Document
Table of Contents


 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-Q

(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2016.
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________

Commission File Number:  0-21184

 mich4ca02a01a01a05.jpg
 
  
MICROCHIP TECHNOLOGY INCORPORATED
(Exact Name of Registrant as Specified in Its Charter)

Delaware
 
86-0629024
(State or Other Jurisdiction of Incorporation or Organization)
 
(IRS Employer Identification No.)

2355 W. Chandler Blvd., Chandler, AZ  85224-6199
(480) 792-7200
(Address, Including Zip Code, and Telephone Number,
Including Area Code, of Registrant's
Principal Executive Offices)

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for the past 90 days. Yes  x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act:
Large accelerated filer
x
 
Accelerated filer
o
Non-accelerated filer
o
 
Smaller reporting company
o
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  (Check One)
Yes    o No   x
Shares Outstanding of Registrant's Common Stock
Class
 
Outstanding at October 31, 2016
Common Stock, $0.001 par value
 
216,016,163 shares
 


MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES

INDEX

 
 
 
Page
 
 
 
PART I.  FINANCIAL INFORMATION
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
PART II.  OTHER INFORMATION
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
CERTIFICATIONS
 
 
 
EXHIBITS
 



Table of Contents
MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
(unaudited)


Item1.
Financial Statements

ASSETS
September 30,
2016
 
March 31,
2016
Cash and cash equivalents
$
489,988

 
$
2,092,751

Short-term investments
848

 
353,284

Accounts receivable, net
451,042

 
290,183

Inventories
424,690

 
306,815

Prepaid expenses
60,817

 
41,992

Assets held for sale
14,080

 
—

Other current assets
49,270

 
11,688

Total current assets
1,490,735

 
3,096,713

Property, plant and equipment, net
716,998

 
609,396

Long-term investments
—

 
118,549

Goodwill
2,384,740

 
1,012,652

Intangible assets, net
2,322,706

 
606,349

Long-term deferred tax assets
68,823

 
14,831

Other assets
90,394

 
79,393

Total assets
$
7,074,396

 
$
5,537,883

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
Accounts payable
$
131,625

 
$
79,312

Accrued liabilities
223,982

 
119,265

Deferred income on shipments to distributors
223,196

 
183,432

Total current liabilities
578,803

 
382,009

Long-term line of credit
1,669,834

 
1,043,156

Senior convertible debentures
1,238,731

 
1,216,313

Junior convertible debentures
196,868

 
193,936

Long-term income tax payable
292,957

 
111,061

Long-term deferred tax liability
416,452

 
399,218

Other long-term liabilities
161,239

 
41,271

Stockholders' equity:
 
 
 
Preferred stock, $0.001 par value; authorized 5,000,000 shares; no shares issued or outstanding
—

 
—

Common stock, $0.001 par value; authorized 450,000,000 shares; 237,465,809 shares issued and 215,954,392 shares outstanding at September 30, 2016; 227,416,789 shares issued and 204,081,727 shares outstanding at March 31, 2016
216

 
204

Additional paid-in capital
1,905,228

 
1,391,553

Common stock held in treasury: 21,511,417 shares at September 30, 2016; 23,335,062 shares at March 31, 2016
(765,904
)
 
(820,066
)
Accumulated other comprehensive loss
(15,896
)
 
(3,357
)
Retained earnings
1,395,868

 
1,582,585

Total stockholders' equity
2,519,512

 
2,150,919

Total liabilities and stockholders' equity
$
7,074,396

 
$
5,537,883

See accompanying notes to condensed consolidated financial statements

3
Table of Contents


MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
 
Three Months Ended
 
Six Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Net sales
$
871,364

 
$
541,391

 
$
1,670,775

 
$
1,075,343

Cost of sales (1)
460,743

 
240,441

 
911,664

 
465,376

Gross profit
410,621

 
300,950

 
759,111

 
609,967

 
 

 
 

 
 

 
 

Research and development  (1)
137,795

 
95,256

 
285,678

 
179,936

Selling, general and administrative  (1)
120,129

 
80,258

 
277,634

 
147,107

Amortization of acquired intangible assets
80,394

 
43,840

 
160,565

 
78,452

Special charges, net
9,543

 
6,648

 
31,578

 
8,205

 Operating expenses
347,861

 
226,002

 
755,455

 
413,700

 
 
 
 
 
 
 
 
Operating income
62,760

 
74,948

 
3,656

 
196,267

Losses on equity method investments
(56
)
 
(56
)
 
(112
)
 
(233
)
Other income (expense):
 
 
 
 
 
 
 
Interest income
445

 
6,405

 
1,264

 
11,933

Interest expense
(35,126
)
 
(25,644
)
 
(69,542
)
 
(49,696
)
Other (loss) income, net
(2,789
)
 
(1,696
)
 
(779
)
 
15,251

Income (loss) before income taxes
25,234

 
53,957

 
(65,513
)
 
173,522

Income tax (benefit) provision
(10,340
)
 
(10,942
)
 
8,138

 
(21,837
)
Net income (loss) from continuing operations
35,574

 
64,899

 
(73,651
)
 
195,359

Discontinued operations:
 
 
 
 
 
 
 
Loss from discontinued operations
(1,850
)
 
—

 
(7,323
)
 
—

Income tax benefit
(195
)
 
—

 
(1,530
)
 
—

Net loss from discontinued operations
(1,655
)
 
—

 
(5,793
)
 
—

 
 
 
 
 
 
 
 
Net income (loss)
33,919

 
64,899

 
(79,444
)
 
195,359

Less: Net loss attributable to noncontrolling interests
—

 
—

 
—

 
207

Net income (loss) attributable to Microchip Technology
$
33,919

 
$
64,899

 
$
(79,444
)
 
$
195,566

 
 
 
 
 
 
 
 
Basic net income (loss) per common share attributable to Microchip Technology stockholders
 
 
 
 
 
 
 
Net income (loss) from continuing operations
$
0.17

 
$
0.32

 
$
(0.34
)
 
$
0.96

Net loss from discontinued operations
(0.01
)
 
—

 
(0.03
)
 
—

Net income (loss) attributable to Microchip Technology
$
0.16

 
$
0.32

 
$
(0.37
)
 
$
0.96

Diluted net income (loss) per common share attributable to Microchip Technology stockholders
 
 
 
 
 
 
 
Net income (loss) from continuing operations
$
0.15

 
$
0.30

 
$
(0.34
)
 
$
0.90

Net loss from discontinued operations
(0.01
)
 
—

 
(0.03
)
 
—

Net income (loss) attributable to Microchip Technology
$
0.14

 
$
0.30

 
$
(0.37
)
 
$
0.90

Dividends declared per common share
$
0.3600

 
$
0.3580

 
$
0.7195

 
$
0.7155

Basic common shares outstanding
215,524

 
204,275

 
214,935

 
203,254

Diluted common shares outstanding
233,960

 
217,099

 
214,935

 
216,933

(1) Includes share-based compensation expense as follows:
 
 
 
 
 
 
 
Cost of sales
$
4,100

 
$
2,398

 
$
11,997

 
$
4,055

Research and development
10,171

 
8,670

 
27,688

 
15,768

Selling, general and administrative
10,119

 
11,958

 
44,284

 
17,315

See accompanying notes to condensed consolidated financial statements

4
Table of Contents


MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
(unaudited)

 
Three Months Ended
 
Six Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Net income (loss)
$
33,919

 
$
64,899

 
$
(79,444
)
 
$
195,359

Less: Net loss attributable to noncontrolling interests
—

 
—

 
—

 
207

Net income (loss) attributable to Microchip Technology
33,919

 
64,899

 
(79,444
)
 
195,566

 
 
 
 
 
 
 
 
