Microchip Technology Incorporated — Form 10-Q Summary
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 technologies. The company operates through semiconductor products and technology licensing segments and serves consumer, automotive, industrial, communications, computing, aerospace and other markets.
This filing covers the quarter and six months ended September 30, 2017, the second quarter of fiscal 2018, with comparisons to the corresponding 2016 periods. Results include Atmel operations acquired on April 4, 2016. The mobile-touch business acquired with Atmel was sold in November 2016 and is presented as discontinued operations in the prior-year periods only.
Key financial metrics
| Metric | Three months ended Sep. 30, 2017 | Three months ended Sep. 30, 2016 | Six months ended Sep. 30, 2017 | Six months ended Sep. 30, 2016 |
|---|---|---|---|---|
| Net sales | $1,012.1 million | $871.4 million | $1,984.3 million | $1,670.8 million |
| Gross profit | $614.1 million | $410.6 million | $1,198.5 million | $759.1 million |
| Gross margin | 60.7% | 47.1% | 60.4% | 45.4% |
| Operating income | $225.4 million | $62.8 million | $447.0 million | $3.7 million |
| Operating margin | 22.3% | 7.2% | 22.5% | 0.2% |
| Net income from continuing operations | $189.2 million | $35.6 million | $359.7 million | $(73.7) million |
| Diluted earnings per share | $0.77 | $0.15 | $1.48 | $(0.34) |
- Second-quarter sales increased 16.2% year over year and 4.1% sequentially from $972.1 million. Six-month sales increased 18.8% year over year.
- Microcontrollers generated $665.2 million, or 65.9% of quarterly sales, up 20.6% year over year. Analog, interface, mixed-signal and timing sales increased 6.3%; memory sales increased 12.1%.
- Research and development expense was $133.6 million in the quarter and $264.1 million for six months, down from $137.8 million and $285.7 million, respectively, primarily from Atmel-related synergies and lower share-based compensation.
- Selling, general and administrative expense was $114.3 million in the quarter and $228.6 million for six months, down from $120.1 million and $277.6 million, respectively.
- Acquired-intangible amortization increased to $120.9 million in the quarter and $241.8 million for six months, compared with $80.4 million and $160.6 million in the prior-year periods.
- Interest expense was $49.5 million in the quarter and $98.9 million for six months, reflecting the 2017 senior and junior convertible debt issued in February 2017.
Cash flow, liquidity and capital structure
- Operating cash flow was $695.1 million for the six months ended September 30, 2017, compared with $446.1 million in the prior-year period.
- Investing cash flow used $592.0 million, including $879.4 million of investment purchases, $363.1 million of investment maturities and $82.0 million of capital expenditures. The prior-year period included $2.75 billion of cash used for the Atmel acquisition.
- Financing cash flow used $185.4 million, including $167.4 million of dividends and $113.0 million of revolving-loan repayments offset by $113.0 million of new borrowings during the period.
- Cash and cash equivalents were $826.4 million at September 30, 2017, down from $908.7 million at March 31, 2017. Cash, cash equivalents and investments totaled $1.844 billion, up $433.6 million from fiscal year-end.
- Total debt principal was $4.499 billion; carrying-value net long-term debt, including current maturities, was $3.018 billion. The company had no borrowings outstanding under its revolving credit facility, which had $2.727 billion of capacity at quarter-end and matures in February 2020.
- The company was in compliance with its credit-facility covenants. Foreign subsidiaries held $1.292 billion of cash and investments, while approximately $551.8 million was available for U.S. operations.
- Inventory was $456.9 million, or 105 days, versus $417.2 million and 103 days at March 31, 2017. Management expected inventory days to increase in the December 2017 quarter toward a longer-term target of 115 to 120 days.
Material changes versus the prior comparable period
- Profitability improved substantially as prior-year cost of sales included $84.3 million in the quarter and $174.8 million for six months of acquisition-related fair-value inventory charges. Gross margin expanded by 13.6 percentage points in the quarter and 15.0 percentage points for six months.
- Operating income rose from $62.8 million to $225.4 million in the quarter and from $3.7 million to $447.0 million for six months.
- Prior-year six-month results included a $13.8 million loss on settlement of convertible debt in the current period, while the prior-year period included significant Atmel acquisition-related charges and discontinued-operation losses.
- The company incurred a $19.5 million charge in the quarter for transitioning its Oregon wafer-fabrication facility to a lower-cost direct-access energy provider. Related payments begin in 2018 and depend on future energy consumption.
- In June 2017, the company exchanged $111.3 million of 2007 junior debt for 2017 junior debt and common stock, generating a $13.8 million settlement loss. Additional 2007 junior debt conversions occurred, and the company announced an intention to call the remaining debt on or after December 15, 2017.
- Technology licensing revenue increased 8.9% in the quarter and 14.8% for six months. Distributor sales represented 53.5% of quarterly sales and 54.5% of six-month sales, down from 56.1% and 56.0%, respectively.
Guidance, outlook, commentary and risks
- Management expected approximately $220 million of capital expenditures over the next twelve months, funded through cash balances and operating cash flow, to support capacity, research and development equipment and bringing some assembly and test activities in-house.
- Management stated that existing liquidity, operating cash flow and available credit were expected to satisfy anticipated cash needs for at least the next twelve months. No specific revenue or earnings guidance is provided in the filing text.
- The company expects continued benefits from Atmel integration, process efficiencies and restructuring, but restructuring and contract-exit costs may continue as additional opportunities are identified. A $52.6 million restructuring accrual remained at September 30, 2017.
- Revenue recognition will change upon adoption of ASC 606, expected no later than April 1, 2018. Distributor revenue currently deferred until sell-through will generally be recognized at shipment, subject to estimated returns and allowances. The company expected to use the modified retrospective method but had not finalized the impact.
- Key risks include semiconductor cyclicality, seasonality, pricing pressure, reliance on distributor sell-through and short-cycle orders, dependence on outside wafer foundries and assembly/test contractors, manufacturing yields and capacity, inventory obsolescence, foreign operations and China exposure, tax audits and tax-law changes, intellectual-property and product-liability claims, cybersecurity, natural disasters and substantial debt service obligations.
- Continental Automotive sought approximately $69.7 million, subject to increase, in an ICC arbitration relating to alleged defects in Atmel airbag-control-unit components. Management intended to defend the matter vigorously. Aggregate potential liability for contingencies considered possible but not probable was estimated at approximately $100 million above accrued amounts.
- Management reported no material adverse effect from pending legal matters, no material goodwill impairment, no material off-balance-sheet arrangements and effective disclosure controls.
Important facts for investors to verify
- Whether sales growth and elevated gross margins persist after the prior-year acquisition-accounting benefits and as product mix, pricing and capacity conditions change.
- The impact of ASC 606 adoption on deferred distributor revenue, reported sales timing, margins, retained earnings and comparability.
- Debt conversion, repayment and refinancing requirements, including the remaining 2007 junior debt and the substantial fair-value premium of the convertible instruments over their carrying amounts.
- Inventory growth toward 115–120 days and the related risk of excess or obsolete inventory if demand weakens.
- Execution of the Atmel integration, realization of expected synergies and any additional restructuring or contract-exit charges.
- Potential exposure from the Continental arbitration, other product-liability and intellectual-property claims, tax audits and indemnification commitments.
- Availability and geographic location of cash, particularly the foreign-subsidiary cash subject to potential tax and repatriation considerations.