The Company amortizes intangible assets over their expected useful lives, which range between 1 and 15 years. During the nine months ended December 31, 2017, $8.9 million of in-process research and development reached technological feasibility and was reclassified as core and developed technology and began being amortized over its estimated useful life. The following is an expected amortization schedule for the intangible assets for the remainder of fiscal 2018 through fiscal 2022, absent any future acquisitions or impairment charges (amounts in thousands):
In the ordinary course of the Company's business, it is exposed to various liabilities as a result of contracts, product liability, customer claims, governmental investigations and other matters. Additionally, the Company is involved in a limited number of legal actions, both as plaintiff and defendant. Consequently, the Company could incur uninsured liability in any of those actions. The Company also periodically receives notifications from various third parties alleging infringement of patents or other intellectual property rights, or from customers requesting reimbursement for various costs. With respect to pending legal actions to which the Company is a party and other claims, although the outcomes are generally not determinable, the Company believes that the ultimate resolution of these matters will not have a material adverse effect on its financial position, cash flows or results of operations. Litigation, governmental investigations and disputes relating to the semiconductor industry are not uncommon, and the Company is, from time to time, subject to such litigation, governmental investigations and disputes. As a result, no assurances can be given with respect to the extent or outcome of any such litigation, governmental investigations or disputes in the future.
As a result of its acquisition of Atmel, which closed April 4, 2016, the Company became involved with the following legal matters:
The Company accrues for claims and contingencies when losses become probable and reasonably estimable. As of the end of each applicable reporting period, the Company reviews each of its matters and, where it is probable that a liability has been or will be incurred, the Company accrues for all probable and reasonably estimable losses. Where the Company can reasonably estimate a range of losses it may incur regarding such a matter, the Company records an accrual for the amount within the range that constitutes its best estimate. If the Company can reasonably estimate a range but no amount within the range appears to be a better estimate than any other, the Company uses the amount that is the low end of such range. As of December 31, 2017,June 30, 2022, the Company's estimate of the aggregate potential liability that is possible but not probable is approximately $100$100.0 million in excess of amounts accrued.
The following table presents the changes in the components of accumulated other comprehensive (loss) income (AOCI),loss, net of tax, for the nine months ended December 31, 2017 (amounts in thousands)(AOCI) (in millions):
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
We begin our Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) with a summary of business and macroeconomic developments followed by a summary of our overall business strategy to give the reader an overview of the goals of our business and the overall direction of our business and products.business. This is followed by a discussion of the Critical Accounting Policies and Estimates that we believe are important to understanding the assumptions and judgments incorporated in our reported financial results. We then discuss our Results of Operations for the three and nine months ended December 31, 2017June 30, 2022 compared to the three and nine months ended December 31, 2016. We then provideJune 30, 2021, followed by an analysis of changes in our balance sheet and cash flows, and discuss our financial commitments in sectionsthe section titled "Liquidity and Capital Resources,Resources." "Contractual Obligations"
We employ proprietary design and manufacturing processes in developing our embedded control products. We believe our processes afford us both cost-effective designs in existing and derivative products and greater functionality in new product designs. While many of our competitors develop and optimize separate processes for their logic and memory product lines, we use a common process technology for both microcontroller and non-volatile memory products. This allows us to more fully leverage our process research and development costs and to deliver new products to market more rapidly. Our engineers utilize advanced computer-aided design (CAD) tools and software to perform circuit design, simulation and layout, and our in-house photomask and wafer fabrication facilities enable us to rapidly verify design techniques by processing test wafers quickly and efficiently.
We are committed to continuing our investment in new and enhanced products, including development systems, and in our design and manufacturing process technologies. We believe these investments are significant factors in maintaining our competitive position. Our current research and development activities focus on the design of new microcontrollers, digital signal controllers, memory, analog and mixed-signal products, FPGAs, timing systems, Flash-IP, systems, development systems, software and application-specific software libraries. We are also developing new design and process technologies to achieve further cost reductions and performance improvements in our products.
We market and sell our products worldwide primarily through a network of direct sales personnel and distributors. Our distributors focus primarily on servicing the product and technical support requirements of a broad base of diverse customers. We believe that our direct sales personnel combined with our distributors provide an effective means of reaching this broad and diverse customer base. Our direct sales force focuses primarily on majora wide variety of strategic accounts in three geographical markets: the Americas, Europe and Asia. We currently maintain sales and technical support centers in major metropolitan areas in North America, Europe and Asia.all three geographic markets. We believe that a strong technical service presence is essential to the continued development of the embedded control market. Many of our client engagement managers (CEMs), embedded system engineers (ESEs),CEMs, ESEs, and sales management personnelmanagers have technical degrees or backgrounds and have been previously employed in an engineering environment.high technology environments. We believe that the technical and business knowledge of our sales force is a key competitive advantage in the sale of our products. The primary mission of our ESE team is to provide technical assistance to strategic accountscustomers and to conduct periodic training sessions for CEMs and distributorthe balance of our sales teams.team. ESEs also frequently conduct technical seminars for our customersand workshops in major cities around the world or through online webcasts. Our licensing division has dedicated sales, technology, design, product, test and work closely withreliability personnel that support the requirements of our distributors to provide technical assistance and end-user support.licensees.
The following table sets forth certain operational data as a percentage of net sales for the periods indicated:covered by this report:
We operate in two industry segments and engage primarily in the design, development, manufacture and sale of semiconductor products as well as the licensing of our SuperFlash and other technologies. We sell our products to
We sell a large number of products to a large and diverse customer base and there was not any single product customer or marketcustomer that accounted for a material portion of the increase.
Historically, average selling prices in the semiconductor industry decrease over the life of any particular product. TheHowever, the overall average selling prices of our microcontroller products have increased in recent periods and have remained relatively constantstable 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 in the past been able to, and expect in the future to be able to, 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
Analog Interface, Mixed Signal and Timing Products
Sales of ourOur analog product line includes analog, interface, mixed signal and timing productsproducts. Our analog product line accounted for approximately 23.3% and 23.8%29.5% of our net sales forin the three and nine months ended December 31, 2017, respectively,June 30, 2022 compared to approximately 26.5% and 26.3%27.5% of our net sales for the three and nine months ended December 31, 2016, respectively.
Net sales of our analog, interface, mixed signal and timing products increased 4.7% and 7.8% in the three and nine months ended December 31, 2017, respectively,June 30, 2021.
Net sales from our analog product line increased 34.2% in the three months ended June 30, 2022 compared to the three and nine months ended December 31, 2016. These sales increases wereJune 30, 2021, primarily due primarily to growthstrength in demand for our business driven by favorable economicanalog products in end markets that we serve and semiconductor industry conditions and market share gains.our price increases.
Analog, interface, mixed signal and timing products can be proprietary or non-proprietary in nature. Currently, weWe consider a majority of the products in our analog interface, mixed signal and timing productsproduct line 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 interface, mixed signal and timing businessproduct line 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, interface, mixed signal and timing 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, interface, mixed signal and timing products will increase over time.
Memory ProductsOther
Sales of our memoryOur other product line includes FPGA products, accounted for approximately 4.8% and 5.0% of our net sales for the three and nine-month periods ended December 31, 2017, respectively, compared to approximately 5.5% of our net sales for each of the three and nine-month periods ended December 31, 2016, respectively.
Net sales of our memory products increased 4.2% and 8.0% in the three and nine months ended December 31, 2017, respectively, compared to the three and nine months ended December 31, 2016. These sales increases were due primarily to growth in our business driven by favorable economic and semiconductor industry conditions.
Memory 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 memory products. We may be unable to maintain the average selling prices of our memory products as a result of increased pricing pressure in the future, which could adversely affect our operating results.
Technology Licensing
Technology licensing revenue includes a combination of royalties associated with licenses for the use of our SuperFlash and other technologies, andsales of our intellectual property, fees for engineering services. Technology licensing accounted for approximately 2.8% and 2.6% of our net sales for the three and nine months ended December 31, 2017, respectively, compared to approximately 2.9% and 2.7% of our net sales for the three and nine months ended December 31, 2016, respectively.
Net sales related to our technology licensing increased 15.5% and 15.1% in the three and nine months ended December 31, 2017, respectively, compared to the three and nine months ended December 31, 2016. Revenue from technology licensing can fluctuate over time based on the production activities of our licensees as well as general economic and semiconductor industry conditions.
Multi-Market and Other
Multi-market and Other (MMO) consists ofservices, memory products, timing systems, manufacturing services (wafer foundry and assembly and test subcontracting), legacy application specific integrated circuits, complex programmable logic devices, and certain products for aerospace products.applications. Revenue from these services and products accounted for approximately 2.6% and 2.7%16.3% of our net sales for the three and nine months ended December 31, 2017, respectively, compared to approximately 3.2% and 2.9% of our net sales for the three and nine months ended December 31, 2016, respectively.
MMO net sales decreased 2.0% in the three months ended December 31, 2017June 30, 2022 compared to approximately 15.0% of our net sales in the three months ended June 30, 2021.
Net sales related to these services and products increased 36.5% in the three months ended June 30, 2022 compared to the three months ended December 31, 2016. MMOJune 30, 2021. The increase in net sales increased 7.9%was primarily due to strength in the nine months ended December 31, 2017 compared to the nine months ended December 31, 2016. MMO netdemand for our products in end markets that we serve and our price increases. Net sales of our other product line can fluctuate over time based on general economic and semiconductor industry conditions as well as changes in demand for our FPGA products, licenses, engineering services, memory products, and manufacturing services (wafer foundry and assembly and test subcontracting) as well as general economic and semiconductor industry conditions..
Distribution
Distributors accounted for approximately 53.7%47% of our net sales in the three months ended December 31, 2017June 30, 2022 and approximately 52.6%50% of our net sales in the three months ended December 31, 2016. DistributorsJune 30, 2021. The decrease in the distribution percentage of our total net sales is due to lower Preferred Supply Program participation among our distributors as priority of supply under the Preferred Supply Program is more prevalent with direct customers. With the exception of Arrow Electronics, our largest distributor, which made up 11% of our net sales, no other distributor or end customer accounted for approximately 54.2%more than 10% of our net sales in the ninethree months ended December 31, 2017 and approximately 54.9%June 30, 2022. In the three months ended June 30, 2021, no distributor or end customer accounted for more than 10% of our net sales in the nine months ended December 31, 2016.sales. Our distributors focus primarily on servicing the product requirements of a broad base of diverse customers. We believe that distributors provide an effective means of reaching this broad and diverse customer base. We believe that customers recognize Microchip for its products and brand name and use distributors as an effective supply channel.
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 advance notice.notice, with the exception of orders placed under our Preferred Supply Program or otherwise designated as non-cancellable. 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, 2017,June 30, 2022, our distributors maintained 3419 days ofinventory of our products compared to 3317 days of inventory at our distributors at March 31, 2017.2022. Over the past fiveten fiscal years, the days of inventory maintained by our distributors have fluctuated between 30approximately 17 days and 3740 days. We do not believe that inventory holding patterns at our distributors
will materially impact our net sales prior to the adoption of ASU 2014-09-Revenue from Contracts with Customers (Topic 606), as we do not recognize revenue until the inventory is sold by the distributors. Upon our adoption of ASC 606 commencing on April 1, 2018, we will be required to recognize revenue from distributors at the time our products are sold to the distributor. As a result, beginning April 1, 2018, inventoryInventory holding patterns at our distributors may have a material impact on our net sales. Our distributor inventory days are near historic lows due to the imbalance between the supply of and the demand for our products in the current supply-constrained environment.
Sales by Geography
Sales by geography for the three and nine months ended December 31, 2017 and 2016periods covered by this report were as follows (dollars in thousands)millions):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | Three Months Ended June 30, |
| | | | | | | | | | | | | | | | | | | | | 2022 | | % | | 2021 | | % |
| Americas | | | | | | | | | | | | | | | | | | | | | $ | 496.2 | | | 25.3 | | | $ | 373.1 | | | 23.8 | |
| Europe | | | | | | | | | | | | | | | | | | | | | 397.6 | | | 20.2 | | | 309.7 | | | 19.7 | |
| Asia | | | | | | | | | | | | | | | | | | | | | 1,069.8 | | | 54.5 | | | 886.6 | | | 56.5 | |
| Total net sales | | | | | | | | | | | | | | | | | | | | | $ | 1,963.6 | | | 100.0 | | | $ | 1,569.4 | | | 100.0 | |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | Nine Months Ended |
| | December 31, | | December 31, |
| | (unaudited) | | (unaudited) |
| | 2017 | | % | | 2016 | | % | | 2017 | | % | | 2016 | | % |
| Americas | $ | 172,637 |
| | 17.4 |
| | $ | 164,442 |
| | 19.7 |
| | $ | 536,996 |
| | 18.0 |
| | $ | 469,613 |
| | 18.7 |
|
| Europe | 228,148 |
| | 22.9 |
| | 199,652 |
| | 23.9 |
| | 697,345 |
| | 23.4 |
| | 581,739 |
| | 23.2 |
|
| Asia | 593,420 |
| | 59.7 |
| | 470,272 |
| | 56.4 |
| | 1,744,144 |
| | 58.6 |
| | 1,453,789 |
| | 58.1 |
|
| Total sales | $ | 994,205 |
| | 100.0 | % | | $ | 834,366 |
| | 100.0 | % | | $ | 2,978,485 |
| | 100.0 | % | | $ | 2,505,141 |
| | 100.0 | % |
Americas sales include sales to customers in the U.S., Canada, Central America and South America. Sales to foreign customers accounted for approximately 85% of our total net sales in each of the three and nine months ended December 31, 2017 compared to approximately 83% and 84%78% of our total net sales in the three and nine months ended December 31, 2016, respectively.June 30, 2022 compared to approximately 79% of our total net sales in the three months ended June 30, 2021. Substantially all of our foreign sales are U.S. dollar denominated. Sales to customers in Asia have generallythe Americas and Europe as a percentage of total net sales increased over timein the three months ended June 30, 2022 compared to June 30, 2021 primarily due to many of our customers transitioning their manufacturing operations to Asia and growthstrength in demand from the emerging Asian market.in our microcontroller and analog product lines. Our sales force in the Americas and Europe supports a significant portion of the design activity for products which are ultimately shipped to Asia.
Gross Profit
Our gross profit in the three months ended December 31, 2017June 30, 2022 was $607.1 million,$1.31 billion, or 61.1%66.7% of net sales, compared to $465.3 million,$1.01 billion, or 55.8%64.2% of net sales, in the three months ended December 31, 2016. Our gross profit in the nine months ended December 31, 2017 was $1,805.6 million, or 60.6% of net sales, compared to $1,224.4 million, or 48.9% of net sales, in the nine months ended December 31, 2016.
The most significant factors affecting our gross profit percentage in the periods covered by this Form 10-Q were:
charges of approximately $12.0 million and $186.7 millionJune 30, 2021. Gross margin increased in the three and nine months ended December 31, 2016, respectively, relatedJune 30, 2022 compared to the recognition of acquired inventory at fair valueJune 30, 2021 primarily as a result of our acquisitions which increased the valuehigher utilization of our acquired inventory and subsequentlyfactories due to increased our cost of sales and reduced our gross margins when the related revenue was recognized;customer demand.
inventory write-downs being higher than the gross margin impact of sales of inventory that was previously written down in the three and nine months ended December 31, 2016;
inventory write-downs being lower than the gross margin impact of sales of inventory that was previously written down in the three and nine months ended December 31, 2017; and
fluctuations in the product mix of microcontrollers, analog, interface, mixed signal and timing products, memory products and technology licensing.
Other factors that impacted our gross profit percentage in the periods covered by this Form 10-Q include:
continual cost reductions in wafer fabrication and assembly and test manufacturing, such as new manufacturing technologies and more efficient manufacturing techniques;
lower depreciation as a percentage of cost of sales;
increases in the level of assembly and test operations performed at our internal facilities compared to assembly and test operations performed by our third-party contractors, which lower our manufacturing costs as these functions are performed internally; and
favorable market conditions and product mix.
We adjust our wafer fabrication and assembly and test capacity utilization as required to respond to actual and anticipated business and industry-related conditions. When production levels are below normal capacity, we charge cost of sales for the unabsorbed capacity. During each of the three and nine months ended December 31, 2017 and 2016, our wafer fabrication facilities and assembly and test facilities operated at normal capacity levels, which we measure as a percentage of the capacity of the installed equipment.
The process technologies utilized in our wafer fabrication facilities impact our gross margins. Our wafer fabrication facility located in Tempe, Arizona (Fab 2) currently utilizes various manufacturing process technologies, but predominantly utilizes our 0.5 micron to 1.0 micron processes. Our wafer fabrication facility located in Gresham, Oregon (Fab 4) predominantly utilizes our 0.13 micron to 0.5 micron processes. We continue to transition products to more advanced process technologies to reduce future manufacturing costs. Substantially all of our production in Fab 2 and Fab 4 has been on 8-inch wafers during the periods covered by this report. We consider normal capacity at Fab 2 and Fab 4 to be 90% to 95%. Our wafer fabrication facility in Colorado Springs, Colorado (Fab 5) currently utilizes processes between 0.25 micron and 1.0 micron that run on 6-inch wafers. We consider normal capacity at Fab 5 to be 70% to 75%. During the nine months ended December 31, 2017, we completed the sale of the decommissioned San Jose wafer fabrication facility and assets from our Micrel acquisition for proceeds of $10.0 million.
Our overall inventory levels were $487.1$911.8 million at December 31, 2017,June 30, 2022, compared to $417.2$854.4 million at March 31, 2017.2022. We maintained 115127 days of inventory on our balance sheet at December 31, 2017June 30, 2022 compared to 103125 days of inventory at March 31, 2017.2022. We expect our days of inventory levellevels at September 30, 2022 to increase modestly in the March 2018 quarter. We believe our existing level of inventory will allow usbe 127 to maintain competitive lead times and provide strong delivery performance to our customers.132 days.
We anticipate that our gross margins will fluctuate over time, driven primarily by capacity utilization levels, the overall product mix of microcontroller, analog, interface, mixed signal and timing products, memory products and technology licensing revenue and the percentage of net sales of each of these products in a particular quarter, as well as manufacturing yields, fixed cost absorption, and competitive and economic conditions in the markets we serve.
We operate assembly and test facilities in Thailand, the Philippines, and as a result of our acquisition of Atmel, we acquired a test facility in Calamba, Philippines. Approximately 41% and 39%other locations throughout the world. During the three months ended June 30, 2022, approximately 58% of our assembly requirements were performed in our Thailandinternal assembly facilities, in the three and nine months ended December 31, 2017, respectively, compared to approximately 32% and 37%59% during the three and nine months ended December 31, 2016, respectively. Third-party contractors located primarily in Asia perform the balance of our assembly operations.June 30, 2021. During the three and nine months ended December 31, 2017,June 30, 2022, approximately 67% and 62%, respectively, of our test requirements were performed in our Thailand and Philippinesinternal test facilities, compared to approximately 58% and 61% of our test requirements performed in our Thailand and Philippines facilities63% during the three and nine months ended December 31, 2016, respectively.June 30, 2021. The percentage of our assembly and test workoperations that isare performed internally fluctuates over time based on supply and demand conditions in the semiconductor industry, our internal capacity capabilities and our acquisition activities. The increases in the percentage of assembly and test work that was performed internally in the three and nine months ended December 31, 2017 compared to the three and nine months ended December 31, 2016 are primarily due to our recent investments in assembly and test equipment, which have increased our internal capacity capabilities. We believe that the assembly and test operations performed at our internal facilities provide us with significant cost savings compared to third party contractor assembly and test costs, as well as increased control over these portions of the manufacturing process. We plan to continue to invest in assembly and test equipment to increase our internal capacity capabilities and transition certain outsourced assembly and test capacity to our internal facilities.