Components of other comprehensive loss:
 
 
 
 
 
 
 
Available-for-sale securities:
 
 
 
 
 
 
 
Unrealized holding (losses) gains, net of tax effect
(404
)
 
2,082

 
(1,729
)
 
70

Reclassification of realized transactions, net of tax effect
7

 
(6
)
 
89

 
(13,965
)
Actuarial losses related to defined benefit pension plans, net of tax benefit of $742, $0, $3,745, and $0, respectively
(1,525
)
 
—

 
(8,330
)
 
—

Change in net foreign currency translation adjustment
454

 
—

 
(2,569
)
 
—

Other comprehensive (loss) income, net of taxes attributable to Microchip Technology
(1,468
)
 
2,076

 
(12,539
)
 
(13,895
)
 
 
 
 
 
 
 
 
Comprehensive income (loss)
32,451

 
66,975

 
(91,983
)
 
181,464

Less: Comprehensive loss attributable to noncontrolling interests
—

 
—

 
—

 
207

Comprehensive income (loss) attributable to Microchip Technology
$
32,451

 
$
66,975

 
$
(91,983
)
 
$
181,671


See accompanying notes to condensed consolidated financial statements


5
Table of Contents
MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

 
Six Months Ended
 
September 30,
 
2016
 
2015
Cash flows from operating activities:
 
 
 
Net (loss) income
$
(79,444
)
 
$
195,359

Adjustments to reconcile net (loss) income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
225,957

 
131,484

Deferred income taxes
(17,820
)
 
(35,999
)
Share-based compensation expense related to equity incentive plans
83,969

 
37,138

Excess tax benefit from share-based compensation
—

 
(407
)
Amortization of debt discount on convertible debentures
24,413

 
23,746

Amortization of debt issuance costs
2,118

 
1,920

Losses on equity method investments
112

 
233

Gains on sale of assets
(75
)
 
(860
)
Losses on write-down of fixed assets
317

 
—

Impairment of intangible assets
1,984

 
530

Realized losses (gains) on available-for-sale investment
89

 
(13,959
)
Realized gains on equity method investment
(468
)
 
(2,225
)
Amortization of premium on available-for-sale investments
—

 
4,732

Special charges
—

 
511

Changes in operating assets and liabilities, excluding impact of acquisitions:
 
 
 
(Increase) decrease in accounts receivable
(25,432
)
 
5,170

Decrease (increase) in inventories
215,950

 
(4,597
)
Increase in deferred income on shipments to distributors
39,764

 
13,492

Decrease in accounts payable and accrued liabilities
(22,017
)
 
(31,443
)
Change in other assets and liabilities
(13,641
)
 
6,589

Operating cash flows related to discontinued operations
10,314

 
—

Net cash provided by operating activities
446,090

 
331,414

Cash flows from investing activities:
 

 
 

Purchases of available-for-sale investments
(25
)
 
(1,112,089
)
Sales and maturities of available-for-sale investments
470,565

 
795,771

Sale of equity method investment
468

 
2,667

Acquisition of Atmel, net of cash acquired
(2,747,516
)
 
—

Acquisition of Micrel, net of cash acquired
—

 
(343,928
)
Purchase of additional controlling interest in ISSC
—

 
(18,051
)
Investments in other assets
(3,232
)
 
(2,981
)
Proceeds from sale of assets
66

 
14,296

Capital expenditures
(36,646
)
 
(63,554
)
Net cash used in investing activities
(2,316,320
)
 
(727,869
)
Cash flows from financing activities:
 

 
 

Repayments of revolving loan under credit facility
(951,500
)
 
(190,000
)
Proceeds from borrowings on revolving loan under credit facility
1,385,000

 
1,024,500

Deferred financing costs
—

 
(406
)
Payment of cash dividends
(154,877
)
 
(145,016
)
Repurchase of common stock
—

 
(363,829
)
Proceeds from sale of common stock
25,452

 
13,520

Tax payments related to shares withheld for vested restricted stock units
(35,843
)
 
(11,124
)
Capital lease payments
(391
)
 
(334
)
Excess tax benefit from share-based compensation
—

 
407

Net cash provided by financing activities
267,841

 
327,718

Effect of foreign exchange rate changes on cash and cash equivalents
(374
)
 
—

Net decrease in cash and cash equivalents
(1,602,763
)
 
(68,737
)
Cash and cash equivalents at beginning of period
2,092,751

 
607,815

Cash and cash equivalents at end of period
$
489,988

 
$
539,078

See accompanying notes to condensed consolidated financial statements

6
Table of Contents



Note 1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of Microchip Technology Incorporated and its majority-owned and controlled subsidiaries (the Company).  All intercompany balances and transactions have been eliminated in consolidation.
 
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (US GAAP), pursuant to the rules and regulations of the Securities and Exchange Commission (the SEC).  The information furnished herein reflects all adjustments which are, in the opinion of management, of a normal recurring nature and necessary for a fair statement of the results for the interim periods reported. Certain information and footnote disclosures normally included in audited consolidated financial statements have been condensed or omitted pursuant to such SEC rules and regulations.  It is suggested that these condensed consolidated financial statements be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 2016.  The results of operations for the six months ended September 30, 2016 are not necessarily indicative of the results that may be expected for the fiscal year ending March 31, 2017 or for any other period.

As further discussed in Note 3, on April 4, 2016, the Company completed its acquisition of Atmel Corporation (Atmel) and the Company's financial results include Atmel's results beginning as of such acquisition date.

Note 2. Recently Issued Accounting Pronouncements

Recently Adopted Accounting Pronouncements

During the three months ended June 30, 2016, the Company adopted Accounting Standards Update (ASU) 2015-03-Simplifying the Presentation of Debt Issuance Costs. The new guidance was adopted on a retrospective basis and as a result, debt issuance costs historically included in other assets have been reclassified as a direct deduction from the carrying amount of the associated debt. Related prior period information included on the Company's condensed consolidated balance sheets has been retrospectively adjusted as follows (amounts in thousands).

 
As of March 31, 2016
 
As Reported
 
Adjustments
 
As Adjusted
Other assets
$
109,025

 
$
(29,632
)
 
$
79,393

Total assets
$
5,567,515

 
$
(29,632
)
 
$
5,537,883

 
 
 
 
 
 
Senior convertible debentures
$
1,234,733

 
$
(18,420
)
 
$
1,216,313

Junior convertible debentures
$
196,304

 
$
(2,368
)
 
$
193,936

Long-term line of credit
$
1,052,000

 
$
(8,844
)
 
$
1,043,156

Total liabilities and stockholder's equity
$
5,567,515

 
$
(29,632
)
 
$
5,537,883


During the three months ended June 30, 2016, the Company elected to early adopt ASU 2016-09, Compensation - Stock Compensation, Improvements to Employee Share-Based Payment Accounting (Topic 718), which simplifies several aspects of the accounting for share-based payment transactions. Under this standard, entities are permitted to make an accounting policy election to either estimate forfeitures on share-based payment awards, as previously required, or to recognize forfeitures as they occur. The Company has elected to recognize forfeitures as they occur and the impact of that change in accounting policy has been recorded as a $2.0 million cumulative effect adjustment as an increase to the Company's retained earnings and a decrease to additional paid-in capital as of April 1, 2016. The Company also recorded a cumulative-effect adjustment to retained earnings for the increase of $2.3 million in long-term deferred tax assets related to the forfeiture rate reduction on outstanding share-based payment awards. Additionally, ASU 2016-09 eliminates the requirement to report excess tax benefits and certain tax deficiencies related to share-based payment transactions in additional paid-in capital. In accordance with the new standard, the Company will record excess tax benefits and tax deficiencies as income tax benefit or provision on a prospective basis in its condensed consolidated statements of operations. The standard also eliminates the requirement that

7
Table of Contents


excess tax benefits be realized before companies can recognize them. Accordingly, the Company has recorded a$47.2 million cumulative-effect adjustment to its retained earnings and long-term deferred tax assets as of April 1, 2016 for previously unrecognized excess tax benefits. ASU 2016-09 also requires excess tax benefits to be reported as operating activities in the statement of cash flows rather than as a financing activity. The Company has elected to apply the change in cash flow classification on a prospective basis and prior periods were not retrospectively adjusted.
 
