Sales by product line for the three and nine months ended December 31,June 30, 2007 and 2006 and December 31, 2005 were as follows (dollars in thousands):
| | Three Months Ended December 31, (unaudited) | | Nine Months Ended December 31, (unaudited) | |
| | 2006 | | % | | 2005 | | % | | 2006 | | % | | 2005 | | % | |
| | | | | | | | | | | | | | | | | |
Microcontrollers | | $ | 200,073 | | | 79.7 | % | $ | 186,235 | | | 79.3 | % | $ | 626,167 | | | 80.1 | % | $ | 540,817 | | | 79.4 | % |
Memory products | | | 30,105 | | | 12.0 | % | | 31,323 | | | 13.3 | % | | 92,843 | | | 11.9 | % | | 93,907 | | | 13.8 | % |
Analog and interface products | | | 20,826 | | | 8.3 | % | | 17,338 | | | 7.4 | % | | 62,485 | | | 8.0 | % | | 45,997 | | | 6.8 | % |
Total sales | | $ | 251,004 | | | 100.0 | % | $ | 234,896 | | | 100.0 | % | $ | 781,495 | | | 100.0 | % | $ | 680,721 | | | 100.0 | % |
| Three Months Ended June 30, (unaudited) | |
| 2007 | | | % | | | 2006 | | | % | |
| | | | | | | | | | | |
Microcontrollers | $ | 213,304 | | | | 80.8 | % | | $ | 211,316 | | | | 80.5 | % |
Memory products | | 30,291 | | | | 11.5 | % | | | 30,607 | | | | 11.7 | % |
Analog and interface products | | 20,477 | | | | 7.7 | % | | | 20,634 | | | | 7.8 | % |
Total sales | $ | 264,072 | | | | 100.0 | % | | $ | 262,557 | | | | 100.0 | % |
Microcontrollers
Our microcontroller product line represents the largest component of our total net sales. Microcontrollers and associated application development systems accounted for approximately 79.7%80.8% of our total net sales for the three-month period ended December 31, 2006 and approximately 80.1%of our total net sales for the nine-month period ended December 31, 2006June 30, 2007 compared to approximately 79.3%80.5% of our total net sales for the three-month period ended December 31, 2005 and approximately 79.4% of our total net sales for the nine-month period ended December 31, 2005.June 30, 2006.
Net sales of our microcontroller products increased approximately 7.4%0.9% in the three-month period ended December 31, 2006 and 15.8% in the nine-month period ended December 31, 2006June 30, 2007 compared to the three and nine-month periodsthree-month period ended December 31, 2005. TheseJune 30, 2006. This sales increases wereincrease was primarily due to increased demand for our microcontroller products in end markets, driven principally by market share gains and those factors described on page 2219 above. The end markets that we serve include the consumer, automotive, industrial control, communications and computing markets.
Historically, average selling prices in the semiconductor industry decrease over the life of any particular product. The overall average selling prices of our microcontroller products have remained relatively constant over time due to the proprietary nature of these products. We have experienced, and expect to continue to experience, moderate pricing pressure in certain microcontroller product lines, primarily due to competitive conditions. We have been able to in the past, and expect to be able to in the future, moderate average selling price declines in our microcontroller product lines by introducing new products with more features and higher prices. We may be unable to maintain average selling prices for our microcontroller products as a result of increased pricing pressure in the future, which would adversely affect our operating results.
Memory Products
Sales of our memory products accounted for approximately 12.0%11.5% of our total net sales for the three-month period ended December 31, 2006 and 11.9% of our total net sales for the nine-month period ended December 31, 2006June 30, 2007 compared to approximately 13.3%11.7% of our total net sales for the three-month period ended December 31, 2005 and 13.8% of our total net sales in the nine-month period ended December 31, 2005.June 30, 2006.
Net sales of our memory products decreased approximately 3.9%1.0% in the three-month period ended December 31, 2006June 30, 2007 compared to the three-month period ended December 31, 2005. NetJune 30, 2006. This sales of our memory products decreased approximately 1.1% in the nine-month period ended December 31, 2006 compared to the nine-month period ended December 31, 2005. These sales decreases weredecrease was driven by market share gains and customer demand conditions within the Serial EEPROM market which products comprise substantially all of our memory product net sales.
Serial EEPROM product pricing has historically been cyclical in nature, with steep price declines followed by periods of relative price stability, driven by changes in industry capacity at different stages of the business cycle. We have experienced, and expect to continue to experience, varying degrees of competitive pricing pressures in our Serial EEPROM products. We may be unable to maintain the average selling prices of our Serial EEPROM products as a result of increased pricing pressure in the future, which could adversely affect our operating results.
Analog and Interface Products
Sales of our analog and interface products accounted for approximately 8.3%7.7% of our total net sales for the three-month period ended December 31, 2006 and 8.0% of our total net sales for the nine-month period ended December 31, 2006June 30, 2007 compared to approximately 7.4%7.8% of our total net sales for the three-month period ended December 31, 2005 and 6.8% of our total net sales for the nine-month period ended December 31, 2005.
Net sales of our analog and interface products increaseddecreased approximately 20.1%0.8% in the three-month period ended December 31, 2006 and 35.8% in the nine-month period ended December 31, 2006June 30, 2007 compared to the three and nine-month periodsthree-month period ended December 31, 2005. TheseJune 30, 2006. This sales increasesdecrease in our analog and interface products werewas driven by market share gains and supply and demand conditions within the analog and interface market.
Analog and interface products can be proprietary or non-proprietary in nature. Currently, we consider more than half of our analog and interface product mix to be proprietary in nature, where prices are relatively stable, similar to the pricing stability experienced in our microcontroller products. The non-proprietary portion of our analog and interface business will experience price fluctuations, driven primarily by the current supply and demand for those products. We may be unable to maintain the average selling prices of our analog and interface products as a result of increased pricing pressure in the future, which would adversely affect our operating results. We anticipate the proprietary portion of our analog and interface products will continue to increase over time.
Turns Orders
Our net sales in any given quarter depend upon a combination of shipments from backlog and orders received in that quarter for shipment in that quarter, which we refer to as turns orders. Historically, we have proven our ability to respond quickly to customer orders as part of our competitive strategy, resulting in customers placing orders with short delivery schedules. Shorter lead times generally mean that turns orders as a percentage of our business are relatively high in any particular quarter and reduce our backlog visibility on future product shipments. Turns orders correlate to overall semiconductor industry conditions and product lead times. Turns orders are difficult to predict, and we may not experience the combination of turns orders and shipments from backlog in a quarter that would be sufficient to achieve anticipated net sales. If we do not achieve a sufficient level of turns orders in a particular quarter, our net sales and operating results may suffer.
Distribution
Distributors accounted for approximately 65% of our net sales in the nine-month periodthree-month periods ended December 31, 2006June 30, 2007 and 2006.
Our largest distributor accounted for approximately 64%11% of our net sales in the nine-monththree-month period ended December 31, 2005.
June 30, 2007. Our two largest distributors accounted for approximately 21%23% of our net sales in the nine-monththree-month period ended December 31, 2006 and approximately 24% of our net sales in the nine-month period ended December 31, 2005.June 30, 2006.
Generally, we do not have long-term agreements with our distributors and we, or our distributors, may terminate our relationships with each other with little or no advanced notice. The loss of, or the disruption in the operations of, one or more of our distributors could reduce our future net sales in a given quarter and could result in an increase in inventory returns.
