Microchip Technology Incorporated — Form 10-Q Summary
Business context and reporting period
Unaudited quarterly report for the three and nine months ended December 31, 2015, representing the third quarter and first nine months of fiscal 2016. Microchip designs, manufactures and sells embedded-control semiconductors, including microcontrollers, analog, interface, mixed-signal and memory products, and licenses semiconductor technologies. Reportable segments are semiconductor products and technology licensing.
Financial performance and position
| Metric | Three months ended Dec. 31, 2015 | Nine months ended Dec. 31, 2015 |
|---|---|---|
| Net sales | $540.3 million | $1.616 billion |
| Gross profit | $292.7 million | $902.7 million |
| Gross margin | 54.2% | 55.9% |
| Operating income | $76.1 million | $272.4 million |
| Operating margin | 14.1% | 16.9% |
| Net income attributable to Microchip | $61.2 million | $256.8 million |
| Diluted earnings per share | $0.28 | $1.18 |
Operating cash flow was $541.9 million for the first nine months, essentially unchanged from $542.7 million in the prior-year period. Capital expenditures were $81.4 million, compared with $120.0 million. Cash and cash equivalents were $331.5 million at December 31, 2015. Total cash, cash equivalents and short- and long-term investments were $2.398 billion, including approximately $2.381 billion held by foreign subsidiaries.
Debt carrying amounts included $1.008 billion outstanding under the revolving credit facility, $1.203 billion of senior convertible debentures and $195.0 million of junior convertible debentures. The revolving facility totaled $2.774 billion after a December 2015 increase. The company was in compliance with its debt covenants at period-end.
Quarterly and nine-month dividends were $0.3585 and $1.0740 per share, respectively. The company repurchased 8.6 million shares for $363.8 million during the first nine months; no shares were repurchased in the December quarter.
Material changes versus the prior comparable period
- Quarterly sales increased 2.2% year over year, while nine-month sales increased 0.7%; sequential quarterly sales declined 0.2% from $541.4 million.
- Quarterly gross profit declined from $302.0 million to $292.7 million, and gross margin fell from 57.1% to 54.2%. Nine-month gross margin also declined from 57.1% to 55.9%.
- Quarterly operating income decreased from $98.0 million to $76.1 million, and diluted EPS declined from $0.39 to $0.28. Nine-month diluted EPS declined from $1.20 to $1.18.
- Average selling prices for semiconductor products fell approximately 5% in the quarter and 4% year to date, while unit volumes increased approximately 11% and 6%, respectively.
- Micrel, acquired August 3, 2015, contributed approximately $45.8 million of quarterly sales and $67.3 million of nine-month sales. The acquisition added approximately $816.2 million of purchase consideration, $439.6 million of goodwill and significant amortizable intangibles.
- Analog, interface and mixed-signal sales increased 27.7% in the quarter and 16.4% year to date, primarily from Micrel and market-share gains. Microcontroller sales declined 4.6% and 3.7%, while memory sales declined 16.5% and 9.4%, respectively.
- Interest expense increased to $27.5 million for the quarter and $77.2 million year to date, primarily because of the 1.625% senior convertible debentures issued in February 2015 and related non-cash debt-discount amortization.
Guidance, outlook, commentary and unusual items
- Management expected March 2016 quarter inventory to increase by 2 to 8 days from December levels, excluding the effect of selling through Micrel acquisition-related inventory fair-value markups. December inventory was $319.5 million, or 118 days.
- Management planned approximately $120 million of capital expenditures over the following 12 months and expected existing cash, operating cash flow and credit availability to fund anticipated requirements.
- On January 19, 2016, Microchip announced an agreement to acquire Atmel for $8.15 per share, consisting of $7.00 in cash and $1.15 in Microchip shares. The proposed transaction had an estimated equity value of $3.56 billion and was expected to close in the second calendar quarter of 2016, subject to shareholder, regulatory and other conditions.
- Management expected to finance the Atmel transaction with approximately $2.175 billion of foreign-subsidiary cash and investments, $782 million of additional credit-facility borrowings and $485 million of newly issued Microchip shares.
- Quarterly special income of $5.0 million included an $11.5 million insurance settlement, partially offset by acquisition-related severance and facility costs and legal settlement costs. A $2.7 million one-time research tax credit benefit also reduced quarterly taxes.
- Gross margin was pressured by $17.8 million of quarterly and $26.7 million of year-to-date acquired-inventory fair-value charges, lower capacity utilization, inventory write-downs and product mix.
Risks and contingencies
- Semiconductor demand is cyclical and affected by global economic conditions, seasonality, customer inventory levels, short-cycle orders, product mix and competitive pricing.
- Approximately 84% of sales were to foreign customers, and approximately 60% of sales were in Asia. The company relies on foreign manufacturing, suppliers, foundries and contractors, including operations and finished-goods inventory in Thailand.
- Distributors represented approximately 53.7% of quarterly sales and 52.8% of nine-month sales. Distributor termination, inventory adjustments, price protection and sell-through changes could affect revenue and margins.
- Approximately 39% of nine-month sales came from products manufactured at outside wafer foundries. Supply disruptions, capacity constraints, yield issues or manufacturing interruptions could adversely affect results.
- The pending Atmel acquisition and increased borrowings may add integration, execution, financing, dilution and leverage risks. The company had substantially greater debt than in prior periods.
- The company reported $257.6 million of unrecognized tax benefits and was under IRS audit for fiscal 2011 and 2012. It also disclosed ordinary-course intellectual-property and other litigation, without recording liabilities for approximately $140 million of potential contractual indemnification exposure.
- Unsuccessful auctions on $9.8 million of auction-rate securities and interest-rate sensitivity on hedging instruments remain liquidity and market-risk considerations.
Investor verification checklist
- Verify the final closing terms, financing, regulatory approvals and integration results of the Atmel acquisition.
- Track gross-margin recovery after Micrel inventory fair-value charges expire and assess the effects of utilization, pricing and product mix.
- Reconcile cash and foreign-subsidiary liquidity with increased debt, planned Atmel funding, dividends, repurchases and capital expenditures.
- Monitor microcontroller and memory demand, average selling prices, distributor inventories and semiconductor end-market conditions.
- Review subsequent tax-audit developments, unrecognized tax benefits, litigation and intellectual-property indemnification exposure.