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MICROCHIP TECHNOLOGY INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) This report, including "Part I - Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Part II - Item 1A Risk Factors" contains certain forward-looking statements that involve risks and uncertainties, including statements regarding our strategy, financial performance and revenue sources. We use words such as "anticipate," "believe," "plan," "expect," "future," "intend" and similar expressions to identify forward-looking statements. Our actual results could differ materially from the results anticipated in these forward-looking statements as a result of certain factors including those set forth under "Risk Factors," beginning at page 37 and elsewhere in this Form 10-Q. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. You should not place undue reliance on these forward-looking statements. We disclaim any obligation to update information contained in any forward-looking statement. These forward-looking statements include, without limitation, statements regarding the following: • The effects that adverse global economic conditions and fluctuations in the global credit and equity markets may have on our financial condition and results of operations; • The effects and amount of competitive pricing pressure on our product lines; • Our ability to moderate future average selling price declines; • The effect of product mix, capacity utilization, yields, fixed cost absorption, competition and economic conditions on gross margin; • The amount of, and changes in, demand for our products and those of our customers; • The level of orders that will be received and shipped within a quarter; • Our expectation that our inventory levels will be relatively flat to down modestly in the March 2014 quarter compared to the December 2013 quarter and that it will allow us to maintain competitive lead times; • The effect that distributor and customer inventory holding patterns will have on us; • Our belief that customers recognize our products and brand name and use distributors as an effective supply channel; • Anticipating increased customer requirements to meet voluntary criteria related to the reduction or elimination of substances in our products; • Our belief that deferred cost of sales are recorded at their approximate carrying value and will have low risk of material impairment; • Our belief that our direct sales personnel combined with our distributors provide an effective means of reaching our customer base; • Our ability to increase the proprietary portion of our analog and interface product lines and the effect of such an increase; • Our belief that our processes afford us both cost-effective designs in existing and derivative products and greater functionality in new product designs; • The impact of any supply disruption we may experience; • Our ability to effectively utilize our facilities at appropriate capacity levels and anticipated costs; • That we adjust capacity utilization to respond to actual and anticipated business and industry-related conditions; • That our existing facilities will provide sufficient capacity to respond to increases in demand with modest incremental capital expenditures; • That manufacturing costs will be reduced by transition to advanced process technologies; • Our ability to maintain manufacturing yields; • Continuing our investments in new and enhanced products; • The cost effectiveness of using our own assembly and test operations; • Our anticipated level of capital expenditures; • Continuation and amount of quarterly cash dividends; • The sufficiency of our existing sources of liquidity to finance anticipated capital expenditures and otherwise meet our anticipated cash requirements, and the effects that our contractual obligations are expected to have on them; • The impact of seasonality on our business; • The accuracy of our estimates used in valuing employee equity awards; • That the resolution of legal actions will not have a material effect on our business, and the accuracy of our assessment of theprobability of loss and range of potential loss; • The recoverability of our deferred tax assets; • The adequacy of our tax reserves to offset any potential tax liabilities, having the appropriate support for our income tax positions and the accuracy of our estimated tax rate; • Our belief that the expiration of any tax holidays will not have a material impact on our overall tax expense or effective tax rate; 21-------------------------------------------------------------------------------- Table of Contents • Our belief that the estimates used in preparing our consolidated financial statements are reasonable; • Our belief that recently issued accounting pronouncements listed in this document will not have a significant impact on ourconsolidated financial statements; • Our actions to vigorously and aggressively defend and protect our intellectual property on a worldwide basis; • Our ability to obtain patents and intellectual property licenses and minimize the effects of litigation; • The level of risk we are exposed to for product liability claims or indemnification claims; • The effect of fluctuations in market interest rates on our income and/or cash flows; • The effect of fluctuations in currency rates; • The accuracy of our estimates of market information that determines the value of our Auction Rate Securities (ARS), and that the lack of markets for the ARS will not have a material impact on ourliquidity, cash flow, or ability to fund operations; • That our offshore earnings are considered to be permanently reinvested offshore and that we could determine to repatriate some of our offshore earnings in future periods to fund stockholder dividends, share repurchases, acquisitions or other corporate activities; • That a significant portion of our future cash generation will be in our foreign subsidiaries; • Our intention to indefinitely reinvest undistributed earnings of certain non-US subsidiaries in those subsidiaries; • Our intent to maintain a high-quality investment portfolio that preserves principal, meets liquidity needs, avoids inappropriate concentrations and delivers an appropriate yield; and • Our ability to collect accounts receivable. We begin our Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) with a summary of Microchip's overall business strategy to give the reader an overview of the goals of our business and the overall direction of our business and products. 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, 2013 compared to the three and nine months ended December 31, 2012. We then provide an analysis of changes in our balance sheet and cash flows, and discuss our financial commitments in sections titled "Liquidity and Capital Resources," "Contractual Obligations" and "Off-Balance Sheet Arrangements." Strategy Our goal is to be a worldwide leader in providing specialized semiconductor products for a wide variety of embedded control applications. Our strategic focus is on the embedded control market, which includes microcontrollers, high-performance linear and mixed signal devices, power management and thermal management devices, connectivity devices, interface devices, Serial EEPROMs, SuperFlash memory products, our patented KeeLoq® security devices and Flash IP solutions. We provide highly cost-effective embedded control products that also offer the advantages of small size, high performance, low voltage/power operation and ease of development, enabling timely and cost-effective embedded control product integration by our customers. We license SuperFlash technology to foundries, integrated device manufacturers and design partners throughout the world for use in the manufacture of advanced microcontroller products. We sell our products to a broad base of domestic and international customers across a variety of industries. The principal markets that we serve include consumer, automotive, industrial, office automation and telecommunications. Our business is subject to fluctuations based on economic conditions within these markets. Our manufacturing operations include wafer fabrication, wafer probe and assembly and test. The ownership of a substantial portion of our manufacturing resources is an important component of our business strategy, enabling us to maintain a high level of manufacturing control resulting in us being one of the lowest cost producers in the embedded control industry. By owning our wafer fabrication facilities and our assembly and test operations, and by employing statistical process control techniques, we have been able to achieve and maintain high production yields. Direct control over manufacturing resources allows us to shorten our design and production cycles. This control also allows us to capture a portion of the wafer manufacturing and the assembly and test profit margin. We do outsource a significant portion of our wafer fabrication and assembly and test requirements to third parties. 