Recently Issued Accounting Pronouncements Not Yet Adopted

In May 2014, the FASB issued ASU 2014-09-Revenue from Contracts with Customers (Topic 606), which will supersede nearly all existing revenue recognition guidance under US GAAP.  In July 2015, the FASB delayed the effective date of the new standard by one year to December 15, 2017, for annual and interim reporting periods beginning after that date. In accordance with the delay, the new standard will be effective for the Company beginning no later than April 1, 2018.  Early adoption is permitted, but not before the original effective date of December 15, 2016. 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. The new standard allows for the amendment to be applied either retrospectively to each prior reporting period presented or retrospectively as a cumulative-effect adjustment as of the date of adoption. In March 2016, the FASB issued ASU 2016-08 - Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net), which clarifies the implementation guidance on principal versus agent considerations. In April 2016, the FASB issued ASU 2016-10 - Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, which clarifies the implementation guidance on identifying performance obligations. In May 2016, the FASB issued ASU 2016-12 - Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients, which addresses implementation issues that were raised by stakeholders and discussed by the Revenue Recognition Transition Resource Group. As described in the Company's significant accounting policies, the Company defers the revenue and cost of sales on shipments to distributors until the distributor sells the product to their end customer. Upon adoption of ASU 2014-09, ASU 2015-14, ASU 2016-08, ASU 2016-10 and ASU 2016-12, the Company 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. The Company is currently evaluating the impact that the adoption of the standards will have on its condensed consolidated financial statements. The Company has not yet elected a transition method.

In July 2015, the FASB issued ASU 2015-11-Simplifying the Measurement of Inventory. This standard requires that entities measure inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. ASU 2015-11 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2016 and is applied prospectively. Early adoption is permitted. The Company does not expect this standard to have a material impact on its condensed consolidated financial statements.

In January 2016, the FASB issued ASU 2016-01-Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. This standard addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. ASU 2016-01 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is not permitted. The Company is currently evaluating the impact the adoption of this standard will have on its condensed consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02-Leases. This standard requires lessees to recognize a lease liability and a right-of-use asset on the balance sheet and aligns many of the underlying principles of the new lessor model with those in Accounting Standards Codification Topic 606, Revenue from Contracts with Customers. ASU 2016-02 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2018, with early adoption permitted. The standard is to be applied using the modified retrospective approach to all periods presented. The Company is currently evaluating the impact the adoption of this standard will have on its condensed consolidated financial statements.

In October 2016, the FASB issued ASU 2016-16-Intra-Entity Transfers of Assets Other Than Inventory. This standard addresses the recognition of current and deferred income taxes resulting from an intra-entity transfer of any asset other than inventory.  Prior to the adoption of ASU 2016-16, a company will defer for financial reporting purposes the income tax expense resulting from an intra-entity asset transfer, including the taxes currently payable or paid. Upon adoption of ASU 2016-16, a company will recognize current and deferred income taxes that result from such transfers in the period in which they occur. ASU 2016-16 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017 and is applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The Company is currently evaluating the impact the adoption of this standard will

8
Table of Contents


have on its condensed consolidated financial statements but expects to recognize its previously deferred tax related to intra-entity transfers upon adoption of ASU 2016-16 as of April 1, 2018 with a cumulative-effect reduction to retained earnings.

Note 3. Business Acquisitions
Acquisition of Atmel
On April 4, 2016, the Company acquired Atmel, a publicly traded company based in San Jose, California. The Company paid an aggregate of approximately $2.98 billion in cash, issued an aggregate of 10.1 million shares of its common stock to Atmel stockholders valued at $486.1 million based on the closing price of the Company's common stock on April 4, 2016 and incurred transaction and other fees of approximately $14.9 million. The total consideration transferred in the acquisition, including approximately $7.5 million of non-cash consideration for the exchange of certain share-based payment awards of Atmel for stock awards of the Company, was approximately $3.47 billion. The Company financed the cash portion of the purchase price using approximately $2.04 billion of cash held by certain of its foreign subsidiaries and approximately $0.94 billion from additional borrowings under its existing credit agreement. As a result of the acquisition, Atmel became a wholly owned subsidiary of the Company. Atmel is a worldwide leader in the design and manufacture of microcontrollers, capacitive touch solutions, advanced logic, mixed-signal, nonvolatile memory and RF components. The Company's primary reason for this acquisition was to expand the Company's range of solutions, products and capabilities by extending its served available market.
The acquisition was accounted for under the acquisition method of accounting, with the Company identified as the acquirer, and the operating results of Atmel have been included in the Company's consolidated financial statements as of the closing date of the acquisition. Under the acquisition method of accounting, the aggregate amount of consideration paid by the Company was allocated to Atmel's net tangible assets and intangible assets based on their estimated fair values as of April 4, 2016.  The excess of the purchase price over the value of the net tangible assets and intangible assets was recorded to goodwill. The factors contributing to the recognition of goodwill were based upon the Company's conclusion that there are strategic and synergistic benefits that are expected to be realized from the acquisition. The goodwill has been allocated to the Company's semiconductor products reporting segment.  None of the goodwill related to the Atmel acquisition is deductible for tax purposes.  The Company retained independent third-party appraisers to assist management in its valuation. The purchase price allocation has not been finalized and is based on estimates and assumptions that are subject to change related to the valuation of inventory, intangible assets, taxes and other assets and liabilities. This could result in adjustments to the fair values of the assets acquired and liabilities assumed, the useful lives of intangible assets, the residual amount allocated to goodwill and deferred income taxes recognized. The preliminary allocation of the purchase price is based on the best estimates of management and is subject to revision based on the final valuation and estimates of useful lives.

The table below represents the preliminary allocation of the purchase price, including adjustments to the purchase price allocation from the previously reported figures at June 30, 2016, to the net assets acquired based on their estimated fair values, as well as the associated estimated useful lives of the acquired intangible assets (amounts in thousands).


9
Table of Contents


Assets acquired
Previously Reported June 30, 2016
 
Adjustments
 
September 30, 2016
Cash and cash equivalents
$
230,266

 
$
—

 
$
230,266

Accounts receivable
135,427

 


 
135,427

Inventories
333,208

 
1,955

 
335,163

Prepaid expenses and other current assets
28,360

 
—

 
28,360

Assets held for sale
24,394

 


 
24,394

Property, plant and equipment
129,587

 
—

 
129,587

Goodwill
1,378,317

 
(6,215
)
 
1,372,102

Purchased intangible assets
1,880,245

 
(2,300
)
 
1,877,945

Long-term deferred tax assets
49,466

 
(106
)
 
49,360

Other assets
5,948

 
1,587

 
7,535

Total assets acquired
4,195,218

 
(5,079
)
 
4,190,139

 
 
 
 
 
 
Liabilities assumed
 
 
 
 
 
Accounts payable
(55,686
)
 
 
 
(55,686
)
Other current liabilities
(119,152
)
 
(317
)
 
(119,469
)
Long-term line of credit
(192,000
)
 
 
 
(192,000
)
Deferred tax liabilities
(74,334
)
 
(551
)
 
(74,885
)
Long-term income tax payable
(174,380
)
 
5,947

 
(168,433
)
Other long-term liabilities
(106,688
)
 
