Microchip Technology Incorporated — Form 10-Q Summary
Reporting period: Quarterly period ended September 30, 2014, representing the second quarter and first six months of fiscal 2015. Results are unaudited and include ISSC from its July 17, 2014 acquisition date and Supertex from April 1, 2014.
Business context
Microchip designs, manufactures and sells embedded-control semiconductors, including microcontrollers, analog, interface and mixed-signal products, memory products, and technology licenses. Principal markets include consumer, automotive, industrial, office automation and telecommunications. Approximately 84% of sales were to foreign customers, and distributors represented approximately 52% of first-half sales.
Financial performance
| Metric | Three months ended Sep. 30, 2014 | Year-over-year change | Six months ended Sep. 30, 2014 | Year-over-year change |
|---|---|---|---|---|
| Net sales | $546.2 million | +10.9% | $1,075.1 million | +12.5% |
| Gross profit | $307.5 million | +6.4% | $614.0 million | +10.5% |
| Gross margin | 56.3% | Down 230 bps | 57.1% | Down 100 bps |
| Operating income | $101.3 million | -13.8% | $217.3 million | +0.6% |
| Operating margin | 18.5% | Down 540 bps | 20.2% | Down 240 bps |
| Net income attributable to Microchip | $93.6 million | -6.2% | $183.6 million | +2.9% |
| Diluted EPS | $0.42 | -$0.04 | $0.82 | -$0.01 |
| Operating cash flow | Not separately provided | — | $357.8 million | +10.1% |
Revenue growth was driven by the Supertex and ISSC acquisitions, market-share gains, semiconductor industry conditions and higher unit volumes. Semiconductor product average selling prices increased approximately 4% in the quarter and 3% for the six-month period, while unit volumes increased approximately 9% and 11%, respectively.
- Product mix: Microcontrollers generated $361.8 million, or 66.2% of quarterly sales; analog, interface and mixed-signal products generated $122.6 million, or 22.5%; memory products generated $32.5 million, or 6.0%; and technology licensing generated $22.6 million, or 4.1%.
- Product trends: Quarterly microcontroller sales rose 12.7%, analog/interface/mixed-signal sales rose 13.0%, memory sales declined 7.1%, and technology licensing revenue declined 9.0% year over year.
- Margin pressure: Gross margin was reduced by approximately $12.7 million in the quarter and $20.2 million year to date from fair-value adjustments to acquired inventory. Acquired-intangible amortization increased to $45.4 million in the quarter and $82.1 million year to date, compared with $23.7 million and $51.4 million in the prior-year periods.
- Tax: The six-month effective tax rate was 8.0%, compared with 11.5% in the prior year. Releases of prior-year tax positions increased quarterly EPS by approximately $0.03 and first-half EPS by approximately $0.04 basic and $0.03 diluted.
- Share-based compensation: Expense was $15.3 million in the quarter and $28.6 million year to date.
Cash flow, liquidity and capital structure
- Cash and cash equivalents were $481.4 million at September 30, 2014, compared with $466.6 million at March 31, 2014.
- Cash, cash equivalents and investments totaled $2.124 billion, down $19.1 million from March 31, 2014. Most of these funds, approximately $2.112 billion, were held by foreign subsidiaries; approximately $12.0 million was available for U.S. operations.
- Operating cash flow was $357.8 million, capital expenditures were $83.4 million, and investing cash flow was negative $520.2 million.
- Investing cash outflows included approximately $252.5 million for ISSC and $375.4 million for Supertex, net of acquired cash and cash equivalents.
- Debt included $965.6 million outstanding under the credit agreement, $376.7 million carrying value of junior convertible debentures, $322.8 million of long-term borrowings, and $17.5 million of short-term borrowings.
- The $2.0 billion credit facility matures in June 2018. The company was in compliance with its leverage and interest-coverage covenants at September 30, 2014.
- Cash dividends paid during the first six months totaled $142.6 million, or $0.7115 per share. A $0.3565 quarterly dividend was declared for payment in December 2014.