22-------------------------------------------------------------------------------- Table of Contents 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, Flash-IP systems, new 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 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 major strategic accounts in three geographical markets: the Americas, Europe and Asia. We currently maintain sales and support centers in major metropolitan areas in North America, Europe and Asia. We believe that a strong technical service presence is essential to the continued development of the embedded control market. Many of our field sales engineers (FSEs), field application engineers (FAEs), and sales management have technical degrees and have been previously employed in an engineering environment. We believe that the technical knowledge of our sales force is a key competitive advantage in the sale of our products. The primary mission of our FAE team is to provide technical assistance to strategic accounts and to conduct periodic training sessions for FSEs and distributor sales teams. FAEs also frequently conduct technical seminars for our customers in major cities around the world, and work closely with our distributors to provide technical assistance and end-user support. Critical Accounting Policies and Estimates General Our discussion and analysis of Microchip's financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. We review the accounting policies we use in reporting our financial results on a regular basis. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, business combinations, share-based compensation, inventories, income taxes, junior subordinated convertible debentures and contingencies. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Our results may differ from these estimates due to actual outcomes being different from those on which we based our assumptions. We review these estimates and judgments on an ongoing basis. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements. We also have other policies that we consider key accounting policies, such as our policy regarding revenue recognition to original equipment manufacturers (OEMs); however, we do not believe these policies require us to make estimates or judgments that are as difficult or subjective as our policies described below. Revenue Recognition - Distributors Our distributors worldwide generally have broad price protection and product return rights, so we defer revenue recognition until the distributor sells the product to their customer. Revenue is recognized when the distributor sells the product to an end-customer, at which time the sales price becomes fixed or determinable. Revenue is not recognized upon shipment to our distributors since, due to discounts from list price as well as price protection rights, the sales price is not substantially fixed or determinable at that time. At the time of shipment to these distributors, we record a trade receivable for the selling price as there is a legally enforceable right to payment, relieve inventory for the carrying value of goods shipped since legal title has passed to the distributor, and record the gross margin in deferred income on shipments to distributors on our condensed consolidated balance sheets. 23-------------------------------------------------------------------------------- Table of Contents Deferred income on shipments to distributors effectively represents the gross margin on the sale to the distributor; however, the amount of gross margin that we recognize in future periods could be less than the deferred margin as a result of credits granted to distributors on specifically identified products and customers to allow the distributors to earn a competitive gross margin on the sale of our products to their end customers and price protection concessions related to market pricing conditions. We sell the majority of the items in our product catalog to our distributors worldwide at a uniform list price. However, distributors resell our products to end customers at a very broad range of individually negotiated price points. The majority of our distributors' resales require a reduction from the original list price paid. Often, under these circumstances, we remit back to the distributor a portion of their original purchase price after the resale transaction is completed in the form of a credit against the distributors' outstanding accounts receivable balance. The credits are on a per unit basis and are not given to the distributor until they provide information to us regarding the sale to their end customer. The price reductions vary significantly based on the customer, product, quantity ordered, geographic location and other factors, and discounts to a price less than our cost have historically been rare. The effect of granting these credits establishes the net selling price to our distributors for the product and results in the net revenue recognized by us when the product is sold by the distributors to their end customers. Thus, a portion of the "deferred income on shipments to distributors" balance represents the amount of distributors' original purchase price that will be credited back to the distributor in the future. The wide range and variability of negotiated price concessions granted to distributors does not allow us to accurately estimate the portion of the balance in the deferred income on shipments to distributors' account that will be credited back to the distributors. Therefore, we do not reduce deferred income on shipments to distributors or accounts receivable by anticipated future concessions; rather, price concessions are typically recorded against deferred income on shipments to distributors and accounts receivable when incurred, which is generally at the time the distributor sells the product. At December 31, 2013, we had approximately $215.5 million of deferred revenue and $72.2 million in deferred cost of sales recognized as $143.3 million of deferred income on shipments to distributors. At March 31, 2013, we had approximately $201.8 million of deferred revenue and $62.8 million in deferred cost of sales recognized as $139.0 million of deferred income on shipments to distributors. The deferred income on shipments to distributors that will ultimately be recognized in our income statement will be lower than the amount reflected on the balance sheet due to additional price credits to be granted to the distributors when the product is sold to their customers. These additional price credits historically have resulted in the deferred income approximating the overall gross margins that we recognize in the distribution channel of our business. Distributor advances, reflected as a reduction of deferred income on shipments to distributors on our condensed consolidated balance sheets, totaled $91.7 million at December 31, 2013 and $70.1 million at March 31, 2013. On sales to distributors, our payment terms generally require the distributor to settle amounts owed to us for an amount in excess of their ultimate cost. The sales price to our distributors may be higher than