We rely on outside wafer foundries for a significant portion of our wafer fabrication requirements. Approximately 43% and 42%63% of our net sales came from products that were produced at outside wafer foundries in the three and nine months ended December 31, 2017, respectively, and approximately 42% and 41% of our net sales came from products that were produced at outside wafer foundriesJune 30, 2022, compared to 58% in the three and nine months ended December 31, 2016, respectively.June 30, 2021.
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, 2017June 30, 2022 were $131.6$269.0 million, or 13.2%13.7% of net sales, compared to $132.4$238.4 million, or 15.9%15.2% of net sales, for the three months ended December 31, 2016. R&D expenses for the nine months ended December 31, 2017 were $395.7 million, or 13.3% of net sales, compared to $418.1 million, or 16.7% of net sales, for
the nine months ended December 31, 2016.June 30, 2021. 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. R&D costs are expensed as incurred. Assets purchased to support our ongoing research and development activities are capitalized when related to products which have achieved technological feasibility or that have alternative future uses and are amortized over their expected useful lives. 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 decreased $0.9increased $30.6 million, or 0.7%12.8%, for the three months ended December 31, 2017 over the same period last year. R&D expenses decreased $22.5 million, or 5.4%, for the nine months ended December 31, 2017June 30, 2022 over the same period last year. The primary reasons for the decreasesincrease in R&D costsexpenses were reductionsincreases in personnelemployee compensation and associated costs in connection with synergies realized from our Atmel acquisition and lower share-based compensation expense due to accelerated vesting of equity awards held by terminated Atmel employees during the three and nine months ended December 31, 2016.higher product development costs.
R&D expenses fluctuate over time, primarily due to revenue and operating expense investment levels.
Selling, General and Administrative
Selling, general and administrative expenses for the three months ended December 31, 2017June 30, 2022 were $109.1$188.9 million, or 11.0%9.6% of net sales, compared to $111.0$174.3 million, or 13.3%11.1% of net sales, for the three months ended December 31, 2016. Selling,June 30, 2021. Our goal is to continue to be more efficient with our selling, general and administrative expenses for the nine months ended December 31, 2017 were $337.6 million, or 11.3% of net sales, compared to $388.7 million, or 15.5% of net sales, for the nine months ended December 31, 2016.expenses. 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 includeas well as costs related to our direct sales force, CEMs and ESEs who work inremotely from sales offices worldwide to stimulate demand by assisting customers in the selection and use of our products.
Selling, general and administrative expenses decreased $2.0increased $14.6 million, or 1.8%8.4%, for the three months ended December 31, 2017 over the same period last year. Selling, general and administrative expenses decreased $51.0 million, or 13.1%, for the nine months ended December 31, 2017June 30, 2022 over the same period last year. The primary reasons for the decreasesincrease in selling, general and administrative expenses were reductions in personnel and associated costs in connection with synergies realized from our Atmel acquisition and lower share-based compensation expensewas primarily due to accelerated vesting of equity awards held by terminated Atmel employees during the period ended June 30, 2016.increases in employee compensation.
Selling, general and administrative expenses fluctuate over time, primarily due to revenue and operating expense investment levels.
Amortization of Acquired Intangible Assets
Amortization of acquired intangible assets for the three and nine months ended December 31, 2017June 30, 2022 was $121.0$167.6 million, and $362.8 million, respectively, compared to $82.8 million and $243.4$215.6 million for the three and nine months ended December 31, 2016, respectively.June 30, 2021. The primary reason for the increasesdecrease was due to the use of accelerated amortization methods for assets placed in acquired intangible asset amortization was amortization of in-process R&D assets from our acquisition of Atmel, which assets started to amortize duringservice in previous fiscal years.
Special (Income) Charges and Other, Net
During the three months ended December 31, 2016.
Special ChargesJune 30, 2022, we incurred special income and Other, Net
During the three and nine months ended December 31, 2017, we incurredother, net of $16.9 million, compared to special charges and other, net of $0.2$10.5 million and $17.3 million, respectively. The special charges and other, net incurred infor the ninethree months ended December 31, 2017 is comprisedJune 30, 2021. The income was primarily related to the favorable resolution of a $19.5 million charge for fees associated with transitioning frompreviously accrued legal matter and the public utility provider in Oregoncharges incurred were primarily related to a lower cost direct access provider. During the threerestructuring of acquired and nine months ended December 31, 2016, we incurred special charges and other, net of $20.9 million and $52.5 million comprised primarily of employee separation costs and impairment charges.existing wafer fabrication operations to increase operational efficiency.
Other Income (Expense)
Interest income in the three and nine months ended December 31, 2017June 30, 2022 was $6.3$0.1 million and $14.4compared to $0.3 million respectively. Interest income in the three and nine months ended December 31, 2016 was $0.5 million and $1.8 million, respectively. The primary reason for the increases in interest income in the three and nine months ended December 31, 2017
compared to the same periods last year relates to higher cash and investment balances. During the quarter ended June 30, 2016, we used cash to finance a significant portion of the purchase price of our April 4, 2016 acquisition of Atmel.2021.
Interest expense in the three and nine months ended December 31, 2017June 30, 2022 was $49.7$50.3 million and $148.7compared to $72.3 million respectively. Interest expense infor the three and nine months ended December 31, 2016 was $35.1 million and $104.7 million, respectively.June 30, 2021. The primary reasonreasons for the increasesdecrease in interest expense in the three and nine months ended December 31, 2017June 30, 2022 compared to the same periodsperiod last year relates primarilywere due to the issuanceadoption of ASU 2020-06 on April 1, 2022, which eliminated the amortization of debt discount on our Convertible Debt, and the cumulative pay down of our 2017 senior and junior debt partially offset by lowerhigher interest expense on amounts borrowed under our credit facility. In February 2017, we paid off the remaining balancerates on our credit facility.outstanding variable rate debt.
During the three and nine months ended December 31, 2017,June 30, 2022, we settledrecognized losses of $6.2 million related to the remainingsettlement of approximately $31.0 million in principal of our 2007 junior debt resulting2017 Senior Convertible Debt and approximately $3.6 million in a loss on settlementprincipal of convertible debt of $2.1 million and $16.0 million, respectively.
Other loss, net inour 2017 Junior Convertible Debt. During the three months ended December 31, 2017 was $3.0June 30, 2021, we recognized losses of $0.3 million and other income, net inrelated to the nine months ended December 31, 2017 was $7.2 million. repayment of $1.00 billion aggregate principal amount outstanding on our 3.922% 2021 Notes.
Other income, net in the three months ended December 31, 2016June 30, 2022 was $0.1$1.7 million and other loss, net incompared to $0.5 million for the ninethree months ended December 31, 2016 was $0.7 million. The primary reason for these changes relates to foreign currency exchange rate fluctuations.June 30, 2021.
Provision for Income Taxes
TheOur provision or benefit for income taxes reflectsis attributable to U.S. federal, state, and foreign income taxes. A comparison of our tax on foreign earnings and federal and state tax on U.S. earnings. We had an effective tax rate of 227.7%rates for the three months ended December 31, 2017June 30, 2022 and a negative effective tax rate of 28.5% for the three months ended December 31, 2016. We had an effective tax rate of 80.2% for the nine months ended December 31, 2017 and a negative effective tax rate of 87.3% for the nine months ended December 31, 2016.
The geographic dispersion of our earnings and losses contributesJune 30, 2021 is not meaningful due to the period-to-period changes in our effectiveamount of pre-tax income, and income tax rate. In fiscal 2018, approximately 18%expense recorded during the prior period.
We are also subject to taxation in many other jurisdictions wherein which we have operations. The effective tax rates that we pay in these jurisdictions vary widely, but they are generally lower than our combined U.S. federal and state effective tax rate. Our domestic blended statutory tax rate forin each of the ninethree months ended December 31, 2017June 30, 2022 and June 30, 2021 was approximately 33% and our domestic statutory tax rate for fiscal 2017 was approximately 37%22%. Our non-U.S. blended statutory tax rates forin the ninethree months ended December 31, 2017June 30, 2022 and fiscal 2017June 30, 2021 were much lower than this amount. The difference in rates applicable in foreign jurisdictions results from a number of factors, including lower statutory rates, historical loss carry-forwards,tax holidays, financing arrangements and other factors. Our effective tax rate has been and will continue to be impacted by the geographical dispersion of our earnings and losses. To the extent that domestic earnings increase while the foreign earnings remain flat or decrease, or increase at a lower rate, our effective tax rate will increase.
Our foreign tax rate differential benefit primarily relates to our operations and assets in Thailand, CaymanMalta, and Ireland. Our Thailand manufacturing operations are currently subject to numerous tax holidays granted to us based on our investment in property, plant, and equipment in Thailand. Our tax holiday periods in Thailand expire at various times in the future,future; however, we actively seek to obtain new tax holidays, orotherwise we will be subject to tax at the statutory tax rate of 20%. 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. The remaining material components of foreign income taxed at a rate lower than the U.S. are earnings accrued in Ireland at a 12.5% statutory tax rate and earnings accrued by Microchip’s offshore technology company which is residentin Malta at a 5.0% tax rate.
In September 2021, we received a Statutory Notice of Deficiency (Notice) from the Internal Revenue Service (IRS) for fiscal 2007 through fiscal 2012. The disputed amounts largely relate to transfer pricing matters. We firmly believe that the assessments are without merit and plan to pursue all available administrative and judicial remedies necessary to resolve this matter. In December 2021, we filed a petition in the Cayman Islands atUnited States Tax Court challenging the Notice. We intend to vigorously defend our position and we are confident in our ability to prevail on the merits. We regularly assess the likelihood of adverse outcomes resulting from examinations such as this to determine the adequacy of our tax reserves. We believe that the final adjudication of this matter will not have a 0% statutorymaterial impact on our consolidated financial position, results of operations or cash flows and that we have adequate tax rate.reserves for all tax matters. However, the ultimate outcome of disputes of this nature is uncertain, and if the IRS were to prevail on all of its assertions, the assessed tax, penalties, and deficiency interest could have a material adverse impact on our financial position, results of operations or cash flows.
Various taxing authorities in the U.S. and other countries in which we do business are increasing their scrutiny of the tax structures employed by businesses. Companies of our size and complexity are regularly audited by the taxing authorities in the jurisdictions in which they conduct significant operations. For U.S. federal, and in general for U.S. state tax returns, our fiscal 20052007 and later tax returns remain effectively open for examination by the taxing authorities. We are currently being audited by the tax authorities in the U.S. and in various foreign jurisdictions. At this time, we do not know what the outcome of these audits will be. We recognize liabilitiesrecord benefits for anticipateduncertain tax audit issues in the U.S. and other tax jurisdictionspositions based on our estimatean assessment of whether andit is more likely than not that the extent to which, additional tax payments are probable. We believepositions will be sustained based on their technical merits under currently enacted law. If this threshold is not met, no tax benefit of the uncertain tax position is recognized. If the threshold is met, we recognize the largest amount of the tax benefit that we maintain adequate tax reserves to offset any potential tax liabilities that may arise upon these and other pending audits in the U.S. and other countries in which we do business. If such amounts ultimately proveis more than 50% likely to be unnecessary, the resulting reversal of such reserves would result in tax benefits being recorded in the period the reserves are no longer deemed necessary. If such amounts ultimately prove to be less than any final assessment, a future charge to expense would be recorded in the period in which the assessment is determined.realized upon ultimate settlement.
Results of Discontinued Operations
Discontinued operations represent the mobile touch operations that we acquired as part of our acquisition of Atmel. On November 10, 2016, we completed the sale of the mobile touch assets to Solomon Systech (Limited) International, a Hong Kong based semiconductor company. The transaction included the sale of certain semiconductor products, equipment, customer list, backlog, patents, and a license to certain other intellectual property and patents related to Atmel's mobile touch product line. We also agreed to provide certain transition services to Solomon Systech. For financial statement purposes, the results of operations for this discontinued business have been segregated from those of the continuing operations and are presented in our condensed consolidated financial statements as discontinued operations. Net loss from discontinued operations for the three and nine months ended December 31, 2016 was $0.2 million and $6.0 million, respectively.
Liquidity and Capital Resources
We had $1,985.0$379.1 million in cash, cash equivalents and short-term and long-term investments at December 31, 2017,June 30, 2022, an increase of $574.8$59.7 million from the March 31, 20172022 balance.
Operating Activities
Net cash provided by operating activities was $1,060.1$840.4 million in the ninethree months ended December 31, 2017, compared to $736.9 million in the nine months ended December 31, 2016. The increase in net cash provided from operating activities wasJune 30, 2022, primarily due to higher net income of $507.2 million, adjusted for non-cash and non-operating charges of $385.4 million and net cash outflows of $52.2 million from changes in our operating assets and liabilities. The primary drivers of the changes in operating assets and liabilities in the three months ended June 30, 2022 include an increase in trade accounts receivable driven primarily by higher net sales as well as operating cash flows resulting from synergies realized from our process efficiency and restructuring effortsan increase in inventories related to increased production levels and higher costs of materials and production costs in support of customer demand for our acquisition of Atmel.
Duringproducts, offset by increases in accrued and other liabilities driven by higher sales related reserves. Net cash provided by operating activities was $629.9 million in the ninethree months ended December 31, 2017,June 30, 2021, primarily due to net income of $252.8 million, adjusted for non-cash and non-operating charges of $366.2 million and net cash inflows of $10.9 million from changes in our operating assets and liabilities.
Investing Activities
Net cash used in investing activities was $961.6 million compared to $2,350.5$153.8 million in the ninethree months ended December 31, 2016. Net cash used in investing activitiesJune 30, 2022 compared to $112.7 million in the ninethree months ended December 31, 2017 was primarily to purchase available-for-sale investments. InJune 30, 2021. During the ninethree months ended December 31, 2016, investing cash flows included net cashJune 30, 2022 and cash equivalents used to finance our acquisition of Atmel of $2,747.5 million. Excluding investing cash flows used for acquisitions in the nine months ended December 31, 2016,June 30, 2021, net investing activities resulted in a source of cash of $397.0 million primarily fromrelated to capital purchases and sales and maturities of available-for-sale securities.investments in other assets.
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, 2017June 30, 2022 were $148.4$121.9 million compared to $52.3$86.3 million in the ninethree months ended December 31, 2016.June 30, 2021. Capital expenditures were primarily for the expansion of production capacity and the addition of research and development equipment. Towards the second half of fiscal 2021, we started to invest more significantly to expand our manufacturing capacity in response to supply constraints relative to current demand levels and we expect this to continue through calendar 2022. We currently expect to invest between $500 million and $550 million in equipment and new office buildings. Capital expenditures in fiscal 2017 were relatively less than we have experienced in recent years as we delayed certain purchases until we had finalized and developed plans following our acquisition of Atmel regarding technology platforms and other manufacturing activities. We currently intend to spend approximately $190.0 millionfacilities during the next twelve months to invest in equipment and facilities.months. We believe that the capital expenditures anticipated to be incurred over the next twelve months will provide sufficient manufacturing capacity to support the growth of our production capabilities for our new products and technologies and to bring in-house more of the assembly and test operationsour production requirements that are currently outsourced. We expect to finance our capital expenditures through our existing cash balances and cash flows from operations.
Financing Activities
Net cash used in financing activities was $335.1$626.9 million in the ninethree months ended December 31, 2017June 30, 2022 compared to net cash provided of $185.8$519.5 million in the ninethree months ended December 31, 2016. TheJune 30, 2021. Significant transactions affecting our net financing cash provided by financing activities was lower flows included:
•in the ninefirst three months ended December 31, 2017 compared to the nine months ended December 31, 2016 because of net proceedsfiscal 2023, $272.5 million of $438.5 million from borrowings under our credit facility to fund operations, finance acquisitions and pay dividends in the nine months ended December 31, 2016. In addition, financing activities in the nine months ended December 31, 2017 includes $73.4 million in cash used to settle conversionspay down certain principal of our 2007debt, including our 2017 Senior Convertible Debt, our 2017 Junior Debt.Convertible Debt, and our Revolving Credit Facility, and
In June 2017, •in connection with the settlementfirst three months of $111.3fiscal 2022, $391.0 million of our 2007 Junior Debt, we amended our credit agreementcash used to (i) extend the time period during which we are permitted to repurchase, redeem or exchange our 2007 Junior Debt and (ii) amend the maximum total leverage ratio covenant to extend the time period for permitted refinancings or exchanges of the 2007 Junior Debt that may be excluded from the calculation of the ratio, subject topay down certain conditions.
In February 2017, we amended our credit agreement to, among other things, increase certain covenant compliance ratios. The February 2017 amendment included a new collateral agreement that secures our borrowings with all assetsprincipal of our guarantor subsidiaries with the exception of real property. Proceeds of loans made under the credit agreement may be used for working capital and general corporate purposes. At December 31, 2017 and March 31, 2017, we had no borrowings outstanding underdebt, including our credit facility, which had a capacity as of December 31, 2017 of $3,122.3 million. See Note 13 of the notes to consolidated financial statements for more information regarding our credit agreement.
Our total cash, cash equivalents, short-term investments and long-term investments held by our foreign subsidiaries was $1,429.5 million at December 31, 2017 and $909.2 million at March 31, 2017. Under tax laws and regulations as of December 31, 2017, if accumulated earnings and profits held by our foreign subsidiaries that U.S. taxes had not previously been provided for were to be distributed to the U.S., in the form of dividends or otherwise, we would be subject to additional U.S. income taxes and foreign withholding taxes. However, under the Act, our earnings and profits (E&P) accumulated after December 31, 2017 held by our foreign subsidiaries are now currently taxed in the U.S., and as such, distributions of E&P to the U.S. no longer generate additional negative U.S. income tax consequences. Foreign withholding may still apply on distributions. Our balance of cash, cash equivalents, short-term investments and long-term investments available for our U.S. operations as of December 31, 2017 and March 31, 2017 was approximately $555.4 million and $501.0 million, respectively. Our U.S. operations and capital requirements are funded primarily by cash generated from U.S. operating activities, which has been and is expected to be sufficient to meet our business needs in the U.S. for the foreseeable future. We utilize a variety of tax planning and financing strategies (including borrowings under our credit agreement) with the objective of having our worldwide cash available in the locations in which it is needed. Should our U.S. cash needs exceed funds generated by our U.S. operations for any reason, including acquisitions of large capital assets or acquisitions of U.S. businesses, we may require additional funds in the U.S. and would expect to borrow such additional funds under our existing credit facility, pursue other U.S. borrowing alternatives, issue equity securities or utilize a combination of these sources. We consider our offshore earnings to be permanently reinvested offshore. The Act may provide opportunities for us to repatriate amounts at a tax rate that would be advantageous to us. However, our management is still evaluating the effects of the ActRevolving Credit Facility and our tax structure and, as such, we have not changed our position on permanent reinvestment of such amounts at this time. We could determine to repatriate some of our offshore earnings in future periods to fund stockholder dividends, share repurchases, acquisitions or other corporate activities. We expect that a significant portion of our future cash generation will be in our foreign subsidiaries.
During the December 2017 quarter, we recognized a one-time transition tax on accumulated unrepatriated foreign earnings, estimated at $627.7 million, as a result of the recent U.S. tax reform. This value is identified as provisional in our condensed consolidated financial statements for the period ended December 31, 2017, and is subject to future measurement period adjustments in accordance with SAB 118. We intend to elect to pay this tax over a period of eight years, with 8% of the transition tax paid each year for fiscal 2018 through fiscal 2022, and 15%, 20%, and 25%, respectively, to be paid during fiscal 2023, 2024, and 2025.