At December 31, 2006,June 30, 2007, our distributors were maintaining an average of approximately 1.91.8 months of inventory of our products. Over the past three fiscal years, the months of inventory maintained by our distributors have fluctuated between approximately 1.91.8 and 2.8 months. Thus, inventory levels at our distributors are at the low end of the range we have experienced over the last three years. As we recognize revenue based on sell through for all of our distributors, we do not believe that inventory holding patterns at our distributors will materially impact our net sales.
Sales by geography for the three and nine-monththree-month periods ended December 31,June 30, 2007 and 2006 and December 31, 2005 were as follows (dollars in thousands):
24 | Three Months Ended June 30, (unaudited) | |
| 2007 | | | % | | | 2006 | | | % | |
| | | | | | | | | | | |
Americas | $ | 70,406 | | | | 26.7 | % | | $ | 73,579 | | | | 28.0 | % |
| | | | | | | | | | | | | | | |
Europe | | 79,842 | | | | 30.2 | % | | | 73,742 | | | | 28.1 | % |
| | | | | | | | | | | | | | | |
Asia | | 113,824 | | | | 43.1 | % | | | 115,236 | | | | 43.9 | % |
| | | | | | | | | | | | | | | |
Total sales | $ | 264,072 | | | | 100.0 | % | | $ | 262,557 | | | | 100.0 | % |
| | Three Months Ended December 31, (unaudited) | | Nine Months Ended December 31, (unaudited) | |
| | 2006 | | % | | 2005 | | % | | 2006 | | % | | 2005 | | % | |
| | | | | | | | | | | | | | | | | |
Americas | | $ | 70,072 | | | 27.9 | % | $ | 66,143 | | | 28.2 | % | $ | 217,280 | | | 27.8 | % | $ | 194,085 | | | 28.5 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Europe | | | 70,749 | | | 28.2 | % | | 60,105 | | | 25.6 | % | | 218,348 | | | 27.9 | % | | 184,293 | | | 27.1 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Asia | | | 110,183 | | | 43.9 | % | | 108,648 | | | 46.2 | % | | 345,867 | | | 44.3 | % | | 302,343 | | | 44.4 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Total sales | | $ | 251,004 | | | 100.0 | % | $ | 234,896 | | | 100.0 | % | $ | 781,495 | | | 100.0 | % | $ | 680,721 | | | 100.0 | % |
Our sales to foreign customers have been predominately in Asia and Europe, which we attribute to the manufacturing strength in those areas for automotive, communications, computing, consumer and industrial control products. Americas sales include sales to customers in the United States, Canada, Central America and South America. Sales to customers in Asia have generally increased over time due to many of our customers transitioning their manufacturing operations to Asia and growth in demand from the emerging Asian market.
Sales to foreign customers accounted for approximately 75% of our net sales in the three-month period ended December 31, 2006 and 74% of our net sales in the three-month period ended December 31, 2005. Sales to foreign customers accounted for 74% of our net sales in the nine-month period ended December 31, 2006June 30, 2007 and 73% of our net sales in the nine-monththree-month period ended December 31, 2005.June 30, 2006. Substantially all of our foreign sales are U.S. dollar denominated.
Gross Profit
Our gross profit was $149.7 $158.5million in the three months ended December 31, 2006,June 30, 2007 and $140.3$158.5 million in the three months ended December 31, 2005. Our gross profit was $470.2 million in the nine months ended December 31, 2006, and $402.3 million in the nine months ended December 31, 2005.June 30, 2006. Gross profit as a percentpercentage of sales was 59.6%60.0% in the three months ended December 31, 2006,June 30, 2007 and 59.7%60.4% in the three months ended December 31, 2005. Gross profit as a percent of sales was 60.2% in the nine months ended December 31, 2006, and 59.1% in the nine months ended December 31, 2005.June 30, 2006.
The most significant factors affecting our gross profit percentage in the periods covered by this report were:
| · | increased cost of sales of $1.6 million in the three months ended December 31, 2006June 30, 2007 associated with share-based compensation expense under the SFAS 123R; |
| · | fluctuations in the product mix of microcontrollers, proprietary and non-proprietary analog products and Serial EEPROM products resulting in higherlower average selling prices for our products; |
| · | lower depreciation expense as a percentage of cost of sales; and |
| · | unfavorable foreign exchange rate fluctuations impacting our Thailand manufacturing operations. |
Other factors that impacted gross profit percentage in the periods covered by this report include:
| · | changes in capacity utilization and absorption of fixed costs; |
| · | gross profit on products sold through the distribution channel; |
| · | continued cost reductions in wafer fabrication and assembly and test manufacturing such as new manufacturing technologies and more efficient manufacturing techniques. |
Other factors that impacted gross profit percentage in the periods covered by this report include:
| · | changes in capacity utilization and absorption of fixed costs; |
| · | gross profit on products sold through the distribution channel; |
| · | depreciation expense as a percentage of cost of sales;techniques; and |
| · | inventory write-offs and the sale of inventory that was previously written off. |
During the three-month period ended December 31, 2006,June 30, 2007, we operated at approximately 99% of our Fab 2 capacity, which is approximately the same level of utilization from the same period of the previous fiscal
year. Our utilization of Fab 4’s total capacity is at relatively low levels although we are utilizing all of the installed equipment base. We expect to maintain approximately the same levels of capacity utilization at Fab 2 and Fab 4 during the fourthsecond quarter of fiscal 2007.2008.
The process technologies utilized impact our gross margins. Fab 2 currently utilizes various manufacturing process technologies, but predominantly utilizes our 0.5 to 1.0 micron processes. At December 31, 2006,June 30, 2007, Fab 4 predominantly utilized our 0.5 micron process technology. We continue to transition products to more advanced process technologies to reduce future manufacturing costs. All of our production has been on 8-inch wafers for the periods covered by this report.
Our overall inventory levels were $121.9$123.8 million at December 31, 2006June 30, 2007 compared to $115.0$121.0 million at March 31, 2006.2007. We had 110107 days of inventory on our balance sheet at December 31, 2006June 30, 2007 compared to 106107 days at March 31, 20062007 and 111102 days at December 31, 2005. In the three and nine months ended December 31, 2006, $1.7June 30, 2006. At June 30, 2007, $3.3 million and $5.0 million, respectively, of share-based compensation expense was capitalizedincluded in inventory compared to inventory$3.2 million at March 31, 2007, as a result of the adoption of SFAS 123R. The adoption of this accounting standard adversely impacted our gross profit in the quarter ending December 31, 2006,June 30, 2007, as the inventory including the share-based compensation was sold.
We anticipate that our gross margins will fluctuate over time, driven primarily by the overall product mix of microcontroller, analog and interface and memory products and the percentage of net sales of each of these products in a particular quarter, as well as manufacturing yields, fixed cost absorption, capacity utilization levels, particularly those at Fab 4, and competitive and economic conditions.
At December 31, 2006,June 30, 2007, approximately 73%69% of our assembly requirements were being performed in our Thailand facility, compared to approximately 62%67% as of December 31, 2005.June 30, 2006. Third-party contractors located in Asia perform the balance of our assembly operations. Substantially all of our test requirements were being performed in our Thailand facility as of December 31, 2006June 30, 2007 and December 31, 2005.June 30, 2006. We believe that the assembly and test operations performed at our Thailand facility provide us with significant cost savings when compared to third-party contractor assembly and test costs, as well as increased control over these portions of the manufacturing process.
We rely on outside wafer foundries for a small portion of our wafer fabrication requirements.
Our use of third parties involves some reduction in our level of control over the portions of our business that we subcontract. While we review the quality, delivery and cost performance of our third-party contractors, our future operating results could suffer if any third-party contractor is unable to maintain manufacturing yields, assembly and test yields and costs at approximately their current levels.
