Microchip Technology Incorporated — Fiscal 2016 Second-Quarter Form 10-Q
Reporting period: Quarter and six months ended September 30, 2015; filed November 9, 2015. Results are unaudited and prepared under U.S. GAAP. Microchip designs, manufactures and sells embedded-control semiconductors and licenses SuperFlash and other technologies.
Financial Performance
| Metric | Three months ended September 30, 2015 | Year-over-year change | Six months ended September 30, 2015 | Year-over-year change |
|---|---|---|---|---|
| Net sales | $541.4 million | Down 0.9% | $1,075.3 million | Essentially flat |
| Gross profit | $301.0 million | Down 2.1% | $610.0 million | Down 0.7% |
| Gross margin | 55.6% | Down 70 bps | 56.7% | Down 40 bps |
| Operating income | $74.9 million | Down 26.0% | $196.3 million | Down 9.7% |
| Operating margin | 13.8% | Down 470 bps | 18.3% | Down 190 bps |
| Net income attributable to Microchip | $64.9 million | Down 30.7% | $195.6 million | Up 6.5% |
| Diluted EPS | $0.30 | Down from $0.42 | $0.90 | Up from $0.82 |
- Net sales increased 1.4% sequentially from $534.0 million, primarily because of the Micrel acquisition, but were pressured by weaker global economic and semiconductor conditions.
- Average selling prices for semiconductor products declined approximately 6% in the quarter and 3% for the six-month period, while unit volumes increased approximately 5% and 3%, respectively.
- Product mix shifted toward analog, interface and mixed-signal products. Six-month sales increased 10.6% in that category, while microcontroller sales declined 3.3% and memory sales declined 5.9%.
- Research and development expense rose to $95.3 million for the quarter and $179.9 million for the six months. Selling, general and administrative expense rose to $80.3 million and $147.1 million, respectively.
- Interest expense increased to $25.6 million for the quarter and $49.7 million for the six months, primarily because of the February 2015 senior convertible debentures and related non-cash debt-discount amortization.
- The six-month effective tax rate was a 12.6% benefit, compared with an 8.0% effective tax rate in the prior-year period, primarily due to favorable Micrel purchase-accounting tax adjustments.
Cash Flow, Liquidity and Capital Structure
- Six-month operating cash flow was $331.4 million, compared with $357.8 million in the prior-year period.
- Investing cash flow used $727.9 million, including $343.9 million for the cash portion of the Micrel acquisition, $63.6 million of capital expenditures and net purchases of available-for-sale investments.
- Financing cash flow provided $327.7 million, including $1,024.5 million of credit-facility borrowings, offset by $363.8 million of share repurchases and $145.0 million of dividends.
- Cash and cash equivalents were $539.1 million at September 30, 2015, versus $607.8 million at March 31, 2015. Total cash, cash equivalents and investments were $2.5865 billion, up $244.3 million from March 31, 2015.
- Revolving credit borrowings were $1.2965 billion, versus $462.0 million at March 31, 2015. The revolving facility capacity was $2.555 billion, with maturities in 2018 and 2020. The company was in compliance with applicable covenants.
- Carrying amounts included $1.1978 billion of senior convertible debentures and $193.6 million of junior convertible debentures. The reported fair values were substantially higher, at $1.6378 billion and $1.0007 billion, respectively.
- Inventory increased to $363.8 million, or 138 days, from $279.5 million, or 111 days, primarily because of $63.0 million acquired from Micrel, including a $37.2 million fair-value step-up.
- Management expected approximately $125 million of capital expenditures over the following 12 months and believed existing liquidity, operating cash flow and available borrowings were sufficient for anticipated requirements over at least the next 12 months.
Material Changes and Unusual Items
- Micrel acquisition: Closed August 3, 2015 for approximately $816.2 million of total consideration, including approximately $430 million in cash and 8,626,795 Microchip shares. Preliminary purchase accounting recorded $437.1 million of goodwill and $274.8 million of acquired intangible assets. Micrel contributed $21.5 million of sales and a $28.5 million net loss from acquisition through September 30.
- The acquisition increased goodwill to $1.009 billion and net intangible assets to $702.4 million. The purchase price allocation remained subject to revision.
- Special charges related to severance, office closures and acquisition activity were $6.6 million in the quarter and $8.2 million for the six months, compared with $0.8 million and $1.1 million, respectively, in the prior-year periods.
- Six-month other income included $14.0 million of realized gains on available-for-sale securities and a $2.2 million gain on an equity-method investment.
- Microchip repurchased 8.6 million shares for $363.8 million during the six months; 11.4 million shares remained authorized for repurchase at September 30, 2015.
- The quarterly dividend was $0.3580 per share. A $0.3585 dividend was declared on November 4, 2015, with an expected aggregate payment of approximately $72.9 million.
Outlook, Commentary and Risks
- Management expected December-quarter inventory to be flat to up six days from September levels, excluding the effect of selling through Micrel’s acquired inventory fair-value markup.
- Management intended to change most Micrel distributor contracts in the December 2015 quarter to Microchip’s standard sell-through model, which would defer revenue recognition until distributors sell to end customers.
- Management expected gross margins to fluctuate with product mix, pricing pressure, capacity utilization, yields, fixed-cost absorption, manufacturing costs and economic conditions.
- Key risks include cyclical and seasonal semiconductor demand, weaker global or Chinese economic conditions, average-selling-price erosion, distributor inventory and sell-through, reliance on third-party wafer foundries and Asian assembly/test contractors, supply disruptions, and manufacturing-yield or capacity issues.
- Acquisition integration, realization of expected synergies, acquired-intangible amortization, goodwill impairment and purchase-accounting adjustments remain material areas of uncertainty.
- The company had $225.1 million of unrecognized tax benefits and was under IRS audit for fiscal 2011 and 2012. It also had $119.8 million of deferred-tax-asset valuation allowances.
- Legal and intellectual-property claims are considered by management unlikely to have a material adverse effect, but outcomes are uncertain. Technology-license indemnification obligations could reach approximately $139 million if all specified limits were fully triggered; no related liability was recorded.
- Approximately 85% of six-month sales were to foreign customers, and $2.5463 billion of cash and investments were held by foreign subsidiaries. Repatriation could result in additional U.S. and foreign withholding taxes.
- Unsuccessful auctions affected $9.8 million of auction-rate securities, with a par value of $22.4 million. Management did not consider the unrealized losses in its investment portfolio to be other-than-temporary.
Investor Verification Points
- Verify the final purchase-price allocation for Micrel and the resulting goodwill, intangible assets, deferred taxes and future amortization.
- Assess whether Micrel integration, distributor-contract changes and acquired inventory sell-through affect reported revenue and gross margin.
- Monitor leverage, interest expense, covenant compliance and potential dilution or cash requirements from the convertible debentures.
- Reconcile operating cash flow with earnings, inventory growth, distributor deferred income and the company’s planned capital expenditures.
- Evaluate the sustainability of the favorable tax rate, the IRS audit, unrecognized tax benefits and offshore cash constraints.
- Track semiconductor demand, pricing, product mix, distributor inventory, foreign-market exposure and reliance on third-party manufacturing.