We enter into derivative transactions from time to time in an attempt to reduce our exposure to currency rate fluctuations. Although none of the countries in which we conduct significant foreign operations has 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. At December 31, 2017, we had no foreign currency forward contracts outstanding.
On April 4, 2016, we completed our acquisition of Atmel. Under the terms of the merger agreement executed on January 19, 2016, Atmel stockholders received $8.15 per share consisting of $7.00 per share in cash and $1.15 per share in shares of Microchip common stock. We financed the purchase price of our Atmel acquisition using approximately $2.04 billion of cash held3.922% 2021 Notes, partially funded by certain of our foreign subsidiaries, approximately $941.6 million from additional borrowings under our existing credit agreement and approximately $486.1 million through the issuance of an aggregateour senior notes, and
•in the first three months of 10.1fiscal 2023 and fiscal 2022, we paid cash dividends to our stockholders of $153.0 million sharesand $113.1 million, respectively, and
•in the first three months of our common stock. The acquisition price represents a total equity value of approximately $3.47 billion, and a total enterprise value of approximately $3.43 billion, after excluding Atmel's cash and investments net of debt on its balance sheet of approximately $39.3 million. The acquisition was structured in a manner that enabled us to utilize a substantial portion of the cash, cash equivalents, short-term investments and long-term investments held by certain of our foreign subsidiaries in a tax efficient manner. Althoughfiscal 2023, we believe our determinations with respect to the tax consequences of the acquisition are reasonable, we are regularly audited by the IRS and may be audited by other taxing authorities, and there can be no assurance as to the outcome of any such audit.
Our Board of Directors previously approved a share repurchase program under which up to 15.0 millionrepurchased shares of our common stock may be repurchasedfor $195.2 million.
In December 2021, we amended and restated our Credit Agreement in its entirety. The amended and restated Credit Agreement provides for an unsecured revolving loan facility up to $2.75 billion that terminates on December 16, 2026. The Credit Agreement also permits us, subject to certain conditions, to add one or more incremental term loan facilities or increase the revolving loan commitments up to $750.0 million. As of June 30, 2022, the principal amount of our outstanding indebtedness was $7.60 billion. At June 30, 2022, we had $1.20 billion of outstanding borrowings under the Revolving Credit Facility compared to $1.40 billion at March 31, 2022.
Capital Returns
In November 2021, our Board of Directors authorized the repurchase of up to $4.00 billion of our common stock in the open market or in privately negotiated transactions. There were no repurchasesIn the first three months of fiscal 2023, we repurchased approximately
2.9 million shares of our common stock duringfor $195.2 million under this authorization. We did not repurchase any shares of our common stock in the ninefirst three months ended December 31, 2017. There is no expiration date associated with this repurchaseof fiscal 2022. As of June 30, 2022, approximately $3.38 billion remained available for repurchases under the program. As of December 31, 2017,June 30, 2022, we held approximately 18.925.3 million shares as treasury shares. Our current intent is to regularly repurchase shares of our common stock over time based on our cash generation, leverage metrics, and market conditions.
OnIn October 28, 2002, we announced that our Board of Directors had approved and instituted a quarterly cash dividend on our common stock. To date, our cumulative dividend payments have totaled approximately $5.20 billion. A quarterly cash dividend of $0.3625$0.276 per share was paid on December 5, 2017June 3, 2022 in the aggregate amount of $84.9$153.0 million. A quarterly dividend of $0.3630$0.301 per share was declared on February 6, 2018August 2, 2022 and will be paid on March 6, 2018September 2, 2022 to stockholders of record as of February 21, 2018.August 19, 2022. We expect the aggregate cash dividend for March 2018the September 2022 quarter to be approximately $85.2$166.5 million. Our Board is free to change our dividend practices at any time and to increase or decrease the dividend paid, or not to pay a dividend on our common stock on the basis of our results of operations, financial condition, cash requirements and
future prospects, and other factors deemed relevant by our Board. Our current intent is to provide for ongoingincrease our quarterly cash dividends depending upon market conditions, our results of operations, and potential changes in tax laws.
We believe that our existing sources of liquidity combined with cash generated from operations and borrowings under our credit agreementRevolving Credit Facility will be sufficient to meet our currently anticipated cash requirements for at least the next 12 months. However,Our long-term liquidity requirements primarily arise from working capital requirements, interest and principal repayments related to our outstanding indebtedness, capital expenditures, cash dividends, share repurchases, and income tax payments. For additional information regarding our cash requirements see "Note 11. Commitments and Contingencies", "Note 7. Debt" and "Note 12. Income Taxes" of the notes to our condensed consolidated financial statements. The semiconductor industry is capital intensive. Inintensive and 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.development and to expand our existing facilities or potentially construct new facilities. We may increase our borrowings under our credit agreementRevolving Credit Facility or seek additional equity or debt financing from time to time to maintain or expand our wafer fabrication and product assembly and test facilities, for cash dividends, for share repurchases or for acquisitions or other purposes. The timing and amount of any such financing requirements will depend on a number of factors, including our level of dividend payments, changes in tax laws and regulations regarding the repatriation of offshore cash, (including the impact of the Act), demand for our products, changes in industry conditions, product mix, competitive factors and our ability to identify suitable acquisition candidates. We may from time to time seek to refinance certain of our outstanding notes or Convertible Debt through issuances of new notes or convertible debt, tender offers, exchange transactions or open market repurchases. Such issuances, tender offers or exchanges or purchases, if any, will depend on prevailing market conditions, our ability to negotiate acceptable terms, our liquidity position and other factors. There can be no assurance that suchany financing will be available on acceptable terms due to uncertainties resulting from rising interest rates, higher inflation, economic uncertainty, the COVID-19 pandemic, or other factors, 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, 2017.
During the December 2017 quarter, we recognized a one-time transition tax on accumulated unrepatriated foreign earnings, estimated at $627.7 million, as a result of the recent U.S. tax reform of which we expect to result in future cash payments of approximately $300.0 million. This one-time transition tax is identified as provisional in our condensed consolidated financial statements for the period ended December 31, 2017, and is subject to future measurement period adjustments in accordance with SAB 118. We intend to elect to pay this tax over a period of eight years, with 8% of the transition tax paid each year for fiscal 2018 through fiscal 2022, and 15%, 20%, and 25%, respectively, to be paid during fiscal 2023, 2024, and 2025.
Off-Balance Sheet Arrangements (Including Guarantees)
As of December 31, 2017, we are not involved in any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K. In the ordinary course of business, we may provide standby letters of credit or other guarantee instruments to certain parties as required for certain transactions initiated by us or our subsidiaries. We have not recorded any liability in connection with these guarantee arrangements. Based on historical experience and information currently available, we believe we will not be required to make any payments under these guarantee arrangements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our investments are intendedAs of June 30, 2022, our long-term debt totaled $7.60 billion. We have no interest rate exposure to establish a high-quality portfolio that preserves principal, meets liquidity needs, avoids inappropriate concentrations, and delivers an appropriate yield in relationship torate changes on our investment guidelines and market conditions. Our investment portfolio, consisting of fixed income securities, money market funds, cash deposits, and marketable securities that we hold on an available-for-sale basis, was $1,985.0 millionrate debt, which totaled $6.40 billion as of December 31, 2017 comparedJune 30, 2022. We have interest rate exposure with respect to $1,410.2 millionthe $1.20 billion of our variable interest rate debt outstanding under our Revolving Credit Facility as of March 31, 2017. TheJune 30, 2022. A 50-basis point increase is due to cash generated from operations. Our available-for-sale debt securities, like all fixed income instruments, are subject to interest rate risk and will decline in value if market interest rates increase. We havewould impact our expected annual interest expense for 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. The amounts for fiscal 2018 refer to the remaining threenext 12 months of the current fiscal year (dollars in thousands):by approximately $6.0 million.
|
| | | | | | | | | | | | | | | | | | | | | | | |
| | Financial instruments maturing during the fiscal year ended March 31, |
| | 2018 | | 2019 | | 2020 | | 2021 | | 2022 | | Thereafter |
| Available-for-sale securities | $ | 258,290 |
| | $ | 166,759 |
| | $ | 170,339 |
| | $ | 715,053 |
| | $ | — |
| | $ | — |
|
| Weighted-average yield rate | 1.21 | % | | 1.52 | % | | 1.76 | % | | 1.84 | % | | — | % | | — | % |
Item 4. Controls and Procedures
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)Act). Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures arewere 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, 2017,June 30, 2022, 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.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Refer to Note 1511 to our condensed consolidated financial statements for information regarding legal proceedings.
Item 1A. Risk Factors
When evaluating Microchip and its business, you should give careful consideration to the factors listed below, in addition toas well as the information provided elsewhere in this Form 10-Q and in other documents thatfilings we filemake with the SecuritiesSEC.
Risk Factor Summary
Risks Related to Our Business, Operations, and Exchange Commission.Industry
•impact of global economic conditions on our operating results, net sales and profitability;
•impact of economic conditions on the financial viability of our licensees, customers, distributors, or suppliers;
•impact of the COVID-19 pandemic, increased tariffs or other factors affecting our suppliers;
•dependency on wafer foundries and other contractors by our licensees and ourselves;
•dependence on foreign sales, suppliers, and operations, which exposes us to foreign political and economic risks;
•limited visibility to product shipments;
•intense competition in the markets we serve, leading to pricing pressures, reduced sales or market share;
•ineffective utilization of our manufacturing capacity or failure to maintain manufacturing yields;
•impact of seasonality and wide fluctuations of supply and demand in the industry;
•dependency on distributors;
•ability to introduce new products on a timely basis;
•business interruptions, including natural disasters, affecting our operations or that of key vendors, licensees or customers;
•technology licensing business exposes us to various risks;
•reliance on sales into governmental projects, and compliance with associated regulations;
•risks related to grants from governments, agencies and research organizations;
•future acquisitions or divestitures;
•future impairments to goodwill or intangible assets;
•our failure to maintain proper and effective internal control and remediate future control deficiencies;
•customer demands to implement business practices that are more stringent than legal requirements;
•ability to attract and retain qualified personnel; and
•the occurrence of events for which we are self-insured, or which exceed our insurance limits.
Risks Related to Cybersecurity, Privacy, Intellectual Property, and Litigation
•attacks on our IT systems, interruptions in our IT systems, or improper handling of data;
•risks related to compliance with privacy and data protection laws and regulations;
•risks related to legal proceedings, investigations or claims;
•risks related to contractual relationships with our customers; and
•protecting and enforcing our intellectual property rights.
Risks Related to Taxation, Laws and Regulations
•impact of new accounting pronouncements or changes in existing accounting standards and practices;
•fines, restrictions or delay in our ability to export or import products, or increase costs associated with the manufacture or transfer of products;
•outcome of future examinations of our income tax returns;
•exposure to greater than anticipated income tax liabilities, changes in or the interpretation of tax rules and regulations including the TCJA, the American Rescue Plan Act of 2021 (ARPA), or unfavorable assessments from tax audits;
•impact of the legislative and policy changes implemented globally by the current or future administrations;
•impact of stringent environmental, climate change, conflict-free minerals and other regulations or customer demands; and
•requirement to fund our foreign pension plans.
Risks Related to Capitalization and Financial Markets
•impact of various factors on our future trading price of our common stock;
•fluctuations in the amount and timing of our common stock repurchases;
•our ability to effectively manage current or future debt;
•our ability to generate sufficient cash flows or obtain access to external financing;
•impact of conversion of our convertible debt on the ownership interest of our existing stockholders; and
•fluctuations in foreign currency exchange rates.
Risks Related to Our Business, Operations, and Industry
Our operating results are impacted by global economic conditions and may fluctuate in the future due to a number of factors that could reduce our net sales and profitability.
Our 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 operating results include:
•general economic, industry, public health or political conditions in the U.S. or internationally;internationally, including uncertain economic conditions in China, increases in interest rates, inflation or the ongoing uncertainty surrounding the COVID-19 pandemic and its implications;
•disruptions in our business, our supply chain or our customers' businesses due to public health concerns (including viral outbreaks such as COVID-19), cybersecurity incidents, terrorist activity, armed conflict, war (including Russia's invasion of Ukraine), worldwide oil prices and supply, fires, natural disasters or disruptions in the transportation system;
•availability of raw materials including rare earth minerals, supplies and equipment due to supply chain constraints or other factors;
•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;
•our ability to continue to increase our factory capacity to respond to changes in customer demand;
•our ability to secure sufficient wafer foundry, assembly and testing capacity;
•increased costs and availability of raw materials, supplies, equipment, utilities, labor, and/or subcontracted services for wafers, assembly and test;
•changes in demand or market acceptance of our products and products of our customers, and market fluctuations in the industries into which such products are sold;
our ability•the level of order cancellations or push-outs due to ramp our factory capacity to meet customer demand;
our ability to secure sufficient wafer foundry, assembly and testing capacity;
changes or fluctuations in customer order patterns and seasonality;
changes in tax regulations and policies in the U.S. and other countries in which we do business including the impact of the Tax CutsCOVID-19 pandemic or other factors;
•trade restrictions and Jobs Act of 2017;increase in tariffs, including those on business in China, or focused on specific companies;
new accounting pronouncements or changes in existing accounting standards and practices, including with respect to revenue recognition;
changes in utilization of our manufacturing capacity and fluctuations in manufacturing yields;
•the mix of inventory we hold and our ability to satisfy orders from our inventory;
our ability to continue to realize the expected benefits•changes in utilization of our acquisitions including our acquisition of Atmel;manufacturing capacity and fluctuations in manufacturing yields;
•changes or fluctuations in customer order patterns and seasonality;
•changes in tax regulations in countries in which we do business;
•new accounting pronouncements or changes in existing accounting standards and practices;
•levels of inventories held by our customers;
•risk of excess and obsolete inventories;
•competitive developments including pricing pressures;
•unauthorized copying of our products resulting in pricing pressure and loss of sales;
availability of raw materials and equipment;
•our ability to successfully transition products to more advanced process technologies to reduce manufacturing costs;
•the level of orders that are received and can be shipped in a quarter;quarter, including the impact of product lead times;
•the level of sell-through of our products through distribution;
•our ability to continue to realize the expected benefits of our past or future acquisitions;
•fluctuations in our mix of product sales;
•announcements of other significant acquisitions by us or our competitors;
disruptions in our business or our customers' businesses due to terrorist activity, armed conflict, war, worldwide oil prices and supply, public health concerns, natural disasters or disruptions in the transportation system;
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, investigation or claims involving intellectual property, our Microsemi acquisition, customers or other issues; and
fluctuations in commodity or energy prices; and
•property damage or other losses, whether or not covered by insurance.
We believe that period-to-periodPeriod-to-period comparisons of our operating results are not necessarily meaningful and that you should not rely upon any such comparisons as indications of our 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. Uncertain global economic and public health conditions, such as the ongoing economic recovery and uncertainty surrounding the strength and duration of such recoveryCOVID-19 pandemic, have caused and may in the future cause our operating results to fluctuate significantly and make comparabilitycomparisons between periods less meaningful.
Our operating results may be adversely impacted if economic conditions impact the financial viability of our licensees, customers, distributors, or suppliers.
We regularly review the financial performance of our licensees, customers, distributors and suppliers. Any downturn in global or regional economic conditions, as a result of the COVID-19 pandemic, the enactment of broad sanctions by the U.S. or other countries against Russia, or risks of rising interest rates or inflation, may adversely impact their financial viability. The financial failure of a large licensee, customer or distributor, an important supplier, or a group thereof, could have an adverse impact on our operating results and could result in our inability to collect our accounts receivable balances, higher allowances for credit losses, and higher operating costs as a percentage of net sales.
We may lose sales if suppliers of raw materials, components or equipment fail to meet our or our customers' needs, increase prices or are impacted by increases in tariffs.
Our manufacturing operations require raw and processed materials and equipment that must meet exacting standards. We generally have multiple sources for these supplies, but there may be a limited number of suppliers capable of meeting our standards. We have experienced supply shortages from time to time in the past, and on occasion our suppliers have told us they need more time to fill our orders, that they cannot fill certain orders, that they will no longer support certain equipment with updates or parts, or that they are increasing prices. In particular, in the first three months of fiscal 2023 and in fiscal 2022, we experienced increased prices at certain suppliers, and longer lead times for certain materials required for production purposes. Such conditions are expected to continue. An interruption of any materials or equipment sources, or the lack of supplier support for a particular piece of equipment, could harm our business. The supplies necessary for our business could become more difficult to obtain as worldwide use of semiconductors increases, or due to supply chain disruptions, trade restrictions or political instability. Additionally, consolidation in our supply chain due to mergers and acquisitions may reduce the number of suppliers or change our relationships with them. Also, the reduced availability of necessary labor, the impact of the COVID-19 pandemic, or the application of sanctions, trade restrictions or tariffs by the U.S. or other countries may adversely impact the industry supply chain. For example, in 2019, the U.S. government increased tariffs on U.S. imports with China as their country of origin. Likewise, the China government increased tariffs on China imports with U.S. as their country of origin. We have taken steps to attempt to mitigate the costs of these tariffs on our business. Although these increases in tariffs did not significantly increase the operating costs of our business, they did, however, adversely impact demand for our products during fiscal 2020 and fiscal 2019. The additional tariffs imposed on components or equipment that we or our suppliers source from China will increase our costs and could have an adverse impact on our operating results in future periods. We may also incur increases in manufacturing costs in mitigating the impact of tariffs on our operations. This could also impair sourcing flexibility.
Our customers may also be adversely affected by these same issues. The labor, supplies and equipment necessary for their businesses could become more difficult to obtain for various reasons not limited to business interruptions of suppliers, reduced availability of labor, consolidation in their supply chain, the impact of the COVID-19 pandemic, or sanctions, trade restrictions or tariffs that impair sourcing flexibility or increase costs. If our customers are not able to produce their products, then their need for our products will decrease. Such interruptions of our customers’ businesses could harm our business.
We do not purchase significant amounts of equipment from Russia, Belarus, or Ukraine. However, the semiconductor industry, and purchasers of semiconductors, use raw materials that are sourced from these regions, such as neon, palladium, cesium, rubidium, and nickel. If we, or our direct or indirect customers, are unable to obtain the requisite raw materials or components needed to manufacture products, our ability to manufacture products, or demand for our products, may be adversely impacted. This could have a material adverse effect on our business, results of operations or financial condition. While there has been an adverse impact on the world’s palladium, neon, cesium, and rubidium supply chains, at this time, our supply chains have been able to meet our needs. While sales of our products into the regions, and to customers that sell into these regions, have been negatively impacted by the Russian invasion of Ukraine, at this time, we have not experienced a material impact on our business, results of operations or financial conditions.
We are dependent on wafer foundries and other contractors, as are our SuperFlash and other licensees.
We rely on outside wafer foundries for a significant portion of our wafer fabrication needs. Specifically, during the first three months of fiscal 2023, approximately 63% of our net sales came from products that were produced at outside wafer foundries compared to 60% of our net sales in fiscal 2022. We also use several contractors for a portion of the assembly and testing of our products. Specifically, during the first three months of fiscal 2023, approximately 42% of our assembly requirements and 38% of our test requirements were performed by third party contractors, compared to approximately 41% and 36%, respectively, during fiscal 2022. Due to increased demand for our products, we have taken actions in recent quarters to increase our capacity allocation from our wafer fabrication, assembly and test subcontractors. However, we
expect foundry capacity to continue to be limited due to strong demand for wafers across the industry and there can be no assurance that we will be able to secure the necessary allocation of capacity from our wafer foundries and other contractors, that any such additional capacity will have the ability to manufacture the process technologies that we need, or that such capacity will be available on acceptable terms. We expect that our reliance on third-party contractors may increase over time as our business grows, and any inability to secure necessary external capacity could adversely affect our operating results.
