Microchip Technology Incorporated — Form 10-Q Summary
Business context and reporting period
Microchip designs, manufactures and markets embedded-control semiconductor products, including microcontrollers, memory, analog and interface products, and Flash intellectual-property licensing. The filing covers the quarter and six months ended September 30, 2011, the second quarter and first six months of fiscal 2012. The financial statements are unaudited.
Key financial metrics
| Metric | Three months ended September 30, 2011 | Year-over-year change | Six months ended September 30, 2011 | Year-over-year change |
|---|---|---|---|---|
| Net sales | $340.6 million | Down 10.9% | $715.1 million | Down 3.3% |
| Gross profit | $195.0 million | Down from $225.0 million | $414.7 million | Down from $432.4 million |
| Gross margin | 57.3% | Down from 58.9% | 58.0% | Down from 58.5% |
| Operating income | $97.6 million | Down from $123.1 million | $214.5 million | Down from $232.4 million |
| Net income | $79.3 million | Down from $103.1 million | $178.6 million | Down from $192.6 million |
| Diluted EPS | $0.40 | Down from $0.54 | $0.88 | Down from $1.01 |
Quarterly operating margin was 28.7%, compared with 32.2% in the prior-year quarter; six-month operating margin was 30.0%, compared with 31.4%. The effective tax rate was 12.2% for the quarter and 12.5% for the six-month period.
Revenue mix for the quarter was approximately 66.6% microcontrollers, 13.1% memory, 12.4% analog and interface products, 6.5% technology licensing and 1.4% other revenue. Technology licensing revenue increased 27.3% year over year for the quarter and 30.7% for the six-month period, partially offsetting declines in semiconductor products.
Six-month operating cash flow was $238.1 million, compared with $291.4 million in the prior-year period. Capital expenditures were $52.4 million, compared with $65.9 million. Cash dividends paid were $132.1 million. Cash and cash equivalents were $675.1 million at September 30, 2011, and total cash, cash equivalents and investments were $1.775 billion.
Inventories increased to $211.2 million from $180.8 million at March 31, 2011, equivalent to 132 days of inventory versus 107 days. Accounts receivable declined to $142.4 million from $181.2 million. Deferred income on shipments to distributors was $144.2 million.
Debt, liquidity and capital resources
The company carried $351.4 million of junior convertible debentures, with $1.15 billion principal amount outstanding and a 2.125% coupon. The debentures mature in 2037, have an adjusted conversion price of approximately $28.48 per share, and had an estimated fair value of $1.351 billion at September 30, 2011.
On August 12, 2011, Microchip entered into a $750 million revolving credit facility maturing August 12, 2016, with potential additional commitments of up to $250 million. No borrowings or letters of credit were outstanding at September 30, 2011. Management stated that existing liquidity and operating cash flow should be sufficient for anticipated cash requirements for at least the next 12 months. Planned capital expenditures for the next 12 months were approximately $50 million.
Material changes versus the prior comparable period
- Quarterly and year-to-date sales declined primarily because of weaker global economic and semiconductor conditions. Semiconductor unit volumes fell approximately 15.0% for the quarter and 8.7% for the six-month period, while semiconductor average selling prices increased approximately 2.0% and 2.9%, respectively.
- Memory revenue declined 27.8% for the quarter and 18.0% for the six-month period, reflecting weaker demand in Serial EEPROM and Flash markets.
- Microcontroller revenue declined 11.6% for the quarter and 3.8% for the six-month period. Analog and interface revenue declined 8.9% and 3.5%, respectively.
- Gross margin decreased because of product mix, inventory write-down activity and manufacturing factors. The company reduced wafer starts and Thailand output in response to slower conditions, which management expected to negatively affect future gross margins.
- Research and development expense increased to $45.4 million for the quarter and $90.7 million for the six-month period, while selling, general and administrative expense declined to $52.0 million and $109.6 million, respectively.
- No special charges were recorded in fiscal 2012; the prior-year periods included $0.6 million for the quarter and $1.0 million for the six months of SST-related severance and office-closing costs.
- The company settled a $19.4 million bankruptcy reorganization liability during the second quarter of fiscal 2012.
Guidance, outlook, commentary and risks
Management expected inventory levels to grow in the December 2011 quarter to maintain competitive lead times and delivery performance, while keeping fiscal 2012 and fiscal 2013 capital expenditures relatively low. The company expected approximately $50 million of capital expenditures over the following 12 months.
Key risks include semiconductor demand cyclicality, pricing pressure, reduced manufacturing utilization and yields, inventory obsolescence, reliance on distributors and third-party foundries and assembly providers, international operations, and limited customer order visibility. Distributors represented approximately 59% of sales in the first six months of fiscal 2012, and the largest distributor represented approximately 10% of sales.
Thailand had recently experienced severe flooding, although company facilities continued to operate normally at the filing date. Substantially all finished-goods inventory was maintained in Thailand, creating potential supply-chain and business-interruption exposure.
The investment portfolio included $11.7 million of auction rate securities subject to failed auctions and estimated using significant unobservable inputs. The company recorded $0.4 million of impairment expense in the quarter and $0.8 million for the six-month period. It also recorded a $1.7 million impairment charge on certain marketable equity securities during the quarter.
The IRS was auditing fiscal years 2009 and 2010. The company had $65.0 million of long-term income tax payable and stated that it maintained reserves for uncertain tax positions. Legal and intellectual-property claims were considered ordinary-course matters; potential indemnification obligations under certain technology licenses were approximately $94 million if all specified limits were triggered, with no related liability recorded.
Management reported effective disclosure controls and procedures and no material change in internal control over financial reporting during the quarter. Recently adopted revenue-recognition standards did not have a significant financial statement impact.
Important facts for investors to verify
- Whether semiconductor demand and unit volumes recover, particularly in memory and microcontroller markets.
- The effect of reduced wafer starts, lower Thailand output and elevated inventory on future gross margins and potential write-downs.
- Distributor inventory levels, sell-through, price concessions and the recoverability of the $144.2 million deferred distributor margin balance.
- The liquidity and valuation of the $11.7 million auction rate securities and any additional investment impairments.
- The terms, potential dilution and refinancing risk associated with the $1.15 billion convertible debentures.
- The impact of Thailand flooding, third-party manufacturing dependencies and other supply-chain disruptions.
- Outcomes of IRS examinations, other tax matters, intellectual-property litigation and indemnification claims.
- The sustainability of quarterly dividends; a $0.348 per-share dividend was declared for payment in December 2011, subject to board discretion.