the amount that the distributors will ultimately owe us because distributors often negotiate price reductions after purchasing the product from us and such reductions are often significant. It is our practice to apply these negotiated price discounts to future purchases, requiring the distributor to settle receivable balances, on a current basis, generally within 30 days, for amounts originally invoiced. This practice has an adverse impact on the working capital of our distributors. As such, we have entered into agreements with certain distributors whereby we advance cash to the distributors to reduce the distributor's working capital requirements. These advances are reconciled at least on a quarterly basis and are estimated based on the amount of ending inventory as reported by the distributor multiplied by a negotiated percentage. Such advances have no impact on our revenue recognition or our condensed consolidated statements of income. We process discounts taken by distributors against our deferred income on shipments to distributors' balance and true-up the advanced amounts generally after the end of each completed fiscal quarter. The terms of these advances are set forth in binding legal agreements and are unsecured, bear no interest on unsettled balances and are due upon demand. The agreements governing these advances can be canceled by us at any time. We reduce product pricing through price protection based on market conditions, competitive considerations and other factors. Price protection is granted to distributors on the inventory they have on hand at the date the price protection is offered. When we reduce the price of our products, it allows the distributor to claim a credit against its outstanding accounts receivable balances based on the new price of the inventory it has on hand as of the date of the price reduction. There is no immediate revenue impact from the price protection, as it is reflected as a reduction of the deferred income on shipments to distributors balance. Products returned by distributors and subsequently scrapped have historically been immaterial to our consolidated results of operations. We routinely evaluate the risk of impairment of the deferred cost of sales component of the deferred income on shipments to distributor's account. Because of the historically immaterial amounts of inventory that have been scrapped, and historically rare instances where discounts given to a distributor result in a price less than our cost, we believe the deferred costs are recorded at their approximate carrying value. 24-------------------------------------------------------------------------------- Table of Contents Business Combinations All of our business combinations are accounted for at fair value under the acquisition method of accounting. Under the acquisition method of accounting, (i) acquisition-related costs, except for those costs incurred to issue debt or equity securities, will be expensed in the period incurred; (ii) non-controlling interests will be valued at fair value at the acquisition date; (iii) in-process research and development will be recorded at fair value as an intangible asset at the acquisition date and amortized once the technology reaches technological feasibility; (iv) restructuring costs associated with a business combination will be expensed subsequent to the acquisition date; and (v) changes in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date will be recognized through income tax expense or directly in contributed capital. The measurement of fair value of assets accrued and liabilities assumed requires significant judgment. The valuation of intangible assets and acquired investments in privately held companies, in particular, requires that we use valuation techniques such as the income approach. The income approach includes the use of a discounted cash flow model, which includes discounted cash flow scenarios and requires the following significant estimates: revenue, expenses, capital spending and other costs, and discount rates based on the respective risks of the cash flows. The valuation of non-marketable equity investments acquired also takes into account variables such as conditions reflected in the capital markets, recent financing activity by the investees, the investees' capital structure and the terms of the investees' issued interests. Share-Based Compensation We measure fair value and recognize compensation expense for all share-based payment awards, including grants of employee stock options, RSUs, stock appreciation rights, and employee stock purchase rights, to be recognized in our financial statements based on their respective grant date fair values. Total share-based compensation during the nine months ended December 31, 2013 was $41.4 million, of which $35.7 million was reflected in operating expenses. Total share-based compensation reflected in cost of sales during the nine months ended December 31, 2013 was $5.7 million. Total share-based compensation included in our inventory balance was $5.5 million at December 31, 2013. Determining the appropriate fair-value model and calculating the fair value of share-based awards at the date of grant requires judgment. The fair value of our RSUs is based on the fair market value of our common stock on the date of grant discounted for expected future dividends. We use the Black-Scholes option pricing model to estimate the fair value of employee stock options and rights to purchase shares under our employee stock purchase plans. Option pricing models, including the Black-Scholes model, also require the use of input assumptions, including expected volatility, expected life, expected dividend rate, and expected risk-free rate of return. We use a blend of historical and implied volatility based on options freely traded in the open market as we believe this is more reflective of market conditions and a better indicator of expected volatility than using purely historical volatility. The expected life of the awards is based on historical and other economic data trended into the future. The risk-free interest rate assumption is based on observed interest rates appropriate for the terms of our awards. The dividend yield assumption is based on our history and expectation of future dividend payouts. We estimate the number of share-based awards which will be forfeited due to employee turnover. Quarterly changes in the estimated forfeiture rate can have a significant effect on reported share-based compensation, as the effect of adjusting the rate for all expense amortization after April 1, 2006 is recognized in the period the forfeiture estimate is changed. If the actual forfeiture rate is higher or lower than the estimated forfeiture rate, then an adjustment is made to increase or decrease the estimated forfeiture rate, which will result in a decrease or increase to the expense recognized in our financial statements. If forfeiture adjustments are made, they would affect our gross margin, research and development expenses, and selling, general and administrative expenses. The effect of forfeiture adjustments in the third quarter of fiscal 2014 was immaterial. We evaluate the assumptions used to value our awards on a quarterly basis. If factors change and we employ different assumptions, share-based compensation expense may differ significantly from what we have recorded in the past. If there are any modifications or cancellations of the underlying unvested securities, we may be required to accelerate, increase or cancel any remaining unearned share-based compensation expense. Future share-based compensation expense and unearned share-based compensation will increase to the extent that we grant additional equity awards to employees. Inventories Inventories are valued at the lower of cost or market using the first-in, first-out method. We write down our inventory for estimated obsolescence or unmarketable inventory in an amount equal to the difference between the cost of inventory and the estimated market value based on assumptions about future demand