Microchip Technology Incorporated — Q1 FY2016 Form 10-Q Summary
Business context and reporting period
Microchip designs, manufactures and licenses semiconductor products for embedded-control applications, including microcontrollers, analog and mixed-signal devices, memory, connectivity and interface products. The company also licenses SuperFlash and other technologies. This unaudited report covers the three months ended June 30, 2015, compared primarily with the three months ended June 30, 2014; the balance sheet comparison is with March 31, 2015.
Key financial metrics
| Metric | Q1 FY2016 | Q1 FY2015 | Change |
|---|---|---|---|
| Net sales | $534.0 million | $528.9 million | Up 1.0% |
| Gross profit | $309.0 million | $306.5 million | Up 0.8% |
| Gross margin | 57.9% | 58.0% | Down 10 bps |
| Operating income | $121.3 million | $115.9 million | Up 4.6% |
| Operating margin | 22.7% | 21.9% | Up 80 bps |
| Net income attributable to Microchip | $130.7 million | $89.9 million | Up 45.3% |
| Diluted EPS | $0.60 | $0.40 | Up 50.0% |
| Cash flow from operations | $181.5 million | $165.8 million | Up 9.5% |
| Capital expenditures | $33.6 million | $44.6 million | Down 24.7% |
Operating cash flow less capital expenditures was approximately $147.9 million. Cash and cash equivalents were $563.5 million at June 30, 2015, compared with $607.8 million at March 31, 2015.
- Product revenue was $510.7 million, with technology licensing revenue of $23.3 million.
- Microcontrollers generated $348.2 million, or 65.2% of sales; analog, interface and mixed-signal products generated $127.1 million, or 23.8%; memory generated $31.8 million, or 5.9%.
- Technology licensing revenue increased 13.8% year over year, while memory revenue declined 4.8%.
- Research and development expense was $84.7 million, or 15.9% of sales. Selling, general and administrative expense was $66.8 million, or 12.5% of sales.
- Approximately 84% of sales were to foreign customers, and distributors represented approximately 52.2% of sales.
Liquidity, debt and balance sheet
- Cash, cash equivalents and short- and long-term investments totaled approximately $2.431 billion at June 30, 2015, up from approximately $2.342 billion at March 31, 2015.
- Investment securities totaled approximately $1.867 billion at fair value. Management did not identify any other-than-temporary impairment in the investment portfolio.
- Debt carrying amounts included approximately $1.170 billion of senior convertible debentures, $192.2 million of junior convertible debentures and $497.0 million of revolving credit borrowings.
- The revolving credit facility was increased to $2.555 billion in February 2015. The company was in compliance with its debt covenants at June 30, 2015.
- Inventory increased to $303.7 million from $279.5 million, or 123 days from 111 days. Deferred income on shipments to distributors was $167.5 million.
- Approximately $2.420 billion of cash, cash equivalents and investments was held by foreign subsidiaries; approximately $11.0 million was available for U.S. operations without relying on foreign funds or financing strategies.
Material changes versus the prior comparable period
- Sales increased modestly despite weaker general economic and semiconductor-industry conditions, primarily reflecting the ISSC acquisition and market-share gains.
- Operating margin improved because of lower selling, general and administrative expense, lower acquired-intangible amortization and normal manufacturing capacity utilization. Gross margin was broadly stable.
- Net income benefited materially from a 9.1% effective tax rate benefit, compared with a 16.0% tax rate in the prior-year quarter. The benefit included reversal of a U.S. deferred-tax valuation allowance and revaluation of foreign deferred-tax liabilities.
- Interest expense increased to $24.1 million from $13.7 million, primarily because of the February 2015 senior convertible debentures and related non-cash debt-discount amortization.
- Other income increased to $16.9 million, including approximately $14.0 million of realized investment gains and a $2.2 million gain on an equity-method investment.
- Cash flow from investing activities improved year over year because the prior-year period included the $375.4 million net cash acquisition of Supertex. Current-period investing included $18.1 million to acquire the remaining ISSC shares and $33.6 million of capital expenditures.
Guidance, outlook, commentary and unusual items
- Management expected inventory excluding Micrel to increase by 2 to 17 days in the September 2015 quarter; the effect of the Micrel acquisition on inventory was uncertain.
- The company expected to spend approximately $125 million on equipment and facilities during the following twelve months, funded by cash balances and operating cash flow.
- Management stated that existing liquidity, operating cash flow and available credit were expected to cover anticipated cash requirements for at least the next twelve months. The filing does not provide clear revenue or EPS guidance.
- Special charges related to acquisition activity, severance and office closures were $1.6 million, compared with $0.3 million in the prior-year quarter.
- On August 3, 2015, after quarter-end, Microchip completed its acquisition of Micrel. It paid approximately $430 million in cash and issued 8,626,795 shares; the cash portion was financed with borrowings under the credit facility.
- The company declared a quarterly dividend of $0.358 per share for payment in September 2015 and expected the aggregate payment to be approximately $75.7 million. It also authorized repurchases of up to 20 million shares but had repurchased none as of June 30, 2015.
Principal risks and contingencies
- Semiconductor demand is cyclical and affected by global economic conditions, seasonality, customer inventory patterns, short-cycle orders and pricing pressure.
- The company relies on distributors, outside wafer foundries and Asian assembly and test contractors. Approximately 40% of sales came from products produced at outside wafer foundries, creating supply, capacity, yield and geopolitical risks.
- Inventory increased materially during the quarter, creating potential exposure to excess or obsolete inventory and future write-downs.
- Higher debt levels, convertible-debt conversion features, interest-rate exposure and the additional Micrel acquisition borrowing may constrain financial flexibility.
- The company was subject to an IRS audit for fiscal years 2011 and 2012 and reported $203.0 million of unrecognized tax benefits at June 30, 2015.
- Ordinary-course litigation and intellectual-property claims remain possible. Technology-license indemnification obligations had potential specified exposure of approximately $139 million, although no related liability was recorded.
- Foreign operations and sales, particularly in Asia and Thailand, expose the company to political instability, currency, flooding, transportation and supply-chain disruptions.
Facts investors should verify
- Whether the Micrel integration, financing costs and issued shares produce the expected revenue, synergies and earnings accretion.
- Whether inventory rises within management’s stated range and whether subsequent inventory growth results in write-downs or margin pressure.
- Whether weaker semiconductor and global economic conditions affect sales, turns orders, utilization and pricing.
- The effect of the 9.1% tax benefit and whether the unusually favorable effective tax rate is sustainable.
- Post-acquisition leverage, credit-facility availability, covenant compliance and the cash cost of dividends and planned share repurchases.
- The outcome of tax audits, intellectual-property matters and any significant changes in distributor or foundry conditions.