As our manufacturing subcontractors move to more advanced process technologies over time, we may find that they do not invest in some of the trailing edge process technologies on which a large portion of our products are manufactured. If this occurs, it may limit the amounts of net sales that we can achieve or require us to make significant investments to be able to manufacture these products in our own existing facilities, at new facilities or at other foundries and assembly and testing contractors. On July 28, 2022, the U.S. Congress passed the CHIPS Act which is to provide billions of dollars of cash incentives to increase domestic manufacturing capacity in our industry. Such incentives may potentially be available to us, our competitors and foundries; however, there can be no assurance as to which companies will receive such incentives and whether the legislation will have a positive or negative impact on our competitive position.
Our use of third parties reduces our control over the subcontracted portions of our business. Our future operating results could suffer if a significant contractor were to experience production difficulties, insufficient capacity, decreased manufacturing, reduced availability of labor, assembly and test yields, or increased costs due to disruptions from the COVID-19 pandemic, political upheaval or infrastructure disruption. Additionally, our future operating results could suffer if our wafer foundries and other contractors increase the prices of the products and services that they provide to us. Some of our subcontractors in China experienced production difficulties due to COVID-19 related disruptions in March 2022, but this did not have a significant impact on our operating results. If third parties do not timely deliver products or services in accordance with our quality standards, we may be unable to qualify alternate manufacturing sources in a timely manner or on favorable terms, or at all. Additionally, these subcontractors could abandon processes that we need, or fail to adopt technologies that we desire to control costs. In such event, we could experience an interruption in production, an increase in manufacturing costs or a decline in product reliability, and our business and operating results could be adversely affected. Further, use of subcontractors increases the risks of misappropriation of our intellectual property.
Certain of our SuperFlash and other technology licensees rely on wafer foundries. If our licensees experienced disruption in supply at such foundries, this would reduce the revenue from our technology licensing business and would harm our operating results.
We are highly dependent on foreign sales, suppliers, 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 the first three months of fiscal 2023, approximately 78% of our net sales were made to foreign customers, including 24% in China and 14% in Taiwan. During fiscal 2022, approximately 78% of our net sales were made to foreign customers, including 22% in China and 15% in Taiwan.
A strong position in the Chinese market is a key component of our global growth strategy. Although our sales in the Chinese market have been strong in recent quarters, competition in China is intense, and China's economic growth has slowed in calendar 2022. In the past, economic weakness in the Chinese market adversely impacted our sales volumes in China. As discussed above, the trade relationship between the U.S. and China remains challenging, economic conditions in China remain uncertain, and we are unable to predict whether such uncertainty will continue or worsen in future periods. Additionally, the impact of COVID-19 related lockdowns in the first quarter of calendar 2022 has adversely impacted Chinese customers and the supply chain. Weakening of foreign markets could result in lower demand for our products, which could have a material adverse effect on our business, results of operations or financial conditions.
We purchase a substantial portion of our raw materials and equipment from foreign suppliers. In addition, we own product assembly and testing facilities, and finished goods warehouses near Bangkok, Thailand, which has experienced periods of political instability and severe flooding in the past. There can be no assurance that any future flooding or political instability in Thailand would not have a material adverse impact on our operations. We have a test facility in Calamba, Philippines. We use foundries and other foreign contractors for a significant portion of our assembly and testing and wafer fabrication requirements.
We do not have significant sales or operations in Russia, Belarus, or Ukraine, and we do not purchase significant amounts of equipment from these regions. However, the semiconductor industry, and purchasers of semiconductors, use raw materials that are sourced from these regions, such as neon, palladium, cesium, rubidium and nickel. If we, or our direct or indirect customers, are unable to obtain the requisite raw materials or components needed to manufacture products, our
ability to manufacture products, or demand for our products, may be adversely impacted. This could have a material adverse effect on our business, results of operations or financial condition. While there has been an adverse impact on the world’s palladium, cesium, rubidium, and neon supply chains due to the Russia Ukraine conflict, at this time, our supply chains have been able to meet our needs. While sales of our products into the regions impacted by the Russia Ukraine conflict, and to customers that sell into these regions, have been negatively impacted by the Russian invasion of Ukraine, at this time, we have not experienced a material impact on our business, results of operations or financial condition.
Our reliance on foreign operations, foreign suppliers, maintenance of substantially all of our finished goods 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 due to the COVID-19 pandemic, wars, or other factors;
•trade restrictions and changes in tariffs;
•supply chain disruptions or delays;
•potentially adverse tax consequences;
•economic uncertainty in the worldwide markets served by us;
•import and export license requirements and restrictions;
•changes in laws related to taxes, environmental, health and safety, technical standards and consumer protection;
•currency fluctuations and foreign exchange regulations;
•difficulties in staffing and managing international operations;
•employment regulations;
•disruptions due to cybersecurity incidents;
•disruptions in international transport or delivery;
•public health conditions (including viral outbreaks such as COVID-19); and
•difficulties in collecting receivables and longer payment cycles.
If any of these risks occur or are worse than we anticipate, our sales could decrease and our operating results could suffer, we could face an increase in the cost of components, production delays, business interruptions, delays in obtaining export licenses, tariffs and other restrictions, longer payment cycles, increased taxes, restrictions on the repatriation of funds and the burdens of complying with a variety of foreign laws, any of which could ultimately have a material adverse effect on our business. Further changes in trade policy, tariffs, additional taxes, or restrictions on supplies, equipment, and raw materials including rare earth minerals, may limit our ability to produce products, increase our selling and/or manufacturing costs, decrease margins, reduce the competitiveness of our products, or inhibit our ability to sell products or purchase necessary equipment and supplies, which could have a material adverse effect on our business, results of operations, or financial conditions.
We depend on orders that are received and shipped in the same quarter and have limited visibility to product shipments other than orders placed under our Preferred Supply Program and under our long-term supply agreements.
Our net sales in any given quarter depend upon a combination of shipments from backlog, and orders that are both received and shipped in the same quarter, which we call 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, our ability to respond quickly to customer orders has been 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 reduce our visibility on future shipments. Turns orders correlate to overall semiconductor industry conditions and product lead times. Although our backlog has been very strong in recent periods due to favorable industry conditions and the impact of our Preferred Supply Program and our long-term supply agreements, turns orders remain important to our ability to meet our business objectives. Because turns orders can be difficult to predict, especially in times of economic volatility where customers may change order levels within the quarter, varying levels of turns orders make it more difficult to forecast net sales. The level of turns orders may also decrease in periods where customers are holding excess inventory of our products. Our customers may have increased their order levels in previous periods to help ensure they have sufficient inventory of our products to meet their needs, or they may have been unable to sell their products at their forecasted levels. As a significant portion of our products are manufactured at foundries, foundry lead times may affect our ability to satisfy certain turns orders. If we do not achieve a sufficient level of turns orders in a particular quarter relative to our revenue targets or effectively manage our production based on changes in order forecasts, our revenue and operating results will likely suffer.
In February 2021, we announced our Preferred Supply Program and, starting in the first quarter of calendar 2022, we began entering into long-term supply agreements, which offer our customers the ability to receive prioritized capacity. To participate in the Preferred Supply Program, customers have to place 12 months of orders, which cannot be cancelled or
rescheduled except in the event of price increases. The capacity priority under the Preferred Supply Program began for shipments in July 2021. The Preferred Supply Program and the long-term supply agreements are not a guarantee of supply; however, they will provide the highest priority for those orders which are under these programs, and the capacity priority will be on a first-come, first-served basis until the available capacity is booked. A significant portion of our capacity is booked under these programs. We believe these programs will enable us to be in a stronger position to make capacity and raw material commitments to our suppliers, buy capital equipment with confidence, hire employees and ramp up manufacturing and manufacture products more efficiently. Since these are new programs, there can be no assurance that the programs will be successful or that they will benefit our business. In the event that customers under these programs attempt to cancel or reschedule orders, we may have to take legal or other action to enforce the terms of the programs, and any such actions could result in damage to our customer relationships or cause us to incur significant costs. Additionally, as orders under these programs cannot be cancelled or returned except in the event of price increases, these programs may result in customers holding excess inventory of our products and thus decrease their need to place new orders in later periods.
Intense competition in the markets we serve may lead to pricing pressures, reduced sales or reduced market share.
The semiconductor industry is intensely competitive and faces 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. The semiconductor industry has experienced significant consolidation in recent years which has resulted in several of our competitors becoming much larger in terms of revenue, product offerings and scale. 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, including, but not limited to:
•the relative impact of the COVID-19 pandemic on us relative to our competitors;
•changes in demand in the markets that we serve and the overall rate of growth or contraction of such markets, including but not limited to the automotive, personal computing and consumer electronics markets;
•our ability to obtain adequate foundry and assembly and test capacity and supplies at acceptable prices;
•our ability to ramp production and increase capacity, at our wafer fabrication and assembly and test facilities;
•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 applications and the success of such applications;
•the rate at which the markets that we serve redesign and change their own products;
•product introductions by our competitors;
•the number, nature and success of our competitors in a given market;
•our ability to protect our products and processes by effective utilization of intellectual property rights;
•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 a product. The average selling prices of our microcontroller, FPGA products, and proprietary products in our analog product line have remained relatively constant over time, while average selling prices of our memory and non-proprietary products in our analog product line have declined over time. The overall average selling price of our products is affected by these trends; however, variations in our product and geographic mix of sales can cause wider fluctuations in our overall average selling price in any given period.
We have experienced, and may experience in the future, modest pricing declines in certain of our more mature proprietary product lines, primarily due to competitive conditions. At this time, we are not experiencing these types of pricing declines due to favorable industry conditions and demand. In the past, we have moderated average selling price declines in many of our proprietary product lines by introducing new products with more features and higher prices. However, we may not be able to do so in the future. We have experienced in the past, and may experience in the future, competitive pricing pressures in our memory and non-proprietary products in our analog product line. At this time, we are not experiencing these types of pricing declines due to favorable industry conditions and demand. In fiscal 2022, we experienced cost increases which we were able to pass on to our customers. However, in the future, we may be unable to maintain average selling prices due to increased pricing pressure, which could adversely impact our operating results.
Our operating results will suffer if we ineffectively utilize our manufacturing capacity or fail to maintain manufacturing yields.
Integrated circuits manufacturing processes are complex and sensitive to many factors, including contaminants in the manufacturing environment or materials used, the performance of our personnel and equipment, and other quality issues. As is typical in the 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 or above approximately the current levels. This could include delays in the recognition of revenue, loss of revenue, and penalties for failure to meet shipment deadlines. Our operating results are adversely affected when we operate below normal capacity. In the first three months of fiscal 2023 and in fiscal 2022, we operated at or above normal capacity levels and we expect this to continue if the current supply constraints relative to demand continue.
Our operating results are impacted by seasonality and wide fluctuations of supply and demand in the industry.
The semiconductor industry is characterized by seasonality and wide fluctuations of supply and demand. Historically, since a significant portion of our revenue is from consumer markets and international sales, our business generates stronger revenues in the first half and comparatively weaker revenues in the second half of our fiscal year. However, broad fluctuations in our business, changes in semiconductor industry and global economic conditions (including the impact of continued strong demand in the industry, the COVID-19 pandemic or trade tensions) and our acquisition activity (including our acquisition of Microsemi) have had and can have a more significant impact on our results than seasonality. In periods when broad fluctuations, changes in business conditions or acquisitions occur, it is difficult to assess the impact of seasonality on our business. The semiconductor industry has had 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 quickly replaced, to a geographically diverse customer base 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.
Our business is dependent on distributors to service our end customers.
Sales to distributors accounted for approximately 47% of our net sales in the first three months of fiscal 2023 and approximately 48% of our net sales in fiscal 2022. With the exception of orders placed under our Preferred Supply Program, we do not have long-term purchase agreements with our distributors, and we and our distributors may each terminate our relationship with little or no advance notice.
Future adverse conditions in the U.S. or global economies and labor markets (including the impact of the COVID-19 pandemic) or credit markets could materially impact distributor operations. Any deterioration in the financial condition, or disruption in the operations of our distributors, could adversely impact the flow of our products to our end customers and adversely impact our results of operation. In addition, during an industry or economic downturn, there may be an oversupply and decrease in demand for our products, which could reduce our net sales in a given period and increase inventory returns. Violations of the Foreign Corrupt Practices Act, or similar laws, by our distributors could have a material adverse impact on our business.
Our success depends on our ability to introduce new products on a timely basis.
Our future operating results depend on our ability to develop and timely introduce new products that compete effectively on the basis of price and performance and which address customer requirements. The success of our new product introductions depends on various factors, including, but not limited to:
•effective new product selection;
•timely completion and introduction of new product designs;
•availability of skilled employees;
•procurement of licenses for intellectual property rights from third parties under commercially reasonable terms;
•timely filing and protection of intellectual property rights for new product designs;
•availability of development and support tools and collateral literature that make complex new products easy for engineers to understand and use; and
•market acceptance of our customers' end products.
Because our products are complex, we have experienced delays from time to time in completing new product development. New products may not receive or maintain substantial market acceptance. We may be unable to timely design, develop and introduce competitive products, 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 others in the industry have, from time to time, experienced difficulties in transitioning to advanced process technologies and 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.
Business interruptions to our operations or those of our key vendors, licensees or customers could harm our business.
Operations at any of our facilities, at the facilities of any of our wafer fabrication or assembly and test subcontractors, or at any of our significant vendors, licensees or customers may be disrupted due to public health concerns (including outbreaks such as COVID-19), work stoppages or reduction in available labor, power loss, insufficient water, cyber attacks, computer network compromises, incidents of terrorism or security risk, political instability, telecommunications, transportation or other infrastructure failure, radioactive contamination, or fire, earthquake, floods, droughts, volcanic eruptions or other natural disasters. We have taken steps to mitigate the impact of some of these events should they occur; however, we cannot be certain that we will avoid a significant impact on our business in the event of a business interruption. For example, in the first three months of fiscal 2023 and in fiscal 2022, COVID-19 related restrictions adversely impacted our manufacturing operations in the U.S., Philippines and Thailand along with our subcontractors' manufacturing operations in Malaysia, Taiwan and China. Similar challenges arose for our logistics service providers, which adversely impacted their ability to ship product to our customers. The pandemic could adversely impact our business in future periods if the impact of COVID-19 becomes more severe. In the future, local governments could require us to reduce production, cease operations at any of our facilities, or implement mandatory vaccine requirements, and we could experience constraints in fulfilling customer orders.
Additionally, operations at our customers and licensees may be disrupted for a number of reasons. In April and May 2020, we received a greater number of order cancellations and requests by our customers to reschedule deliveries to future dates. Some customers requested order cancellations within our firm order window and claimed applicability of force majeure clauses. Likewise, if our licensees are unable to manufacture and ship products incorporating our technology, or if there is a decrease in product demand due to a business disruption, our royalty revenue may decline.
Also, Thailand has experienced periods of severe flooding in recent years. While our facilities in Thailand have continued to operate normally, there can be no assurance that future flooding in Thailand would not have a material adverse impact on our operations. If operations at any of our facilities, or our subcontractors' facilities are interrupted, we may not be able to timely shift production to other facilities, and we may need to spend significant amounts to repair or replace our facilities and equipment. Business interruptions would likely cause 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, cancellation of orders, or loss of customers. Although we maintain business interruption insurance, such insurance will likely not compensate us for any losses or damages, and business interruptions could significantly harm our business.
Our technology licensing business exposes us to various risks.
Our technology licensing business is based on our SuperFlash and other technologies. The success of our licensing business depends on the continued market acceptance of these technologies and on our ability to further develop such technologies and to introduce new technologies. To be successful, any such technology must be able to be repeatably implemented by licensees, provide satisfactory yield rates, address licensee and customer requirements, and perform competitively. The success of our technology licensing business depends on various other factors, including, but not limited to:
•proper identification of licensee requirements;
•timely development and introduction of new or enhanced technology;
•our ability to protect and enforce our intellectual property rights for our licensed technology;
•our ability to limit our liability and indemnification obligations to licensees;
•availability of development and support services to assist licensees in their design and manufacture of products;
•availability of foundry licensees with sufficient capacity to support OEM production; and
•market acceptance of our customers' end products.
Because our licensed technologies are complex, there may be delays from time to time in developing and enhancing such technologies. There can be no assurance that our existing or any enhanced or new technology will achieve or maintain substantial market acceptance. Our licensees may experience disruptions in production or reduced production levels which would adversely affect the revenue that we receive. Our technology license agreements generally include a clause that indemnifies the licensee against liability and damages (including legal defense costs) arising from certain intellectual property matters. We could be exposed to substantial liability for claims or damages related to intellectual property matters or indemnification claims. Any claim could result in significant legal fees and require significant attention from our management. These issues may adversely impact the success of our licensing business and adversely affect our future operating results.
Reliance on sales into governmental projects could have a material adverse effect on our results of operations.
A significant portion of the sales of Microsemi, which we acquired in May 2018, are from or are derived from government agencies or customers who sell to U.S. government agencies. Such sales are subject to uncertainties regarding governmental spending levels, spending priorities, regulatory and policy changes. Future sales into U.S. government projects are subject to uncertain government appropriations and national defense policies and priorities, including the budgetary process, changes in the timing and spending priorities, the impact of any past or future government shutdowns, contract terminations or renegotiations, future sequestrations, changes in regulations that we must comply with to be eligible to accept new contracts, such as the Cybersecurity Maturity Model Certification requirements and mandatory vaccine requirements, or the impact of the COVID-19 pandemic. For example, in fiscal 2022, as a result of the COVID-19 pandemic, we experienced suspensions and stop work orders for some of our subcontracts. Although such actions have not yet had a material adverse impact on our business, there can be no assurance as to the future costs or implications of such actions. Sales into government projects are also subject to uncertainties related to monetary, regulatory, tax and trade policies implemented by current or future administrations or by the U.S. Congress.
In the past, Microsemi has experienced delays and reductions in appropriations on programs that included its products. For example, in 2018 there were two federal government shutdowns. Further delays, reductions in or terminations of government contracts or subcontracts, including those caused by any past or future shutdown of the U.S. federal government, could materially and adversely affect our operating results. If the U.S. government fails to complete its annual budget process or to provide for a continuing resolution to fund government operations, another federal government shutdown may occur, during which we may experience further delays, reductions in or terminations of government contracts or subcontracts, which could materially and adversely affect our operating results. While we generally function as a subcontractor in these type of transactions, further changes in U.S. government procurement regulations and practices, particularly surrounding initiatives to reduce costs or increase compliance obligations (such as the Cybersecurity Maturity Model Certification and mandatory vaccine requirements), may adversely impact the contracting environment, our ability to hire and retain employees, and our operating results.
The U.S. government and its contractors may terminate their contracts with us at any time. For example, in 2014, the U.S. government terminated a $75 million contract with Microsemi. Uncertainty in government spending and termination of contracts for government related projects could have a material adverse impact on the revenue from our Microsemi acquisition. Our contracts with U.S. governmental agencies or prime customers require us to comply with the contract terms, and governmental regulations, particularly for our facilities, systems and personnel that service such customers. To be awarded new contracts, we may be required to meet certain levels of the Cybersecurity Maturity Model Certification that we may not meet, or choose to meet. Complying with these regulations, including audit requirements, requires that we devote significant resources to such matters in terms of training, personnel, information technology and facilities. Any failure to comply with these requirements may result in fines and penalties, or loss of current or future business, that may materially and adversely affect our operating results.
From time to time we receive grants from governments, agencies and research organizations. If we are unable to comply with the terms of those grants, we may not be able to receive or recognize grant benefits or we may be required to repay grant benefits and recognize related charges, which would adversely affect our operating results and financial position.
