Microchip Technology Incorporated: Fiscal 2014 Third-Quarter Form 10-Q
Reporting period: Three and nine months ended December 31, 2013; unaudited interim results. Microchip designs, manufactures and markets embedded-control semiconductors and licenses SuperFlash intellectual property. Fiscal year-end is March 31.
Financial Highlights
| Metric | Three months ended Dec. 31, 2013 | Year-over-year change | Nine months ended Dec. 31, 2013 | Year-over-year change |
|---|---|---|---|---|
| Net sales | $482.4 million | Up 15.9% | $1.438 billion | Up 24.9% |
| Gross profit | $282.7 million | Up from $200.4 million | $838.2 million | Up from $599.4 million |
| Gross margin | 58.6% | Up from 48.2% | 58.3% | Up from 52.1% |
| Operating income | $116.9 million | Up from $17.4 million | $332.8 million | Up from $121.8 million |
| Net income | $105.4 million | Up from $10.2 million | $283.8 million | Up from $67.7 million |
| Diluted EPS | $0.48 | Up from $0.05 | $1.31 | Up from $0.33 |
| Operating cash flow | Not provided for the quarter | Not provided | $473.2 million | Up from $331.5 million |
- Revenue declined 2.1% sequentially from $492.7 million in the preceding quarter, primarily because of general economic and semiconductor industry conditions.
- Semiconductor products generated $458.3 million of third-quarter sales and technology licensing generated $24.1 million. Microcontrollers represented 65.0% of sales, analog/interface/mixed-signal products 22.6%, memory 6.7%, and licensing 5.0%.
- Unit volume for semiconductor products increased approximately 16% year over year in the quarter, while average selling prices increased approximately 1%.
- At December 31, 2013, cash, cash equivalents and investments totaled $2.031 billion, including $375.1 million of cash and cash equivalents, $932.3 million of short-term investments and $723.9 million of long-term investments.
- Cash, cash equivalents and investments increased $195.3 million from March 31, 2013, although cash and cash equivalents alone decreased $153.2 million during the nine-month period.
- Debt included $650.0 million outstanding under the June 2013 credit agreement, $369.6 million carrying value of junior convertible debentures and $14.2 million of short-term borrowings. The credit agreement provides $2.0 billion of total commitments and matures June 27, 2018.
- Capital expenditures were $79.5 million for the first nine months, compared with $36.1 million in the prior-year period. Management expects approximately $100 million of capital expenditures during the following twelve months.
- Inventory was $274.6 million, or 126 days, at December 31, 2013, compared with $242.3 million, or 116 days, at March 31, 2013.
Material Changes Versus the Prior Comparable Period
- Profitability improved substantially because the prior-year periods included significant acquired-inventory valuation adjustments related to acquisition activity: approximately $30.8 million in the third quarter and $55.0 million in the first nine months of fiscal 2013.
- The nine-month comparison benefited from the August 2012 acquisition of Standard Microsystems Corporation, or SMSC, as well as market-share gains and broader semiconductor demand. SMSC also increased research and development and other operating costs.
- Research and development expense increased 7.0% in the quarter and 23.5% for the nine months, while selling, general and administrative expense decreased 3.6% in the quarter and increased 2.6% for the nine months.
- Special charges declined to $0.8 million in the quarter and $2.5 million for the nine months, compared with $2.6 million and $13.4 million, respectively, in the prior-year periods. The prior-year nine-month period also included approximately $11.5 million of legal settlement costs related to Silicon Storage Technology.
- Interest expense increased to $12.5 million in the quarter and $36.8 million for the nine months, primarily because of increased borrowings used in part to finance the SMSC acquisition.
- Memory sales were essentially flat in the quarter and declined 7.5% for the nine months, reflecting weaker Serial EEPROM and Flash memory demand. Analog, interface and mixed-signal sales increased 16.7% in the quarter and 52.3% for the nine months.
Cash Flow, Liquidity and Other Items
- Operating cash flow of $473.2 million exceeded capital expenditures of $79.5 million and cash dividends of $210.3 million during the first nine months.
- Investing cash outflows were $448.4 million, primarily reflecting purchases of available-for-sale investments and $79.5 million of capital expenditures; the prior-year period included $731.7 million of net cash consideration for SMSC.
- Financing cash outflows were $178.1 million, including $210.3 million of dividends and net debt repayments. A quarterly dividend of $0.3545 per share was paid in December 2013; a $0.355 dividend was declared for payment in March 2014.
- Management stated that existing liquidity, operating cash flow and available credit are expected to fund anticipated requirements for at least the next twelve months.
- Approximately $2.022 billion of cash, cash equivalents and investments was held by foreign subsidiaries, while approximately $9.2 million was available for U.S. operations without considering repatriation-related taxes. Foreign earnings are generally considered permanently reinvested offshore.
Guidance, Outlook, Risks and Unusual Items
- Management expected March 2014 quarter inventory to be flat to modestly lower than the December 2013 level and believed current inventory supported competitive lead times.
- Gross margins are expected to fluctuate with capacity utilization, product mix, manufacturing yields, fixed-cost absorption, pricing pressure and economic conditions. Wafer-fabrication utilization remained below normal capacity, producing $17.2 million of under-absorption charges for the first nine months.
- The effective tax rate was 9.7% for the first nine months, compared with 34.1% in the prior-year period. The current period included a net one-time tax benefit of approximately $6.2 million related primarily to a favorable IRS examination settlement. Unrecognized tax benefits were $179.2 million, and SMSC was under IRS audit for fiscal 2011 and 2012.
- The Company completed a smaller acquisition in November 2013, paying $9.0 million for the remaining interest and recognizing an approximately $2.4 million gain on remeasurement of its prior investment.
- The investment portfolio included $9.8 million of auction-rate securities with failed auctions and limited liquidity. Management recorded no impairment in the current period but warned that further credit deterioration or continued auction failures could require an earnings charge.
- Key risks include semiconductor cyclicality, uncertain customer orders and limited backlog visibility, pricing pressure, inventory obsolescence, reliance on distributors and third-party foundries, manufacturing and yield disruptions, Thailand political and flood risks, foreign-market exposure, intellectual-property litigation, tax audits, debt obligations, and possible dilution from convertible debentures.
- Distributors represented approximately 53.6% of sales in the first nine months, and foreign customers represented approximately 84% of sales. Approximately 38% of sales related to wafers purchased from outside foundries.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. No material off-balance-sheet arrangements were reported.
Investor Verification Checklist
- Verify whether the sharp margin and earnings improvement is sustainable after excluding prior-year acquisition-related inventory charges and current-period tax and acquisition gains.
- Assess inventory growth to $274.6 million and the planned March 2014 inventory reduction against demand, distributor inventory and semiconductor-cycle conditions.
- Review debt maturities, interest-rate exposure, credit-agreement covenants and the potential economic dilution or cash requirement associated with the convertible debentures.
- Monitor the concentration of cash and investments offshore and the potential tax cost or liquidity constraints associated with repatriation.
- Evaluate the liquidity and valuation assumptions for the $9.8 million of auction-rate securities.
- Track SMSC integration, acquisition-related charges, tax audits and the remaining $5.7 million of contingent liabilities related to the SST acquisition.
- Confirm the effect of distributor sell-through, pricing concessions, foundry dependence and Thailand operating conditions on future revenue and gross margin.