $315.3 million | $332.8 million |
| Operating margin | 18.5% | 24.2% | 19.7% | 23.1% |
| Net income attributable to Microchip | $86.1 million | $105.4 million | $269.6 million | $283.8 million |
| Diluted EPS | $0.39 | $0.48 | $1.20 | $1.31 |
Quarterly sales increased 9.6% year over year but declined 3.2% sequentially from $546.2 million, primarily because of weaker general economic and semiconductor-industry conditions. Nine-month sales increased 11.5% year over year. Semiconductor product average selling prices increased approximately 1% in the quarter and 2% for the nine-month period, while unit volumes increased approximately 9% and 12%, respectively.
Gross margin declined because of approximately $4.2 million of acquired-inventory fair-value charges in the quarter and $24.4 million for the nine-month period, together with product-mix effects. The prior-year periods included larger underutilized-capacity charges. Acquired-intangible amortization increased to $47.6 million in the quarter and $129.7 million for nine months, versus $21.8 million and $73.2 million, respectively, in the prior-year periods.
- Product mix: Microcontrollers generated 64.0% of quarterly sales; analog, interface and mixed-signal products generated 23.8%; memory generated 6.3%; and technology licensing generated 4.3%.
- Operating costs: R&D was $88.7 million, or 16.8% of sales, in the quarter; SG&A was $66.7 million, or 12.6%. R&D increased primarily because of acquisitions and higher headcount.
- Taxes: The nine-month effective tax rate was 6.0%, compared with 9.7% in the prior-year period. Prior-year tax-position releases increased nine-month EPS by approximately $0.04.
- Dividends: The quarterly dividend was $0.3565 per share; $214.4 million was paid during the first nine months. A $0.357 per-share dividend was declared for payment in March 2015.
Cash Flow, Liquidity and Capital Structure
- Operating cash flow for the nine months was $542.7 million, compared with $473.2 million in the prior-year period.
- Investing cash flow was negative $676.8 million, including $252.5 million for ISSC, $375.4 million for Supertex and $120.0 million of capital expenditures.
- Cash and cash equivalents were $456.3 million at December 31, 2014. Cash, cash equivalents and investments totaled $2.230 billion, up from $2.144 billion at March 31, 2014.
- Credit Agreement borrowings totaled $981.3 million, comprising $644.4 million of revolving borrowings and $336.9 million of term borrowings. The facility matures June 27, 2018, and the company was in compliance with its covenants.
- Carrying value of the junior subordinated convertible debentures was $379.3 million; the $1.15 billion principal amount is due December 2037. The debentures were convertible during the first quarter of calendar 2015 and contributed 18.9 million shares to quarterly diluted share count.
- Inventory was $276.1 million, or 111 days, versus 118 days at March 31, 2014. Accounts receivable was $242.6 million and deferred distributor income was $154.3 million.
Management expects approximately $150 million of capital expenditures during the next twelve months, funded through cash balances and operating cash flow, and believes existing liquidity, operating cash flow and available borrowings will meet anticipated requirements for at least the next twelve months. However, approximately $2.217 billion of cash, cash equivalents and investments was held by foreign subsidiaries, while approximately $12.9 million was available for U.S. operations without considering financing or repatriation strategies.
Material Changes, Outlook and Unusual Items
- The Supertex and ISSC acquisitions increased sales and expanded the analog, mixed-signal, wireless and IoT portfolios, but also increased amortization, acquisition-related charges and debt.
- ISSC contributed approximately $8.7 million of quarterly sales and a $10.0 million net loss attributable to the company; its sales were negatively affected by approximately $7.1 million from changing distributor revenue recognition to a sell-through model.
- Acquisition-related charges were $1.0 million for the quarter and $2.1 million for nine months. The company also recognized $1.3 million of intangible-asset impairment in the quarter and $1.9 million for nine months.
- Management expected March 2015-quarter inventory to increase by 3 to 8 days from the December level to support competitive lead times.
- The company planned to close the San Jose wafer fabrication facility and transfer production to Fab 2 within six months, and planned to close the acquired Hong Kong test facility during the March 2015 quarter.
- Management stated that the semiconductor business remains exposed to economic conditions, seasonality, customer and distributor inventory patterns, pricing pressure, capacity utilization, manufacturing yields and limited order visibility.
Risks and Contingencies
- Approximately 40% of sales came from products manufactured at outside wafer foundries, creating supplier, capacity, yield and disruption risks.
- Distributors represented approximately 52% of nine-month sales, generally without long-term contracts; distributor inventory increased to 36 days from 33 days at March 31, 2014.
- Competition and pricing pressure are particularly relevant to memory and non-proprietary analog products. Revenue is also affected by seasonal weakness and short-cycle “turns” orders.
- Foreign operations and sales create exposure to China and broader geopolitical, currency, tax, transportation and Thailand operating risks.
- The company had $222.0 million of unrecognized tax benefits and was under IRS audit for Microchip and SMSC fiscal 2011 and 2012 tax years.
- Pending litigation and intellectual-property claims were not expected by management to have a material adverse effect, but outcomes are uncertain. Technology-license indemnification obligations could reach approximately $138 million where contractual limits are specified; no related liability was recorded.
- Unsuccessful auctions affected $9.8 million of auction-rate securities, with a par value of $22.4 million. Management did not consider the unrealized losses to be other-than-temporary.
- Goodwill totaled $565.3 million at December 31, 2014, principally from Supertex and ISSC. No goodwill impairment had been recorded, but future impairment remains possible.
Investor Verification Checklist
- Verify the sustainability of revenue growth after separating Supertex and ISSC contributions from organic growth.
- Assess whether gross margin can recover after acquisition-related inventory charges and as acquired-intangible amortization remains elevated.
- Review acquisition purchase-price allocations, ISSC integration and the timing and cost of facility closures.
- Monitor leverage, convertible-debt conversion risk, interest expense and covenant headroom.
- Evaluate foreign cash availability, potential repatriation taxes and the adequacy of U.S. liquidity for dividends, capital expenditures and acquisitions.
- Track distributor inventory, deferred distributor income, inventory growth and expected March 2015 inventory increases.
- Review tax audits, unrecognized tax benefits, intellectual-property contingencies and possible goodwill or intangible-asset impairments.
- Confirm subsequent quarterly results against management’s stated capital-expenditure, dividend and liquidity expectations.