and market conditions. If actual market conditions are less favorable than those we projected, additional inventory write-downs may be required. Inventory impairment charges establish a new cost basis for inventory and charges are not subsequently reversed to income even if circumstances later suggest that increased carrying amounts are recoverable. In estimating our inventory obsolescence, we primarily evaluate estimates of demand over a 12-month period and record impairment charges for inventory on hand in excess of the estimated 25-------------------------------------------------------------------------------- Table of Contents 12-month demand. Estimates for projected 12-month demand are based on the average shipments of the prior three-month period, which are then annualized to adjust for any potential seasonality in our business. The estimated 12-month demand is compared to our most recently developed sales forecast to further reconcile the 12-month demand estimate. Management reviews and adjusts the estimates as appropriate based on specific situations. For example, demand can be adjusted up for new products for which historic sales are not representative of future demand. Alternatively, demand can be adjusted down to the extent any existing products are being replaced or discontinued. In periods where our production levels are substantially below our normal operating capacity, the reduced production levels of our manufacturing facilities are charged directly to cost of sales. Approximately $1.8 million and $17.2 million was charged to cost of sales in the three and nine months ended December 31, 2013, respectively, as a result of decreased production in our wafer fabs compared to approximately $10.5 million and $18.8 million in the three and nine months ended December 31, 2012, respectively. Income Taxes As part of the process of preparing our condensed consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our condensed consolidated balance sheets. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income within the relevant jurisdiction and to the extent we believe that recovery is not likely, we must establish a valuation allowance. We have provided valuation allowances for certain of our deferred tax assets, including state net operating loss carryforwards, foreign tax credits and state tax credits, where it is more likely than not that some portion, or all of such assets, will not be realized. At December 31, 2013, the valuation allowances totaled $93.0 million. Should we determine that we would not be able to realize all or part of our net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made. At December 31, 2013, our deferred tax asset, net of valuation allowances, was $72.1 million. Various taxing authorities in the U.S. and other countries in which we do business scrutinize 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. SMSC is currently under IRS audit for fiscal years 2011 and 2012. We recognize liabilities for anticipated tax audit issues in the U.S. and other tax jurisdictions based on our estimate of whether, and the extent to which, additional tax payments are probable. We believe 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 prove 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 an ultimate assessment, a future charge to expense would be recorded in the period in which the assessment is determined. Junior Subordinated Convertible Debentures We separately account for the liability and equity components of our junior subordinated convertible debentures in a manner that reflects our nonconvertible debt (unsecured debt) borrowing rate when interest cost is recognized. This results in a bifurcation of a component of the debt, classification of that component in equity and the accretion of the resulting discount on the debt to be recognized as part of interest expense in our condensed consolidated statements of income. Additionally, certain embedded features of the debentures qualify as derivatives and are bundled as a compound embedded derivative that is measured at fair value. Lastly, we include the dilutive effect of the shares of our common stock issuable upon conversion of the outstanding junior subordinated convertible debentures in our diluted income per share calculation regardless of whether the market price trigger or other contingent conversion feature has been met. We apply the treasury stock method as we have adopted an accounting policy to settle the principal amount of the junior subordinated convertible debentures in cash. This method results in incremental dilutive shares when the average fair value of our common stock for a reporting period exceeds the conversion price per share which was $26.07 at December 31, 2013 and adjusts as dividends are recorded in the future. 26-------------------------------------------------------------------------------- Table of Contents Contingencies In the ordinary course of our business, we are involved in a limited number of legal actions, both as plaintiff and defendant, and could incur uninsured liability in any one or more of them. We also periodically receive notifications from various third parties alleging infringement of patents, intellectual property rights or other matters. With respect to pending legal actions to which we are a party, although the outcomes of these actions are not generally determinable, we believe that the ultimate resolution of these matters will not have a material adverse effect on our financial position, cash flows or results of operations. Litigation relating to the semiconductor industry is not uncommon, and we are, and from time to time have been, subject to such litigation. No assurances can be given with respect to the extent or outcome of any such litigation in the future. Results of Operations The following table sets forth certain operational data as a percentage of net sales for the periods indicated: Three Months Ended Nine Months Ended December 31, December 31, 2013 2012 2013 2012 Net sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of sales 41.4 51.8 41.7 47.9 Gross profit 58.6 48.2 58.3 52.1 Research and development 15.8 17.2 15.8 16.0 Selling, general and administrative 13.9 16.7 14.1 17.1 Amortization of acquired intangible assets 4.5 9.5 5.1 6.2 Special charges 0.2 0.6 0.2 2.2 Operating income 24.2 % 4.2 % 23.1 % 10.6 % Net Sales We operate in two industry segments and engage primarily in the design, development, manufacture and marketing of semiconductor products as well as the licensing of SuperFlash intellectual property. We sell our products to distributors and OEMs, in a broad range of markets, perform ongoing credit evaluations of our customers and generally require no collateral. In certain circumstances, a customer's financial condition may require collateral, and, in such cases, the collateral would be provided primarily by letters of credit. Our net sales for the quarter ended December 31, 2013 were $482.4 million, a decrease of 2.1% from the previous quarter's sales of $492.7 million, and an increase of 15.9% from net sales of $416.0 million in the quarter ended December 31, 2012. Our net sales for the nine months ended December 31, 2013 were $1,437.8 million, an increase of 24.9% from net sales of $1,151.5 million in the nine months ended December 31, 2012. The decrease in net sales in the quarter ended December 31, 2013 over the previous quarter was due primarily to general economic and semiconductor industry conditions. The increase in net sales in the three months ended December 31, 2013 compared to the three months ended December 31, 2012 was due primarily to general economic and semiconductor industry conditions and market share gains. The increase in net sales in the nine months ended December 31, 2013 compared to the nine months ended December 31, 2012 was due primarily to our acquisition of SMSC on August 2, 2012, general economic and semiconductor industry conditions and market share gains. Average selling prices for our semiconductor products were up approximately 1% and 5% for the