Research and Development (R&D)
R&D expenses for the three months ended December 31, 2006June 30, 2007 were $28.0$29.7 million, or 11.2%11.3% of sales, compared to $23.4$28.0 million, or 10.0%10.7% of sales, for the three months ended December 31, 2005. R&D expenses for the nine months ended December 31, 2006 were $85.2 million, or 10.9% of sales, compared to $70.4 million, or 10.3% of sales, for the nine months ended December 31, 2005.June 30, 2006. We are committed to investing in new and enhanced products, including development systems software, and in our design and manufacturing process technologies. We believe these investments are significant factors in maintaining our competitive position. We expense all R&D costs as incurred. R&D expenses include labor, depreciation, masks, prototype wafers, and expenses for the development of process technologies, new packages, and software to support new products and design environments.
R&D expenses increased $4.7$1.7 million, or 20.0%6.1%, for the three months ended December 31, 2006 over the same period last year. R&D expenses increased $14.7 million, or 20.9%, for the nine months ended December 31, 2006June 30, 2007 over the same period last year. The primary reasonsreason for the increasesincrease in R&D expenses in these periods
were was higher labor costs as a result of expanding our internal R&D headcount, increases in bonuses and $2.4 million and $7.2 million of share-based compensation as a result of the adoption of SFAS 123R in the three and nine months ended December 31, 2006, respectively.headcount.
Selling, General and Administrative
Selling, general and administrative expenses for the three months ended December 31, 2006June 30, 2007 were $40.2$43.8 million, or 16.0%16.5% of sales, compared to $32.3$40.8 million, or 13.8%15.5% of sales, for the three months ended December 31, 2005. Selling, general and administrative expense for the nine months ended December 31, 2006 were $122.5 million, or 15.7% of sales, compared to $95.0 million, or 14.0% of sales, for the nine months ended December 31, 2005.June 30, 2006. Selling, general and administrative expenses include salary expenses related to field sales, marketing and administrative personnel, advertising and
promotional expenditures and legal expenses. Selling, general and administrative expenses also include costs related to our direct sales force and field applications engineers who work in sales offices worldwide to stimulate demand by assisting customers in the selection and use of our products.
Selling, general and administrative expenses increased $7.9$3.0 million, or 24.4%7.4%, for the three months ended December 31, 2006 over the same period last year. Selling, general and administrative expenses increased $27.5 million, or28.9%, for thenine months ended December 31, 2006June 30, 2007 over the same period last year. The primary reasonsreason for the increasesincrease in selling, general and administrative expenses in these periods werewas higher labor costs as a result of expanding our internal resources involved in the technical aspect of selling our products, increases in bonuses and $2.8 million and $8.2million of share-based compensation as a result of the adoption of SFAS 123R, in the three and nine-month periods ended December 31, 2006, respectively.products.
Selling, general and administrative expenses fluctuate over time, primarily due to revenue and operating expense levels.
Other Income (Expense)
Interest income in the three and nine-month periodsthree-month period ended December 31, 2006June 30, 2007 increased from interest income in the three and nine-month periodsthree-month period ended December 31, 2005June 30, 2006 as our average invested cash balances and the average interest rates on those invested cash balances were at higher levels in the periodsperiod ended December 31, 2006June 30, 2007 compared to the same periodsperiod in the prior fiscal year.
Provision for Income Taxes
Provisions for income taxes reflect tax on foreign earnings and federal and state tax on U.S. earnings. We had an effective tax rate of 20.3% for the three-month period ending June 30, 2007 and 24.0% for the three-month period ending June 30, 2006. The lower tax rate in the three and nine-month periods ending December 31, 2006 and December 31, 2005.months ended June 30, 2007 compared to the same period last year was primarily driven by the impact of the resolution of certain tax matters through a tax settlement that was finalized with the IRS in the fourth quarter of fiscal 2007.
At December 31, 2006,June 30, 2007, our gross deferred tax asset was $69.0$63.3 million. Our gross deferred tax asset decreasedincreased by $9.6$1.3 million in the ninethree months ended December 31, 2006June 30, 2007 compared to the level at March 31, 2006,2007, due primarily to increases in income, which allowed us to utilize tax credits, and changes in various temporary differences between our book and tax reporting. At December 31, 2006,June 30, 2007, our deferred tax liability was $13.2$6.2 million. Our gross deferred tax liability decreased by $1.4$2.1 million in the ninethree months ended December 31, 2006June 30, 2007 compared to the level at March 31, 2006,2007, due primarily to changes in temporary differences in depreciation between our book and tax reporting.
Our Thailand manufacturing operations currently benefit from numerous tax holidays that have been granted to us by the Thailand government based on our investments in property, plant and equipment in Thailand. Our tax holiday periods in Thailand expire at various times in the future. One of our Thailand tax holidays expired in September 2006 and the expiration did not have a material impact on our effective tax rate. We do not expect the future expiration of any of our tax holiday periods in Thailand to have a material impact on our
effective tax rate. Any expiration of tax holidays are expected to have a minimal impact on our overall tax expense due to other tax holidays and an increase in income in other taxing jurisdictions with lower statutory rates.
Liquidity and Capital Resources
We had $1,264$1,343 million in cash, cash equivalents and short-term and long-term investments at December 31, 2006, a decreaseJune 30, 2007, an increase of $20.6$65.1 million from the March 31, 20062007 balance. The decreaseincrease in cash, cash equivalents and short-term and long-term investments over this time period is primarily attributable to a $239.5 million pay down of short-term debt offset by cash generated from operating activities.
Net cash provided from operating activities was $357.8$122.6 million for the nine-monththree-month period ended December 31, 2006June 30, 2007 compared to $323.1$129.8 million for the nine-monththree-month period ended December 31, 2005.June 30, 2006. The increasechange in cash flow from operations was primarily from increases in profitability, $19.4 million of additional share-based compensation expenses as a result of the adoption of SFAS 123R, changes in accounts receivable, other assets and liabilities, accounts payable and accrued liability balances, and changes in deferred income on shipments to distributors.
During the ninethree months ended December 31, 2006,June 30, 2007, net cash used in investing activities increased $221.9decreased $314.2 million, to $436.8 $91.3million, from $214.9$405.5 million for the ninethree months ended December 31, 2005.June 30, 2006. The increasedecrease was due primarily to changes in our net purchases, sales and maturities of short-term and long-term investments in the ninethree months ended December 31, 2006. Capital expenditures were $51.4 million in the nine-month period ended December 31, 2006 compared to $42.8 million in the nine-month period ended December 31, 2005.June 30, 2007.
We enter into hedging transactions from time to time in an attempt to reduce our exposure to currency rate fluctuations. The amount of theThere were no hedges outstanding at December 31, 2006 were immaterial.June 30, 2007. Although none of the countries in which we conduct significant foreign operations have had a highly inflationary economy in the last five years, there is no assurance that inflation rates or fluctuations in foreign currency rates in countries where we conduct operations will not adversely affect our operating results in the future.
Our level of capital expenditures varies from time to time as a result of actual and anticipated business conditions. Capital expenditures in the ninethree months ended December 31, 2006June 30, 2007 were $51.4$25.5 million compared to $42.8$16.6 million for the ninethree months ended December 31, 2005.June 30, 2006. Capital expenditures are primarily for the expansion of production capacity and the addition of research and development equipment. We currently anticipate spending approximately $60 million to $65$70 million during the next 12 months to invest in equipment and facilities to maintain, and selectively increase, capacity to meet our currently anticipated needs.
We expect to finance capital expenditures through our existing cash balances and cash flows from operations. We believe that the capital expenditures anticipated to be incurred over the next 12 months will provide sufficient manufacturing capacity to meet our currently anticipated needs.
