Microchip Technology Incorporated — Form 10-Q Summary
Business context and reporting period
Microchip designs, manufactures, sells and licenses embedded-control semiconductor products, including microcontrollers, analog and mixed-signal products, FPGAs, memory and connectivity products. The filing covers the three months ended June 30, 2020, the first quarter of fiscal 2021, with comparisons to June 30, 2019. Results were affected by the COVID-19 pandemic, including weaker automotive, consumer and industrial demand, stronger demand in computing and communications, supply-chain disruptions and increased order cancellations or delivery deferrals.
Key financial metrics
| Metric | Q1 FY2021 | Q1 FY2020 | Change |
|---|---|---|---|
| Net sales | $1,309.7 million | $1,322.6 million | Down 1.0% |
| Gross profit | $798.3 million | $815.2 million | Down 2.1% |
| Gross margin | 61.0% | 61.6% | Down 60 basis points |
| Operating income | $218.3 million | $171.6 million | Up 27.2% |
| Operating margin | 16.7% | 13.0% | Up 370 basis points |
| Net income | $123.6 million | $50.7 million | Up 143.8% |
| Diluted earnings per share | $0.48 | $0.20 | Up $0.28 |
| Operating cash flow | $501.8 million | $380.6 million | Up 31.8% |
Net sales were composed primarily of semiconductor products of $1,287.8 million and technology licensing revenue of $21.9 million. Microcontroller revenue increased 1.1% to $716.4 million, while analog, interface, mixed-signal and timing revenue declined 4.2% to $370.2 million and FPGA revenue declined 4.6% to $86.8 million.
Gross margin declined because of lower semiconductor sales, $13.9 million of unabsorbed capacity charges versus $7.3 million in the prior-year quarter, and unfavorable product mix. Operating income improved primarily because research and development, selling, general and administrative, acquired-intangible amortization and special-charge expenses declined.
Cash and cash equivalents were $378.2 million at June 30, 2020, compared with $401.0 million at March 31, 2020. Cash, cash equivalents and short-term investments totaled $380.2 million. Operating cash flow was $501.8 million; investing cash flow used $16.9 million, including $9.5 million of capital expenditures; and financing cash flow used $507.7 million, including $90.4 million of dividends and substantial debt settlements.
Gross debt was $10.20 billion, including current maturities, and net debt after discounts and issuance costs was $9.33 billion. Variable-rate debt totaled approximately $3.16 billion; management estimated that a 50-basis-point increase in rates would increase annual interest expense by approximately $15.8 million. Inventory was $657.2 million, or 117 days, compared with $685.7 million, or 122 days, at March 31, 2020.
Material changes versus the prior comparable period
- End-market demand declined 4.2% excluding changes in distributor inventory, with weakness in automotive, consumer and industrial markets partly offset by strength in computing and communications.
- Asia represented 55.1% of sales versus 51.8% in the prior-year quarter; Europe declined to 18.7% from 22.0%, reflecting COVID-19 effects on automotive and industrial customers.
- Research and development expense declined 9.6% to $198.0 million, and selling, general and administrative expense declined 12.9% to $146.3 million, primarily from discretionary-spending controls, lower headcount costs and reduced travel.
- Interest expense declined to $99.1 million from $132.6 million because of debt paydowns and lower rates on variable-rate debt.
- The company issued $1.0 billion of 2.670% senior secured notes due 2023 and $1.2 billion of 4.250% senior unsecured notes due 2025. Proceeds funded settlements of approximately $1.03 billion of convertible debt, repayment of the $615.0 million bridge facility and repayment of revolving debt.
- The company recognized a $26.8 million loss on debt settlements, compared with a $1.9 million loss on term-loan prepayment in the prior-year quarter.
- The effective tax rate was unusually favorable because of discrete tax benefits, including a $60.9 million benefit from an intra-group intellectual-property transfer. This was partly offset by a $21.8 million tax expense related to the Altera litigation decision.
- No goodwill impairment was recorded, and no intangible-asset impairment was recorded versus $0.5 million in the prior-year quarter.
Guidance, outlook, commentary and risks
- Management expected September 2020 inventory days to increase by 1 to 13 days from the June level and believed current inventory supported competitive lead times and delivery performance.
- Capital expenditures were expected to total $50 million to $70 million over the next twelve months, funded through cash balances and operating cash flow.
- Management expected to incur less than $7.0 million in fiscal 2021 remaining costs related to the Fab 5 restructuring and repurposing program.
- The company expected existing liquidity, operating cash flow and available revolving-credit capacity to meet anticipated requirements for at least the next twelve months, but noted that future financing may be needed for capital expenditures, dividends, acquisitions or other corporate purposes.
- COVID-19 remained the principal near-term uncertainty. Manufacturing sites were operational, although some operated at reduced utilization; disruptions affected facilities, subcontractors and logistics providers. Management cautioned that conditions could worsen in the September 2020 quarter.
- Other significant risks include high leverage and refinancing requirements, semiconductor cyclicality, pricing pressure, reliance on distributors and third-party foundries, trade restrictions and tariffs, foreign operations, cybersecurity, intellectual-property claims, tax audits and litigation.
- Legal contingencies include shareholder litigation and governmental investigations relating to the Microsemi acquisition, an arbitration claim by Continental alleging approximately $217 million of damages, and other acquired-business matters. The company estimated aggregate possible but not probable liability of approximately $100 million above recorded accruals.
- Technology-license agreements contain indemnification provisions; potential specified indemnification exposure was approximately $168.1 million, although no related liability was recorded.
- A quarterly dividend of $0.3680 per share was declared on August 4, 2020, with an expected aggregate payment of approximately $93.0 million.
Most important facts for investors to verify
- Whether COVID-19-related demand weakness, order cancellations and supply-chain constraints persist or intensify after June 30, 2020.
- Whether gross margin recovers from 61.0% as capacity utilization, product mix and manufacturing conditions normalize.
- The company’s ability to generate sufficient cash to service approximately $10.20 billion of debt, including the $1.0 billion 2021 note maturity and other near-term obligations.
- The conversion, refinancing or cash-settlement consequences of the remaining convertible debt and any resulting equity dilution.
- Whether the unusually favorable tax benefits in the quarter recur; the filing does not provide a normalized ongoing tax rate.
- Progress on Fab 5 restructuring, internal assembly and test expansion, and the planned $50 million to $70 million of capital expenditures.
- Developments in the Microsemi-related investigations, shareholder litigation, Continental arbitration and other legal contingencies.
- Distributor inventory levels, end-market demand by region and product line, and the effect of trade restrictions and tariffs on sales and costs.