three and nine-month periods ended December 31, 2013, over the corresponding periods of the previous fiscal year. The number of units of our semiconductor products sold were up approximately 16% and 19% for the three and nine-month periods ended December 31, 2013 over the corresponding periods of the previous fiscal year. The average selling prices and the unit volumes of our sales are impacted by the mix of our products sold and overall semiconductor market conditions. Key factors related to the amount of net sales during the three and nine-month periods ended December 31, 2013 compared to the three and nine-month periods ended December 31, 2012 include: 27-------------------------------------------------------------------------------- Table of Contents • our acquisition of SMSC during the second quarter of fiscal 2013; • global economic conditions in the markets we serve; • semiconductor industry conditions; • inventory holding patterns of our customers; • increasing semiconductor content in our customers' products; • customers' increasing needs for the flexibility offered by our programmable solutions; • our new product offerings that have increased our served available market; and • continued market share gains in the segments of the markets we address. Sales by product line for the three and nine months ended December 31, 2013 and 2012 were as follows (dollars in thousands): Three Months Ended Nine Months Ended December 31, December 31, (unaudited) (unaudited) 2013 % 2012 % 2013 % 2012 % Microcontrollers $ 313,305 65.0 $ 266,033 64.0 $ 934,614 65.0 $ 759,690 66.0 Analog, interface and mixed signal products 108,925 22.6 93,305 22.4 320,600 22.3 210,558 18.3 Memory products 32,503 6.7 32,476 7.8 101,482 7.0 109,764 9.5 Technology licensing 24,074 5.0 21,338 5.1 71,418 5.0 61,741 5.4 Other 3,565 0.7 2,895 0.7 9,719 0.7 9,726 0.8 Total sales $ 482,372 100.0 % $ 416,047 100.0 % $ 1,437,833 100.0 % $ 1,151,479 100.0 % Microcontrollers Our microcontroller product line represents the largest component of our total net sales. Microcontrollers and associated application development systems accounted for approximately 65.0% of our total net sales for each of the three and nine-month periods ended December 31, 2013 compared to approximately 64.0% of our total net sales for the three-month period ended December 31, 2012 and approximately 66.0% of our total net sales for the nine-month period ended December 31, 2012. Net sales of our microcontroller products increased approximately 17.8% in the three-month period ended December 31, 2013 and approximately 23.0% in the nine-month period ended December 31, 2013 compared to the three and nine-month periods ended December 31, 2012. The sales increase in the three-month period ended December 31, 2013 compared to the three-month period ended December 31, 2012 was driven primarily by market share gains and general economic and semiconductor industry conditions in the end markets we serve including the consumer, automotive, industrial control, communications and computing markets. The sales increase in the nine-month period ended December 31, 2013 compared to the nine-month period ended December 31, 2012 was driven primarily by our acquisition of SMSC, market share gains and general economic and semiconductor industry 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 products have remained relatively constant over time due to the proprietary nature of these products. We have experienced, and expect to continue to experience, moderate pricing pressure in certain microcontroller product lines, primarily due to competitive conditions. We have 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 of increased pricing pressure in the future, which would adversely affect our operating results. Analog, Interface and Mixed Signal Products Sales of our analog, interface and mixed signal products accounted for approximately 22.6% of our total net sales for the three-month period ended December 31, 2013 and approximately 22.3% of our total net sales for the nine-month period ended December 31, 2013 compared to approximately 22.4% of our total net sales for the three-month period ended December 31, 2012 and approximately 18.3% of our total net sales for the nine-month period ended December 31, 2012. 28-------------------------------------------------------------------------------- Table of Contents Net sales of our analog, interface and mixed signal products increased approximately 16.7% in the three-month period ended December 31, 2013 and approximately 52.3% in the nine-month period ended December 31, 2013 compared to the three and nine-month periods ended December 31, 2012. The sales increase in the three-month period ended December 31, 2013 compared to the three-month period ended December 31, 2012 was driven primarily by general economic and semiconductor industry conditions and market share gains achieved within the analog, interface and mixed signal market. The sales increase in the nine-month period ended December 31, 2013 compared to the nine-month period ended December 31, 2012 was driven primarily by our acquisition of SMSC, general economic and semiconductor industry conditions and market share gains achieved within the analog, interface and mixed signal market. Analog, interface and mixed signal products can be proprietary or non-proprietary in nature. Currently, we consider more than 80% of our analog, interface and mixed signal product mix to be proprietary in nature, where prices are relatively stable, similar to the pricing stability experienced in our microcontroller products. The non-proprietary portion of our analog, interface and mixed signal business will experience price fluctuations driven primarily by the current supply and demand for those products. We may be unable to maintain the average selling prices of our analog, interface and mixed signal 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 and mixed signal products will increase over time. Memory Products Sales of our memory products accounted for approximately 6.7% of our total net sales for the three-month period ended December 31, 2013 and approximately 7.0% of our total net sales for the nine-month period ended December 31, 2013 compared to approximately 7.8% of our total net sales for the three-month period ended December 31, 2012 and approximately 9.5% of our total net sales for the nine-month period ended December 31, 2012. Net sales of our memory products were essentially flat in the three-month period ended December 31, 2013 and decreased approximately 7.5% in the nine-month period ended December 31, 2013 compared to the three and nine-month periods ended December 31, 2012. The sales decrease in the nine-month period ended December 31, 2013 compared to the nine-month period ended December 31, 2012 was driven primarily by adverse customer demand conditions within the Serial EEPROM and Flash memory markets. 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 technology licensed for the use of our SuperFlash technology and fees for engineering services. Technology licensing accounted for approximately 5.0% of our total net sales for each of the three and nine-month periods ended December 31, 2013 compared to approximately 5.1% of our total net sales for the three-month period ended December 31, 2012 and approximately 5.4% of our total net sales for the nine-month period ended December 31, 2012. Net sales related to our technology licensing increased approximately 12.8% in the three-month period ended December 31, 2013 and approximately 15.7% in the nine-month period ended December 31, 2013 compared to the three and nine-month periods ended December 31, 2012. These sales increases were driven primarily by the adoption of our technology by more manufacturers of semiconductors as well as semiconductor industry and global economic conditions. Other Revenue from assembly and test subcontracting services performed during each of the three and nine-month periods ended December 31, 2013 and 2012 was less than one percent of our total net sales. 