Net cash used in financing activities was $333.0$30.8 million for the ninethree months ended December 31, 2006June 30, 2007 compared to $19.4$152.9 million for the ninethree months ended December 31, 2005.June 30, 2006. Proceeds from the exercise of stock options and employee purchases under our employee stock purchase plan were $42.3$21.7 million for the ninethree months ended December 31, 2006June 30, 2007 and $63.5$17.5 million for the ninethree months ended December 31, 2005.June 30, 2006. We paid cash dividends to our shareholders of $150.5$61.1 million in the ninethree months ended December 31, 2006June 30, 2007 and $$46.1 79.6million in the ninethree months ended December 31, 2005.June 30, 2006. During the ninethree months ended December 31,June 30, 2006, we paid down $239.5 $131.5million in short-term borrowings, resulting in a short-term borrowing balance of $29.5 million at December 31, 2006. The short-term borrowings related to transactions associated with our repatriation of foreign earnings under the American Jobs Creation Act in fiscal 2006. To complete the repatriation of $500 million, we initiated certain borrowings which were collateralized against investments held in our foreign locations. We presently expect to pay down the short-term borrowings as our investments mature and new cash is generated in
the foreign locations.borrowings. Excess tax benefits from share-based payment arrangements were $14.7$8.7 million in the ninethree months ended December 31,June 30, 2007 and $7.1 million in the three months ended June 30, 2006.
On April 22, 2004, our Board of Directors authorized the repurchase of 2.5 million shares of our common stock in the open market or in privately negotiated transactions. As of December 31, 2006,June 30, 2007, we had repurchased 1,004,834 common shares under this authorization for a total of $26.6 million. As of December 31, 2006,June 30, 2007, all of the purchased shares under the authorization were used to fund stock option exercises, vesting of RSUs and purchases under our employee stock purchase plan. On October 25, 2006, our Board of Directors authorized the repurchase of up to an additional 10 million shares of our common stock in the open market or in privately negotiated transactions. The timing and amount of any future repurchases will depend upon market conditions, interest rates and corporate considerations.
On October 28, 2002, we announced that our Board of Directors had approved and instituted a quarterly cash dividend on our common stock. The initial quarterly dividend of $0.02 per share was paid on December 6, 2003 in the aggregate amount of $4.0 million. We have continued to pay quarterly dividends and have increased the amount of such dividends on a regular basis. A quarterly dividend of $0.25$0.28 per share was paid on November 22, 2006May 24, 2007 in the aggregate amount of $54.0$61.1 million. A quarterly dividend of $0.265$0.295 per share was declared
on January 31, 2007 andJuly 26, 2007and will be paid on February 28,August 23, 2007 to shareholders of record as of February 14,August 9, 2007. We expect the FebruaryAugust 2007 cash dividend to be approximately $57.4 million. During fiscal 2006, we paid dividends in the aggregate amount of $0.57per share for a total dividend payment of $120.1$64.5 million. Since the inception of our dividend program, we have paid aggregate dividends of $345.1$463.6 million.
We believe that our existing sources of liquidity combined with cash generated from operations will be sufficient to meet our currently anticipated cash requirements for at least the next 12 months. However, the semiconductor industry is capital intensive. In order to remain competitive, we must constantly evaluate the need to make significant investments in capital equipment for both production and research and development. We may seek additional equity or debt financing from time to time to maintain or expand our wafer fabrication and product assembly and test facilities, or for other purposes. The timing and amount of any such financing requirements will depend on a number of factors, including demand for our products, changes in industry conditions, product mix, and competitive factors. There can be no assurance that such financing will be available on acceptable terms, and any additional equity financing would result in incremental ownership dilution to our existing stockholders.
Contractual Obligations
There have not been any material changes in our contractual obligations from what we disclosed in our Annual Report on Form 10-K for the fiscal year ended March 31, 2006.2007.
Off-Balance Sheet Arrangements
As of December 31, 2006,June 30, 2007, we are not involved in any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.
Recently Issued Accounting Pronouncements
In JulyJune 2006, the FASBFinancial Accounting Standards Board (FASB) issued FASB Interpretation (FIN) No. 48, “AccountingAccounting for Uncertainty in Income Taxes” (“Taxes – an Interpretation of FASB Statement 109 (FIN 48”)48). FIN 48 is an interpretation of FASB Statement No. 109, “Accountingestablishes a single model to address accounting for Income Taxes,” and it seeks to reduceuncertain tax positions. FIN 48 clarifies the diversity in practice associated with certain aspects of measurement and recognition in accounting for income taxes. In addition,taxes by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 requires expandedalso provides guidance on de-recognition, measurement classification, interest and penalties, accounting in interim periods, disclosure with respect to the uncertainty in income taxes and is effective for us as of the beginning fiscal 2008.transition. We are currently evaluating the impact, if any, thatadopted FIN 48 will have on April 1, 2007, and did not recognize any cumulative-effect adjustment associated with our financial statements.
unrecognized tax benefits, interest, and penalties.
In September 2006, the FASB issued SFAS No. 157, “FairFair Value Measurements” (“SFAS 157”)Measurement (SFAS No. 157). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. The provisions ofmeasurements, but does not require any new fair value measurement. SFAS No. 157 areis effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. We are in the process of determining the effect, if any, that the adoption of SFAS No. 157 will have on our consolidated financial statements. Because Statement No. 157 does not require any new fair value measurements or re-measurements of previously computed fair values, we do not believe the adoption of this Statement will have a material effect on our results of operations or financial condition.
On February 15, 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS No. 159). Under this Standard, we may elect to report financial instruments and certain other items at fair value on a contract-by-contract basis with changes in value reported in earnings. This election is irrevocable. SFAS No. 159 provides an opportunity to mitigate volatility in reported earnings that is caused by measuring hedged assets and liabilities that were previously required to use a different accounting method than the related hedging contracts when the complex provisions of SFAS No. 133 hedge accounting are not met. SFAS No. 159 is effective for years beginning after November 15, 2007.Early adoption within 120 days of the beginning of our 2008 fiscal year is permissible, provided we have not yet issued interim financial statements for 2008 and have adopted SFAS No. 157. We are currently evaluating the potential impact if any, that SFAS 157 will have on our financial statements.of adopting this Standard. In September 2006, the FASB issued SFAS 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R)” (“SFAS 158”) and is effective for our fiscal year ended March 31, 2007. This standard requires companies to recognize, on a prospective basis, the funded status of their defined benefit pension and other postretirement benefit plans as a net liability or asset on their balance sheets. We are currently evaluating the impact, if any, that SFAS 158 will have on our financial statements.