 
 
(106,688
)
Total liabilities assumed
(722,240
)
 
5,079

 
(717,161
)
Purchase price allocated
$
3,472,978

 
$
—

 
$
3,472,978


Purchased Intangible Assets
Weighted Average
 
 
 
Useful Life
 
April 4, 2016
 
(in years)
 
(in thousands)
Core/developed technology
11
 
$
1,076,540

In-process technology
—
 
140,700

Customer-related
6
 
630,600

Backlog
1
 
28,300

Other
5
 
1,805

Total purchased intangible assets
 
 
$
1,877,945

Purchased intangible assets include core and developed technology, in-process research and development, customer-related intangibles, acquisition-date backlog and other intangible assets. The estimated fair values of the core and developed technology and in-process research and development were determined based on the present value of the expected cash flows to be generated by the respective existing technology or future technology. The core and developed technology intangible assets are being amortized in a manner based on the expected cash flows used in the initial determination of fair value. In-process technology is capitalized until such time as the related projects are completed or abandoned at which time the capitalized amounts will begin to be amortized or written off. Customer-related intangible assets consist of Atmel's contractual relationships and customer loyalty related to its distributor and end-customer relationships, and the fair values of the customer-related intangibles were determined based on Atmel's projected revenues. An analysis of expected attrition and revenue growth for existing customers was prepared from Atmel's historical customer information.  Customer relationships are being amortized in a manner based on the estimated cash flows associated with the existing customers and anticipated retention rates. Backlog relates to the value of orders not yet shipped by Atmel at the acquisition date, and the preliminary fair values were based on the

10
Table of Contents


estimated profit associated with those orders. Backlog related assets have a one year useful life and are being amortized on a straight-line basis over that period. The total weighted average amortization period of intangible assets acquired as a result of the Atmel transaction is 9 years. Amortization expense associated with acquired intangible assets is not deductible for tax purposes.  Thus, approximately $159.6 million was established as a net deferred tax liability for the future amortization of the intangible assets.
The amount of continuing Atmel net sales included in the Company's condensed consolidated statements of operations for the three and six months ended September 30, 2016 was approximately $274.1 million and $493.1 million, respectively. The amount of Atmel's net loss from continuing operations included in the Company's condensed consolidated statements of operations was $95.8 million and $259.4 million for the three and six months ended September 30, 2016, respectively.
The following unaudited pro-forma consolidated results of operations for the three and six months ended September 30, 2016 and 2015 assume the closing of the Atmel acquisition occurred as of April 1, 2015. The pro-forma adjustments are mainly comprised of acquired inventory fair value costs, amortization of purchased intangible assets, distributor revenue recognition adjustments and share based compensation due to accelerated vesting of outstanding equity awards. The pro-forma results of operations are presented for informational purposes only and are not indicative of the results of operations that would have been achieved if the acquisition had taken place on April 1, 2015 or of results that may occur in the future (amounts in thousands except per share data):

 
Three Months Ended
 
Six Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Net sales
$
872,034

 
$
827,924

 
$
1,709,152

 
$
1,624,716

Net income (loss) from continuing operations
$
82,332

 
$
(78,526
)
 
$
82,102

 
$
(150,366
)
Basic net income (loss) per common share
$
0.38

 
$
(0.37
)
 
$
0.38

 
$
(0.70
)
Diluted net income (loss) per common share
$
0.35

 
$
(0.37
)
 
$
0.35

 
$
(0.70
)
Acquisition of Micrel
On August 3, 2015, the Company acquired Micrel, Incorporated (Micrel), a publicly traded company based in San Jose, California. The Company paid an aggregate of approximately $430.0 million in cash and issued an aggregate of 8.6 million shares of its common stock to Micrel shareholders. The number of shares issued in the transaction was subsequently repurchased by the Company in the open market during the fiscal year ended March 31, 2016. The total consideration transferred in the acquisition, including approximately $4.1 million of non cash consideration for the exchange of certain share-based payment awards of Micrel for stock awards of the Company, and approximately $13.1 million of cash consideration for the payout of vested employee stock awards, was approximately $816.2 million. The Company financed the cash portion of the purchase price using borrowings under its existing credit agreement. As a result of the acquisition, Micrel became a wholly owned subsidiary of the Company. Micrel's business is to design, develop, manufacture and market a range of high-performance analog, power and mixed-signal integrated circuits. Micrel's products address a wide range of end markets including industrial, automotive and communications. Micrel also manufactures custom analog and mixed-signal circuits and provides wafer foundry services for customers which produce electronic systems utilizing semiconductor manufacturing processes as well as micro-electrical mechanical system technologies. The Company's primary reason for this acquisition was to expand the Company's range of solutions, products and capabilities by extending its served available market.
The acquisition was accounted for under the acquisition method of accounting, with the Company identified as the acquirer, and the operating results of Micrel have been included in the Company's condensed consolidated financial statements as of the closing date of the acquisition. Under the acquisition method of accounting, the aggregate amount of consideration paid by the Company was allocated to Micrel's net tangible assets and intangible assets based on their estimated fair values as of August 3, 2015.  The excess of the purchase price over the value of the net tangible assets and intangible assets was recorded to goodwill. The factors contributing to the recognition of goodwill were based upon the Company's conclusion that there are strategic and synergistic benefits that are expected to be realized from the acquisition. The goodwill has been allocated to the Company's semiconductor products reporting segment.  None of the goodwill related to the Micrel acquisition is deductible for tax purposes.  The Company retained an independent third-party appraiser to assist management in its valuation.

11
Table of Contents


The table below represents the allocation of the purchase price to the net assets acquired based on their estimated fair values as of August 3, 2015, as well as the associated estimated useful lives of the acquired intangible assets at that date. The purchase price allocation was finalized as of June 30, 2016 (amounts in thousands):
Assets acquired
Final
Cash and cash equivalents
$
99,196

Accounts receivable, net
14,096

Inventories
73,468

Prepaid expenses and other current assets
10,652

Property, plant and equipment, net
38,491

Goodwill
440,978

Purchased intangible assets
273,500

Other assets
4,268

Total assets acquired
954,649

 
 
Liabilities assumed
 
Accounts payable
(11,068
)
Other current liabilities
(31,552
)
Deferred tax liabilities
(88,035
)
Long-term income tax payable
(7,637
)
Other long-term liabilities
(127
)
Total liabilities assumed
(138,419
)
Purchase price allocated
$
816,230


Purchased Intangible Assets
Weighted Average
 
 
 
Useful Life
 
August 3, 2015
 
(in years)
 
(in thousands)
Core/developed technology
10
 
$
175,800

In-process technology
—
 
21,000

Customer-related
5
 
71,100

Backlog
1
 
5,600

Total purchased intangible assets
 
 
$
273,500

Purchased intangible assets include core and developed technology, in-process research and development, customer-related intangibles and acquisition-date backlog. The estimated fair values of the core and developed technology and in-process research and development were determined based on the present value of the expected cash flows to be generated by the respective existing technology or future technology. The core and developed technology intangible assets are being amortized commensurate with the expected cash flows used in the initial determination of fair value. In-process technology is capitalized until such time as the related projects are completed or abandoned at which time the capitalized amounts will begin to be amortized or written off.
Customer-related intangible assets consist of Micrel's contractual relationships and customer loyalty related to its distributor and end-customer relationships, and the fair values of the customer-related intangibles were determined based on Micrel's projected revenues. An analysis of expected attrition and revenue growth for existing customers was prepared from Micrel's historical customer information.  Customer relationships are being amortized in a manner consistent with the estimated cash flows associated with the existing customers and anticipated retention rates. Backlog relates to the value of orders not yet shipped by Micrel at the acquisition date, and the preliminary fair values were based on the estimated profit associated with those orders. Backlog related assets are being recognized commensurate with recognition of the revenue for the orders on which the backlog intangible assets were determined.  Amortization expense associated with acquired intangible assets is not deductible for tax purposes.  Thus, approximately $99.7 million was established as a net deferred tax liability for the future amortization of the intangible assets offset by $11.4 million of net deferred tax assets.


