Business Context and Reporting Period
Company: Microchip Technology Incorporated
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: December 31, 2007 (Third Quarter of Fiscal Year 2008)
Business Overview: Microchip designs, develops, manufactures, and markets semiconductor products, primarily embedded control products including microcontrollers, memory, and analog/interface devices. The company operates wafer fabrication and assembly/test facilities, with significant operations in Thailand.
Key Financial Metrics
| Metric | Three Months Ended Dec 31, 2007 | Nine Months Ended Dec 31, 2007 |
|---|---|---|
| Net Sales | $252.6 million | $775.3 million |
| Gross Profit | $153.0 million (60.6% margin) | $466.3 million (60.1% margin) |
| Operating Income | $79.2 million | $219.9 million |
| Net Income | $80.1 million | $221.1 million |
| Diluted EPS | $0.38 | $1.00 |
| Cash & Equivalents (Dec 31, 2007) | $831.0 million | |
| Total Investments (Short & Long Term) | $822.4 million | |
| Convertible Debentures (Long-term Debt) | $1.15 billion |
Material Changes vs. Prior Period
- Revenue: Net sales for the three months ended Dec 31, 2007, increased 0.6% year-over-year to $252.6 million. For the nine-month period, sales decreased 0.8% to $775.3 million. Unit volume was flat for the quarter but up 3% for the nine months, offset by a 4% decline in average selling prices.
- Profitability: Gross margin improved to 60.6% for the quarter (from 59.6% prior year) due to lower depreciation and favorable product mix, despite share-based compensation impacts. Operating income decreased 2.7% for the quarter and 16.2% for the nine months, primarily due to a one-time loss on the sale of Fab 3.
- Debt Structure: In December 2007, the company issued $1.15 billion in 2.125% convertible debentures due 2037. This significantly increased long-term debt compared to the prior period where no such debt existed.
- Share Repurchases: The company repurchased $964.8 million of common stock during the nine months ended Dec 31, 2007, including a block of 21.5 million shares purchased concurrently with the debenture issuance.
Guidance, Outlook, Risks, and Unusual Items
Unusual Items
- Loss on Sale of Fab 3: The company sold its Puyallup, Washington facility (Fab 3) in October 2007, recognizing a loss of $26.8 million. This was a non-recurring item impacting the nine-month operating results.
- Tax Benefits: The effective tax rate was lowered by a $5.7 million favorable resolution of a foreign tax matter and a $10.3 million tax benefit associated with the Fab 3 sale.
Outlook and Commentary
- Market Conditions: Management notes weakness in the U.S. housing market and general economic conditions impacting consumer market sales. Average selling prices are under pressure, particularly in memory and non-proprietary analog products.
- Capacity: Fab 2 operated at 99% capacity. Fab 4 utilization remains relatively low, though all installed equipment is being utilized. Capital expenditures are expected to be approximately $90 million over the next 12 months.
- Dividends: A quarterly dividend of $0.32 per share was declared in January 2008, a 20.8% increase over the prior year's quarter.
Risks and Contingencies
- Auction Rate Securities: $24.9 million of auction rate securities failed to auction in September 2007 and remain illiquid. The company recognized a $0.9 million impairment charge. While $22.4 million of these are insured, there is no assurance insurers will fulfill obligations if credit ratings deteriorate.
- Distributor Relations: The company terminated its relationship with Arrow Electronics (approx. 7% of recent sales) in February 2008, partnering instead with Avnet and Future Electronics. The long-term impact is uncertain.
- Accounting Changes: Proposed FASB guidance (FSP APB 14-a) regarding convertible debt could require the recognition of additional non-cash interest expense on the new debentures if adopted.
Investor Verification Checklist
- Liquidity of Investments: Verify the status of the $24.9 million in failed auction rate securities and the solvency of the insurers (Ambac, FGIC, MBIA) covering $22.4 million of that amount.
- Debt Covenants and Interest: Review the terms of the $1.15 billion convertible debentures, specifically the conversion price ($34.16) and potential dilution if stock prices rise significantly.
- Distributor Transition: Monitor the impact of the Arrow Electronics termination on sales volume and distributor inventory levels in the coming quarters.
- Inventory Levels: Assess the 114 days of inventory on hand against current demand trends to evaluate potential obsolescence risks.
- Accounting Impact: Track the finalization of FSP APB 14-a to determine if retrospective interest expense adjustments will be required for the convertible debentures.