Our investment portfolio, consisting of fixed income securities and money market funds that we hold on an available-for-sale basis, was $1.3 billion as of December 31, 2006. This amount includes securities with original maturities that are within 90 days when acquired and are classified as cash and cash equivalents on our balance sheet. The securities in our investment portfolio, like all fixed income instruments, are subject to interest rate and credit risk and will decline in value if market interest rates increase. We have the ability to hold our fixed income investments until maturity and, therefore, we would not expect to recognize any material adverse impact in income or cash flows if market interest rates increase. The following table provides information about our available-for-sale securities that are sensitive to changes in interest rates. We have aggregated our available-for-sale securities for presentation purposes since they are all very similar in nature (dollars in thousands):
| | Financial instruments mature during the fiscal year ended March 31, | |
| | 2007 | | 2008 | | 2009 | | 2010 | | 2011 | | Thereafter | |
| | | | | | | | | | | | | |
Available-for-sale securities | | $ | 191,661 | | $ | 219,004 | | $ | 203,302 | | $ | 222,791 | | $ | 45,491 | | $ | 229,035 | |
| | | | | | | | | | | | | | | | | | | |
Weighted-average yield rate | | | 4.96 | % | | 3.68 | % | | 3.85 | % | | 4.29 | % | | 5.76 | % | | 5.34 | % |
We have international operations and are thus subject to foreign currency rate fluctuations. To date, our exposure related to exchange rate volatility has not been significant. Approximately 99% of our sales are denominated in U.S. dollars. At times we maintain hedges of foreign currency exposure of a net investment in a foreign operation. We had no foreign currency hedges outstanding as of December 31, 2006. If foreign currency rates fluctuate by 15% from the rates at December 31, 2006, the effect on our financial position and results of operation would not be material.Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
During the normal course of business, we are routinely subjectedsubject to a variety of market risks, examples of which include, but are not limited to, interest rate movements and foreign currency fluctuations as we discuss in this Item 3, and collectability of accounts receivable. We continuously assess these risks and have established policies and procedures to help protect against theany material adverse effects of these and other potential exposures. Although we do not anticipate any material losses in these risk areas, no assurance can be made that material losses will not be incurred in these areas in the future. During the three months ended June 30, 2007, there were no material changes in our exposure to market risk as disclosed in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended March 31, 2007.
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this Quarterly Report on Form 10-Q, as required by paragraph (b) of Rule 13a-15 or Rule 15d-15 under the Securities Exchange Act of 1934, as amended, we evaluated under the
supervision of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) of the Securities Exchange Act of 1934, as amended). Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 (i) is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Our disclosure controls and procedures are designed to provide reasonable assurance that such information is accumulated and communicated to our management. Our disclosure controls and procedures include components of our internal control over financial reporting. Management’s assessment of the effectiveness of our internal control over financial reporting is expressed at the level of reasonable assurance because a control system, no matter how well designed and operated, can provide only reasonable, but not absolute, assurance that the control system’s objectives will be met.
Changes in Internal Control over Financial Reporting
During the three months ended December 31, 2006,June 30, 2007, there was no change in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
In the ordinary course of our business, we are involved in a limited number of legal actions, both as plaintiff and defendant, and could incur uninsured liability in any one or more of them. Although the outcome of these actions is not presently determinable, we believe that the ultimate resolution of these matters will not harm our business and will not have a material adverse effect on our financial position, cash flows or results of operations. Litigation relating to the semiconductor industry is not uncommon, and we are, and from time to time
have been, subject to such litigation. No assurances can be given with respect to the extent or outcome of any such litigation in the future.
When evaluating Microchip and its business, you should give careful consideration to the factors listed below, in addition to the information provided elsewhere in this Form 10-Q and in other documents that we file with the Securities and Exchange Commission.
Our quarterly operating results may fluctuate due to factors that could reduce our net sales and profitability.
Our quarterly operating results are affected by a wide variety of factors that could reduce our net sales and profitability, many of which are beyond our control.
Some of the factors that may affect our quarterly operating results include:
| · | changes in demand or market acceptance of our products and products of our customers |
| · | levels of inventories at our customers |
| · | the mix of inventory we hold and our ability to satisfy orders from our inventory |
| · | changes in utilization of our manufacturing capacity and fluctuations in manufacturing yields |
| · | our ability to secure sufficient assembly and testing capacity |
| · | availability of raw materials and equipment |
| · | competitive developments including pricing pressures |
| · | the level of orders that are received and can be shipped in a quarter |
| · | the level of sell-through of our products through distribution |
| · | changes or fluctuations in customer order patterns and seasonality |
| · | ability to timely introduce products |
| · | constrained availability from other electronic suppliers impacting our customers’ ability to ship their products, which in turn may adversely impact our sales to those customers |
| · | costs and outcomes of any current or future tax audits or any litigation involving intellectual property, customers or other issues |
| · | disruptions in our business or our customers’ businesses due to terrorist activity, armed conflict, war, worldwide oil prices and supply, public health concerns or disruptions in the transportation system |
| · | property damage or other losses which are not covered by insurance |
| · | general economic, industry or political conditions in the United States or internationally |
We believe that period-to-period comparisons of our operating results are not necessarily meaningful and that you should not rely upon any such comparisons as indications of future performance. In future periods our operating results may fall below our public guidance or the expectations of public market analysts and investors, which would likely have a negative effect on the price of our common stock.
Our operating results will suffer if we ineffectively utilize our manufacturing capacity or fail to maintain manufacturing yields.
The manufacture and assembly of integrated circuits, particularly non-volatile, erasable CMOS memory and logic devices such as those that we produce, are complex processes. These processes are sensitive to a wide variety of factors, including the level of contaminants in the manufacturing environment, impurities in the materials used, the performance of our wafer fabrication personnel and equipment, and other quality issues. As is typical in the semiconductor industry, we have from time to time experienced lower than anticipated manufacturing yields. Our operating results will suffer if we are unable to maintain yields at approximately the current levels. This could include delays in the recognition of revenue, loss of revenue or future orders, and customer-imposed penalties for failure to meet contractual shipment deadlines.
Our operating results are also adversely affected when we operate at less than optimal capacity. Lower capacity utilization results in certain costs being charged directly to expense and lower gross margins.
We are dependent on orders that are received and shipped in the same quarter and are therefore limited in our visibility of future product shipments.
Our net sales in any given quarter depend upon a combination of shipments from backlog and orders received in that quarter for shipment in that quarter, which we refer to as turns orders. We measure turns orders at the beginning of a quarter based on the orders needed to meet the shipment targets that we set entering the quarter. Historically, we have proven our ability to respond quickly to customer orders as part of our competitive strategy, resulting in customers placing orders with relatively short delivery schedules. Shorter lead times generally mean that turns orders as a percentage of our business are relatively high in any particular quarter and reduces our backlog visibility on future product shipments. Turns orders correlate to overall semiconductor industry conditions and product lead times. Because turns orders are difficult to predict, varying levels of turns orders make our net sales more difficult to forecast. If we do not achieve a sufficient level of turns orders in a particular quarter relative to our revenue targets, our revenue and operating results may suffer.
Intense competition in the markets we serve may lead to pricing pressures, reduced sales of our products or reduced market share.
The semiconductor industry is intensely competitive and has been characterized by price erosion and rapid technological change. We compete with major domestic and international semiconductor companies, many of which have greater market recognition and substantially greater financial, technical, marketing, distribution and other resources than we do with which to pursue engineering, manufacturing, marketing and distribution of their products. We may be unable to compete successfully in the future, which could harm our business.
Our ability to compete successfully depends on a number of factors both within and outside our control, including, but not limited to:
| · | the quality, performance, reliability, features, ease of use, pricing and diversity of our products |
| · | our success in designing and manufacturing new products including those implementing new technologies |
| · | the rate at which customers incorporate our products into their own applications |
| · | product introductions by our competitors |
| · | the number, nature and success of our competitors in a given market |
| · | our ability to obtain adequate supplies of raw materials and other supplies at acceptable prices |
| · | our ability to protect our products and processes by effective utilization of intellectual property rights |
| · | the quality of our customer service and our ability to address the needs of our customers, and |
| · | general market and economic conditions. |
Historically, average selling prices in the semiconductor industry decrease over the life of any particular product. The overall average selling prices of our microcontroller and proprietary analog and interface products have remained relatively constant, while average selling prices of our Serial EEPROM and non-proprietary analog and interface products have declined over time.