12
Table of Contents


Note 4. Discontinued Operations and Assets Held for Sale

Discontinued operations include the mobile touch business that the Company acquired as part of its acquisition of Atmel. The mobile touch business has been marketed for sale since the acquisition of Atmel on April 4, 2016 based on management's decision that it was not a strategic fit for the Company's product portfolio. The Company announced on November 1, 2016, that it had entered into an agreement to sell the foregoing mobile touch business assets. See Note 26, Subsequent Event, for further information.

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 the Company's condensed consolidated financial statements as discontinued operations and the net assets of the remaining discontinued business have been presented as assets held for sale.

The results of discontinued operations for the three and six months ended September 30, 2016 are as follows (amounts in thousands):

 
September 30, 2016
 
Three Months Ended
 
Six Months Ended
Net sales
$
8,035

 
$
17,411

Cost of sales
6,939

 
15,363

Operating expenses
2,946

 
9,371

Income tax benefit
(195
)
 
(1,530
)
Net loss from discontinued operations
$
(1,655
)
 
$
(5,793
)

As of September 30, 2016, assets held for sale are comprised of the following (amounts in thousands):

 
Assets Held for Sale
Inventories
$
6,580

Intangible assets
7,500

Total assets held for sale
$
14,080


Note 5. Special Charges

The Company incurred special charges related to severance, office closing and other costs associated with its acquisition activity of $9.5 million and $31.6 million for the three and six months ended September 30, 2016, respectively (of which $25.6 million was paid during the six months ended September 30, 2016) compared to $6.6 million and $8.2 million for the three and six months ended September 30, 2015, respectively.

Note 6. Segment Information
 
The Company's reportable segments are semiconductor products and technology licensing.  The Company does not allocate operating expenses, interest income, interest expense, other income or expense, or provision for or benefit from income taxes to these segments for internal reporting purposes, as the Company does not believe that allocating these expenses is beneficial in evaluating segment performance.  Additionally, the Company does not allocate assets to segments for internal reporting purposes as it does not manage its segments by such metrics.


13
Table of Contents


The following table represents net sales and gross profit for each segment for the three and six months ended September 30, 2016 (amounts in thousands):
 
Three Months Ended
 
Six Months Ended
 
September 30, 2016
 
September 30, 2016
 
Net Sales
 
Gross Profit
 
Net Sales
 
Gross Profit
Semiconductor products
$
847,694

 
$
386,951

 
$
1,626,517

 
$
714,853

Technology licensing
23,670

 
23,670

 
44,258

 
44,258

Total
$
871,364

 
$
410,621

 
$
1,670,775

 
$
759,111


The following table represents net sales and gross profit for each segment for the three and six months ended September 30, 2015 (amounts in thousands):
 
Three Months Ended
 
Six Months Ended
 
September 30, 2015
 
September 30, 2015
 
Net Sales
 
Gross Profit
 
Net Sales
 
Gross Profit
Semiconductor products
$
518,216

 
$
277,775

 
$
1,028,905

 
$
563,529

Technology licensing
23,175

 
23,175

 
46,438

 
46,438

Total
$
541,391

 
$
300,950

 
$
1,075,343

 
$
609,967


Note 7. Investments
 
The Company's investments are intended to establish a high-quality portfolio that preserves principal, meets liquidity needs, avoids inappropriate concentrations, and delivers an appropriate yield in relationship to the Company's investment guidelines and market conditions.  The following is a summary of available-for-sale securities at September 30, 2016 (amounts in thousands):
 
Available-for-sale Securities
 
Adjusted
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
Marketable equity securities
$
2,140

 
$
—

 
$
(1,292
)
 
$
848


The following is a summary of available-for-sale securities at March 31, 2016 (amounts in thousands):
 
Available-for-sale Securities
 
Adjusted
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
Government agency bonds
$
468,290

 
$
439

 
$
(99
)
 
$
468,630

Corporate bonds and debt
1,000

 
—

 
—

 
1,000

Marketable equity securities
2,195

 
8

 
—

 
2,203

 
$
471,485

 
$
447

 
$
(99
)
 
$
471,833


At September 30, 2016, the Company's available-for-sale securities are $0.8 million presented on the condensed consolidated balance sheets as short-term investments.  At March 31, 2016, the Company's available-for-sale securities are presented on the condensed consolidated balance sheets as short-term investments of $353.3 million and long-term investments of $118.5 million.

The Company sold available-for-sale investments for proceeds of $470.6 million during the six months ended September 30, 2016. An immaterial amount of available-for-sale investments were sold during the three months ended September 30, 2016. The Company sold available-for-sale investments during the first quarter of fiscal 2017 and the fourth quarter of fiscal 2016 to finance a portion of the purchase price of its Atmel acquisition which closed on April 4, 2016. The Company sold available-for-sale investments for proceeds of $46.7 million and $135.8 million during the three and six months ended September 30, 2015, respectively. The Company had no material realized gains from the sale of available-for-sale securities during the three and six months ended September 30, 2016. During the three months ended September 30, 2015, the

14
Table of Contents


Company had no material realized gains from sales of available-for-sale marketable equity and debt securities and for the six months ended September 30, 2015, the Company had net realized gains of $14.0 million from sales of available-for-sale marketable equity and debt securities. The Company determines the cost of available-for-sale debt securities sold on a FIFO basis at the individual security level for sales from multiple lots. For sales of marketable equity securities, the Company uses an average cost basis at the individual security level. Gains and losses recognized in earnings are credited or charged to other income (expense) on the consolidated statements of operations.

The following tables show all investments in an unrealized loss position for which an other-than-temporary impairment has not been recognized and the related gross unrealized losses and fair value, aggregated by investment category and the length of time that the individual securities have been in a continuous unrealized loss position (amounts in thousands):
 
September 30, 2016
 
Less than 12 Months
 
12 Months or Greater
 
Total
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
Marketable equity securities
$
848

 
$
(1,292
)
 
$
—

 
$
—

 
$
848

 
$
(1,292
)

 
March 31, 2016
 
Less than 12 Months
 
12 Months or Greater
 
Total
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
Government agency bonds
$
148,562

 
$
(99
)
 
$
—

 
$
—

 
$
148,562

 
$
(99
)
Corporate bonds and debt
—

 
—

 
1,000

 
—

 
1,000

 
—

 
$
148,562

 
$
(99
)
 
$
1,000

 
$
—

 
$
149,562

 
$
(99
)

Management does not believe any of the unrealized losses represent an other-than-temporary impairment based on its evaluation of available evidence as of September 30, 2016 and the Company's intent is to hold these investments until these assets are no longer impaired. 

Note 8. Fair Value Measurements

Accounting rules for fair value clarify that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.  As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability.  As a basis for considering such assumptions, the Company utilizes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:

Level 1-
Observable inputs such as quoted prices in active markets;
Level 2-
Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and
Level 3-
Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.


