Microchip Technology Incorporated — Q3 FY2010 Form 10-Q Summary
Reporting period: Quarterly period ended December 31, 2009, with comparisons to the three and nine months ended December 31, 2008. The filing was signed February 9, 2010. Microchip designs, manufactures and sells embedded-control semiconductors, including microcontrollers, memory, analog and interface products.
Financial Performance and Position
| Metric | Q3 FY2010 | Q3 FY2009 | 9M FY2010 | 9M FY2009 |
|---|---|---|---|---|
| Net sales | $250.1 million | $192.2 million | $669.7 million | $730.0 million |
| Gross profit | $146.0 million | $104.8 million | $365.8 million | $432.5 million |
| Gross margin | 58.4% | 54.5% | 54.6% | 59.3% |
| Operating income | $72.6 million | $40.5 million | $156.5 million | $214.3 million |
| Operating margin | 29.0% | 21.1% | 23.4% | 29.4% |
| Net income | $69.4 million | $72.4 million | $141.3 million | $223.6 million |
| Diluted EPS | $0.37 | $0.39 | $0.76 | $1.19 |
Q3 net sales increased 30.1% year over year and 10.3% sequentially from $226.7 million. Nine-month sales declined 8.3% year over year. Average selling prices decreased approximately 11% in the quarter and 7% for the nine-month period, while unit volumes increased approximately 44% in the quarter and declined approximately 2% for the nine-month period.
- Product mix: Microcontrollers generated $202.4 million, or 80.9% of quarterly sales. Memory generated $21.2 million, or 8.5%, and analog and interface products generated $26.5 million, or 10.6%.
- Geography: Asia represented 52.3% of quarterly sales and 50.9% of nine-month sales. Foreign customers represented approximately 78% of quarterly sales and 77% of nine-month sales.
- Operating expenses: Q3 research and development expense was $30.3 million and SG&A was $43.1 million. Nine-month R&D was $87.5 million and SG&A was $120.5 million.
- Taxes: The effective tax rate was 0.7% for Q3 and 8.2% for the nine-month period. Q3 and nine-month results included an $8.5 million one-time benefit from settlement of IRS examinations for fiscal 2002–2004. Prior-year periods included substantially larger tax benefits, including a $33.0 million benefit from revised Treasury Regulations.
- Cash flow: Nine-month operating cash flow was $344.0 million versus $264.6 million in the prior-year period. Investing cash flow was negative $263.1 million, primarily reflecting investment purchases and maturities, while financing cash flow was negative $166.0 million.
- Capital expenditures: Nine-month capital expenditures were $28.4 million versus $91.8 million in the prior-year period.
- Liquidity: Cash, cash equivalents and investments totaled approximately $1.50 billion at December 31, 2009. Cash and cash equivalents were $361.3 million, short-term investments were $716.7 million and long-term investments were $421.6 million.
- Debt: The company had $1.15 billion principal amount of 2.125% junior subordinated convertible debentures due December 2037. The accounting carrying value was $339.0 million, while estimated fair value was $1.17 billion. No conversion conditions had been met at December 31, 2009.
- Dividends and repurchases: Nine-month cash dividends were $186.6 million. No shares were repurchased during the period, compared with $123.9 million of repurchases in the prior-year nine-month period.
Material Changes and Unusual Items
- Improving semiconductor industry conditions, market-share gains and increased capacity utilization drove the quarterly recovery. Management stated that wafer fabs operated near peak levels late in Q3.
- Gross margin improved year over year in Q3 as production increased and fixed-cost under-absorption declined. However, nine-month gross margin fell because of the earlier downturn, lower production levels and related under-absorption. Under-absorbed fixed costs charged to Q3 and nine-month cost of sales were approximately $1.7 million and $22.3 million, respectively.
- The company adopted accounting guidance for convertible debt and retrospectively adjusted prior periods. The adoption increased reported interest expense and reduced previously reported prior-year net income and EPS.
- The company recognized $1.2 million of special charges in Q1 FY2010 for a patent license settlement. A $0.5 million in-process research and development charge was recorded in Q3 FY2009 in connection with the Hampshire acquisition.
- Auction-rate securities totaled $43.2 million at fair value. Failed auctions continued for certain securities, and the company recorded impairment charges of $0.5 million in Q3 and $2.2 million for the nine-month period. A $29.2 million tranche was supported by broker rights allowing a put at par beginning June 30, 2010.
- Deferred income on distributor shipments increased to $97.6 million from $83.9 million at March 31, 2009. The balance includes deferred revenue and deferred cost of sales and will be affected by future distributor price concessions.
Outlook, Management Commentary and Risks
Management expected high wafer-fab utilization in the March 2010 quarter, with no anticipated under-absorption of fixed costs. The company expected to spend approximately $60 million on equipment and facilities during the following twelve months and stated that existing liquidity and operating cash flow should fund anticipated requirements for at least twelve months.
On February 2, 2010, Microchip agreed to acquire Silicon Storage Technology, Inc. for $2.85 per share in cash, or approximately $275 million, with closing expected in the first quarter of fiscal 2011.
- Key risks include semiconductor demand cyclicality, short order visibility and reliance on same-quarter orders, competitive pricing pressure, average selling price erosion and changing product mix.
- Approximately 61% of nine-month sales were through distributors, generally without long-term agreements. Distributor inventory increased to 40 days from 35 days at March 31, 2009.
- Manufacturing risks include yield problems, capacity utilization, supply constraints, reliance on Asian assembly and test contractors, outside wafer foundries and potential disruptions at the Thailand facility.
- Investment risk remains concentrated in auction-rate securities valued using Level 3 assumptions. Further market deterioration or credit-rating declines could result in additional impairment charges.
- The company was under IRS audit for fiscal 2006–2008 and maintained reserves for uncertain tax positions. Litigation reserves were immaterial, but management could not reasonably estimate the potential loss range for pending litigation.
- Foreign operations and sales, political and infrastructure risks in Thailand, foreign currency exposure, intellectual-property claims, environmental regulation and potential acquisition-integration costs could affect future results.
Investor Verification Items
- Verify the retrospective impact of convertible-debt accounting on prior-year comparisons and the distinction between the $1.15 billion principal amount, $339.0 million carrying value and $1.17 billion fair value of the debentures.
- Assess the sustainability of the Q3 gross margin improvement after the expected elimination of under-absorbed fixed costs.
- Review the liquidity, valuation assumptions and put-right timing for the $43.2 million auction-rate securities portfolio.
- Reconcile operating cash flow with the $87.0 million contribution from trading-securities activity and distinguish recurring operating cash generation from investment-portfolio movements.
- Evaluate distributor exposure, including 61% of nine-month sales, 40 days of distributor inventory and $97.6 million of deferred distributor income.
- Monitor the proposed $275 million Silicon Storage Technology acquisition, its funding, closing conditions and integration effects.
- Review the outcomes of ongoing IRS audits, open tax years, pending litigation and the adequacy of related reserves.