We have experienced, and expect to continue to experience, modest pricing declines in certain of our more mature proprietary product lines, due primarily to competitive conditions. We have been able to moderate average selling price declines in many of our proprietary product lines by continuing to introduce new products with more features and higher prices. We have experienced in the past and expect to continue to experience in the future varying degrees of competitive pricing pressures in our Serial EEPROM and non-proprietary analog products.
We may be unable to maintain average selling prices for our products as a result of increased pricing pressure in the future, which could adversely impact our operating results.
Our business is dependent on selling through distributors.
Sales through distributors accounted for 65% of our net sales in fiscal 20062007 and during the first ninethree months of fiscal 2007.2008. Our two largest distributors together accounted for approximately 24%21% of our net sales in fiscal 2006, and 21%2007. Our largest distributor accounted for approximately 11% of our net sales induring the first ninethree months of fiscal 2007.2008. We do not have long-term agreements with our distributors and both we and our distributors may each terminate our relationship with little or no advanced notice. We believe that customers recognize Microchip for its products and brand name and use distributors as an effective supply channel.
During fiscal 2006, we reduced the gross margin that certain of our distributors earn when they sell our products. We reduced these distributors’ gross margins because we believebelieved these distributors did not have sufficient technical sales resources to properly address the marketplace for our products. WeSince fiscal 2006, we have added a significant number of technical sales employees throughout our worldwide sales organization to address the support requirements for both our OEM and distribution customers. We cannot predictAlthough these actions have not had a material adverse impact on the overall effectiveness of our distribution channel, there can be no assurance that there will not be an adverse impact if any, that our actions will have on our relationships with such distributors.
The loss of, or a disruption in the operations of, one or more of our distributors could reduce our net sales in a given period and could result in an increase in inventory returns.
Our success depends on our ability to introduce new products on a timely basis.
Our future operating results will depend on our ability to timely develop and introduce new products on a timely basis that can compete effectively on the basis of price and performance and fulfillwhich address customer requirements. The success of our new product introductions depends on various factors, including, but not limited to:
| · | proper new product selection |
| · | timely completion and introduction of new product designs |
| · | development of support tools and collateral literature that make complex new products easy for engineers to understand and use, |
| · | our ability to ramp new products to volume production, and |
| · | market acceptance of our customers’ end products. |
Because our products are complex, we have experienced delays from time to time in completing development of new products. In addition, our new products may not receive or maintain substantial market acceptance. We may be unable to timely design, develop and introduce competitive products on a timely basis, which could adversely impact our future operating results.
Our success also depends upon our ability to develop and implement new design and process technologies. Semiconductor design and process technologies are subject to rapid technological change and require significant R&D expenditures. We and other companies in the industry have, from time to time, experienced difficulties in effecting transitions to advanced process technologies and, consequently, have suffered reduced manufacturing yields or delays in product deliveries. Our future operating results could be adversely affected if any transition to future process technologies is substantially delayed or inefficiently implemented.
We must attract and retain qualified personnel to be successful, and competition for qualified personnel is intense in our market.
Our success depends upon the efforts and abilities of our senior management, engineering and other personnel. The competition for qualified engineering and management personnel is intense.
We may be unsuccessful in retaining our existing key personnel or in attracting and retaining additional key personnel that we require. The loss of the services of one or more of our key personnel or the inability to add key personnel could harm our business. Our employees’We have no employment agreements with any member of our senior management team. As a result of the anticipated impact that the adoption of SFAS No. 123R in our first fiscal quarter of 2007 would have on our results of operations, we changed our equity compensation program during fiscal 2006. We now grant fewer equity based shares per employee and officers’ employmentthe type of equity instrument is at will.generally restricted stock units rather than stock options. This change in our equity compensation program may make it more difficult for us to attract or retain qualified management and engineering personnel, which could have an adverse effect on our business.
We are dependent on several contractors to perform key manufacturing functions for us.
We use several contractors located in Asia for a portion of the assembly and testing of our products. We also rely on outside wafer foundries for a portion of our wafer fabrication. Although we own the majority of our manufacturing resources, the disruption or termination of any of our contractors could harm our business and operating results.
Our use of third parties involves some reduction in our level of control over the portions of our business that we subcontract. Our future operating results could suffer if any contractor were to experience financial, operations or production difficulties or situations when demand exceeds capacity, or if they were unable to maintain manufacturing yields, assembly and test yields and costs at approximately their current levels, or if due to their locations in foreign countries they were to experience political upheaval or infrastructure disruption. Further, procurement from third parties is done by purchase order and contracts. If these third parties are unable or unwilling to timely deliver products or services conforming to our quality standards, we may not be able to qualify additional manufacturing sources for our products in a timely manner or at all, and such arrangements, if
any, may not be on favorable terms to us. In such event, we could experience an interruption in production, an increase in manufacturing and production costs, or a decline in product reliability, and our business and operating results could be adversely affected.
We may lose sales if our suppliers of raw materials and equipment fail to meet our needs.
Our semiconductor manufacturing operations require raw materials and equipment that must meet exacting standards. We generally have more than one source for these supplies, but there are only a limited number of suppliers capable of delivering various raw materials and equipment that meet our standards. The raw materials and equipment necessary for our business could become more difficult to obtain as worldwide use of semiconductors in product applications increases. We have experienced supply shortages from time to time in the past, and on occasion our suppliers have told us they need more time than expected to fill our orders or that they will no longer support certain equipment with updates or spare and replacements parts. An interruption of any raw materials or equipment sources, or the lack of supplier support for a particular piece of equipment, could harm our business.
Our operating results may be impacted by both seasonality and the wide fluctuations of supply and demand in the semiconductor industry.
The semiconductor industry is characterized by seasonality and wide fluctuations of supply and demand. Since a significant portion of our revenue is from consumer markets and international sales, our business may be subject to seasonally lower revenues in the third and fourthparticular quarters of our fiscal year. However, broad strength in our overall business in recent periods hasand semiconductor industry conditions have had a more significant impact on our results than seasonality, and has made it difficult to assess the impact of seasonal factors on our business. The industry has also experienced significant economic downturns, characterized by diminished product demand and production over-capacity. We have sought to reduce our exposure to this industry cyclicality by selling proprietary products that cannot be easily or quickly replaced, to a geographically diverse base of customers across a broad range of market segments. However, we have experienced substantial period-to-period fluctuations in operating results and expect, in the future, to experience period-to-period fluctuations in operating results due to general industry or economic conditions.
We are exposed to various risks related to legal proceedings or claims.
We are currently, and in the future may be, involved in legal proceedings or claims regarding patent infringement, intellectual property rights, contracts and other matters. As is typical in the semiconductor industry, we receive notifications from customers from time to time who believe that we owe them indemnification or other obligations related to infringement claims made against the customers by third parties. These legal proceedings and claims, whether with or without merit, could result in substantial cost to us and divert our resources. If we are not able to defend, resolve or settle a claim, negotiate a settlement of a matter, obtain necessary licenses on commercially reasonable terms, reengineer our products or processes to avoid infringement, and/or successfully prosecute or defend our position, we could incur uninsured liability in any of them, needbe required to take an appropriate charge to operations, be enjoined from selling a material portion of our product line or using certain processes, suffer a reduction or elimination in value of inventories, and as a result, our business, financial condition or results of operations could be harmed.
It is also possible that from time to time we may be subject to warranty or product liability claims that could lead to significant expenses related to the defense of such claims, diversion of resources, increased costs associated with the replacement of affected products, lost revenue or delay in recognition of revenue due to cancellation of orders and unpaid receivables, customer imposed fines or penalties for failure to meet contractual requirements, and a requirement to pay damages claims. Because the systems into which our products are integrated have a higher cost of goods than the products we sell, these expenses and damages may be significantly higher than the sales and profits we received from the products involved. While we specifically exclude consequential damages in our standard terms and conditions, our ability to avoid such liabilities may be limited by applicable law. We do have generalproduct liability insurance, but it is unlikelywe do not expect that such insurance will cover all claims or be of a sufficient amount to fully protect against such claims. Costs or payments we may make in connection with warranty or product liability claims may adversely affect ourthe results of our operations.
