MICROCHIP TECHNOLOGY INC quarterly report, Q2 FY2010

Microchip Technology Incorporated — Q2 FY2010 Form 10-Q Summary

Business context and reporting period

Microchip designs, manufactures and markets embedded-control semiconductors, including microcontrollers, memory, analog and interface products. The filing covers the quarter and six months ended September 30, 2009, with comparisons to the corresponding 2008 periods. Management reported improving semiconductor-market conditions and market-share gains in strategic product lines, but revenue and profitability remained below the prior year because of the global economic downturn.

Key financial metrics

Metric	Three months ended Sept. 30, 2009	Three months ended Sept. 30, 2008	Six months ended Sept. 30, 2009	Six months ended Sept. 30, 2008
Net sales	$226.7 million	$269.7 million	$419.6 million	$537.9 million
Gross profit	$123.3 million	$164.2 million	$219.8 million	$327.8 million
Gross margin	54.4%	60.9%	52.4%	60.9%
Operating income	$52.7 million	$87.2 million	$83.9 million	$173.8 million
Operating margin	23.3%	32.3%	20.0%	32.3%
Net income	$44.5 million	$75.7 million	$71.9 million	$151.3 million
Diluted EPS	$0.24	$0.40	$0.39	$0.80

Quarterly sales increased 17.5% sequentially from $192.9 million in the June 2009 quarter but declined 16.0% year over year. Six-month sales declined 22.0% year over year. Average selling prices declined approximately 5%, while unit volumes declined approximately 11% in the quarter and 18% for the six-month period.

Microcontrollers represented 81.2% of quarterly sales and 81.5% of six-month sales; sales declined 15.1% and 21.3%, respectively, year over year.
Memory sales declined 30.8% for the quarter and 36.4% for six months.
Analog and interface sales declined 6.1% for the quarter and 10.9% for six months.
Foreign customers represented approximately 78% of quarterly sales and 77% of six-month sales; Asia represented 51.3% and 50.1%, respectively.

Cash flow, liquidity, debt and balance sheet

Net cash provided by operations was $243.1 million for the six months, compared with $267.5 million in the prior-year period.
Net cash used in investing was $34.0 million, versus $230.4 million in the prior year, primarily reflecting lower net investment purchases and reduced capital expenditures.
Net cash used in financing was $114.4 million, including $124.1 million of dividends. No shares were repurchased during the period.
Cash and cash equivalents were $541.0 million at September 30, 2009, compared with $446.3 million at March 31, 2009.
Cash, cash equivalents and short- and long-term investments totaled $1.473 billion. Management stated that liquidity and operating cash flow should cover anticipated requirements for at least the next 12 months.
Capital expenditures were $9.7 million for six months, compared with $68.0 million in the prior year. Management expected approximately $40 million of capital expenditures over the following 12 months.
The company had $1.15 billion principal amount of 2.125% junior subordinated convertible debentures due December 2037. The carrying value was $337.4 million, while estimated fair value was $1.055 billion. None of the conversion conditions had been met at September 30, 2009.
Inventory declined to $108.5 million from $131.5 million at March 31, 2009, or 96 days versus 134 days. Accounts receivable increased to $106.7 million from $88.5 million.

Material changes versus the prior comparable period

Revenue, gross profit, operating income and net income fell substantially year over year, despite sequential recovery from the June 2009 quarter.
Gross margin decreased 650 basis points to 54.4% in the quarter and 850 basis points to 52.4% for six months. Lower factory utilization, inventory write-downs and product mix were the primary pressures.
Combined Fab 2 and Fab 4 utilization was approximately 68%, compared with 99% in the prior-year quarter. Under-absorbed manufacturing costs charged to cost of sales were $8.5 million for the quarter and $20.6 million for six months; no comparable charges were recorded in 2008.
R&D and selling, general and administrative expenses declined in dollars because of cost reductions, but increased as percentages of sales to 13.0% and 18.1%, respectively, in the quarter.
Interest income decreased because of lower interest rates, while interest expense increased because of the accounting accretion associated with the convertible debentures.
The six-month 2008 comparative figures were retrospectively adjusted for the cash-conversion accounting guidance, increasing reported interest expense and reducing prior-period net income and EPS.

Guidance, outlook, commentary, risks and unusual items

Management expected wafer fabs to operate below peak levels in the following quarter, although production output had begun to increase with improving demand.
The company expected ongoing gross-margin variability from capacity utilization, product mix, manufacturing yields, fixed-cost absorption, pricing and economic conditions.
A $1.4 million patent-license payment settled alleged infringement claims; $1.2 million was expensed as a special charge in the June 2009 quarter and $0.2 million was recorded as a prepaid royalty.
At September 30, the company held $45.3 million of auction-rate securities, including securities subject to failed auctions. A $0.4 million impairment charge was recorded in the quarter. Fair values used Level 3 estimates and could change materially.
The company intended to sell $24.9 million of failed auction-rate securities and held a right to put approximately $30.5 million of other auction-rate securities to the broker at par beginning June 30, 2010.
Income tax rates were 13.3% for the quarter and 14.4% for six months, compared with 17.8% for the 2008 comparative periods. The company was under IRS examination for several fiscal years and had $75.5 million of long-term income-tax payable at September 30.
Key risks include semiconductor cyclicality, weak demand, pricing pressure, low capacity utilization, manufacturing-yield and supply disruptions, distributor dependence, foreign operations, failed auction-rate securities, tax audits, intellectual-property litigation, environmental and export regulations, and the substantial convertible-debt obligation.
Management stated that there were no material changes in contractual obligations, no off-balance-sheet arrangements, and no material changes to internal control over financial reporting. Disclosure controls were considered effective.

Important facts for investors to verify

Whether the sequential revenue recovery continued and whether demand returned to prior-year levels.
Fab utilization, unabsorbed-capacity charges, inventory levels and resulting gross-margin trends.
Valuation, liquidity and potential additional impairment exposure related to auction-rate securities and other Level 3 investments.
Convertible-debt maturity, cash-settlement intentions, potential dilution and the large difference between carrying and estimated fair value.
Distributor sell-through, deferred income on distributor shipments, price concessions and distributor financial condition.
Outcomes of IRS examinations, uncertain tax positions and any future changes in tax law affecting foreign earnings.
Patent, product-liability and other legal proceedings, including potential liabilities not reasonably estimable at the filing date.
Continuation of the quarterly dividend and any future share-repurchase activity; the November 2009 dividend was declared at $0.34 per share.