Microchip Technology Incorporated — Form 10-Q Summary
Business context and reporting period
This unaudited Form 10-Q covers the three and six months ended September 30, 2012, the second quarter and first six months of fiscal 2013. Microchip designs, manufactures and markets embedded-control semiconductors, including microcontrollers, analog and interface products, memory products and technology-licensing solutions.
On August 2, 2012, Microchip completed its acquisition of Standard Microsystems Corporation (SMSC) for approximately $919.6 million. SMSC results are included from the acquisition date. Microchip also acquired Roving Networks on April 18, 2012, for approximately $20.6 million plus contingent consideration.
Financial highlights
| Metric | Three months ended September 30, 2012 | Three months ended September 30, 2011 | Six months ended September 30, 2012 | Six months ended September 30, 2011 |
|---|---|---|---|---|
| Net sales | $383.3 million | $340.6 million | $735.4 million | $715.1 million |
| Gross profit | $194.2 million | $196.7 million | $399.0 million | $418.2 million |
| Gross margin | 50.7% | 57.8% | 54.3% | 58.5% |
| Operating income | $8.1 million | $97.6 million | $104.4 million | $214.5 million |
| Net income (loss) | $(21.2) million | $79.3 million | $57.5 million | $178.6 million |
| Diluted earnings per share | $(0.11) | $0.40 | $0.28 | $0.88 |
Second-quarter sales increased 12.5% year over year and 8.9% from the preceding quarter. Six-month sales increased 2.8% year over year. Sales growth was driven primarily by the SMSC acquisition and market-share gains, partially offset by weak global economic and semiconductor-industry conditions.
- Microcontroller sales increased 11.6% in the quarter and 2.3% for the six-month period.
- Analog and interface sales increased 65.7% in the quarter and 38.2% for the six-month period, principally from SMSC and market-share gains.
- Memory sales declined 18.1% in the quarter and 19.3% for the six-month period because of weaker demand and industry conditions.
- Technology-licensing revenue declined 8.5% in the quarter and 5.2% for the six-month period.
Profitability declined substantially. Gross margin was pressured by approximately $22.7 million of acquired-inventory valuation adjustments in the quarter, $4.5 million of under-absorbed manufacturing costs, weaker capacity utilization, product mix and competitive conditions. Operating expenses also increased because of SMSC-related costs, higher research and development spending, amortization of acquired intangible assets and special charges.
Special charges totaled $22.4 million in the quarter and six-month period, including approximately $10.9 million of SMSC severance, office-closing and other integration costs and $11.5 million of legal settlement costs related to Silicon Storage Technology. Acquired-intangible amortization was $27.9 million in the quarter and $31.9 million for the six-month period, compared with $2.7 million and $5.5 million, respectively, in the prior-year periods.
Cash flow, balance sheet, debt and liquidity
- Operating cash flow was $192.3 million for the six months ended September 30, 2012, compared with $238.1 million in the prior-year period.
- Investing cash flow used $873.2 million, including $731.7 million of net cash consideration for SMSC and $20.6 million for other acquisitions. Capital expenditures were $26.2 million versus $52.4 million in the prior-year period.
- Financing cash flow provided $480.5 million, primarily from $600.0 million of borrowings under the revolving credit facility, partially offset by $135.9 million of dividends.
- Cash and cash equivalents declined to $436.7 million from $635.8 million at March 31, 2012. Total cash, cash equivalents and investments were $1.707 billion at September 30, 2012, down $80.2 million from fiscal year-end.
- Accounts receivable were $230.5 million and inventories were $289.5 million, including a $26.2 million SMSC fair-value inventory adjustment. Inventory represented approximately 140 days on hand.
- The company had $600.0 million outstanding under a $750.0 million revolving credit facility maturing in August 2016 and was in compliance with its leverage and interest-coverage covenants.
- Junior subordinated convertible debentures had a carrying value of $359.7 million and a fair value of approximately $1.447 billion. The debentures have $1.15 billion of principal and a 2.125% coupon.
- Management stated that existing liquidity and operating cash flow should be sufficient for anticipated requirements for at least the next 12 months.
The company expects approximately $50.0 million of capital expenditures over the next 12 months. It paid a quarterly dividend of $0.351 per share and declared a subsequent dividend of $0.352 per share, expected to total approximately $68.5 million.
Material changes, outlook and management commentary
- The SMSC acquisition materially expanded revenue, goodwill and intangible assets, but also increased amortization, integration costs, outsourced manufacturing exposure, debt and customer concentration.
- Goodwill increased to $260.1 million and net intangible assets increased to $607.1 million at September 30, 2012. The preliminary SMSC purchase-price allocation remained subject to revision.
- Management reduced wafer starts further in late September 2012 and expected this to negatively affect gross margin in the December 2012 quarter.
- Management expected inventory to decline in the December 2012 quarter as SMSC acquisition-related inventory adjustments were recognized through cost of sales.
- Management expected a future effective tax rate below 20%, excluding changes in tax law, nonrecurring tax events and acquisition-related tax effects. The six-month effective tax rate was 38.1%, compared with 12.5% in the prior-year period.
- Management identified ongoing risks from global economic conditions, semiconductor cyclicality, pricing pressure, capacity utilization, manufacturing yields, distributor inventory and sell-through, and limited visibility from short-term customer orders.
- Approximately 82% of sales were to foreign customers. Asia represented 57.4% of quarterly sales and 57.5% of six-month sales.
- Approximately $34.3 million of auction-rate securities remained subject to failed auctions and valuation uncertainty. The company recorded a $0.3 million impairment charge during the period.
- The company had $179.8 million of unrecognized tax benefits, including a $109.3 million increase primarily associated with SMSC. The IRS was auditing fiscal 2009 and 2010 tax returns.
- Remaining SST-related contingent liabilities were $5.7 million at September 30, 2012. Potential future payments under technology-license indemnifications were approximately $105 million if all specified limits were reached; no related liability was recorded.
Most important facts for investors to verify
- Whether SMSC integration delivers the expected revenue, cost synergies and strategic benefits without additional restructuring, impairment or control costs.
- The effect of acquired-inventory adjustments, reduced wafer starts, capacity utilization and product mix on December 2012 and subsequent gross margins.
- The company’s ability to reduce inventory while maintaining customer service and avoiding additional inventory write-downs.
- Debt repayment capacity and compliance with the revolving credit facility’s covenants, including the impact of $600 million of new borrowings.
- The sustainability of quarterly dividends and the allocation of cash held by foreign subsidiaries, where approximately $1.643 billion of cash and investments were held at September 30, 2012.
- Potential changes in tax reserves and unrecognized tax benefits arising from IRS and other tax examinations.
- Exposure to failed auction-rate securities, marketable equity investments, foreign operations, Thailand facilities, third-party foundries and assembly/test contractors.
- Legal, intellectual-property, indemnification and SST-related contingencies, including the $11.5 million settlement charge recorded in the quarter.