Further, we sell to customers in industries such as automotive, aerospace, and medical, where failure of their systems could cause damage to property or persons. We may be subject to product liability claims if our products cause the system failures. Based on our historical experience, we believe that ourthe risk of exposure to product liability claims is currently low. However, we will face increased exposure to product liability claims if there are substantial increases in either the volume of our sales into these applications or the frequency of system failures caused by our devices.
Our failureFailure to adequately protect our intellectual property could result in lost revenue or market opportunities.
Our ability to obtain patents, licenses and other intellectual property rights covering our products and manufacturing processes is important for our success. To that end, we have acquired certain patents and patent licenses and intend to continue to seek patents on our inventions and manufacturing processes. The process of seeking patent protection can be long and expensive, and patents may not be issued from currently pending or future applications. In addition, our existing patents and any new patents that are issued may not be of sufficient scope or strength to provide meaningful protection or any commercial advantage to us. We may be subject to or may ourselves initiate interference proceedings in the U.S. Patent and Trademark Office, which can require significant financial and management resources. In addition, the laws of certain foreign countries do not protect our intellectual property rights to the same extent as the laws of the United States. Infringement of our intellectual property rights by a third party could result in uncompensated lost market and revenue opportunities for us.
We do not typically have long-term contracts with our customers.
We do not typically enter into long-term contracts with our customers and we cannot be certain about future order levels from our customers. When we do enter into customer contracts, the contract is generally cancelable at the convenience of the customer. Even though we have over 55,00058,000 end customers and our ten largest customers make up less than 15%approximately 10% of our total revenue, cancellation or modification of long-term and short-term customer contracts could have an adverse financial impact on our revenue and profits.
Further, as the practice has become more commonplace in the industry, we have entered into contracts with certain customers that differ from our standard terms of sale. Under these contracts we commit to supply quantities of products on scheduled delivery dates. If we become unable to supply the customer as required under the contract, the customer may incur additional production costs, lost revenues due to subsequent delays in their own manufacturing schedule, or quality related issues. Under these contracts, we may be liable for the costs the customer has incurred. While we try to limit such liabilities, if they should arise, there may be a material adverse impact on our results of operation and financial condition.
Business interruptions could harm our business.
Operations at any of our manufacturing facilities, or at any of our wafer fabrication or test and assembly subcontractors, may be disrupted for reasons beyond our control, including work stoppages, power loss, incidents of terrorism or security risk, political instability, public health issues, telecommunications, transportation or other infrastructure failure, fire, earthquake, floods, or other natural disasters. If operations at any of our facilities, or our subcontractors’ facilities are interrupted, we may not be able to shift production to other facilities on a timely basis. If this occurs, we would likely experience delays in shipments of products to our customers and alternate sources for production may be unavailable on acceptable terms. This could result in reduced revenues and profits and the cancellation of orders or loss of customers. In addition, business interruption insurance will likely not be enough to compensate us for any losses that may occur and any losses or damages incurred by us as a result of business interruptions could significantly harm our business.
We are highly dependent on foreign sales and operations, which exposes us to foreign political and economic risks.
Sales to foreign customers account for a substantial portion of our net sales. During fiscal 20062007 and the first ninethree months of fiscal 2007,2008, approximately 74% of our net sales were made to foreign customers. We purchase a substantial portion of our raw materials and equipment from foreign suppliers. In addition, we own product assembly and testing facilities located near Bangkok, Thailand. We also use various foreign contractors for a portion of our assembly and testing and for a portion of our wafer fabrication requirements. Substantially all of our finished goods inventory is maintained in Thailand. Although we did not suffer any material disruption in our business as a result of the recent military coup in Thailand, there can be no assurance that similar events in the future in Thailand or other countries will not adversely impact our operations.
Our reliance on foreign operations, foreign suppliers, maintenance of substantially all of our finished goods in inventory at foreign locations and significant foreign sales exposes us to foreign political and economic risks, including, but not limited to:
| · | political, social and economic instability |
| · | public health conditions |
| · | trade restrictions and changes in tariffs |
| · | import and export license requirements and restrictions |
| · | difficulties in staffing and managing international operations |
| · | disruptions in international transport or delivery |
| · | fluctuations in currency exchange rates |
| · | difficulties in collecting receivables |
| · | public health conditions |
| · | economic slowdown in the worldwide markets served by us, and |
| · | potentially adverse tax consequences. |
If any of these risks materialize, our sales could decrease andand/or our operating results could suffer.
Interruptions in information technology systems could adversely affect our business.
We rely on the efficient and uninterrupted operation of complex information technology systems and networks to operate our business. Any significant system or network disruption, including but not limited to computer viruses, security breaches, or energy blackouts could have a material adverse impact on our operations, sales and operating results. We have implemented measures to manage our risks related to such disruptions, but such disruptions could negatively impact our operations and financial results. In addition, we may incur additional costs to remedy the damages caused by these disruptions or security breaches.
The occurrence of events for which we are self-insured, or which exceed our insurance limits may adversely affect our profitability and liquidity.
We have insurance contracts with independent insurance companies related to many different types of risk. However,risk; however, we self-insure for some risks and obligations. In these circumstances, we have determined that it is more cost effective to self-insure thesecertain risks than to pay the increased premium costs in place since the disruption in the insurance market after the events of September 11, 2001. The risks and exposures that we self-insure include, but are not limited to, certain property, product defects, political risks, and patent infringement. Should there be a loss or adverse judgment or other decision in an area for which we are self-insured, then our financial condition, result of operations and liquidity may be adversely affected.
We are subject to stringent environmental regulations, which may force us to incur significant expenses.
We must comply with many different federal, state, local and foreign governmental regulations related to the use, storage, discharge and disposal of toxic, volatile or otherwise hazardous chemicals used in our products and manufacturing process. Although we believe that our activities conform to presently applicable environmental regulations, our failure to comply with present or future regulations could result in the imposition of fines, suspension of production or a cessation of operations. Any such environmental regulations could require us to acquire costly equipment or to incur other significant expenses to comply with such regulations. OurAny failure by us to control the use of or adequately restrict the discharge of hazardous substances could subject us to future liabilities. Environmental problems may occur that could subject us to future costs or liabilities.
Over the past few years, there has been an expansion in environmental laws focusing on reducing or eliminating hazardous substances in electronic products. For example, the EU RoHS Directive provided that beginning July 1, 2006, electronic products sold into Europe were required to meet stringent chemical restrictions, including the absence of lead. China is adopting similar requirements. The first phase of the China legislation requires labeling and chemical content disclosure for all electronic products sold into or within China after February 28, 2007. While at this time our semiconductor products do not directly fall under the China legislation, we have complied with it in order to support our customers' compliance efforts. As the law is further implemented, we may need to take additional compliance activities. These laws impact our products and may make it more expensive to manufacture and sell our products. It may be difficult to timely comply with these laws and we may not have sufficient quantities of compliant materials to meet customers’ needs, thereby adversely impacting our sales and profitability.
Compliance with future changesRegulatory authorities in jurisdictions into which we ship our products could levy fines or restrict our ability to securities laws and related regulations could result in increased costs to us.export products.
