Microchip Technology Incorporated: Fiscal 2017 Third-Quarter Form 10-Q
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 semiconductor technology. The report covers the three and nine months ended December 31, 2016, with comparisons to the prior-year periods. Results include Atmel from its April 4, 2016 acquisition and Micrel from its August 3, 2015 acquisition.
Key financial metrics
| Metric | Three months ended Dec. 31, 2016 | Three months ended Dec. 31, 2015 | Nine months ended Dec. 31, 2016 | Nine months ended Dec. 31, 2015 |
|---|---|---|---|---|
| Net sales | $834.4 million | $540.3 million | $2.505 billion | $1.616 billion |
| Gross profit | $465.3 million | $292.7 million | $1.224 billion | $902.7 million |
| Gross margin | 55.8% | 54.2% | 48.9% | 55.9% |
| Operating income | $118.1 million | $76.1 million | $121.7 million | $272.4 million |
| Net income attributable to Microchip | $107.2 million | $61.2 million | $27.7 million | $256.8 million |
| Diluted earnings per share | $0.46 | $0.28 | $0.12 | $1.18 |
| Operating cash flow | Not separately provided | Not separately provided | $736.9 million | $541.9 million |
- Quarterly sales increased 54.4% year over year but declined 4.2% from the preceding quarter's $871.4 million, primarily because certain Atmel distributor practices were conformed to Microchip's deferred-revenue model beginning October 1, 2016.
- Nine-month sales increased 55.1% year over year, driven mainly by Atmel and Micrel, historical-business growth and semiconductor-market conditions. Semiconductor products generated $810.5 million of quarterly sales and technology licensing generated $23.8 million.
- Quarterly operating margin was 14.2%, compared with 14.1% in the prior-year quarter. Nine-month operating margin fell to 4.9% from 17.0%, primarily because of acquisition-related inventory fair-value charges, higher amortization, restructuring and increased operating expenses.
- Acquired inventory fair-value charges reduced gross profit by approximately $12.0 million in the quarter and $186.7 million for the nine-month period.
- Atmel contributed approximately $263.2 million of quarterly sales and $756.3 million of nine-month sales, but also contributed losses from continuing operations of $34.7 million and $294.1 million, respectively.
- Cash and cash equivalents were $663.9 million at December 31, 2016. Cash, cash equivalents and investments totaled approximately $699.7 million, down from $2.565 billion at March 31, 2016, largely because of the Atmel acquisition.
- Inventories were $419.6 million, or 104 days, compared with $306.8 million, or 110 days, at March 31, 2016. Accounts receivable were $475.1 million.
- Outstanding credit-facility borrowings were approximately $1.683 billion, versus $1.052 billion at March 31, 2016. Senior and junior convertible debentures had carrying values of $1.250 billion and $198.4 million, respectively.
- Total debt obligations consisted of substantial revolving borrowings and convertible debentures; the company remained in compliance with its credit-facility covenants at December 31, 2016.
- The company paid $232.8 million in dividends during the first nine months and declared a quarterly dividend of $0.3610 per share payable March 7, 2017.
Material changes versus the prior comparable period
- Atmel substantially expanded revenue, goodwill and intangible assets. At December 31, 2016, goodwill was $2.362 billion and net intangible assets were $2.234 billion, compared with $1.013 billion and $606.3 million, respectively, at March 31, 2016.
- Operating expenses increased materially, including nine-month research and development expense of $418.1 million versus $277.0 million and selling, general and administrative expense of $388.7 million versus $223.4 million.
- Acquired-intangible amortization increased to $82.8 million for the quarter and $243.4 million for nine months, compared with $48.3 million and $126.8 million, respectively.
- Nine-month net income declined despite higher sales because of acquisition-related inventory charges, amortization, restructuring, higher interest expense and other acquisition-related costs. The nine-month tax benefit was $15.7 million, producing a negative effective tax rate of 87.3%, primarily because of acquisition-related deductions and favorable tax-reserve developments.
- The company sold Atmel's mobile-touch assets on November 10, 2016. The business generated a nine-month net loss from discontinued operations of $6.0 million. A Micrel wafer fabrication facility was classified as held for sale.
- Special charges were $20.9 million for the quarter and $52.5 million for nine months, compared with special income of $5.0 million and charges of $3.2 million in the respective prior-year periods.
Guidance, outlook, commentary and risks
- Management expects inventory days in the March 2017 quarter to range from four days below to four days above the December 2016 level.
- Management intends to spend approximately $120 million on capital expenditures during the next 12 months, funded through cash balances and operating cash flow.
- Management believes existing liquidity, operating cash flow and available credit will meet anticipated cash requirements for at least the next 12 months, but notes that future acquisitions, dividends, capital spending or share repurchases could require additional financing.
- Revenue recognition for distributors is a significant judgment. Deferred income on distributor shipments was $294.3 million at December 31, 2016, including approximately $424.0 million of deferred revenue and $129.7 million of deferred cost of sales before netting.
- The company is evaluating the expected impact of the new revenue-recognition standard, which will generally require recognition when products are sold to distributors rather than when distributors sell to end customers. Adoption is required no later than April 1, 2018, and the transition method had not been selected.
- Key risks include semiconductor cyclicality, pricing pressure, demand and distributor inventory fluctuations, reliance on external wafer foundries and assembly/test contractors, acquisition integration, goodwill and intangible-asset impairment, high debt levels, foreign operations and tax-law changes.
- Atmel-related legal matters include a putative class action involving airbag-control units and Continental ICC arbitration seeking approximately $61.6 million, subject to increase. The company intends to defend these matters vigorously. Aggregate potential liability assessed as possible but not probable was approximately $100 million above accrued amounts.
- Unrecognized tax benefits were $406.4 million at December 31, 2016, excluding timing estimates for future payments. The company was undergoing tax examinations in Germany and France.
- Disclosure controls were assessed as effective. Integration of Atmel's systems and internal controls remained in progress.
Important facts for investors to verify
- Separate underlying organic performance from revenue and earnings contributed by Atmel and Micrel.
- Track the normalization of Atmel distributor revenue recognition and the resulting effects on quarterly sales, deferred revenue and cash conversion.
- Assess the path to improved margins as acquired inventory fair-value charges and restructuring costs diminish, while recurring intangible amortization remains significant.
- Review debt maturities, leverage-covenant headroom, refinancing requirements and potential dilution or cash obligations from convertible debentures.
- Monitor integration costs, restructuring progress, asset-sale execution and potential goodwill or intangible-asset impairments.
- Evaluate the resolution and potential financial exposure from Continental-related product-liability and arbitration claims, other litigation and tax examinations.
- Confirm the effect of the forthcoming revenue-recognition adoption and any changes to dividend, capital-expenditure or acquisition financing plans.