29-------------------------------------------------------------------------------- Table of Contents Distribution Distributors accounted for approximately 53.6% of our net sales in the three-month period ended December 31, 2013 and approximately 52.5% of our net sales in the three-month period ended December 31, 2012. Distributors accounted for approximately 53.6% of our net sales in the nine-month period ended December 31, 2013 and approximately 53.7% of our net sales in the nine-month period ended December 31, 2012. 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. 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, 2013, our distributors maintained 33 days of inventory of our products compared to 30 days at March 31, 2013. Over the past three fiscal years, the days of inventory maintained by our distributors have fluctuated between 27 days and 47 days. We do not believe that inventory holding patterns at our distributors will materially impact our net sales, due to the fact that we recognize revenue based on sell-through for all our distributors. Sales by Geography Sales by geography for the three and nine months ended December 31, 2013 and 2012 were as follows (dollars in thousands): Three Months Ended Nine Months Ended December 31, December 31, (unaudited) (unaudited) 2013 % 2012 % 2013 % 2012 % Americas $ 90,698 18.8 $ 77,299 18.6 $ 272,811 19.0 $ 228,835 19.9 Europe 95,423 19.8 84,066 20.2 295,584 20.5 245,051 21.3 Asia 296,251 61.4 254,682 61.2 869,438 60.5 677,593 58.8 Total sales $ 482,372 100.0 % $ 416,047 100.0 % $ 1,437,833 100.0 % $ 1,151,479 100.0 % 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 the three-month period ended December 31, 2013 and approximately 84% of our total net sales in the nine-month period ended December 31, 2013. Sales to foreign customers accounted for approximately 82% of our total net sales in each of the three and nine-month periods ended December 31, 2012. Substantially all of our foreign sales are U.S. dollar denominated. Sales to customers in Asia have generally increased over time due to many of our customers transitioning their manufacturing operations to Asia and growth in demand from the emerging Asian market. 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 was $282.7 million in the three months ended December 31, 2013 and $200.4 million in the three months ended December 31, 2012. Our gross profit was $838.2 million in the nine months ended December 31, 2013 and $599.4 million in the nine months ended December 31, 2012. Gross profit as a percent of sales was 58.6% in the three months ended December 31, 2013 and 48.2% in the three months ended December 31, 2012. Gross profit as a percent of sales was 58.3% in the nine months ended December 31, 2013 and 52.1% in the nine months ended December 31, 2012. 30-------------------------------------------------------------------------------- Table of Contents The most significant factors affecting our gross profit percentage in the periods covered by this Form 10-Q were: • charges of approximately $30.8 million and $55.0 million in the three and nine months ended December 31, 2012, respectively, related to acquired inventory valuation adjustments as a result of our acquisition activity reducing margins below their historical levels; • production levels being below the range of normal capacity levels, resulting in under absorption of fixed costs, in all periods covered by this report, but particularly during the nine months ended December 31, 2013 and the three and nine months ended December 31, 2012; • for the nine months ended December 31, 2013, inventory write-downs being lower than the gross margin impact of sales of inventory that was previously written down: • for the three months ended December 31, 2013 and the three and nine months ended December 31, 2012, inventory write-downs being higher than the gross margin impact of sales of inventory that was previously written down; and • fluctuations in our product mix of microcontrollers, analog 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; and • lower depreciation as a percentage of cost of sales. 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-month periods ended December 31, 2013 and 2012, we operated below normal capacity levels, which we typically consider to be 90% to 95% of the actual capacity of our installed equipment, in our wafer fabrication facilities in response to uncertain global economic conditions and our inventory position. As a result of decreased production in our wafer fabs, approximately $1.8 million and $17.2 million was charged to cost of sales during the three and nine months ended December 31, 2013, respectively, compared to $10.5 million and $18.8 million during the three and nine months ended December 31, 2012, respectively. We operated at normal capacity levels in our Thailand assembly and test facility during the three and nine months ended December 31, 2013. During the three and nine months ended December 31, 2012, we operated below normal capacity levels in our Thailand assembly and test facility which had a negative impact on our gross margin during such periods. The process technologies utilized in our wafer fabs impact our gross margins. Fab 2 currently utilizes various manufacturing process technologies, but predominantly utilizes our 0.5 to 1.0 micron processes. Fab 4 predominantly utilizes our 0.22 to 0.5 micron processes. We continue to transition products to more advanced process technologies to reduce future manufacturing costs. All of our production has been on 8-inch wafers during the periods covered by this Form 10-Q. Our overall inventory levels were $274.6 million at December 31, 2013, compared to $242.3 million at March 31, 2013. We maintained 126 days of inventory on our balance sheet at December 31, 2013 compared to 116 days of inventory at March 31, 2013. We expect our inventory levels in the March 2014 quarter to be flat to down modestly over those levels at December 31, 2013. We believe our existing level of inventory will allow us to maintain competitive lead times and provide strong delivery performance to our customers and allow us to keep our fiscal 2014 capital expenditures at relatively low levels. We anticipate that our gross margins will fluctuate over time, driven primarily by capacity utilization levels, the overall mix of microcontroller products, analog, interface and mixed signal 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. During the three months ended December 31, 2013, approximately 49% of our assembly requirements were performed in our Thailand facility compared to approximately 60% of our assembly requirements during the three months ended December 31, 2012. The percentage of our assembly work that is performed internally fluctuates over time based on supply and demand conditions in the semiconductor industry and our internal capacity capabilities. Third-party contractors located in Asia perform the balance of our assembly operations. During each of the three-month periods ended December 31, 2013 and 2012, approximately 86% of our test requirements were performed in our Thailand facility. We believe that the assembly and test operations performed at our Thailand facility provide us with significant cost savings when compared to contractor assembly and test costs, as well as increased control over these portions of the manufacturing process. 