15
Table of Contents


Marketable Debt Instruments

Marketable debt instruments include instruments such as corporate bonds and debt, government agency bonds, bank deposits, municipal bonds, and money market mutual funds. When the Company uses observable market prices for identical securities that are traded in less active markets, the Company classifies its marketable debt instruments as Level 2. When observable market prices for identical securities are not available, the Company prices its marketable debt instruments using non-binding market consensus prices that are corroborated with observable market data; quoted market prices for similar instruments; or pricing models, such as a discounted cash flow model, with all significant inputs derived from or corroborated with observable market data. Non-binding market consensus prices are based on the proprietary valuation models of pricing providers or brokers. These valuation models incorporate a number of inputs, including non-binding and binding broker quotes; observable market prices for identical or similar securities; and the internal assumptions of pricing providers or brokers that use observable market inputs and, to a lesser degree, unobservable market inputs. The Company corroborates non-binding market consensus prices with observable market data using statistical models when observable market data exists. The discounted cash flow model uses observable market inputs, such as LIBOR-based yield curves, currency spot and forward rates, and credit ratings.
 
Assets Measured at Fair Value on a Recurring Basis
 
Assets measured at fair value on a recurring basis at September 30, 2016 are as follows (amounts in thousands):
 
Quoted Prices
in Active
Markets for
Identical
Instruments
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Total
Balance
Assets
 
 
 
 
 
Cash and cash equivalents:
 
 
 
 
 
Money market mutual funds
$
41,494

 
$
—

 
$
41,494

Deposit accounts
—

 
448,494

 
448,494

Short-term investments:
 
 
 
 
 
Marketable equity securities

848

 
—

 
848

Total assets measured at fair value
$
42,342

 
$
448,494

 
$
490,836


Assets measured at fair value on a recurring basis at March 31, 2016 are as follows (amounts in thousands):
 
Quoted Prices
in Active
Markets for
Identical
Instruments
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Total
Balance
Assets
 
 
 
 
 
Cash and cash equivalents:
 
 
 
 
 
Money market mutual funds
$
1,787,446

 
$
—

 
$
1,787,446

Deposit accounts
—

 
305,305

 
305,305

Short-term investments:
 
 
 
 
 
Marketable equity securities
2,203

 
—

 
2,203

Corporate bonds and debt
—

 
1,000

 
1,000

Government agency bonds
—

 
350,081

 
350,081

Long-term investments:
 
 
 
 
 
Government agency bonds
—

 
118,549

 
118,549

Total assets measured at fair value
$
1,789,649

 
$
774,935

 
$
2,564,584


There were no transfers between Level 1 and Level 2 during the three and six-months ended September 30, 2016 or the fiscal year ended March 31, 2016.


16
Table of Contents


Assets and Liabilities Measured and Recorded at Fair Value on a Non-Recurring Basis
 
The Company's non-marketable equity, cost method investments, certain acquired liabilities and non-financial assets, such as intangible assets, assets held for sale and property, plant and equipment, are recorded at fair value on a non-recurring basis. These assets are subject to fair value adjustments in certain circumstances, for example, when there is evidence of impairment.  

The Company's non-marketable and cost method investments are monitored on a quarterly basis for impairment charges.  The fair values of these investments have been determined as Level 3 fair value measurements because the valuations use unobservable inputs that require management's judgment due to the absence of quoted market prices. There were no impairment charges recognized on these investments during each of the three and six-month periods ended September 30, 2016 and September 30, 2015. These investments are included in other assets on the condensed consolidated balance sheet.

The fair value measurements related to the Company's non-financial assets, such as intangible assets, assets held for sale and property, plant and equipment are based on available market prices at the measurement date based on transactions of similar assets and third-party independent appraisals, less costs to sell where appropriate. The Company classifies these measurements as Level 2.
  
Note 9. Fair Value of Financial Instruments
 
The carrying amount of cash equivalents approximates fair value because their maturity is less than three months.  Management believes the carrying amount of the equity and cost-method investments materially approximated fair value at September 30, 2016 based upon unobservable inputs. The fair values of these investments have been determined as Level 3 fair value measurements. The fair values of the Company's line of credit borrowings are estimated using discounted cash flow analyses, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements and approximate carrying value excluding debt issuance costs. Based on the borrowing rates currently available to the Company for bank loans with similar terms and average maturities, the fair value of the Company's line of credit borrowings at September 30, 2016 approximated the carrying value and are considered Level 2 in the fair value hierarchy described in Note 8. The carrying amount of accounts receivable, accounts payable and accrued liabilities approximates fair value due to the short-term maturity of the amounts and are considered Level 2 in the fair value hierarchy. 

Fair Value of Subordinated Convertible Debentures

The Company measures the fair value of its senior and junior subordinated convertible debentures for disclosure purposes. These fair values are based on observable market prices for these debentures, which are traded in less active markets and are therefore classified as a Level 2 fair value measurement.

The following table shows the carrying amounts and fair values of the Company’s senior and junior subordinated convertible debentures as of September 30, 2016 and March 31, 2016 (amounts in thousands). As of September 30, 2016, the carrying amounts of the Company's senior and junior subordinated convertible debentures have been reduced by debt issuance costs of $17.5 million and $2.3 million, respectively. As of March 31, 2016, the carrying amounts of the Company's senior and junior subordinated convertible debentures have been reduced by debt issuance costs of $18.4 million and $2.4 million, respectively.

 
September 30, 2016
 
March 31, 2016
 
Carrying Amount
 
Fair Value
 
Carrying Amount
 
Fair Value
1.625% Senior Subordinated Convertible Debentures
$
1,238,731

 
$
2,216,539

 
$
1,216,313

 
$
1,762,088

2.125% Junior Subordinated Convertible Debentures
$
196,868

 
$
1,484,805

 
$
193,936

 
$
1,143,117




17
Table of Contents


Note 10.
Accounts Receivable
 
Accounts receivable consists of the following (amounts in thousands):
 
September 30, 2016
 
March 31, 2016
Trade accounts receivable
$
449,495

 
$
289,013

Other
3,931

 
3,710

Total accounts receivable, gross
453,426

 
292,723

Less allowance for doubtful accounts
2,384

 
2,540

Total accounts receivable, net
$
451,042

 
$
290,183


Note 11.
Inventories

The components of inventories consist of the following (amounts in thousands):
 
September 30, 2016
 
March 31, 2016
Raw materials
$
15,227

 
$
12,179

Work in process
292,536

 
208,283

Finished goods
116,927

 
86,353

Total inventories
$
424,690

 
$
306,815


Inventories are valued at the lower of cost or market using the first-in, first-out method. 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.

Note 12.
Property, Plant and Equipment

Property, plant and equipment consists of the following (amounts in thousands):
 
September 30, 2016
 
March 31, 2016
Land
$
73,692

 
$
63,907

Building and building improvements
500,462

 
458,379

Machinery and equipment
1,750,646

 
1,645,617

Projects in process
107,801

 
99,370

Total property, plant and equipment, gross
2,432,601

 
2,267,273

Less accumulated depreciation and amortization
1,715,603

 
1,657,877

Total property, plant and equipment, net
$
716,998

 
$
609,396

 
Depreciation expense attributed to property, plant and equipment was $30.0 million and $61.0 million for the three and six months ended September 30, 2016, respectively. Depreciation expense attributed to property, plant and equipment was $26.2 million and $50.9 million for the three and six months ended September 30, 2015, respectively.




