Microchip Technology Incorporated — Fiscal 2021 Third-Quarter Form 10-Q
Reporting period: Three and nine months ended December 31, 2020. The filing is unaudited and covers Microchip’s semiconductor products and technology licensing businesses. Results include comparisons with the corresponding periods ended December 31, 2019.
Business Context and Reporting Period
Microchip designs, manufactures and sells embedded-control semiconductor products, including microcontrollers, analog products, FPGAs and memory-related products, and licenses SuperFlash and other technologies. Its principal end markets include consumer, automotive, industrial, aerospace, office communications and computing.
Manufacturing and logistics operations were fully operational at quarter-end, but supply-chain constraints became more challenging as demand recovered in consumer, automotive and industrial markets. Management expected these constraints to continue through most of calendar 2021.
Financial Performance and Key Metrics
| Metric | Three months ended December 31, 2020 | Three months ended December 31, 2019 | Nine months ended December 31, 2020 | Nine months ended December 31, 2019 |
|---|---|---|---|---|
| Net sales | $1,352.1 million | $1,287.4 million | $3,971.3 million | $3,947.8 million |
| Gross profit | $845.8 million | $785.5 million | $2,452.0 million | $2,428.2 million |
| Gross margin | 62.6% | 61.0% | 61.7% | 61.5% |
| Operating income | $245.6 million | $131.2 million | $690.1 million | $486.4 million |
| Operating margin | 18.2% | 10.2% | 17.4% | 12.3% |
| Net income | $36.2 million | $311.1 million | $233.4 million | $470.7 million |
| Diluted earnings per share | $0.13 | $1.20 | $0.87 | $1.84 |
| Dividends declared per share | $0.3685 | $0.3665 | $1.1040 | $1.0980 |
Revenue mix: Third-quarter revenue increased 5.0%, led by microcontrollers and analog products. Microcontroller revenue increased 5.9%, analog revenue increased 2.6%, FPGA revenue increased 7.0% and LMO revenue increased 5.6%. For the first nine months, revenue increased 0.6%; excluding distributor inventory changes, underlying demand decreased 1.5%.
Operating expenses: Third-quarter research and development expense decreased 3.2% to $210.1 million, selling, general and administrative expense decreased 9.7% to $154.2 million, acquired-intangible amortization decreased to $231.6 million, and special charges decreased to $4.3 million. Similar reductions occurred for the nine-month period.
Interest and unusual items: Interest expense decreased to $86.5 million in the quarter and $278.9 million for the nine months, primarily because of debt paydown and lower rates on variable-rate debt. Debt settlement losses were $142.1 million in the quarter and $214.0 million for the nine months, materially reducing net income.
Cash flow: Operating cash flow was $1.47 billion for the nine months, compared with $1.17 billion in the prior-year period. Investing cash flow used $110.1 million, including $37.2 million of capital expenditures. Financing cash flow used $1.39 billion, reflecting debt settlements and repayments, dividends and other financing activity. Cash and cash equivalents were $370.7 million at December 31, 2020, compared with $401.0 million at March 31, 2020; cash, cash equivalents and short-term investments totaled $372.7 million.
Balance Sheet, Debt and Liquidity
- Total assets were $16.58 billion at December 31, 2020, compared with $17.43 billion at March 31, 2020.
- Net long-term debt, including current maturities, was $9.14 billion; gross principal debt was approximately $9.58 billion.
- Current maturities totaled $1.49 billion, including the 3.922% 2021 Notes due June 1, 2021 and portions of convertible debt.
- Revolving Credit Facility borrowings were approximately $2.36 billion against commitments of approximately $3.57 billion, with the facility scheduled to mature in May 2023.
- Fixed-rate debt totaled approximately $7.22 billion, while variable-rate debt totaled approximately $2.36 billion. Management estimated that a 50-basis-point increase in interest rates would increase annual interest expense by approximately $11.8 million.