From time to time, we receive economic incentive grants and allowances from European governments, agencies and research organizations targeted at increasing employment at specific locations. The subsidy grant agreements typically contain economic incentive, headcount, capital and research and development expenditures and other covenants that must be met to receive and retain grant benefits, and these programs can be subjected to periodic review by the relevant governments. Noncompliance with the conditions of the grants could result in our forfeiture of all or a portion of any future amounts to be received, as well as the repayment of all or a portion of amounts received to date.
We may not fully realize the anticipated benefits of our completed or future acquisitions or divestitures including our acquisition of Atmel.divestitures.
We have acquired, and expect in the future to acquire, additional businesses that we believe will complement or augment our existing businesses. On April 4, 2016,In May 2018, we acquired Atmel,Microsemi, which was our largest and most complex acquisition ever. In addition, in August 2015, we completed our acquisitionIntegration of Micrel; in July 2014, we completed our acquisition of a controlling interest in ISSC; in April 2014, we completed our acquisition of Supertex, Inc.; and in August 2012, we completed our acquisition of SMSC. The integration process for our acquisitions is complex and may be costly and time consuming and include unanticipated issues, expenses and liabilities. We may not be able to successfully or profitably integrate, operate, maintain and manage any newly acquired operations or employees. We may not be able to maintain uniform standards, procedures and policies and wepolicies. We may be unable tonot realize the expected synergies and cost savings from the integration. There may be increased risk due to integrating financial reporting and internal control systems. WeIt may have difficulty in developing, manufacturingbe difficult to develop, manufacture and marketingmarket the products of a newly acquired company, or in growinggrow the business at the rate we anticipate. Following an acquisition, we may not achieve the revenue
or net income levels that justify the acquisition. We may suffer loss of key employees, customers and strategic partners of acquired companies and it may be difficult to implement our corporate culture at acquired companies. We have been and may in the future be subject to claims from terminated employees, shareholders of Microchip or the acquired companies and other third parties related to the transaction. In particular, as a result ofin connection with our Microsemi and Atmel acquisition,acquisitions, we became involved with third-party claims, litigation, governmental investigations and disputes related to the Atmel business.such businesses and transactions. See Note 1511 to our condensed consolidated financial statements for information regarding pending litigation.such matters. Acquisitions may also result in charges (such as acquisition-related expenses, write-offs, restructuring charges, or future impairment of goodwill), contingent liabilities, adverse tax consequences, additional share-based compensation expense and other charges that adversely affect our operating results. To fund our acquisition of Atmel,Microsemi, we used a significant portion of our cash balances borrowed under our credit agreement and issuedincurred approximately 10.1 million shares$8.10 billion of our common stock. Additionally, weadditional debt. We may fund future acquisitions of new businesses or strategic alliances by utilizing cash, borrowings under our credit agreement,Revolving Credit Facility, raising debt, issuing shares of our common stock, or other mechanisms.
Further, if we decide to divest assets or a business, weit may encounter difficulty in findingbe difficult to find or completingcomplete divestiture opportunities or alternative exit strategies, which may include site closures, timely or on acceptable terms or in a timely manner.terms. These circumstances could delay the achievement of our strategic objectives or cause us to incur additional expenses with respect to assetsthe desired divestiture, or a business that we want to dispose of, or we may dispose of assets or a business at athe price or on terms that areof the divestiture may be less favorable than we had anticipated. Even following a divestiture or other exit strategy, we may be contractually obligated with respect tohave certain continuing obligations to former employees, customers, vendors, landlords or other third parties. We may also have continuing obligations for pre-existing liabilities related to theformer employees, assets or businesses. Such obligations may have a material adverse impact on our results of operations and financial condition.
In addition to acquisitions, we have in the past, and expect in the future, to enter into joint development agreements or other business or strategic relationships with other companies. These transactions are subject to a number of risks similar to those we face with our acquisitions including our ability to realize the expected benefits of any such transaction, to successfully market and sell any products resulting from such transactions or to successfully integrate any technology developed through such transactions.
Our financial condition and results of operations could be adversely affected if we do not effectively manage our current or future debt.
As of December 31, 2017, the principal amount of our outstanding indebtedness was $4,481.3 million. In February 2017, we issued $2,645.0 million of aggregate principal value of senior and junior convertible debt and amended our existing credit agreement to, among other things, increase certain covenant compliance ratios. The February 2017 credit agreement amendment included a new collateral agreement that secures our borrowings with all assets of our guarantor subsidiaries with the exception of real property. We used a portion of the proceeds from the issuance of the 2017 senior and junior convertible debt to settle $431.3 million in principal value of our 2007 Junior Debt and $1,682.5 million to pay off the outstanding balance under our credit facility. In June 2017, we exchanged $111.3 million of our outstanding 2007 Junior Debt with $111.3 million of our 2017 Junior Debt. In November 2017, we called $14.6 million in principal value of the remaining outstanding 2007 Junior Debt with an effective date of December 15, 2017 for which substantially all holders submitted requests to convert. Prior to the call, conversion requests were received in both the second and third quarters of fiscal 2018. Total conversions for the nine months ending December 31, 2017 were for a principal amount of $32.4 million for which we settled in cash and shares. At December 31, 2017, there were no outstanding borrowings under our credit facility which had a capacity of $3,122.3 million and is comprised of one tranche expiring in February 2020. In February 2015, we issued $1,725.0 million of principal value of our 2015 Senior Debt. As a result of such transactions, we have a substantially greater amount of debt than we had maintained in the past. Our maintenance of substantial levels of debt could adversely affect our ability to take advantage of
corporate opportunities and could adversely affect our financial condition and results of operations. We may need or desire to refinance our convertible debt or any other future indebtedness and there can be no assurance that we will be able to refinance any of our indebtedness on commercially reasonable terms, if at all.
Servicing our debt may require a significant amount of cash, and we may not have sufficient cash flow from our business to fund future payments.
Our ability to make scheduled payments of principal, to pay interest on or to refinance our indebtedness, including our outstanding debentures, depends on our future performance, which is subject to economic, financial, competitive and other factors. Our business may not continue to generate cash flow from operations in the future sufficient to service our debt and to fund capital expenditures, dividend payments, share repurchases or acquisitions. If we are unable to generate such cash flow, we may be required to adopt one or more alternatives, such as selling assets, restructuring debt or obtaining additional equity capital on terms that may be onerous or highly dilutive. Our ability to refinance our indebtedness will depend on the capital markets and our financial condition at such time.
We are dependent on orders that are received and shipped in the same quarter and therefore have limited visibility to future product shipments.
Our net sales in any given quarter depend upon a combination of shipments from backlog and customer orders that are both received and shipped in that same 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 relied on 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 reduce 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 it more difficult to forecast net sales. As a significant portion of our products are manufactured at foundries, foundry lead times may affect our ability to satisfy certain turns orders. 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 will likely 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. The semiconductor industry has experienced significant merger and acquisition activity and consolidation in recent years which has resulted in several of our competitors becoming much larger in terms of revenue, product offerings and scale. 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;
our ability to ramp production and increase capacity, as needed, at our wafer fabrication and assembly and test facilities;
the rate at which customers incorporate our products into their own applications and the success of such applications;
the rate at which the markets that we serve redesign and change their own products;
our ability to obtain adequate foundry and assembly and test capacity and supplies of raw materials and other supplies at acceptable prices;
changes in demand in the markets that we serve and the overall rate of growth or contraction of such markets, including but not limited to the automotive, personal computing and consumer electronics markets;
product introductions by our competitors;
the number, nature and success of our competitors in a given market;
our ability to protect our products and processes by effective utilization of intellectual property rights;
our ability to remain price competitive against companies that have copied our proprietary product lines, especially in countries where intellectual property rights protection is difficult to achieve and maintain;
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, interface, mixed signal and timing products have remained relatively constant, while average selling prices of our memory and non-proprietary analog, interface, mixed signal and timing 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, primarily due 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. However, there can be no assurance that we will be able to do so in the future. We have experienced in the past, and expect to continue to experience in the future, varying degrees of competitive pricing pressures in our memory and non-proprietary analog, interface, mixed signal and timing 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.
We are dependent on wafer foundries and other contractors to perform key manufacturing functions for us, and our licensees of our SuperFlash and other technologies also rely on foundries and other contractors.
We rely on outside wafer foundries for a significant portion of our wafer fabrication needs. Specifically, during the first nine months of fiscal 2018, approximately 42% of our net sales came from products that were produced at outside wafer foundries. During fiscal 2017, approximately 41% of our net sales came from products that were produced at outside wafer foundries. We also use several contractors located primarily in Asia for a portion of the assembly and testing of our products. Specifically, during the first nine months of fiscal 2018, approximately 61% of our assembly requirements and 38% of our test requirements were performed by third party contractors compared to approximately 64% of our assembly requirements and 40% of our test requirements during fiscal 2017. Our reliance on third party contractors and foundries increased as a result of our acquisitions of Atmel, Micrel, SMSC, Supertex and ISSC. The disruption or termination of any of our contractors could harm our business and operating results.
Our use of third parties somewhat reduces our control over the subcontracted portions of our business. Our future operating results could suffer if any contractor were to experience financial, operational 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 the countries in which such contractors are located were to experience political upheaval or infrastructure disruption. 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 on terms favorable to us, or at all. Additionally, these subcontractors could abandon fabrication processes that are important to us, or fail to adopt advanced manufacturing technologies that we desire to control costs. In any 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. Further, our use of subcontractors increases the risks of potential misappropriation of our intellectual property.
Certain of our SuperFlash and other technology licensees also rely on outside wafer foundries for wafer fabrication services. If our licensees were to experience any disruption in supply from outside wafer foundries, this would reduce the revenue we receive in our technology licensing business and would harm our operating results.
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 and assembly and test 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 or above approximately the current levels. This could include delays in the recognition of revenue, loss of revenue or future orders, and customer-imposed penalties for our failure to meet contractual shipment deadlines. Our operating results are also adversely affected when we operate at less than optimal capacity. Although we operated at normal capacity levels during fiscal 2017 and the first three quarters of fiscal 2018, there can be no assurance that such production levels will be maintained in future periods.
Our operating results are 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 tends to generate historically stronger revenues in the first and second quarters and comparatively weaker revenues in the third and fourth quarters of our fiscal year. However, broad fluctuations in our overall business, changes in semiconductor industry and global economic conditions, and our acquisition activity (including our acquisition of Atmel) can have a more significant impact on our results than seasonality. As a result, in periods when these broad fluctuations, changes in business conditions or acquisitions occur, it is difficult to assess the impact of seasonal factors on our business. The semiconductor 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 cyclically by selling proprietary products, that cannot be easily or quickly replaced, to a geographically diverse customer base 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.
Our business is dependent on selling through distributors.
Sales through distributors accounted for approximately 54.2% of our net sales in the first nine months of fiscal 2018 and approximately 55.3% of our net sales in fiscal 2017. We do not have long-term agreements with our distributors, and we and our distributors may each terminate our relationship with little or no advance notice.
Any future adverse conditions in the U.S. or global economies or in the U.S. or global credit markets could materially impact the operations of our distributors. Any deterioration in the financial condition of our distributors or any disruption in the operations of our distributors could adversely impact the flow of our products to our end customers and adversely impact our results of operation. In addition, during an industry or economic downturn, it is possible there will be an oversupply of products and a decrease in demand for our products from our distributors, which could reduce our net sales in a given period and result in an increase in inventory returns. Violations of the Foreign Corrupt Practices Act, or similar laws, by our distributors or other channel partners could have a material adverse impact on our business.
Our success depends on our ability to introduce new products on a timely basis.
Our future operating results depend on our ability to develop and timely introduce new products that compete effectively on the basis of price and performance and which 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;
procurement of licenses for intellectual property rights from third parties under commercially reasonable terms;
timely filing and protection of intellectual property rights for new product designs;
availability of development and support tools and collateral literature that make complex new products easy for engineers to understand and use; and
market acceptance of our customers' end products.
Because our products are complex, we have experienced delays from time to time in completing new product development. 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, 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 may lose sales if our suppliers of raw materials and equipment fail to meet our needs.
Our semiconductor manufacturing operations require raw and processed 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 materials and equipment that meet our standards. The materials and equipment necessary for our business could become more difficult to obtain as worldwide use of semiconductors in product applications increases. Additionally, consolidation in our supply chain due to mergers and acquisitions may reduce the number of suppliers or change the relationships that we have with our suppliers. This could impair sourcing flexibility or increase costs. 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 replacement parts. In particular, we have recently experienced longer lead times for equipment which we need for capacity expansion at certain of our manufacturing facilities. An interruption of any materials or equipment sources, or the lack of supplier support for a particular piece of equipment, could harm our business.
Our technology licensing business exposes us to various risks.
Our technology licensing business is based on our SuperFlash and other technologies. The success of our licensing business depends on the continued market acceptance of these technologies and on our ability to further develop and enhance such technologies and to introduce new technologies in the future. To be successful, any such technology must be able to be repeatably implemented by licensees, provide satisfactory yield rates, address licensee and customer requirements, and perform competitively. The success of our technology licensing business depends on various other factors, including, but not limited to:
proper identification of licensee requirements;
timely development and introduction of new or enhanced technology;
our ability to protect and enforce our intellectual property rights for our licensed technology;
our ability to limit our liability and indemnification obligations to licensees;
availability of sufficient development and support services to assist licensees in their design and manufacture of products integrating our technology;
availability of foundry licensees with sufficient capacity to support original equipment manufacturers (OEM) production; and
market acceptance of our customers' end products.
Because our licensed technologies are complex, there may be delays from time to time in developing and enhancing such technologies. There can be no assurance that our existing or any enhanced or new technology will achieve or maintain substantial market acceptance. Our licensees may experience disruptions in production or lower than expected production levels which would adversely affect the revenue that we receive from them. Our technology license agreements generally include an indemnification clause that indemnifies the licensee against liability and damages (including legal defense costs) arising from intellectual property matters. We could be exposed to substantial liability for claims or damages related to intellectual property matters or indemnification claims. Any claim, with or without merit, could result in significant legal fees and require significant attention from our management. Any of the foregoing issues may adversely impact the success of our licensing business and adversely affect our future operating results.
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, other intellectual property rights, product failures, contracts and other matters. As is typical in the semiconductor industry, we receive notifications from third parties from time to time who believe that we owe them indemnification or other obligations related to claims made against us, our direct or indirect customers or our licensees. These legal proceedings and claims, even if meritless, could result in substantial costs to us and divert our resources. If we are not able to resolve a claim, settle a matter, obtain necessary licenses on commercially reasonable terms, reengineer our products or processes to avoid infringement, provide a cost-effective remedy, or successfully prosecute or defend our position, we could incur uninsured liability in any of them, be required to take an appropriate charge to operations, be enjoined from selling a material portion of our products or using certain processes, suffer a reduction or elimination in the value of our inventories, and 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 claims related to the manufacture, performance or use of our products. These claims may be due to injuries, economic damage or environmental exposures related to manufacturing, a product's nonconformance to our specifications or specifications agreed upon with the customer, changes in our manufacturing
processes, or unexpected customer system issues due to the integration of our products or insufficient design or testing by our customers. We could incur significant expenses related to such matters, including, but not limited to:
costs related to writing off the value of our inventory of nonconforming products;
recalling nonconforming products;
providing support services, product replacements, or modifications to products and the defense of such claims;
diversion of resources from other projects;
lost revenue or a delay in the recognition of revenue due to cancellation of orders or unpaid receivables;
customer imposed fines or penalties for failure to meet contractual requirements; and
a requirement to pay damages or penalties.
Because the systems into which our products are integrated have a higher cost of goods than the products we sell, the expenses and damages we are asked to pay 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, certain of our contracts may not exclude such liabilities. Further, our ability to avoid such liabilities may be limited by applicable law. We do have liability insurance which covers certain damages arising out of product defects, but we do not expect that 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 these customer claims may adversely affect the results of our operations.
Further, we sell to customers in industries such as automotive, aerospace, defense, safety, security, and medical, where failure of the systems in which our products are integrated could cause damage to property or persons. We may be subject to claims if our products, or the integration of our products, cause system failures. We will face increased exposure to claims if there are substantial increases in either the volume of our sales into these applications or the frequency of system failures integrating our products.
Failure 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 technology 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 and new patents, trademarks and copyrights that issue may not have sufficient scope or strength to provide meaningful protection or commercial advantage to us. We may be subject to, or may ourselves initiate, interference proceedings in the U.S. Patent and Trademark Office, patent offices of a foreign country or U.S. or foreign courts, 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 U.S. Infringement of our intellectual property rights by a third party could result in uncompensated lost market and revenue opportunities for us. Although we continue to vigorously and aggressively defend and protect our intellectual property on a worldwide basis, there can be no assurance that we will be successful in our endeavors.
Our operating results may be adversely impacted if economic conditions impact the financial viability of our licensees, customers, distributors, or suppliers.
We regularly review the financial performance of our licensees, customers, distributors and suppliers. However, any downturn in global economic conditions may adversely impact the financial viability of our licensees, customers, distributors or suppliers. The financial failure of a large licensee, customer or distributor, an important supplier, or a group thereof, could have an adverse impact on our operating results and could result in our not being able to collect our accounts receivable balances, higher reserves for doubtful accounts, write-offs for accounts receivable, and higher operating costs as a percentage of net sales.
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 the first nine months of fiscal 2018, approximately 85% of our net sales were made to foreign customers, including 31% in China. During fiscal 2017, approximately 84% of our net sales were made to foreign customers, including 32% in China.
A strong position in the Chinese market is a key component of our global growth strategy. The market for integrated circuit products in China is highly competitive, and both international and domestic competitors are aggressively seeking to increase their market share. Increased competition or economic weakness in the China market may make it difficult for us to achieve our desired sales volumes in China. In particular, economic conditions in China remain uncertain and we are unable to predict whether such uncertainty will continue or worsen in future periods.
We purchase a substantial portion of our raw materials and equipment from foreign suppliers. In addition, we own product assembly and testing facilities near Bangkok, Thailand, which has experienced periods of political instability in the past. A large portion of our finished goods inventory is maintained in Thailand. From time to time, Thailand has also experienced periods of severe flooding. There can be no assurance that any future flooding or political instability in Thailand would not have a material adverse impact on our operations. As part of our Atmel acquisition, we acquired a test facility in Calamba, Philippines. We use various foundries and other foreign contractors for a significant portion of our assembly and testing and wafer fabrication requirements.
Our reliance on foreign operations, foreign suppliers, maintenance of substantially all of our finished goods 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;
economic uncertainty in the worldwide markets served by us;
trade restrictions and changes in tariffs;
import and export license requirements and restrictions;
changes in rules and laws related to taxes, environmental, health and safety, technical standards and consumer protection in various jurisdictions;
currency fluctuations and foreign exchange regulations;
difficulties in staffing and managing international operations;
employment regulations;
disruptions in international transport or delivery;
public health conditions;
difficulties in collecting receivables and longer payment cycles; and
potentially adverse tax consequences.
If any of these risks materialize, or are worse than we anticipate, our sales could decrease and our operating results could suffer.
Our contractual relationships with our customers expose us to risks and liabilities.
We do not typically enter into long-term contracts with our customers, and therefore 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 had over 115,000 customers and our ten largest direct customers made up approximately 12% of our total revenue for the nine months ended December 31, 2017 and three of our top ten direct customers are contract manufacturers that perform manufacturing services for many customers, cancellation of customer contracts could have an adverse impact on our revenue and profits.