18
Table of Contents


Note 13.     Intangible Assets and Goodwill
 
Intangible assets consist of the following (amounts in thousands):
 
 
September 30, 2016
 
 
Gross Amount
 
Accumulated Amortization
 
Net Amount
Core and developed technology
 
$
1,813,689

 
$
(347,137
)
 
$
1,466,552

Customer-related
 
909,141

 
(258,151
)
 
650,990

Trademarks and trade names
 
11,700

 
(8,604
)
 
3,096

Backlog
 
28,300

 
(14,150
)
 
14,150

In-process technology
 
186,067

 
—

 
186,067

Distribution rights
 
5,580

 
(5,324
)
 
256

Other
 
1,805

 
(210
)
 
1,595

Total
 
$
2,956,282

 
$
(633,576
)
 
$
2,322,706


 
 
March 31, 2016
 
 
Gross Amount
 
Accumulated Amortization
 
Net Amount
Core and developed technology
 
$
724,883

 
$
(255,460
)
 
$
469,423

Customer-related
 
278,542

 
(200,331
)
 
78,211

Trademarks and trade names
 
11,700

 
(7,571
)
 
4,129

In-process technology
 
54,308

 
—

 
54,308

Distribution rights
 
5,580

 
(5,302
)
 
278

Total
 
$
1,075,013

 
$
(468,664
)
 
$
606,349


The Company amortizes intangible assets over their expected useful lives, which range between 1 and 15 years.  During the three months ended June 30, 2016, as a result of the Atmel transaction, the Company acquired $1,076.5 million of core and developed technology which has a weighted average amortization period of 11 years, $630.6 million of customer-related intangible assets which have a weighted average amortization period of 6 years, $28.3 million of intangible assets related to backlog with an amortization period of 1 year, $1.8 million of other intangible assets which have a weighted average amortization period of 5 years and $140.7 million of in-process technology which will begin amortization once the technology reaches technological feasibility. During the six months ended September 30, 2016, $8.9 million of in-process technology 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 2017 through fiscal 2021, absent any future acquisitions or impairment charges (amounts in thousands):

Year ending
March 31,
Projected Amortization
Expense
2017
$170,507
2018
492,584
2019
364,138
2020
314,558
2021
257,223
 

19
Table of Contents


Amortization expense attributed to intangible assets was $82.8 million and $165.3 million for the three and six months ended September 30, 2016, respectively. Amortization expense attributed to intangible assets was $44.9 million and $80.6 million for the three and six months ended September 30, 2015, respectively. In the three and six months ended September 30, 2016, approximately $1.0 million and $1.9 million was charged to cost of sales, respectively, and approximately $81.8 million and $163.4 million was charged to operating expenses, respectively.  In the three and six months ended September 30, 2015, approximately $0.9 million and $1.7 million was charged to cost of sales, respectively, and approximately $44.0 million and $78.9 million was charged to operating expenses, respectively.  The Company recognized no impairment charges for the three months ended September 30, 2016 and $2.0 million for the six months ended September 30, 2016. The Company recognized impairment charges of $0.5 million in each of the three and six months ended September 30, 2015.
 
Goodwill activity for the six months ended September 30, 2016 was as follows (amounts in thousands):
 
Semiconductor Products
Reporting Unit
 
Technology
Licensing
Reporting Unit
Balance at March 31, 2016
$
993,452

 
$
19,200

Additions due to the acquisition of Atmel
1,372,102

 
—

Adjustments due to the acquisition of Micrel
(14
)
 
—

Balance at September 30, 2016
$
2,365,540

 
$
19,200

 
At March 31, 2016, the Company applied a qualitative goodwill impairment test to its two reporting units, concluding it was not more likely than not that goodwill was impaired. Through September 30, 2016, the Company has never recorded an impairment charge against its goodwill balance.

Note 14.
Income Taxes

The provision for income taxes reflects tax on foreign earnings and federal and state tax on U.S. earnings.  The Company had a negative effective tax rate of 12.4% for the six months ended September 30, 2016 and a negative effective tax rate of 12.6% for the six months ended September 30, 2015.  The Company's effective tax rate for the six months ended September 30, 2016 is lower compared to the prior year primarily due to acquisition related expenses. The Company's effective tax rate is lower than statutory rates in the U.S. due primarily to its mix of earnings in foreign jurisdictions with lower tax rates as well as numerous tax holidays it receives related to its Thailand manufacturing operations based on its investment in property, plant and equipment in Thailand. The Company's tax holiday periods in Thailand expire at various times in the future, however, the Company actively seeks to obtain new tax holidays. The Company does not expect the future expiration of any of its tax holiday periods in Thailand to have a material impact on its effected tax rate. The remaining material components of foreign income taxed at a rate lower than the U.S. are earnings accrued in Ireland and earnings accrued by the Company's offshore technology company which is resident in the Cayman Islands.

The following tables summarize the activity related to the Company's gross unrecognized tax benefits for the six months ended September 30, 2016 and the year ended March 31, 2016 (amounts in thousands):
 
 
Six Months Ended
 
September 30, 2016
Balance at March 31, 2016
$
220,669

Increases related to acquisitions
194,018

Decreases related to settlements with tax authorities
(7,654
)
Decreases related to statute of limitation expirations
(1,338
)
Increases related to current year tax positions
15,796

Decreases related to prior year tax positions
(134
)
Balance at September 30, 2016
$
421,357



20
Table of Contents


 
Year Ended
 
March 31, 2016
Balance at March 31, 2015
$
170,654

Increases related to acquisitions
46,245

Decreases related to settlements with tax authorities
(7,954
)
Decreases related to statute of limitation expirations
(4,591
)
Increases related to current year tax positions
16,315

Balance at March 31, 2016
$
220,669


As of September 30, 2016 and March 31, 2016, the Company had accrued approximately $15.9 million and $2.4 million, respectively, related to the potential payment of interest on the Company's uncertain tax positions with the increase being primarily composed of a $9.3 million increase related to acquisitions. As of September 30, 2016 and March 31, 2016, the Company had accrued for approximately $60.7 million and $27.6 million respectively, in penalties related to its uncertain tax positions with the increase being primarily composed of a $25.6 million increase related to acquisitions. The Company's practice is to recognize interest and/or penalties related to income tax matters in income tax expense.
 
The Company files U.S. federal, U.S. state, and foreign income tax returns.  For U.S. federal, and in general for U.S. state tax returns, the fiscal 2005 and later tax years remain effectively open for examination by tax authorities.  The U.S. Internal Revenue Service (IRS) is currently auditing the Company's 2011 and 2012 tax years.  For foreign tax returns, the Company is generally no longer subject to income tax examinations for years prior to fiscal 2007.
 
The Company recognizes liabilities for anticipated tax audit issues in the U.S. and other domestic and international tax jurisdictions based on its estimate of whether, and the extent to which, additional tax payments are more likely than not.  The Company believes that it has appropriate support for the income tax positions taken and to be taken on its tax returns and that its accruals for tax liabilities are adequate for all open years based on an assessment of many factors including past experience and interpretations of tax laws applied to the facts of each matter.
 
The Company believes it maintains appropriate reserves to offset any potential income tax liabilities that may arise upon final resolution of matters for open tax years.  If such reserve 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 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.  Although the timing of the resolution or closure of audits is highly uncertain, the Company does not believe it is reasonably possible that the unrecognized tax benefits would materially change in the next 12 months.

Note 15.
1.625% Senior Subordinated Convertible Debentures

In February 2015, the Company issued $1,725.0 million principal amount of 1.625% senior subordinated convertible debentures due February 15, 2025. The debentures are subordinated to the Company's senior debt, including amounts borrowed under its amended credit facility, but are senior to the Company's outstanding 2.125% junior subordinated convertible debentures. The debentures are convertible, subject to certain conditions, into cash, shares of the Company's common stock or a combination thereof, at the Company's election, at an initial base conversion rate of 14.5654 shares of common stock per $1,000 principal amount of debentures, representing an initial base conversion price of approximately $68.66 per share of common stock.  As a result of cash dividends paid since the issuance of the debentures, the conversion rate has been adjusted to 15.3437 shares of common stock per $1,000 of principal amount of debentures, representing a base conversion price of approximately $65.17 per share of common stock. In addition, if at the time of conversion the applicable price of the Company's common stock exceeds the base conversion price, the conversion rate will be increased by up to an additional initial base conversion rate of 7.2827 shares of common stock per $1,000 principal amount of debentures, as determined pursuant to a specified formula. As a result of cash dividends paid since the issuance of the debentures, the maximum number of additional shares that may be issued if the stock price of the Company's common stock exceeds the base conversion price has been adjusted to 7.6718 shares of common stock per $1,000 principal amount of debentures. However, in no event will the

21
Table of Contents


conversion rate exceed 20.3915 (adjusted to 21.4811 as a result of cash dividends paid since the issuance of the debentures) shares of common stock per $1,000 principal amount of debentures. The Company received net proceeds of approximately $1,694.7 million from the issuance of its senior subordinated convertible debentures after deduction of issuance costs of approximately $30.3 million. The $30.3 million in issuance costs was split between a debt component of $20.4 million and an equity component of $9.9 million.  The debt component of the debt issuance costs is recorded as a direct deduction from the carrying value of the debentures and is being amortized using the effective interest method over the term of the debentures.

