Microchip Technology Incorporated — Form 10-Q Summary
Business context and reporting period
Microchip designs, manufactures and sells embedded-control semiconductor products, including microcontrollers, analog and mixed-signal devices, memory, connectivity and interface products, and licenses SuperFlash technology. The report covers the three months ended June 30, 2013, the first quarter of fiscal 2014. Results include the August 2, 2012 acquisition of SMSC.
Key financial metrics
| Metric | Q1 FY2014 | Q1 FY2013 |
|---|---|---|
| Net sales | $462.8 million | $352.1 million |
| Gross profit | $266.6 million | $204.8 million |
| Gross margin | 57.6% | 58.2% |
| Operating income | $98.4 million | $96.3 million |
| Operating margin | 21.3% | 27.4% |
| Net income | $78.6 million | $78.7 million |
| Diluted EPS | $0.37 | $0.39 |
| Operating cash flow | $164.4 million | $129.0 million |
| Capital expenditures | $27.8 million | $10.3 million |
Sales increased 31.4% year over year and 7.6% from the preceding quarter. Semiconductor products generated $440.3 million of sales and technology licensing generated $22.5 million. Product mix included microcontrollers at 64.9% of sales, analog/interface/mixed-signal products at 22.3%, memory at 7.3%, and licensing at 4.9%.
R&D expense increased 49.7% to $73.1 million, primarily due to SMSC-related costs and higher headcount and bonus costs. SG&A increased 18.2% to $65.7 million. Acquired-intangible amortization rose to $27.7 million from $4.0 million, and special charges were $1.7 million. Approximately $10.4 million of under-absorbed wafer-fab costs was charged to cost of sales.
Balance sheet, debt and liquidity
- Cash and cash equivalents were $403.2 million at June 30, 2013, compared with $528.3 million at March 31, 2013.
- Total cash, cash equivalents and investments were $1.895 billion, up $59.2 million from March 31, 2013. Approximately $1.844 billion was held by foreign subsidiaries and approximately $50 million was available for U.S. operations.
- Inventory was $256.1 million, or 119 days, compared with $242.3 million, or 116 days, at March 31, 2013. Accounts receivable were $232.3 million.
- At June 30, 2013, borrowings included $260.0 million under the revolving credit facility, $350.0 million of term borrowings net of discount, and $365.6 million carrying value of junior subordinated convertible debentures. The debentures had $1.15 billion of principal value and a $26.52 conversion price after dividend adjustments.
- On June 27, 2013, the company entered into a $2.0 billion credit agreement consisting of a $350 million term loan and a $1.65 billion revolving facility, maturing June 27, 2018. The company was in compliance with its financial covenants at quarter-end.
- Net cash used in investing activities was $209.2 million, principally reflecting investment purchases. Net cash used in financing activities was $80.3 million, including $69.7 million of dividends.
Material changes versus the prior comparable period
- Revenue growth was driven primarily by the SMSC acquisition, market share gains, and general economic and semiconductor-industry conditions.
- Average semiconductor selling prices increased approximately 13% and unit volume increased approximately 19%, with SMSC materially affecting both comparisons.
- Analog, interface and mixed-signal sales increased 118.8%, while memory sales declined 16.5% because of weaker Serial EEPROM and Flash demand.
- Gross margin declined 60 basis points because of product mix and capacity underutilization, despite higher gross profit dollars.
- Operating margin declined materially because acquired-intangible amortization, R&D, SG&A and special charges increased faster than gross profit.
- Net income was essentially flat because higher operating income was offset by increased interest expense, acquired-intangible amortization and other acquisition-related costs.
- Foreign-foundry exposure increased: wafers purchased from outside foundries represented approximately 38% of sales versus 21% in the prior-year quarter, largely because of SMSC.
Guidance, outlook, commentary and risks
Management expected September 2013-quarter inventory to remain relatively flat compared with June 30 levels and believed existing inventory supported competitive lead times. The company intended to spend approximately $90 million on capital expenditures over the following twelve months and expected to fund those expenditures with existing cash and operating cash flow. Management believed available liquidity, operating cash flow and credit-facility capacity were sufficient for anticipated requirements for at least the next twelve months.
The company declared a quarterly dividend of $0.354 per share for payment in September 2013 and indicated an intention to continue quarterly dividends subject to board approval, operating results, cash requirements, market conditions and tax-law changes.
- Semiconductor demand, pricing, product mix, seasonality, customer and distributor inventory levels, and short-cycle “turns” orders can cause substantial quarterly volatility.
- Approximately 54% of quarterly sales were through distributors. Distributor relationships generally lack long-term contractual commitments, and revenue is recognized on distributor sell-through.
- Failed-auction-rate securities had a fair value of $34.6 million and remained illiquid. Management stated that further market deterioration could result in additional impairment charges.
- The company had $186.6 million of unrecognized tax benefits and was under IRS audits covering Microchip fiscal years 2009 and 2010 and SMSC fiscal years 2011 and 2012.
- Legal, intellectual-property, product-liability, indemnification, manufacturing-yield, supplier, foundry, Thailand operations, foreign-currency and business-interruption risks could adversely affect results. The maximum potential payments under certain specified license indemnification limits were approximately $112 million, although no related liability was recorded.
- Outstanding convertible debentures were convertible during July 1–September 30, 2013, subject to the stated conditions, and conversion could dilute existing shareholders.
Most important facts for investors to verify
- Whether revenue growth and improved unit volumes remain sustainable after the SMSC acquisition contribution normalizes.
- Progress in integrating SMSC and the effect of acquired-intangible amortization and other acquisition-related costs on earnings.
- Gross-margin trends, wafer-fab utilization, inventory days and the planned $90 million capital-expenditure program.
- Availability and location of cash, particularly the concentration of liquidity in foreign subsidiaries and the potential tax cost of repatriation.
- Credit-facility borrowings, convertible-debt conversion activity, covenant compliance and future interest expense.
- Valuation and liquidity of the $34.6 million auction-rate-securities portfolio.
- Outcomes of IRS audits, unrecognized tax-benefit balances, pending litigation and the $5.7 million remaining SST acquisition-related contingent liability.