We have contracts with certain customers that differ from our standard terms of sale. For several of the significant markets that we sell into, such as the automotive and personal computer markets, our current or potential customers may possess significant leverage over us in negotiating the terms and conditions of supply as a result of their market size and position. For example, under certain contracts we may commit to supply specific quantities of products on scheduled delivery dates, or agree to extend our obligations for certain liabilities such as warranties or indemnification for quality issues or claims of intellectual property infringement. If we are 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. We may be liable for the customer's costs, expenses and damages associated with their claims and we may be obligated to defend the customer against claims of intellectual property infringement and pay the associated legal fees. While we try to minimize the number of contracts which contain such provisions, manage the risks underlying such liabilities, and set caps on our liability exposure, sometimes we are not able to do so. In order to win important designs, avoid losing business to competitors, maintain existing business, or be permitted to bid on new business, we have been, and may in the future be, forced to agree to uncapped liability for such items as intellectual property infringement, product failure, or confidentiality. Such provisions expose us to risk of liability far exceeding the purchase price of the products we sell under such contracts, the lifetime revenues we receive from such products, or various forms of potential consequential damages. Further, where we do
not have negotiated contracts with our customers, the terms of our customer's orders may govern the transaction and contain terms that are not favorable to us. These significant additional risks could result in a material adverse impact on our results of operations and financial condition.
We must attract and retain qualified personnel to be successful, and competition for qualified personnel can be intense.
Our success depends upon the efforts and abilities of our senior management, engineering, manufacturing and other personnel. The competition for qualified engineering and management personnel can be 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. The loss of, or any inability to attract personnel, even if not key personnel, if experienced in sufficient numbers could harm our business. We have no employment agreements with any member of our senior management team.
Our reported financial results may be adversely affected by new accounting pronouncements or changes in existing accounting standards and practices.
We prepare our financial statements in conformity with accounting principles generally accepted in the U.S. These accounting principles are subject to interpretation or changes by the FASB and the SEC. New accounting pronouncements and varying interpretations of accounting standards and practices have occurred in the past and are expected to occur in the future. New accounting pronouncements or a change in the interpretation of existing accounting standards or practices may have a significant effect on our reported financial results and may even affect our reporting of transactions completed before the change is announced or effective. In May 2014, the FASB issued Accounting Standards Update (ASU) 2014-09 - Revenue from Contracts with Customers (Topic 606), which supersedes nearly all existing revenue recognition guidance under US GAAP. The standard's core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. Upon our adoption of ASU 2014-09 beginning with our fiscal year commencing on April 1, 2018, we will no longer defer revenue until sale by the distributor to the end customer, but rather, will be required to estimate the effects of returns and allowances provided to distributors and record revenue at the time of sale to the distributor. We will adopt the standard under the modified retrospective method. Refer to Note 2 to our consolidated financial statements for additional information on the new guidance and its potential impact on us.
Business interruptions to our operations or the operations of our key vendors, subcontractors, licensees or customers, whether due to natural disasters or other events, could harm our business.
Operations at any of our facilities, at the facilities of any of our wafer fabrication or assembly and test subcontractors, or at any of our significant vendors or customers may be disrupted for reasons beyond our control. These reasons may include work stoppages, power loss, cyber attacks, incidents of terrorism or security risk, political instability, public health issues, telecommunications, transportation or other infrastructure failure, radioactive contamination, fire, earthquake, floods, volcanic eruptions or other natural disasters. We have taken steps to mitigate the impact of some of these events should they occur; however, we cannot be certain that our actions will be effective to avoid a significant impact on our business in the event of a disaster or other business interruption.
In particular, Thailand has experienced periods of severe flooding in recent years. While our facilities in Thailand have continued to operate normally, there can be no assurance that any future flooding in Thailand would not have a material adverse impact on our operations. 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, and we may need to spend significant amounts to repair or replace our facilities and equipment. If we experienced business interruptions, 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. Although we maintain business interruption insurance, such 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.
Additionally, operations at our customers and licensees may be disrupted for a number of reasons. In the event of customer disruptions, sales of our products may decline and our revenue, profitability and financial condition could suffer. Likewise, if our licensees are unable to manufacture and ship products incorporating our technology, or if there is a decrease in product demand due to a business disruption, our royalty revenue may decline.
Fluctuations in foreign currency exchange rates could adversely impact our operating results.
We use forward currency exchange contracts in an attempt to reduce the adverse earnings impact from the effect of exchange rate fluctuations on our non-U.S. dollar net balance sheet exposures. Nevertheless, in periods when the U.S. dollar significantly fluctuates in relation to the non-U.S. currencies in which we transact business, the value of our non-U.S. dollar transactions can have an adverse effect on our results of operations and financial condition. In particular, in periods when a foreign currency significantly declines in value in relation to the U.S. dollar, customers transacting in that foreign currency may find it more difficult to fulfill their previously committed contractual obligations or to undertake new obligations to make payments or purchase products. In periods when the U.S. dollar is significantly declining in relation to the British pound, Euro and Thai baht, the operational costs in our European and Thailand subsidiaries are adversely affected. Although our business has not been materially adversely impacted by recent changes in the value of the U.S. dollar, there can be no assurance as to the future impact that the strength of the U.S. dollar will have on our business or results of operations.
Interruptions in our information technology systems, or improper handling of data, 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 disruption to our systems or networks, including, but not limited to, new system implementations, computer viruses, security breaches, facility issues, natural disasters, terrorism, war, telecommunication failures or energy blackouts could have a material adverse impact on our operations, sales and operating results. Such disruption could result in a loss of our intellectual property or the release of sensitive competitive information or supplier, customer or employee personal data. Any loss of such information could harm our competitive position, result in a loss of customer confidence, and cause us to incur significant costs to remedy the damages caused by any such disruptions or security breaches. Additionally, any failure to properly manage the collection, handling, transfer or disposal of personal data of employees and customers may result in regulatory penalties, enforcement actions, remediation obligations, litigation, fines and other sanctions.
From time to time, we have experienced verifiable attacks on our data, attempts to breach our security and attempts to introduce malicious software into our IT systems; however, such attacks have not previously resulted in any material damage to us. Were future attacks successful, we may be unaware of the incident, its magnitude, or its effects until significant harm is done. In recent years, we have implemented improvements to our protective measures which are not limited to the following: firewalls, antivirus measures, patches, log monitors, routine backups with offsite retention of storage media, system audits, data partitioning and routine password modifications. There can be no assurance that such system improvements will be sufficient to prevent or limit the damage from any future cyber attacks or disruptions. Any such attack or disruption could result in additional costs related to rebuilding of our internal systems, defending litigation, responding to regulatory actions, or paying damages. Such attacks or disruptions could have a material adverse impact on our business, operations and financial results.
Third-party service providers, such as wafer foundries, assembly and test contractors, distributors, credit card processors and other vendors have access to certain portions of our and our customers' sensitive data. In the event that these service providers do not properly safeguard the data that they hold, security breaches and loss of data could result. Any such loss of data by our third-party service providers could negatively impact our business, operations and financial results, as well as our relationship with our customers.
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, we self-insure for some potentially significant risks and obligations. In these circumstances, we believe that it is more cost effective for us to self-insure certain risks than to pay the high premium costs. The risks and exposures that we self-insure include, but are not limited to certain property, product defects, employment risks, environmental matters, political risks, and intellectual property matters. Should there be a loss or adverse judgment or other decision in an area for which we are self-insured, then our financial condition, results of operations and liquidity may be adversely affected.
We are subject to stringent environmental and other regulations, which may force us to incur significant expenses.
We must comply with all applicable federal, state, local and foreign governmental regulations related to the use, storage, discharge and disposal of toxic, volatile or otherwise hazardous substances used in our products and manufacturing processes. Our failure to comply with applicable regulations could result in fines, suspension of production, cessation of operations or future liabilities. Such environmental regulations have required us in the past, and could require us in the future, to buy costly equipment or to incur significant expenses to comply with such regulations. Our failure to control the use of, or
adequately restrict the discharge of, hazardous substances could impact the health of our employees and others and could impact our ability to operate. Such failure could also restrict our ability to ship certain products to certain countries, require us to modify our operations' logistics, or require us to incur other significant costs and expenses. There is a continuing expansion in environmental laws with a focus on reducing or eliminating hazardous substances and substances of high concern in electronic products and shipping materials. These and other future environmental regulations could require us to reengineer certain of our existing products and may make it more expensive for us to manufacture, sell and ship our products. In addition, the number and complexity of laws focused on the energy efficiency of electronic products and accessories, the recycling of electronic products, and the reduction in the quantity and the recycling of packing materials have expanded significantly. It may be difficult for us to timely comply with these laws and we may not have sufficient quantities of compliant products to meet customers' needs, thereby adversely impacting our sales and profitability. We may also have to write off inventory in the event that we hold unsaleable inventory as a result of changes to regulations or customer requirements. We expect these risks and trends to continue. In addition, we anticipate increased customer requirements to meet voluntary criteria related to the reduction or elimination of substances of high concern in our products, energy efficiency measures, and supplier practices associated with sourcing and manufacturing. These requirements may increase our own costs, as well as those passed on to us by our supply chain.
Customer demands for us to implement business practices that are more stringent than existing legal requirements may reduce our revenue opportunities or cause us to incur higher costs.
Some of our customers and potential customers are requiring that we implement operating practices that are more stringent than what is required by applicable laws with respect to workplace and labor requirements, the type of materials we use in our products, environmental matters or other items. To comply with such requirements, we may have to pass these same operating practices on to our suppliers. Our suppliers may refuse to implement these operating practices, or may charge us more for complying with them. The cost to implement such practices may cause us to incur higher costs and reduce our profitability, and if we choose not to implement such practices, such customers may disqualify us as a supplier, resulting in decreased revenue opportunities. Developing, administering, monitoring and auditing these customer-requested practices at our own sites and those in our supply chain will increase our costs and may require that we hire more personnel.
Customer demands and regulations related to conflict-free minerals may force us to incur additional expenses.
As required by the Dodd-Frank Wall Street Reform and Consumer Protection Act, in August 2012, the SEC released investigation, disclosure and reporting requirements regarding the use of "conflict" minerals mined from the Democratic Republic of Congo and adjoining countries and which are necessary to the functionality or production of products. We filed a report on Form SD with the SEC regarding such matters on May 31, 2017. Other countries are considering similar regulations. If we cannot certify that we are using conflict-free minerals, customers may demand that we change the sourcing of minerals and other materials used in the manufacture of our products, even if the costs for compliant minerals and materials significantly increases and availability is limited. If we make changes to materials or suppliers, there will likely be costs associated with qualifying new suppliers and production capacity and quality could be negatively impacted. Our relationships with customers and suppliers may be adversely affected if we are unable to certify that our products are "conflict-free." We have incurred, and expect in the future to incur, additional costs associated with complying with these new disclosure requirements, such as costs related to determining the source of any conflict minerals used in our products. We may also encounter challenges to satisfy those customers who require that all of the components of our products be certified as conflict free in a materially different manner than advocated by the Conflict Free Smelter Initiative or the Dodd-Frank Wall Street Reform and Consumer Protection Act. If we are not able to meet customer requirements, customers may choose to disqualify us as a supplier and we may have to write off inventory in the event that it cannot be sold.
Regulatory authorities in jurisdictions into which we ship our products could levy fines or restrict our ability to export or transfer products.
A significant portion of our sales are made through the exporting and importing of products. In addition to local jurisdictions' trade regulations, our U.S.-manufactured products or products based on U.S. technology are subject to U.S. laws and regulations governing international trade, including, but not limited to the Foreign Corrupt Practices Act, Export Administration Regulations (EAR), International Traffic in Arms Regulations (ITAR) and trade sanctions against embargoed countries and denied entities administered by the U.S. Department of the Treasury, Office of Foreign Assets Control (OFAC). Licenses or proper license exceptions are required for the shipment of our products to certain countries. A determination by the U.S. or foreign government that we have failed to comply with trade or export regulations or anti-bribery regulations can result in penalties which may include denial of export privileges, fines, civil or criminal penalties, and seizure of products. Such penalties could have a material adverse effect on our business, sales and earnings. Further, a change in these laws and regulations could restrict our ability to transfer product to previously permitted countries, customers, distributors or other third
parties. Any one or more of these sanctions or a change in laws or regulations could have a material adverse effect on our business, financial condition and results of operations.
The outcome of future examinations of our income tax returns could have an adverse effect on our results of operations.
We are subject to examination of our income tax returns by the IRS and other tax authorities for fiscal 2005 and later. We are subject to certain income tax examinations in foreign jurisdictions for fiscal 2007 and later. 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.
Exposure to greater than anticipated income tax liabilities, changes in tax rules and regulations (including the Act), changes in the interpretation of tax rules and regulations, or unfavorable assessments from tax audits could affect our effective tax rates, financial condition and results of operations
We are a U.S.-based multinational company subject to tax in multiple U.S. and foreign tax jurisdictions. Our income tax obligations could be affected by many factors, including but not limited to changes to our corporate operating structure, intercompany arrangements and tax planning strategies.
Our income tax expense is computed based on tax rates at the time of the respective financial period. Our future effective tax rates, financial condition and results from operations could be unfavorably affected by changes in the tax rates in jurisdictions where our income is earned, by changes in the tax rules and regulations or the interpretation of tax rules and regulations in the jurisdictions in which we do business or by changes in the valuation of our deferred tax assets
Currently, a majority of our revenue is generated from customers located outside the U.S., and a substantial portion of our assets, including employees, are located outside of the U.S. Recently enacted U.S. tax legislation will significantly change the taxation of U.S.-based multinational corporations, by, among other things, reducing the U.S. corporate income tax rate, adopting elements of a territorial tax system, assessing a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred, and creating new taxes on certain foreign-sourced earnings. The new legislation is unclear in some respects and will require interpretations and implementing regulations by the Internal Revenue Service, as well as state tax authorities, and the legislation could be subject to potential amendments and technical corrections, any of which could lessen or increase certain adverse impacts of the legislation. A significant portion of our earnings are earned by our subsidiaries outside the U.S. Changes to the taxation of certain foreign earnings resulting from the newly enacted U.S. tax legislation, along with the state tax impact of these changes and potential future cash distributions, will likely have an adverse effect on our effective tax rate. Furthermore, changes to the taxation of undistributed foreign earnings could change our future intentions regarding reinvestment of such earnings. The foregoing items could have a material adverse effect on our business, cash flow, results of operations or financial conditions.
In addition, we are subject to examinations of our income tax returns by domestic and foreign tax authorities. We regularly assess the likelihood of outcomes resulting from these examinations to determine the adequacy of our provision for income taxes and have reserved for potential adjustments that may result from the current examinations. There can be no assurance that the final determination of any of these examinations will not have an adverse effect on our effective tax rates, financial position and results of operations.
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, but not limited to:
quarterly variations in our operating results or the operating results of other technology companies;
general conditions in the semiconductor industry;
global economic and financial conditions;
changes in our financial guidance or our failure to meet such guidance;
changes in analysts' estimates of our financial performance or buy/sell recommendations;
any acquisitions we pursue or complete; and
actual or anticipated announcements of technical innovations or new products by us or our competitors.
In addition, the stock market has from time to time experienced significant price and volume fluctuations that have affected the market prices for many companies and that often have been unrelated to the operating performance of such companies. These broad market fluctuations and other factors have harmed and may harm the market price of our common stock. Some or all of the foregoing factors could also cause the market price of our convertible debentures to decline or fluctuate substantially.
Anti-takeover defenses in our charter documents and under Delaware law could discourage takeover attempts, which could also reduce the market price of our common stock.
Our certificate of incorporation and bylaws contain provisions that could delay or prevent a change in control of Microchip. These provisions could also make it difficult for stockholders to elect directors that are not nominated by the current members of our board of directors or take other corporate actions, including effecting changes in our management. These provisions include:
the ability of our board of directors to issue shares of preferred stock and to determine the price and other terms of those shares, including preferences and voting rights, without stockholder approval, which could be used to significantly dilute the ownership of a hostile acquiror;
the right of our board of directors to elect a director to fill a vacancy created by the expansion of our board of directors or the resignation, death or removal of a director, which prevents stockholders from being able to fill vacancies on our board of directors;
the requirement that a special meeting of stockholders may be called only by the holders of 50% or more of the combined voting power of all classes of our capital stock, which could delay the ability of our stockholders to force consideration of a proposal or to take action, including the removal of directors;
the ability of our board of directors, by majority vote, to amend the bylaws, which may allow our board of directors to take additional actions to prevent an unsolicited takeover and inhibit the ability of an acquiror to amend the bylaws to facilitate an unsolicited takeover attempt; and
advance notice procedures with which stockholders must comply to nominate candidates to our board of directors or to propose matters to be acted upon at a stockholders' meeting, which may discourage or deter a potential acquiror from conducting a solicitation of proxies to elect the acquiror's own slate of directors or otherwise attempting to obtain control of us.
In addition, as a Delaware corporation, we are subject to Section 203 of the Delaware General Corporation Law. These provisions may prohibit large stockholders, in particular those owning 15% or more of our outstanding voting stock, from merging or combining with us for a certain period of time. The application of Section 203 also could have the effect of delaying or preventing a change in control of us.
Any of these provisions could, under certain circumstances, depress the market price of our common stock.
As a result of our acquisition activity, our goodwill and intangible assets have increased significantly in recent years and we may in the future incur impairments to goodwill or intangible assets.
When we acquire a business, a substantial portion of the purchase price of the acquisition is allocated to goodwill and other identifiable intangible assets. The amount of the purchase price which is allocated to goodwill is determined by the excess of the purchase price over the net identifiable assets acquired. As of December 31, 2017,June 30, 2022, we had goodwill of $2,299.0 million$6.67 billion and net intangible assets of $1,784.6 million.$3.87 billion. In connection with the completion of our acquisition of Microsemi in May 2018, our goodwill and intangible assets increased significantly. We review our indefinite-lived intangible assets, including goodwill, for impairment annually in the fourth fiscal quarter or whenever events or changes in circumstances indicate that the carrying amount of those assets is more likely than not impaired. Factors that may be considered in assessing whether goodwill or intangible assets may be impaired include a decline in our stock price or market capitalization, reduced estimates of future cash flows and slower growth rates in our industry. Our valuation methodology for assessing impairment requires management to make judgments and assumptions based on historical experience and to rely heavily on projections of future operating performance. Because we operate in highly competitive environments, projections of our future operating results and cash flows may vary significantly from our actual results. No goodwill impairment charges were recorded in the first ninethree months of fiscal 20182023 or in fiscal 2017.2022. No material intangible asset impairment charges were recorded in the first ninethree months of fiscal 2018. In2023 or in fiscal 2017, we recognized $11.9 million of intangible asset impairment charges.2022. If in future periods, we determine that our goodwill or intangible assets are impaired, we will be required to write down these assets which would have a negative effect on our condensed consolidated financial statements.
If we fail to maintain proper and effective internal control and remediate any future control deficiencies, our ability to produce accurate and timely financial statements could be impaired, which could harm our operating results, our ability to operate our business and our reputation with investors.
We have in the past identified a material weakness in our internal controls related to accounting for income taxes and we also identified a material weakness in our internal controls related to IT system access. Although such material weaknesses were remediated in fiscal 2020, there can be no assurance that similar control issues will not be identified in the future. If we cannot remediate future material weaknesses or significant deficiencies in a timely manner, or if we identify additional control deficiencies that individually or together constitute significant deficiencies or material weaknesses, our ability to accurately record, process, and report financial information and our ability to prepare financial statements within required time periods, could be adversely affected. Failure to maintain effective internal controls could result in violations of applicable securities laws, stock exchange listing requirements, and the covenants under our debt agreements, subject us to litigation and investigations, negatively affect investor confidence in our financial statements, and adversely impact our stock
price and our ability to access capital markets.