- Management expects approximately $130 million of capital expenditures during the next twelve months and believes existing liquidity, operating cash flow and available borrowing capacity will meet anticipated requirements for at least the next twelve months.
Material changes versus the prior comparable period
- Supertex was acquired on April 1, 2014 for total consideration of approximately $391.8 million, financed with credit-facility borrowings. It contributed approximately $34.4 million of first-half sales and $16.6 million of second-quarter sales.
- ISSC was acquired on July 17, 2014 for approximately $267.6 million for an 83.5% controlling interest. It contributed approximately $16.9 million of second-quarter sales and $8.2 million of first-half sales, with a net loss attributable to the company of approximately $1.6 million.
- Goodwill increased to $558.0 million from $276.1 million, and net intangible assets increased to $599.0 million from $445.5 million, primarily due to the acquisitions.
- Debt increased substantially to fund the Supertex acquisition; credit-facility borrowings were $965.6 million at quarter-end versus $300.0 million of long-term line-of-credit borrowings at March 31, 2014.
- Gross margin and operating margin declined because of acquired-inventory fair-value charges, higher acquired-intangible amortization and product mix, partly offset by normal capacity utilization and lower excess-capacity charges than in the prior year.
- Inventory was $275.7 million, or 105 days, versus $262.7 million, or 118 days, at March 31, 2014. Management expected inventory days to increase by four to 14 days in the December 2014 quarter.
Guidance, outlook, risks and unusual items
- Management expected December-quarter inventory levels to increase and planned approximately $130 million of capital expenditures over the following twelve months.
- Management identified ongoing risks from semiconductor cyclicality, seasonality, customer and distributor inventory patterns, pricing pressure, product mix, manufacturing yields, capacity utilization and limited visibility from short-cycle orders.
- Approximately 40% of first-half sales came from products manufactured at outside wafer foundries. Disruptions, capacity constraints or quality issues at foundries and assembly/test contractors could adversely affect results.
- Thailand operations and finished-goods inventory are exposed to political instability, flooding, transportation disruption and other regional risks.
- Acquisition purchase-price allocations for ISSC and Supertex remained preliminary and could change the carrying values, useful lives of intangible assets and goodwill.
- The $1.15 billion principal amount of 2.125% junior subordinated convertible debentures was convertible during the period following the stock-price conversion trigger. The adjusted conversion price was approximately $25.47 per share, creating potential dilution.
- The company reported $212.1 million of unrecognized tax benefits and ongoing IRS audits of Microchip, SMSC and Supertex. Management did not believe the unrecognized tax benefits would materially change in the following 12 months.
- Legal proceedings and intellectual-property claims are considered ordinary-course risks. Technology-license indemnification obligations with specified limits could require payments of approximately $138 million if all such indemnifications were triggered; no related liability was recorded.
- Unrealized losses on available-for-sale debt securities were $3.4 million. Management did not consider them other-than-temporary. Auction-rate securities of $9.8 million remained classified as Level 3 investments with an estimated seven- to ten-year liquidity horizon.
- On October 15, 2014, Hua Hong Semiconductor completed an IPO. Microchip estimated its 27.96 million shares at approximately $39.2 million at October 31, 2014, versus a September 30 carrying value of $3.6 million.
Most important facts for investors to verify
- Whether acquisition-related revenue and margin effects are being separated from organic growth and whether ISSC and Supertex achieve expected synergies.
- The sustainability of the 56.3% quarterly gross margin after acquired-inventory charges roll off, including the effect of product mix, pricing and capacity utilization.
- Future cash generation relative to dividends, approximately $130 million of planned capital expenditures and acquisition-related debt repayment.
- The final purchase-price allocations for ISSC and Supertex and the resulting amortization, goodwill and impairment exposure.
- Foreign cash availability, repatriation tax consequences and reliance on borrowings to fund U.S. obligations.
- Memory and technology-licensing revenue trends, distributor inventory levels and potential pricing pressure.
- Potential dilution and cash requirements associated with the convertible debentures.
- Outcomes of tax audits, intellectual-property matters, indemnification claims and other contingencies.