31-------------------------------------------------------------------------------- Table of Contents We rely on outside wafer foundries for a significant portion of our wafer fabrication requirements. In each of the three and nine-month periods ended December 31, 2013, approximately 38% of our total net sales related to wafers purchased from outside foundries. In the three and nine-month periods ended December 31, 2012, approximately 39% and 31%, respectively, of our total net sales related to wafers purchased from outside foundries. The primary reason for the increased percentage in the nine months ended December 31, 2013 compared to the nine months ended December 31, 2012 is our acquisition of SMSC in the September 2012 quarter, as SMSC relied solely on outside wafer foundries for their wafer fabrication requirements. Our use of third parties involves some reduction in our level of control over the portions of our business that we subcontract. While we review the quality, delivery and cost performance of our third-party contractors, our future operating results could suffer if any third-party contractor is unable to maintain manufacturing yields, assembly and test yields and costs at approximately their current levels. Research and Development (R&D) R&D expenses for the three months ended December 31, 2013 were $76.3 million, or 15.8% of net sales, compared to $71.4 million, or 17.2% of net sales, for the three months ended December 31, 2012. R&D expenses for the nine months ended December 31, 2013 were $227.7 million, or 15.8% of net sales, compared to $184.3 million, or 16.0% of net sales, for the nine months ended December 31, 2012. 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 increased $5.0 million, or 7.0%, for the three months ended December 31, 2013 over the same period last year. The primary reasons for the increase in R&D costs in the 2013 period were higher headcount and bonus costs. R&D expenses increased $43.4 million, or 23.5%, for the nine months ended December 31, 2013 over the same period last year. The primary reasons for the increase in R&D costs in the 2013 period were additional costs from our acquisition of SMSC as well as higher headcount and bonus 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, 2013 were $66.9 million, or 13.9% of net sales, compared to $69.4 million, or 16.7% of net sales, for the three months ended December 31, 2012. Selling, general and administrative expenses for the nine months ended December 31, 2013 were $201.9 million, or 14.1% of net sales, compared to $196.7 million, or 17.1% of net sales, for the nine months ended December 31, 2012. Selling, general and administrative expenses include salary expenses related to field sales, marketing and administrative personnel, advertising and promotional expenditures and legal expenses. Selling, general and administrative expenses also include costs related to our direct sales force and field applications engineers who work in sales offices worldwide to stimulate demand by assisting customers in the selection and use of our products. Selling, general and administrative expenses decreased $2.5 million, or 3.6%, for the three months ended December 31, 2013 over the same period last year. The primary reasons for the dollar decrease in selling, general and administrative costs in the 2013 period were lower SMSC headcount costs partially offset by higher bonus costs. Selling, general and administrative expenses increased $5.2 million, or 2.6%, for the nine months ended December 31, 2013 over the same period last year. The primary reasons for the dollar increase in selling, general and administrative costs for the 2013 period were higher headcount costs related to our acquisition of SMSC and higher bonus costs partially offset by lower acquisition related legal, professional service and share-based compensation expenses. Selling, general and administrative expenses fluctuate over time, primarily due to revenue and operating expense investment levels. 32-------------------------------------------------------------------------------- Table of Contents Amortization of Acquired Intangible Assets Amortization of acquired intangible assets for the three and nine months ended December 31, 2013 were $21.8 million and $73.2 million, respectively. Amortization of acquired intangible assets for the three and nine months ended December 31, 2012 were $39.7 million and $71.6 million, respectively. Special Charges During the three and nine months ended December 31, 2013, we incurred severance-related, office closing and other costs associated with our acquisition activity of $0.8 million and $2.5 million, respectively. During the three and nine months ended December 31, 2012, we incurred approximately $2.6 million and $13.4 million, respectively, of severance-related, office closing costs, and other costs associated with the acquisition of SMSC. Also, during the nine months ended December 31, 2012, we incurred legal settlement costs of approximately $11.5 million for certain legal matters related to Silicon Storage Technology, Inc. (which we acquired in April 2010) in excess of previously accrued amounts. Other Income (Expense) Interest income in the three and nine months ended December 31, 2013 was $4.2 million and $12.2 million, respectively, compared to interest income of $3.8 million and $11.9 million in the three and nine months ended December 31, 2012, respectively. Interest expense in the three and nine months ended December 31, 2013 was $12.5 million and $36.8 million, respectively, compared to $11.1 million and $31.0 million in the three and nine months ended December 31, 2012, respectively. The primary reason for the increases in interest expense in the three and nine months ended December 31, 2013 relates to increased borrowings under our credit facility to partially finance our acquisition of SMSC. Other income, net in the three and nine months ended December 31, 2013 was $3.8 million and $6.1 million, respectively, compared to other expense, net of $0.2 million and other income, net of $0.3 million in the three and nine months ended December 31, 2012, respectively. The change in other income (expense), net in the three months ended December 31, 2013 compared to the same period last year primarily relates to a gain of $2.4 million recognized on a strategic investment in a company in which we previously owned an 18.3% interest and which we acquired in the three months ended December 31, 2013. The change in other income (expense), net in the nine months ended December 31, 2013 compared to the same period last year primarily relates to realized gains of $2.3 million from the sale of marketable equity and debt securities and the aforementioned gain of $2.4 million recognized on a strategic investment in a company we acquired compared to a prior year gain of $1.3 million related to the sale of inventory previously considered discontinued and fluctuations on our foreign currency derivatives. Provision for Income Taxes Our provision for income taxes reflects tax on foreign earnings and federal and state tax on U.S. earnings. We had an effective tax rate from continuing operations of 9.7% for the nine-month period ended December 31, 2013 and 34.1% for the nine-month period ended December 31, 2012. Our effective tax rate is lower than statutory rates in the U.S. due primarily to our mix of earnings in foreign jurisdictions with lower tax rates and a net one-time tax benefit associated with a favorable IRS examination partially offset by unfavorable items associated with the filing of our fiscal 2013 tax returns. Our effective tax rate was higher in the December 31, 2012 period due to certain tax expenses associated with our acquisition of SMSC. 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 2011 and later tax returns remain open for examination by the taxing authorities. SMSC is currently under IRS audit for fiscal years 2011 and 2012. We recognize liabilities for anticipated tax audit issues in the U.S. and other tax jurisdictions based on our estimate of whether, and the extent to which, additional tax payments are probable. We believe 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 prove 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. 