- The company issued $1.40 billion of 0.972% senior secured notes due 2024 and used the proceeds, together with revolver borrowings, to repay the Term Loan Facility.
- Management believed existing liquidity, operating cash flow and revolver availability would be sufficient for anticipated cash requirements for at least the next 12 months.
- Planned capital expenditures for the next 12 months were $175 million to $200 million, compared with $37.2 million incurred in the first nine months of fiscal 2021.
Material Changes Versus the Prior Comparable Period
- Quarterly revenue rose 5.0%, while nine-month revenue was broadly stable, up 0.6%.
- Quarterly gross margin improved 160 basis points to 62.6%; nine-month gross margin improved 20 basis points to 61.7%.
- Quarterly operating income increased 87.2%, and the operating margin expanded to 18.2% from 10.2%. The improvement reflected higher revenue, lower operating expenses, lower acquired-intangible amortization and lower special charges.
- Net income declined sharply because the prior-year period included a $300.5 million income tax benefit, while the current quarter included a $142.1 million debt-settlement loss. Nine-month net income decreased to $233.4 million from $470.7 million.
- Operating cash flow increased approximately $295 million, supported by working-capital management and discretionary spending controls.
- The company substantially reshaped its capital structure through new senior notes, convertible-debt settlements and repayment of the Term Loan and Bridge Loan facilities.
- Shares outstanding increased as convertible debt settlements involved stock issuance. Weighted-average diluted shares increased to 275.4 million from 258.3 million in the quarter.
Guidance, Outlook, Risks and Unusual Items
- Supply-chain constraints, longer lead times and higher material and subcontracted manufacturing costs were expected to persist through most of calendar 2021. The company was adding internal and subcontractor capacity.
- Management expected March 2021 inventory days to decline by 1 to 9 days from the December 2020 level of 120 days.
- The company expected to incur less than $2.0 million of additional Fab 5 restructuring costs in the fourth quarter of fiscal 2021 after $7.0 million in such costs during the first nine months.
- A quarterly dividend of $0.39 per share was declared on February 4, 2021, with an expected aggregate payment of approximately $105 million in March 2021.
- COVID-19 continued to affect demand unevenly: consumer, automotive and industrial markets were recovering, while office-related demand remained weak. Future effects remained uncertain.
- Key risks include semiconductor cyclicality, demand volatility, distributor inventory patterns, reliance on external wafer foundries and assembly/test contractors, pricing pressure, trade restrictions and tariffs, foreign operations, cybersecurity, intellectual-property claims, tax examinations and acquisition integration.
- Pending matters include shareholder litigation and governmental investigations related to the Microsemi acquisition, an arbitration involving alleged defective Atmel components, and other acquired-business claims. The company estimated approximately $100 million of aggregate potential liability that was possible but not probable, in excess of accrued amounts.
- The company reported no goodwill impairment through December 31, 2020, but carried $6.67 billion of goodwill and $5.03 billion of net intangible assets, creating exposure to future impairment charges.
- Management stated that disclosure controls and procedures were effective and that no material change in internal control over financial reporting occurred during the quarter.
Important Facts for Investors to Verify
- Whether supply-chain constraints and capacity expansion affect shipments, backlog, margins and customer service through calendar 2021.
- How the June 2021 maturity of the $1.0 billion 3.922% Notes and other near-term obligations will be refinanced or repaid.
- Whether operating cash flow remains sufficient to fund debt service, dividends and the planned $175 million to $200 million of capital expenditures.
- The effect of convertible-debt settlements and potential future conversions on diluted share count and shareholder dilution.
- Whether demand recovery in automotive, industrial and consumer markets offsets weakness in office-related demand and broader macroeconomic risks.
- The ultimate costs and timing of litigation, governmental investigations, tax audits and other contingencies.
- Whether the large goodwill and intangible-asset balances remain recoverable under changing industry and market conditions.