Changes in the laws and regulations affecting public companies, including the provisionsA significant portion of our sales are made outside of the Sarbanes-Oxley ActUnited States through exporting and re-exporting of 2002products. In addition to local jurisdictions’ export regulations, our U.S. manufactured products or products based on U.S. technology are subject to Export Administration Regulations (“EAR”) when exported and rules enactedre-exported to and proposed by the Securities and Exchange Commission (SEC), The NASDAQ Stock Market® (NASDAQ) and the New York Stock Exchange (NYSE), resulted in significantly increased costs to us in fiscal 2005 as we responded to their requirements. In particular, complying with the internal control audit requirements of Sarbanes-Oxley Section 404 in fiscal 2005 resulted in increased internal efforts and significantly higher fees from our independent accounting firm. In fiscal 2006, our costs associated with these activities were at approximately the same levels as in fiscal 2005. We expect our fiscal 2007 costs associated with these activities to be at approximately the same levels as in fiscal 2006. Further changes in applicable legalall international jurisdictions. Licenses or accounting requirements could result in additional costs in future periods.
Our fiscal 2006 report on Form 10-K contained a report by our management on our internal control over financial reporting including an assessment of the effectiveness of our internal control over financial reporting as of March 31, 2006. Our fiscal 2006 Form 10-K also contained an attestation and report by our auditors with respect to our management’s assessment of the effectiveness of internal control over financial reporting under Section 404. While these assessments and reports did not reveal any material weaknesses in our internal control over financial reporting, compliance with Section 404 is an ongoing process and willproper license exceptions may be required for each future fiscal year. We expect that the ongoing complianceshipment of our products to certain countries. Non-compliance with Section 404 will continue to be both very costly and very challenging and therethe EAR or other export regulations can be no assurance that material weaknesses with not be identified in future periods. Any adverse results from such ongoing compliance efforts could result in penalties including denial of export privileges, fines, criminal penalties, and seizure of products. Such penalties could have a loss of investor confidence in our financial reports and have anmaterial adverse effect on our stock price.
Recent regulations related to equity compensation may adversely affectbusiness including our ability to attractmeet our net sales and retain key personnel and have adversely affected our earnings.earnings targets.
From our inception through fiscal 2006, we have used stock options and other long-term equity incentives as a fundamental component of our employee compensation packages and have accounted for them using the intrinsic value method of APB No. 25, “Accounting for Stock Issued to Employees.” We believe that stock options and other long-term equity incentives directly motivate our employees to maximize long-term stockholder value and, through the use of vesting, encourage employees to remain with Microchip. In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payments,” (“SFAS 123R”) which changed U.S. Generally Accepted Accounting Principles in such a way to require us to record a charge to earnings for the fair value of employee stock option grants and other share based compensation beginning in the first quarter of fiscal 2007. This regulation has negatively impacted our earnings for those share based awards that vest in fiscal 2007 and later years. Furthermore, adoption of SFAS 123R required us to make certain assumptions and judgments in the valuation of stock options that we may grant in the future. A change in any of those assumptions or judgments could change the compensation expense that is charged against our earnings and, consequently, adversely affect our results of operations. If there are any modifications or cancellations of the underlying unvested securities, we may be required to accelerate, increase or cancel any remaining unearned share-based compensation expense. Future share-based compensation expense and unearned share-based compensation will increase to the extent that
we grant additional equity awards to employees or assume unvested equity awards in connection with acquisitions. See also Note 3 to the Condensed Consolidated Financial Statements - Share-Based Compensation.
In addition, recent NASDAQ regulations requiring shareholder approval for all stock option plans as well as recent NYSE regulations prohibiting NYSE member organizations from giving a proxy to vote on equity-compensation plans unless the beneficial owner of the shares has given voting instructions could make it more difficult for us to grant equity-based awards to employees in the future. To the extent that these or other new regulations make it more difficult or expensive to grant equity incentives to employees, we may incur compensation costs, productivity losses, change our equity compensation strategy or find it difficult to attract, retain and motivate employees, each of which could materially and adversely affect our business.
The future trading price of our common stock could be subject to wide fluctuations in response to a variety of factors.
The market price of our common stock has fluctuated significantly in the past and is likely to fluctuate in the future. The future trading price of our common stock could be subject to wide fluctuations in response to a variety of factors, many of which are beyond our control, including:including, but not limited to:
| · | quarterly variations in our operating results and the operating results of other technology companies |
| · | actual or anticipated announcements of technical innovations or new products by us or our competitors |
| · | changes in analysts’ estimates of our financial performance or buy/sell recommendations |
| · | changes in our financial guidance or our failure to meet such guidance |
| · | general conditions in the semiconductor industry, and |
| · | worldwide economic and financial conditions. |
In addition, the stock market has experienced significant price and volume fluctuations that have particularly affected the market prices for many high technology companies and that often have been unrelated to the operating performance of such companies. These broad market fluctuations and other factors may harm the market price of our common stock.
The outcome of currently ongoing and future auditsexaminations of our income tax returns by the IRS could have an adverse effect on our results of operations.
We are subject to continued examination of our income tax returns by the Internal Revenue Service and other domestic and international tax authorities. We are currently under audit by the United States Internal Revenue Service (“IRS”) for our fiscal years ended March 31, 1998, 1999, 2000 and 2001. As part of this ongoing audit, the IRS has proposed certain adjustments related to positions reflected on these returns. The IRS has issued formal assessments for these adjustments. We do not agree with these adjustments and are appealing these assessments. The IRS is also currently auditing our fiscal years ended March 31, 2002, 2003 and 2004. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. There can be no assurance that the outcomes from these continuing examinations will not have an adverse effect on our future operating results.
In the event we make acquisitions, we may not be able to successfully integrate such acquisitions or attain the anticipated benefits.
While acquisitions do not represent a major part of our growth strategy, from time to time we may consider financially attractive and strategic acquisitions.acquisitions if such opportunities arise. Any transactions that we complete may involve a number of risks, includingincluding: the diversion of our management’s attention from our existing business to integrate the operations and personnel of the acquired business, or possible adverse effects on our operating results during the integration process. In addition, we may not be able to successfully or profitably integrate, operate, maintain and
manage any newly acquired operations or employees oremployees. We may not be able to maintain uniform standards, controls, procedures and policies, and this may lead to operational inefficiencies.
3.1 | Amended and Restated Bylaws amended through January 29, 2007 (incorporated by reference to an exhibit filed with our Form 8-K filed January 31, 2007) |
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4.1 | First Amendment to Rights Agreement dated January 29, 2007 |
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10.1 | Change of Control Severance Agreement (incorporated by reference to an exhibit filed with our Form 8-K filed October 27, 2006) |
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10.2 | Change of Control Severance Agreement (incorporated by reference to an exhibit filed with our Form 8-K filed October 27, 2006) |
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10.3 | 2004 Equity Incentive Plan as amended and restated (incorporated by reference to an exhibit filed with our Form 8-K filed August 24, 2006) |
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10.4 | Executive Management Incentive Compensation Plan (incorporated by reference to an exhibit filed with our Form 8-K filed August 24, 2006) |
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10.5 | Discretionary Executive Management Incentive Compensation Plan (incorporated by reference to an exhibit filed with our Form 8-K filed August 24, 2006) |
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10.6 | Management Incentive Compensation Plan (incorporated by reference to an exhibit filed with our Form 8-K filed August 24, 2006) |
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31.1 | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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31.2 | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 20022002. |
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32 | Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
| MICROCHIP TECHNOLOGY INCORPORATED |
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Date: February 6,August 7, 2007 | By: /s/ Gordon W. Parnell �� |
| Gordon W. Parnell |
| Vice President and Chief Financial Officer |
| (Duly Authorized Officer, and |
| Principal Financial and Accounting Officer) |