33-------------------------------------------------------------------------------- Table of Contents Our Thailand manufacturing operations currently benefit from numerous tax holidays that have been granted to us by the Thailand government based on our investments in property, plant and equipment in Thailand. Our tax holiday periods in Thailand expire at various times in the future. Any expiration of our tax holidays are expected to have a minimal impact on our overall tax expense due to other tax holidays and an increase in income in other taxing jurisdictions with lower statutory rates. Liquidity and Capital Resources We had $2,031.3 million in cash, cash equivalents and short-term and long-term investments at December 31, 2013, an increase of $195.3 million from the March 31, 2013 balance. The increase in cash, cash equivalents and short-term and long-term investments over this time period is primarily attributable to cash generated from operating activities offset in part by dividend payments of $210.3 million. Net cash provided from operating activities was $473.2 million for the nine-month period ended December 31, 2013 compared to $331.5 million for the nine-month period ended December 31, 2012. The increase in cash flow from operations in the nine-month period ended December 31, 2013 compared to the nine-month period ended December 31, 2012 was primarily due to higher sales and net income during the nine-month period ended December 31, 2013. During the nine months ended December 31, 2013, net cash used in investing activities was $448.4 million compared to net cash used in investing activities of $931.1 million for the nine months ended December 31, 2012. The decrease in net cash used in investing activities was due primarily to $731.7 million of cash consideration, net of $180.9 million of cash and cash equivalents acquired, used in our acquisition of SMSC. Our level of capital expenditures varies from time to time as a result of actual and anticipated business conditions. Capital expenditures in the nine months ended December 31, 2013 were $79.5 million compared to $36.1 million in the nine months ended December 31, 2012. Capital expenditures were primarily for the expansion of production capacity and the addition of research and development equipment. We currently intend to spend approximately $100 million during the next twelve months to invest in equipment and facilities to maintain, and selectively increase capacity to meet our currently anticipated needs. We expect to finance our capital expenditures through our existing cash balances and cash flows from operations. We believe that the capital expenditures anticipated to be incurred over the next twelve months will provide sufficient manufacturing capacity to meet our currently anticipated needs. Net cash used in financing activities was $178.1 million for the nine months ended December 31, 2013 compared to net cash provided by financing activities of $428.2 million for the nine months ended December 31, 2012. We made payments on our borrowings under our credit agreements of $803.5 and $130.0 million during the nine months ended December 31, 2013 and 2012, respectively. Cash received on borrowings under our credit agreements totaled $833.5 million and $740.0 million during the nine months ended December 31, 2013 and 2012, respectively. We paid cash dividends to our stockholders of $210.3 million in the nine months ended December 31, 2013 and $204.6 million in the nine months ended December 31, 2012. Proceeds from the exercise of stock options and employee purchases under our employee stock purchase plans were $24.8 million for the nine months ended December 31, 2013 and $22.6 million for the nine months ended December 31, 2012. On June 27, 2013, we entered into a $2.0 billion credit agreement with certain lenders. The credit agreement provides for a $350.0 million term loan and a $1.65 billion revolving credit facility, with a $125 million foreign currency sublimit, a $35 million letter of credit sublimit and a $25 million swingline loan sublimit, terminating on June 27, 2018. The credit agreement also contains an increase option permitting us, subject to certain requirements, to arrange with existing lenders and/or new lenders for them to provide up to an aggregate of $300 million in additional commitments, which may be for revolving loans or term loans. Proceeds of loans made under the credit agreement may be used for working capital and general corporate purposes. The new credit agreement replaced another credit agreement we had in place since August 2011. At December 31, 2013, $650.0 million of borrowings were outstanding under the credit agreement consisting of $300.0 million of a revolving line of credit and $350.0 million of a term loan, net of $1.2 million of debt discount resulting from amounts paid to the lenders. See Note 16 of the notes to condensed consolidated financial statements for more information regarding the credit agreement. Our total cash, cash equivalents, short-term investments and long-term investments held by our foreign subsidiaries was $2,022.2 million at December 31, 2013 and $1,782.0 million at March 31, 2013. Under current tax laws and regulations, 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. Our balance of cash, cash equivalents, short-term investments and long-term investments available for our U.S. operations as of December 31, 2013 and March 31, 2013 was approximately $9.2 million and $100.0 million, 34-------------------------------------------------------------------------------- Table of Contents respectively. 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. We consider our offshore earnings to be permanently reinvested offshore. However, we could determine to repatriate some of our offshore earnings in future periods to fund stockholder dividends, share repurchases, acquisitions or other corporate activities in the future. We expect that a significant portion of our future cash generation will be in our foreign subsidiaries. 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, 2013, we had no foreign currency forward contracts outstanding. On December 11, 2007, we announced that our Board of Directors had authorized the repurchase of up to 10.0 million shares of our common stock in the open market or in privately negotiated transactions. As of December 31, 2013, we had repurchased 7.5 million shares under this 10.0 million share authorization for a total of $234.7 million. There is no expiration date associated with this program. The timing and amount of future repurchases will depend upon market conditions, interest rates, and corporate considerations. As of December 31, 2013, we held approximately 19.7 million shares as treasury shares. On October 28, 2002, we announced that our Board of Directors had approved and instituted a quarterly cash dividend on our common stock. A quarterly dividend of $0.3545 per share was paid on December 5, 2013 in the aggregate amount of $70.6 million. A quarterly dividend of $0.355 per share was declared on January 30, 2014 and will be paid on March 7, 2014 to stockholders of record as of February 21, 2014. We expect the aggregate March 2014 cash dividend to be approximately $70.7 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 ongoing 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 agreement will be sufficient to meet our currently anticipated cash requirements for at least the next 12 months. However, the semiconductor industry is capital intensive. In order to remain competitive, we must constantly evaluate the need to make significant investments in capital equipment for both production and research and development. We may further borrow under our credit agreement 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 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, demand for our products, changes in industry conditions, product mix, competitive factors and our ability to identify suitable acquisition candidates. There can be no assurance that such financing will be available on acceptable terms, and any additional equity financing would result in incremental ownership dilution to our existing stockholders. Contractual Obligations There have not been any material changes in our contractual obligations from what we disclosed in our Annual Report on Form 10-K for the fiscal year ended March 31, 2013. Off-Balance Sheet Arrangements As of December 31, 2013, we are not involved in any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K. |