Ensuring that we have adequate internal financial and accounting controls and procedures so that we can produce accurate financial statements on a timely basis is a costly and time-consuming effort that needs to be re-evaluated frequently. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with U.S. GAAP. We are required to comply with Section 404 of the Sarbanes-Oxley Act of 2002 which requires an annual management assessment of the effectiveness of our internal control over financial reporting and a report by our independent auditors. In addition to the identified material weaknesses related to accounting for income taxes and to IT system access, which were remediated as of March 31, 2020, we have from time to time identified other significant deficiencies. If we fail to remediate any future material weaknesses or significant deficiencies or to maintain proper and effective internal control over financial reporting in the future, our ability to produce accurate and timely financial statements could be impaired, which could harm our operating results, harm our ability to operate our business and reduce the trading price of our stock.
Customer demands for us to implement business practices that are more stringent than legal requirements may reduce our revenue opportunities or cause us to incur higher costs.
Some of our customers require that we implement practices that are more stringent than those required by applicable laws with respect to labor requirements, the materials contained in our products, energy efficiency, environmental matters or other items. To comply with such requirements, we also require our suppliers to adopt such practices. Our suppliers may in the future refuse to implement these practices, or may charge us more for complying with them. If certain of our suppliers refuse to implement the practices, we may be forced to source from alternate suppliers. The cost to implement such practices may cause us to incur higher costs and reduce our profitability, and if we do not implement such practices, such customers may disqualify us as a supplier, resulting in decreased revenue opportunities. Developing, enforcing, and auditing customer-requested practices at our own sites and in our supply chain will increase our costs and may require more personnel.
We must attract and retain qualified personnel to be successful, and competition for qualified personnel has intensified.
We must attract and retain qualified personnel to be successful, and competition for qualified personnel has intensified in recent periods in our industry due to high demand for skilled employees. Availability of labor is currently constrained in certain geographic markets in which we operate due to the tight and competitive labor market in our industry. Competition for available labor has intensified for a variety of reasons, including the increase in work-from home arrangements brought about by COVID-19, and the wage inflation in our industry.
Our ability to attract and retain skilled employees such as management, technical, marketing, sales, research and development, manufacturing, and operational personnel is critical to our business. We rely on a direct labor force at our manufacturing facilities. Any inability to maintain our labor force at our facilities may disrupt our operations, delay production, shipments and revenue and result in us being unable to timely satisfy customer demand, and ultimately could materially and adversely affect our business, financial condition and results of operations. Our inability to attract and retain hardware and software engineers and sales and marketing personnel, could delay the development and introduction of, and harm our ability to sell, our products. We have no employment agreements with any member of our senior management team, and it is possible that they could leave with little or no notice, which could make it more difficult for us to execute our planned business strategy. Our inability to retain, attract or motivate personnel could have a material adverse effect on our business, financial condition and results of operations.
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 coverage related to many different types of risk; however, we self-insure for some potentially significant risks and obligations, because we believe that it is more cost effective for us to self-insure than to pay the high premium costs. The risks and exposures that we self-insure include, but are not limited to, employee health matters, certain property matters, product defects, cybersecurity matters, employment risks, environmental matters, political risks, and intellectual property matters. Should there be a loss or adverse judgment in an area for which we are self-insured, then our financial condition, results of operations and liquidity may be materially adversely affected.
Risks Related to Cybersecurity, Privacy, Intellectual Property, and Litigation
We continue to be the target of attacks on our IT systems. Interruptions in and unauthorized access to our IT systems, or improper handling of data, could adversely affect our business.
We rely on the uninterrupted operation of complex IT systems and networks to operate our business. Any significant disruption to our systems or networks, including, but not limited to, new system implementations, computer viruses, security breaches, facility issues, natural disasters, terrorism, war, telecommunication failures or energy blackouts could have a material adverse impact on our business, operations, supply chain, sales and operating results. Such disruption could result in an unauthorized release of our, our suppliers’ or our customers’ intellectual property or confidential, proprietary or sensitive information, or the release of personal data. Any release of such information or data could harm our business or competitive position, result in a loss of customer confidence, and cause us to incur significant costs to remedy the damages. In addition, any release of such information or data or the failure to properly manage the collection, handling, transfer or disposal of such information may result in regulatory inquiries or penalties, enforcement actions, remediation obligations, claims for damages, litigation, and other sanctions.
We have experienced verifiable attacks on our IT systems and data, including network compromises, attempts to breach our security measures and attempts to introduce malicious software into our IT systems. For example, in fiscal 2019, we learned of an ongoing compromise of our computer networks by what is believed to be sophisticated hackers. We engaged outside legal counsel and a leading forensic investigatory firm with experience in such matters. We took steps to identify malicious activity on our network including a compromise of our network and, in May 2019, we began implementing a containment plan. We routinely evaluate the effectiveness of the containment mechanisms that were implemented and continue to implement additional measures. We have analyzed the information that was compromised. We do not believe that this IT system compromise has had a material adverse effect on our business or resulted in any material damage to us. As a result of the IT system compromise, our management, including our chief executive officer and our chief financial officer, concluded that our internal controls related to IT system access were not effective resulting in a material weakness in our internal controls for fiscal 2019. Although this material weakness in our internal control was remediated in fiscal 2020, there can be no assurance that similar control issues will not be identified in future periods.
Due to the types of products we sell and the significant amount of sales we make to government agencies or customers whose principal sales are to U.S. government agencies, we have experienced and expect to continue to experience in the future, attacks on our IT systems and data, including attempts to breach our security, network compromises and attempts to introduce malicious software into our IT systems. Were any future attacks to be successful, we may be unaware of the incident, its magnitude, or its effects until significant harm is done. In recent years, we have regularly implemented improvements to our protective measures which include, but are not limited to, implementation of the following: firewalls, endpoint intrusion detection and response software, regular patches, log monitors, event correlation tools, network segmentation, routine backups with offsite retention of storage media, system audits, dual factor identification, data partitioning, privileged account segregation and monitoring, routine password modifications, and an enhanced information security program including training classes and phishing exercises for employees and contractors with system access, along with tabletop exercises conducted by information security personnel. As a result of the material weakness in our internal controls resulting from the IT systems compromise in fiscal 2019, we have taken remediation actions and implemented additional controls and we are continuing to take actions to attempt to address evolving threats. However, recent system improvements have not been fully effective in preventing attacks on our IT systems and data, including breaches of our security measures, and there can be no assurance that any future system improvements will be effective in preventing future cyber-attacks or disruptions or limiting the damage from any future cyber-attacks or disruptions. Such system improvements have resulted in increased costs to us and any future improvements, attacks or disruptions could result in additional costs related to rebuilding our internal systems, defending litigation, complaints or other claims, providing notices to regulatory agencies or other third parties, responding to regulatory actions, or paying damages. Such attacks or disruptions could have a material adverse impact on our business, operations and financial results.
Third-party service providers, such as wafer foundries, assembly and test contractors, distributors, credit card processors and other vendors have access to portions of our and our customers' data. In the event that these service providers do not properly safeguard the data that they hold, security breaches and loss of data could result. Any such breach or loss of data by our third-party service providers could negatively impact our business, operations and financial results, as well as our relationship with our customers.
Our failure to comply with federal, state, or international privacy and data protection laws and regulations may materially adversely affect our business, results of operations and financial condition.
We are subject to numerous laws and regulations in the U.S. and internationally regarding privacy and data protection such as the European Union’s (EU) General Data Protection Regulation (GDPR), the U.K. equivalent to the GDPR, the California Consumer Privacy Act, and the California Privacy Rights Act. The scope of these laws and regulations is rapidly evolving, subject to differing interpretations, and may be inconsistent among jurisdictions. Some of these laws create a broad definition of personal information, establish data privacy rights, impose data breach notification requirements, and create potentially severe statutory damages frameworks and private rights of action for certain data breaches. Some of the laws and regulations also place restrictions on our ability to collect, store, use, transmit and process personal information and other data across our business. For example, the GDPR restricts the ability of companies to transfer personal data from the European Economic Area (EEA) to the U.S. and other countries. Further, such laws and regulations have resulted and will continue to result in significantly greater compliance burdens and costs for companies such as us that have employees, customers, and operations in the EEA.
In order to comply with the GDPR, we have relied mainly on the European Commission’s Standard Contractual Clauses (SCCs), for transfers of personal information from the EEA to the U.S. or other countries. However, the Court of Justice of the EU in a July 2020 decision (Schrems II) invalidated the EU-U.S. Privacy Shield Framework, and also called for stricter conditions in the use of the SCCs. Following the Schrems II decision, certain data protection authorities in the EU have issued statements advising companies within their jurisdiction not to transfer personal data to the U.S. under the SCCs. At present, there are few, if any, viable alternatives to the SCCs. If we are unable to implement sufficient safeguards to ensure that our transfers of personal information from the EEA are lawful, we may face increased exposure to regulatory actions and substantial fines and injunctions against processing personal information from the EEA. The loss of our ability to lawfully transfer personal data out of the EEA may cause reluctance or refusal by European customers to communicate with us as they are currently, and we may be required to increase our data processing capabilities in the EEA at significant expense. Additionally, other countries outside of the EEA have passed or are considering passing laws requiring local data residency which could increase the cost and complexity of providing our products in those jurisdictions.
Furthermore, the GDPR and the U.K. equivalent of the GDPR expose us to two parallel data protection regimes in Europe, each of which potentially authorizes fines and enforcement actions for certain violations. Substantial fines may be imposed for breaches of data protection requirements, which can be up to 4% of a company’s worldwide revenue or 20 million Euros, whichever is greater. Although the U.K. data protection regime currently permits data transfers from the U.K. to the EEA and other third countries, covered by a European Commission 'adequacy decision' through the continued use of SCCs and binding corporate rules, these laws and regulations are subject to change, and any such changes could have adverse implications for our transfer of personal data from the U.K. to the EEA and other third countries.
While we plan to continue to undertake efforts to conform to current regulatory obligations and evolving best practices, such efforts may be unsuccessful or result in significant costs. We may also experience reluctance, or refusal by European or multi-national customers to continue to provide us with personal data due to the potential risk exposure of personal data transfers and the current data protection obligations imposed on them by applicable data protection laws or by certain data protection authorities. These and any other data privacy laws and their interpretations continue to develop and their uncertainty and inconsistency may increase the cost of compliance, cause compliance challenges, restrict our ability to offer products in certain locations in the same way that we have been, potentially adversely affect certain third-party service providers, or subject us to sanctions by data protection regulators, all of which could adversely affect our business, financial condition and results of operations.
We are exposed to various risks related to legal proceedings, investigations or claims.
We are currently, and in the future may be, involved in legal proceedings, investigations or claims regarding intellectual property rights, product failures, our Microsemi acquisition, contracts and other matters. As is typical in the semiconductor industry, we receive notifications from third parties from time to time who believe that we owe them indemnification or other obligations related to claims made against us, our direct or indirect customers, or our licensees. These legal proceedings and claims, even if meritless, have in the past and could in the future result in substantial costs to us. If we are unable to resolve or settle a matter, obtain necessary licenses on reasonable terms, reengineer products or processes to avoid infringement, provide a cost-effective remedy, or successfully prosecute or defend our position, we could incur uninsured liability in any of them, be required to take a charge to operations, be enjoined from selling a material portion of our products or using certain processes, suffer a reduction or elimination in the value of our inventories, and 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 claims related to the manufacture, performance, or use of our products. These claims may be due to injuries, economic damage or environmental exposures related to manufacturing, a product's nonconformance to our or our customer’s specifications, changes in our manufacturing processes, or unexpected customer system issues due to the integration of our products or insufficient design or testing by our customers. We could incur significant expenses related to such matters, including, but not limited to:
•costs related to writing off the value of our inventory of nonconforming products;
•recalling nonconforming products;
•providing support services, product replacements, or modifications to products and the defense of such claims;
•diversion of resources from other projects;
•lost revenue or a delay in the recognition of revenue due to cancellation of orders or unpaid receivables;
•customer imposed fines or penalties for failure to meet contractual requirements; and
•a requirement to pay damages or penalties.
Because the systems into which our products are integrated have a higher cost of goods than the products we sell, the expenses and damages we are asked to pay may be significantly higher than the revenue and profits we received. While we exclude consequential damages in our standard terms and conditions, certain of our contracts may not exclude such liabilities. Further, our ability to avoid such liabilities may be limited by law. We have liability insurance which covers certain damages arising out of product defects, but we do not expect that insurance will fully protect against such claims. Payments we may make in connection with these customer claims may adversely affect the results of our operations.
Further, we sell to customers in industries such as automotive, aerospace, defense, safety, security, and medical, where failure of the application could cause damage to property or persons. We may be subject to claims if our products, or the integration of our products, cause system failures. We will face increased exposure to claims if there are substantial increases in either the volume of our sales into these applications or the frequency of system failures integrating our products.
Our contractual relationships with our customers expose us to risks and liabilities.
With the exception of orders placed under our Preferred Supply Program and long-term supply agreements, we do not typically enter into long-term contracts with our non-distributor customers, and therefore we cannot be certain about future order levels from our customers. When we enter into customer contracts (other than under our Preferred Supply Program and long-term supply agreements), the contracts are generally cancelable based on standard terms and conditions. Under our Preferred Supply Program and long-term supply agreements, customers may cancel contracts in the event of price increases. While we had approximately 125,000 customers, and our ten largest direct customers accounted for approximately 12% of our total revenue in the first three months of fiscal 2023, and four of our top ten direct customers are contract manufacturers that perform manufacturing services for many customers, cancellation of customer contracts could have an adverse impact on our revenue and profits. For example, due to uncertainty related to the COVID-19 pandemic, we experienced an increase in order cancellations and requests to reschedule deliveries to future dates in the first quarter of fiscal 2021.
Certain customer contracts differ from our standard terms of sale. For some of the markets that we sell into, such as the automotive and personal computer markets, our customers may have negotiating leverage over us as a result of their market size. For example, under certain contracts we have committed to supply products on scheduled delivery dates, or extended our obligations for liabilities such as warranties or indemnification for quality issues or intellectual property infringement. If we are unable to supply the customer as contractually required, the customer may incur additional production costs, lost revenues due to delays in their manufacturing schedule, or quality-related issues. We may be liable for costs and damages associated with customer claims, and we may be obligated to defend the customer against claims of intellectual property infringement and pay associated legal fees. While we try to minimize the number of contracts which contain such provisions, manage the risks of such liabilities, and set caps on our liability exposure, sometimes we are unable to do so. In order to win important designs, avoid losing business to competitors, maintain existing business, or be permitted to bid on new business, we have, and may in the future, have to agree to uncapped liability for such items as intellectual property infringement or product failure, or have to agree to liquidated damage provisions. This exposes us to risk of liability far exceeding the purchase price of the products sold under such contracts, the lifetime revenues we receive under such contracts, or potential consequential damages. Further, where we do not have negotiated customer contracts, our customer's order terms may govern the transaction and contain terms unfavorable to us. These risks could result in a material adverse impact on our results of operations and financial condition.
Failure 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 licenses and intend to continue to seek patents on our technology and manufacturing processes. The process of seeking patent protection can be expensive, and patents may not be issued from currently pending or future applications. In addition, our existing and new patents, trademarks and copyrights that are issued may not have sufficient scope or strength to provide meaningful protection or commercial advantage to us. We may be subject to, or may initiate, interference proceedings in the U.S. Patent and Trademark Office, patent offices of a foreign country or U.S. or foreign courts, which can require significant financial 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 U.S. Infringement of our intellectual property rights by a third-party could result in uncompensated lost market and revenue opportunities for us. Although we continue to aggressively defend and protect our intellectual property on a worldwide basis, there can be no assurance that we will be successful.
Risks Related to Taxation, Laws and Regulations
Our reported financial results may be adversely affected by new accounting pronouncements or changes in existing accounting standards and practices.
We prepare our financial statements in conformity with U.S. GAAP. These accounting principles are subject to interpretation or changes by the FASB and the SEC. New accounting pronouncements and interpretations of accounting standards and practices have occurred in the past and are expected to occur in the future. New accounting pronouncements or a change in the interpretation of accounting standards or practices may have a significant effect on our reported financial results and may affect our reporting of transactions completed before the change is effective.
Regulatory authorities in jurisdictions into or from which we ship our products or import supplies could levy fines, restrict or delay our ability to export products or import supplies, or increase costs associated with the manufacture or transfer of products.
A significant portion of our sales require export and import activities. Our U.S.-manufactured products or products based on U.S. technology are subject to laws and regulations on international trade, including but not limited to the Foreign Corrupt Practices Act, EARs, International Traffic in Arms Regulations and trade sanctions against embargoed countries and denied entities, including those administered by the U.S. Department of the Treasury, Office of Foreign Assets Control. Licenses or license exceptions are required for the shipment of our products to certain countries. Our inability to timely obtain a license, for any reason, including a delay in license processing due to a federal government shutdown like that which occurred in 2018, could cause a delay in scheduled shipments which could have a material adverse impact on our revenue within the quarter of a shutdown, and in following quarters depending on the extent that license processing is delayed. Further, determination by a government that we have failed to comply with trade regulations or anti-bribery regulations can result in penalties which may include denial of export privileges, fines, penalties, and seizure of products, any of which could have a material adverse effect on our business, sales and earnings. A change in laws and regulations could restrict our ability to transfer product to previously permitted countries, customers, distributors or others. For example, in February 2022, the U.S. began implementing widescale sanctions against Russia due to Russia's invasion of Ukraine. Sanctions against Belarus and certain Ukrainian regions were later implemented. Because the actions by Russia against Ukraine are in conflict with our Guiding Values, Microchip chose to cease shipments into Russia and Belarus, and we will continue to comply with applicable U.S. sanctions regarding Ukraine. While sales of our products into these regions, and to customers that sell into these regions, have been negatively impacted, at this time, we have not experienced a material adverse impact on our revenue. An additional example occurred in April 2018, when the U.S. Commerce Department banned U.S. companies from selling products or transferring technology to ZTE, a Chinese company, and certain subsidiaries. This ban was lifted in July 2018. In fiscal 2020, when the U.S. Commerce Department banned U.S. companies from selling products or transferring technology to certain Chinese companies, including Huawei and certain subsidiaries. In fiscal 2020, the U.S. Federal Acquisition Regulation prohibited U.S. governmental agencies from buying equipment using covered telecommunications equipment as a substantial component or critical technology where the technology came from certain Chinese companies. In July 2020, this was expanded to prohibit U.S. governmental agencies from entering into a contract with any company that uses covered telecommunications equipment whether or not the Chinese technology is related to the procurement. Effective June 2020, amendments to the EAR regarding prohibitions of sales of items with a “military end use” into China, Russia, and Venezuela, and Belarus effective March 2021, and elimination of an EAR License Exception, apply to more of our products than the previous regulations. Any of the foregoing changes could adversely impact our operational costs due to the administrative impacts of complying with these regulations, and may limit those with whom we conduct business. Any one or more of these sanctions, future sanctions, a change in laws or regulations, or a prohibition on shipment of our products or transfer of our technology to significant customers could have a material adverse effect on our business, financial condition and results of operations.
The U.S. and other countries have levied tariffs and taxes on certain goods, implemented trade restrictions, and introduced national security protection policies. Trade tensions between the U.S. and China, which escalated in 2018, have continued and include the U.S. increasing tariffs on Chinese origin goods and China increasing tariffs on U.S. origin goods. We took steps to mitigate the costs of these tariffs on our business by making adjustments in operations and supply. Although these tariff increases did not result in a material adverse impact on our operating costs in fiscal 2019 or fiscal 2020, they did reduce demand for our products during fiscal 2019 and fiscal 2020. Increased tariffs on our customers' products could adversely impact their sales, and increased tariffs on our products in comparison to those of our competitors could each result in lower demand for our products.
Further changes in trade or national security protection policy, tariffs, additional taxes, restrictions on exports or other trade barriers, may limit our ability to produce products, increase our selling and/or manufacturing costs, decrease margins, reduce the competitiveness of our products, or reduce our ability to sell products, which could have a material adverse effect on our business, results of operations or financial conditions.
The outcome of future examinations of our income tax returns could have an adverse effect on our results of operations.
We are subject to examination of our U.S. and certain foreign income tax returns for fiscal 2007 and later. We regularly assess the likelihood of adverse outcomes of these examinations to determine the adequacy of our provision for income taxes and have reserved for potential adjustments that may result from current or future examinations. There can be no assurance that the final determination of any of these or any future examinations will not have an adverse effect on our effective tax rates, financial position and results of operations.
Exposure to greater than anticipated income tax liabilities, changes in tax rules and regulations, changes in the interpretation of tax rules and regulations, or unfavorable assessments from tax audits could affect our effective tax rates, financial condition and results of operations.
We are a U.S.-based multinational company subject to tax in many U.S. and foreign jurisdictions. Our income tax obligations could be affected by many factors, including changes to our operating structure, intercompany arrangements and tax planning strategies.
Our income tax expense is computed based on tax rates at the time of the respective financial period. Our future effective tax rates, financial condition and results from operations could be unfavorably affected by changes in the tax rates in jurisdictions where our income is earned, by changes in the tax rules and regulations or the interpretation of tax rules and regulations in the jurisdictions in which we do business or by changes in the valuation of our deferred tax assets. For example, the Organization for Economic Cooperation and Development has been working on a Base Erosion and Profit Shifting Project and is expected to continue to issue guidelines and proposals that may change aspects of the existing framework under which our tax obligations are determined in many of the countries where we do business. Similarly, the European Commission and several countries have issued proposals that would change aspects of the current tax framework under which we are taxed. These proposals include changes to the existing income tax framework, possibilities of a global minimum tax, and proposals to change or impose new types of non-income taxes, including taxes based on a percentage of revenue.
Our business, financial condition and operating results may be adversely impacted by policies implemented globally by the current or future administrations.
The current administration in the U.S. and administrations in other global jurisdictions in which we operate, have indicated support for significant legislative and policy changes in areas including but not limited to tax, trade, labor, and the environment. If implemented, these changes could increase our effective tax rate, and increase our selling and/or manufacturing costs, which could have a material adverse effect on our business, results of operations or financial conditions. Changes in tax policy, trade regulations or other matters, and any uncertainty surrounding the scope or timing of such changes, could negatively impact the stock market, and reduce the trading price of our stock. For example, in February 2022, the U.S. began implementing widescale sanctions against Russia due to Russia's invasion of Ukraine. Sanctions against Belarus and certain Ukrainian regions were later implemented. Because the actions by Russia against Ukraine are in conflict with our Guiding Values, Microchip chose to cease shipments into Russia and Belarus, and we will continue to comply with applicable U.S. sanctions regarding Ukraine. While sales of our products into these regions, and to customers that sell into these regions, have been negatively impacted, at this time, we have not experienced a material adverse impact on our revenue. Retaliatory acts by Russia in response to the sanctions could include cyber attacks, sanctions, or other actions that could disrupt the economy. As a result of the foregoing risks or similar risks, the imposition of sanctions could have a material adverse effect on
our business, results of operations or financial condition.
We are subject to stringent environmental and other regulations, which may force us to incur significant expenses.
We must comply with federal, state, local and foreign governmental regulations related to the use, storage, discharge and disposal of hazardous substances used in our products and manufacturing processes. Our failure to comply, or the failure of entities that we have acquired over time to have complied, with regulations could result in significant fines, liability for clean-up, suspension of production, cessation of operations or future liabilities. Such regulations have required us in the past, and could require us in the future, to incur significant expenses to comply with such regulations. Our failure to control the use of, or adequately restrict the discharge of, hazardous substances could impact the health of our employees and others and could impact our ability to operate. Such failure could also restrict our ability to ship certain products to certain countries, require us to modify our logistics, or require us to incur other significant costs and expenses. Environmental laws continue to expand with a focus on reducing or eliminating hazardous substances in electronic products and shipping materials. Future environmental regulations could require us to reengineer certain of our existing products and may make it more expensive for us to manufacture, sell and ship our products. In addition, the number and complexity of laws focused on the energy efficiency of electronic products, the recycling of electronic products, and the reduction in the amount and the recycling of packing materials have expanded significantly. It may be difficult for us to timely comply with these laws and we may have insufficient quantities of compliant products to meet customers' needs, thereby adversely impacting our sales and profitability. We may have to write off inventory if we hold unsaleable inventory as a result of changes to regulations. We expect these risks to continue. These requirements may increase our own costs, as well as those passed on to us by our supply chain.
Climate change regulations and sustained adverse climate change pose risks that could harm our results of operations.
Climate change regulations or voluntary actions we may have taken as part of our Environmental, Social, and Governance initiatives could require us to limit emissions, change manufacturing processes, substitute materials which may cost more or be less available, fund offset projects, obtain new permits or undertake other costly activities. Failure to obtain required permits could result in fines, suspension or cessation of production. Restrictions on emissions could result in significant costs such as higher energy costs, carbon taxes, and emission cap and trade programs. The cost of compliance with such regulations could restrict our manufacturing operations, increase our costs, and have an adverse effect on our operating results.
In March 2022, the SEC proposed a rule entitled Enhancement and Standardization of Climate-Related Disclosures for Investors. While the proposed rule is not yet in effect and is subject to change as a result of the SEC comment process, if it were to go in effect in its current form, we would incur significant additional costs of compliance due to the need for expanded data collection, analysis, and certification. Further, certain elements of the proposed rule, such as mandatory third-party verification of emissions, may be difficult to comply with in the proposed required timeframe as there may be an insufficient number of qualified third-party verification entities to meet demand.
Sustained adverse change in climate could have a direct adverse economic impact on us, such as utility shortages, and higher costs of utilities. Certain of our operations are located in arid or tropical regions, which some experts believe may become vulnerable to fires, storms, severe floods and droughts. While our business recovery plans are intended to allow us to recover from natural disasters or other disruptive events, our plans may not protect us from all events.
Customer demands and regulations related to conflict-free minerals may force us to incur additional expenses.
Under the Dodd-Frank Wall Street Reform and Consumer Protection Act, in August 2012, the SEC released investigation, and disclosure requirements regarding the use of "conflict" minerals mined from the Democratic Republic of Congo and adjoining countries. We filed a Form SD with the SEC regarding such matters on May 27, 2022. Other countries are considering similar regulations. If we cannot certify that our supply chain is free from the risk of irresponsible sourcing, customers may demand that we change the sourcing of materials used in the manufacture of our products, even if the costs for compliant materials significantly increases or availability is limited. If we change materials or suppliers, there will likely be costs associated with qualifying new suppliers and production capacity and quality could be negatively impacted. Our relationships with customers and suppliers may be adversely affected if we are unable to certify that our products are free from the risk of irresponsible sourcing. We have incurred, and expect in the future to incur, additional costs associated with complying with these disclosure requirements, such as costs related to determining the source of any conflict minerals used in our products. We may be unable to satisfy customers who require that all of the components of our products be certified as conflict free in a materially different manner than advocated by the Responsible Minerals Initiative or the Dodd-Frank Wall Street Reform and Consumer Protection Act. If we are unable to meet customer requirements, customers may disqualify us
as a supplier and we may have to write off inventory if it cannot be sold.
In addition to concerns over “conflict” minerals mined from the Democratic Republic of Congo, our customers may require that other minerals and substances used within our supply chain be evaluated and reported on. An increase in reporting obligations will increase associated operating costs. This could have negative effects on our overall operating profits.
A requirement to fund our foreign pension plans are unfunded, and any requirement to fund these plans in the future could negatively affect our cash position and operating capital.
In connection with our acquisitionacquisitions of Microsemi and Atmel, we assumed unfunded defined benefit pension plans that cover certain of our French and German employees. Plan benefits are managed in accordance with local statutory requirements. Benefits are based on yearsMost of service and employee compensation levels. The projected benefit obligation totaled $57.4 million at December 31, 2017. Thethese plans are unfunded in compliance with local statutory regulations,requirements, and we have no immediate intention of funding these plans. The projected benefit obligation totaled $74.6 million at March 31, 2022. Benefits are paid when amounts become due, commencing when participants retire.due. We expect to pay approximately $0.7$1.6 million in fiscal 20182023 for benefits earned. Should legislative regulations require complete or partial funding of these plans in the future, it could negatively affect our cash position and operating capital.
FromRisks Related to Capitalization and Financial Markets
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 recent 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, but not limited to:
•global economic and financial uncertainty due to higher interest rates, inflation, the COVID-19 pandemic or other factors;
•quarterly variations in our operating results or the operating results of other technology companies;
•changes in our financial guidance or our failure to meet such guidance;
•changes in analysts' estimates of our financial performance or buy/sell recommendations;
•general conditions in the semiconductor industry;
•the amount and timing of repurchases of shares of our common stock;
•our ability to realize the expected benefits of our completed or future acquisitions; and
•actual or anticipated announcements of technical innovations or new products by us or our competitors.
In addition, the stock market has recently and in the past experienced significant price and volume fluctuations that have affected the market prices for many companies and that often have been unrelated to their operating performance. These broad market fluctuations and other factors have harmed and may harm the market price of our common stock. The foregoing factors could also cause the market price of our Convertible Debt to decline or fluctuate substantially.
The amount and timing of our share repurchases may fluctuate in response to a variety of factors.
The amount, timing, and execution of repurchases of shares of our common stock may fluctuate based on the share price of our common stock, general business and market conditions, tax regulations impacting share repurchases and other factors including our operating results, level of cash flow, capital expenditures and dividend payments. Although our Board of Directors has authorized share repurchases of up to $4.00 billion, the authorization does not obligate us to acquire any particular amount of shares. We cannot guarantee that our share repurchase authorization will be fully consummated or that it will enhance long-term shareholder value. The repurchase authorization may be suspended or discontinued at any time at our discretion and may affect the trading price of our common stock and increase volatility.
Our financial condition and results of operations could be adversely impacted if we do not effectively manage current or future debt.
As of June 30, 2022, the principal amount of our outstanding indebtedness was $7.60 billion. As a result of our acquisition of Microsemi, we have substantially more debt than we had prior to timeMay 2018. At June 30, 2022, we receive grants from governments, agencieshad $1.20 billion in outstanding borrowings under our Revolving Credit Facility which provides up to $2.75 billion of revolving loan commitments that terminate in 2026. At June 30, 2022, we had $5.60 billion in aggregate principal amount of Senior Notes and research organizations.$803.5 million in aggregate principal of Convertible Debt outstanding.
Our maintenance of substantial levels of debt could adversely affect our ability to take advantage of opportunities and could adversely affect our financial condition and results of operations. We may need or desire to refinance our current or
future debt and there can be no assurance that we will be able to do so on reasonable terms, if at all.
Servicing our debt requires a significant amount of cash, we may not have sufficient cash to fund payments and adverse changes in our credit ratings could increase our borrowing costs and adversely affect our ability to access the debt markets.
Our ability to make scheduled payments of principal, interest, or to refinance our indebtedness, including our outstanding Convertible Debt and Senior Notes, depends on our future performance, which is subject to economic, competitive and other factors including those related to the COVID-19 pandemic. Our business may not continue to generate sufficient cash flow to service our debt and to fund capital expenditures, dividend payments, share repurchases or acquisitions. If we are unable to comply with the terms of those grants, we may not be able to receive or recognize grant benefits orgenerate such cash flow, we may be required to repay grant benefits previously paidundertake alternatives, such as selling assets, restructuring debt or obtaining additional equity capital on onerous or highly dilutive terms. Our ability to usrefinance our indebtedness will depend on the capital markets and recognize related charges, which wouldour financial condition at such time. Our senior notes are rated by certain major credit rating agencies. These credit ratings impact our cost of borrowing and our ability to access the capital markets and are based on our financial performance and financial metrics including debt levels. There is no assurance that we will maintain our current credit ratings. A downgrade of our credit rating by a major credit rating agency could result in increased borrowing costs and could adversely affect our operating results and financial position.ability to access the debt markets to refinance our existing debt or finance future debt.
From time to time, we receive economic incentive grants and allowances from European governments, agencies and research organizations targeted at increasing employment at specific locations. The subsidy grant agreements typically contain economic incentive, headcount, capital and research and development expenditure and other covenants that must be met to receive and retain grant benefits, and these programs can be subjected to periodic review by the relevant governments. Noncompliance by us with the conditions of the grants could result in our forfeiture of all or a portion of any future amounts to be received, as well as the repayment of all or a portion of amounts received to date.
Conversion of our debenturesConvertible Debt will dilute the ownership interest of our existing stockholders.
The conversion of some or all of our outstanding debenturesConvertible Debt will dilute the ownership interest of our existing stockholders to the extent we deliver common stock upon conversion of the debentures. Uponsuch debt. Following our irrevocable settlement election made on April 1, 2022, upon conversion, we mayare required to satisfy our conversion obligation with respect to such converted Convertible Debt by delivering cash equal to the principal amount of such converted Convertible Debt and cash and shares of common stock or any combination, at our option. If upon conversion we electoption, with respect to deliver cash for the lesser of the conversion value and principal amount of the debentures, we would pay the holder the cash value of the applicable number of shares of our common stock. Upon conversion, we intend to satisfy the lesser of the principal amount or the conversion value of the debentures in cash. If the conversion value of a debenture exceeds the principal amount of the debenture, we may also elect to deliver cash in lieu of common stock for theany conversion value in excess of the one thousand dollars principal amountthereof (i.e., the conversion spread). There would be no adjustment to the numerator in the net income per common share computation for the cash settled portion of the debenturesConvertible Debt as that portion of the debt instrument will always be settled in cash. The conversion spread will be included in the denominator for the computation of diluted net income per common share. Any sales in the public market of any common stock issuable upon conversion of our debenturesConvertible Debt could adversely affect prevailing market prices of our common stock. In addition, the existence of the debenturesConvertible Debt may encourage short selling by market participants because the conversion of the debenturesConvertible Debt could be used to satisfy short positions, or anticipated conversion of the debenturesConvertible Debt into shares of our common stock could depress the price of our common stock.
Climate change regulations and sustainedFluctuations in foreign currency exchange rates could adversely impact our operating results.
We use forward currency exchange contracts in an attempt to reduce the adverse climate change pose regulatory and physical risks that could harmearnings impact from the effect of exchange rate fluctuations on our resultsnon-U.S. dollar net balance sheet exposures. Nevertheless, in periods when the U.S. dollar significantly fluctuates in relation to the non-U.S. currencies in which we transact business, the value of operations or affect the way we conduct business.
Climate change regulations at the federal, state or local level or in international jurisdictions could require us to limit emissions, change our manufacturing processes, obtain substitute materials which may cost more or be less available, increase our investment in control technology for greenhouse gas emissions, fund offset projects or undertake other costly activities. These regulations could significantly increase our costs and restrict our manufacturing operations by virtue of requirements for new equipment. New permits may be required for our current operations, or expansions thereof. Failure to timely receive permits could result in fines, suspension of production, or cessation of operations at one or more facilities. In addition, restrictions on carbon dioxide or other greenhouse gas emissions could result in significant costs such as higher energy costs, and utility companies passing down carbon taxes, emission cap and trade programs and renewable portfolio standards. The cost of complying, or of failing to comply, with these and other climate change and emissions regulations couldnon-U.S. dollar transactions can have an adverse effect on our operating results.results of operations and financial condition. In particular, in periods when the value of a non-U.S. currency significantly declines relative to the U.S. dollar, customers transacting in that currency may be unable to fulfill their contractual obligations or to undertake new obligations to make payments or purchase products. In periods when the U.S. dollar declines significantly relative to the British pound, Euro, Thai baht and Taiwan dollar, the operational costs in our European and Thailand subsidiaries are adversely affected. Although our business has not been materially adversely impacted by recent changes in the value of the U.S. dollar, there can be no assurance as to the future impact that any weakness or strength in the U.S. dollar will have on our business or results of operations.
Further, any sustained adverse change in climate could have a direct adverse economic impact on us, such as water and power shortages, and higher costs of water or energy to control the temperature of our facilities. Certain of our operations are located in arid or tropical regions, such as Arizona and Thailand. Some environmental experts predict that these regions may become vulnerable to storms, severe floods and droughts due to climate change. While we maintain business recovery plans that are intended to allow us to recover from natural disasters or other events that can interrupt business, we cannot be certain that our plans will protect us from all such disasters or events.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
We did not repurchase any sharesThe following table sets forth our purchases of our common stock in the three months ended December 31, 2017.June 30, 2022:
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| Period | | Total number of shares purchased | | Average price paid per share | | Total number of shares purchased as part of publicly announced program | | Approximate dollar value of shares that may yet be purchased under the program(1) (in millions) |
| April 1, 2022 - April 30, 2022 | | — | | | $ | — | | | — | | | $ | 3,574.4 | |
| May 1, 2022 - May 31, 2022 | | 1,610,162 | | | $ | 67.28 | | | 1,610,162 | | | $ | 3,466.1 | |
| June 1, 2022 - June 30, 2022 | | 1,310,238 | | | $ | 66.32 | | | 1,310,238 | | | $ | 3,379.2 | |
| | 2,920,400 | | | | | 2,920,400 | | | $ | 3,379.2 | |
(1) In November 2021, our Board of Directors authorized the repurchase of up to $4.00 billion of our common stock in the open market or in privately negotiated transactions. There is no expiration date associated with this authorization.
Item 3. Defaults Upon Senior Securities
Not Applicable.
Item 4. Mine Safety Disclosures
Not Applicable.
Item 5. Other Information
None.
Item 6. Exhibits
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| | Incorporated by Reference | |
| Exhibit Number | Exhibit Description | Form | File Number | Exhibit | Filing Date | Included Herewith |
| 3.1 | | 8-K | 000-21184 | 3.1 | August 26, 2021 | |
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| 3.2 | | 8-K | 000-21184 | 3.1 | May 28, 2021 | |
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| 32* | | | | | | X |
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| 101.INS | Inline XBRL Instance Document - the instance document does not appear in the Interactive File because its XBRL tags are embedded within the Inline XBRL document | | | | | X |
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| 101.SCH | Inline XBRL Taxonomy Extension Schema Document | | | | | X |
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| 101.CAL | Inline XBRL Taxonomy Extension Calculation Linkbase Document | | | | | X |
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| 101.DEF | Inline XBRL Taxonomy Extension Definition Linkbase Document | | | | | X |
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| 104 | Cover Page Interactive Data File - the cover page XBRL tags are embedded within the Inline XBRL document or included within the Exhibit 101 attachments | | | | | X |
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* This certification is being furnished solely to accompany this Quarterly Report on Form 10-Q pursuant to 18 U.S.C. Section 1350, and is not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference into any filing of the registrant under the Securities Act of 1933, as amended, or Securities Exchange Act of 1934, as amended, whether made before or after the date hereof, regardless of any general incorporation language in such filing.
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101.INS | XBRL Instance Document |
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101.SCH | XBRL Taxonomy Extension Schema Document |
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101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document |
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101.DEF | XBRL Taxonomy Extension Definition Linkbase Document |
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101.LAB | XBRL Taxonomy Extension Label Linkbase Document |
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101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document |
SIGNATURES
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.
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| | | MICROCHIP TECHNOLOGY INCORPORATED |
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| Date: | | February 7, 2018August 2, 2022 | By: /s/ J. Eric Bjornholt |
| | | J. Eric Bjornholt |
| | | Senior Vice President and Chief Financial Officer |
| | | (Duly Authorized Officer, and |
| | | Principal Financial and Accounting Officer)
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