Prior to the close of business on the business day immediately preceding November 15, 2024, the debentures will be convertible at the option of the debenture holders only upon the satisfaction of specified conditions and during certain periods. Thereafter until close of business on the second scheduled trading day immediately preceding February 15, 2025, the debentures will be convertible at the option of the debenture holders at any time regardless of these conditions. Accrued and unpaid interest will be considered fully paid upon settlement of shares.
 
As the debentures can be settled in cash upon conversion, for accounting purposes, the debentures were bifurcated into a liability component and an equity component, which are both initially recorded at fair value.  The carrying value of the equity component at September 30, 2016 and March 31, 2016 was $564.9 million.  The estimated fair value of the liability component of the debentures at the issuance date was $1,160.1 million resulting in a debt discount of $564.9 million.  The debt discount is being amortized to interest expense at the effective interest rate of 5.9% over the contractual term of the note. The unamortized debt discount was $468.7 million at September 30, 2016 and $490.3 million at March 31, 2016.  The remaining period over which the unamortized debt discount will be recognized as non-cash interest expense is 8.38 years.  In the three and six months ended September 30, 2016, the Company recognized $10.8 million and $21.5 million, respectively, in non-cash interest expense related to the amortization of the debt discount, compared to $10.6 million and $21.1 million in the three and six months ended September 30, 2015, respectively.  The Company recognized $7.0 million and $14.0 million of interest expense related to the 1.625% coupon on the debentures in each of the three and six month periods ended September 30, 2016, and 2015, respectively.

Note 16.
2.125% Junior Subordinated Convertible Debentures
 
The Company's remaining $575.0 million principal amount of 2.125% junior subordinated convertible debentures due December 15, 2037, are subordinated in right of payment to any future senior debt of the Company (including the Company's senior subordinated convertible debentures) and are effectively subordinated in right of payment to the liabilities of the Company's subsidiaries.  The debentures are convertible, subject to certain conditions, into cash, shares of the Company's common stock or a combination thereof, at the Company's election, at an initial conversion rate of 29.2783 shares of common stock per $1,000 principal amount of debentures, representing an initial conversion price of approximately $34.16 per share of common stock.  As of September 30, 2016, the holders of the debentures had the right to convert their debentures between October 1, 2016 and December 31, 2016 because for at least 20 trading days during the 30 consecutive trading day period ending on September 30, 2016, the Company's common stock had a last reported sale price greater than 130% of the conversion price. As of September 30, 2016, the Company has classified the junior subordinated convertible debentures as long-term on its consolidated balance sheets as the Company has the intent and ability to refinance the obligation on a long-term basis. As of September 30, 2016, a holder could realize more economic value by selling its debentures in the over the counter market than from converting its debentures. As a result of cash dividends paid since the issuance of the debentures, the conversion rate has been adjusted to 41.6895 shares of common stock per $1,000 of principal amount of debentures, representing a conversion price of approximately $23.99 per share of common stock. The if-converted value of the debentures exceeded the principal amount by $914.6 million at September 30, 2016. The debentures include a contingent interest mechanism that begins in December 2017. The terms of the contingent interest include a 0.25% additional interest rate if the debentures are trading at less than $400 and a 0.5% additional interest rate if the debentures are trading at greater than $1,500. Based on the current trading price of the debentures, the contingent interest rate beginning in December 2017 would be 0.5% of the average trading price.
 
As the debentures can be settled in cash upon conversion, for accounting purposes, the debentures were bifurcated into a liability component and an equity component, which were both initially recorded at fair value.  The carrying value of the equity component at September 30, 2016 and at March 31, 2016 was $411.2 million.  The estimated fair value of the liability component of the debentures at the issuance date was $163.8 million, resulting in a debt discount of $411.2 million.  The debt discount is being amortized to interest expense at the effective interest rate of 9.1% over the contractual term of the note. The unamortized debt discount was $375.4 million at September 30, 2016 and $378.3 million at March 31, 2016.  The remaining

22
Table of Contents


period over which the unamortized debt discount will be recognized as non-cash interest expense is 21.21 years.  In the three and six months ended September 30, 2016, the Company recognized $1.5 million and $2.9 million, respectively, in non-cash interest expense related to the amortization of the debt discount compared to $1.3 million and $2.6 million for the three and six months ended September 30, 2015, respectively.  The Company recognized $3.1 million and $6.2 million of interest expense related to the 2.125% coupon on the debentures in the three and six month periods ended September 30, 2016, compared to $3.1 million and $6.1 million for the three and six month periods ended September 30, 2015, respectively.

Note 17.     Credit Facility

In February 2015, the Company amended its existing $2.0 billion credit agreement by increasing the revolving credit facility to $2.555 billion and removing the term loan portion of the agreement. The new credit agreement includes two tranches. One tranche consists of bank commitments through February 2020 and another tranche consists of bank commitments through June 2018, the maturity date of the original credit agreement. The increase option permitting the Company, subject to certain requirements, to arrange with existing lenders or new lenders to provide up to an aggregate of $300 million in additional commitments, was also adjusted to $249.4 million. The credit agreement provides for a $125 million foreign currency sublimit, a $25 million letter of credit sublimit and a $25 million swingline loan sublimit. The amended credit agreement was accounted for as a modification and as such any remaining unamortized deferred costs associated with the prior credit agreement was associated with the new agreement since the borrowing capacity was increased. At September 30, 2016, $1.678 billion of revolving credit facility borrowings were outstanding under the credit agreement compared to $1.052 billion at March 31, 2016. The carrying values reflected in the Company's condensed consolidated balance sheets as of September 30, 2016 and March 31, 2016 have been reduced by debt issuance costs of $7.7 million and $8.8 million, respectively.

In December 2015, the Company secured additional revolving credit commitments of $219 million from various banks in the February 2020 tranche under the increase option of the credit agreement, bringing its revolving credit facility to $2.774 billion. The remaining increase option was $30.4 million as of September 30, 2016.

In December 2015, the Company amended the maximum total leverage ratio in Section 6.11 of its existing credit agreement to allow the Total Leverage Ratio (as defined in that agreement) to be temporarily increased to 5.00 to 1.00 for a period of four consecutive quarters in conjunction with a permitted acquisition occurring during the first of the four quarters.
The Total Leverage Ratio then decreases to 4.75 to 1.00 for three consecutive quarters, finally returning to the stated 4.50 to 1.00 Total Leverage Ratio of the credit agreement after a period of seven consecutive fiscal periods. The Company can elect to use this special feature, also referred to as an Adjusted Covenant Period, no more than two times during the term of the credit agreement and also can terminate an Adjusted Covenant Period earlier than the seven consecutive quarters allowed. The Company elected to use this feature in conjunction with its acquisition of Atmel during the quarter ended June 30, 2016.

The loans under the credit agreement bear interest, at the Company's option, at the base rate plus a spread of 0.25% to 1.25% or an adjusted LIBOR rate (based on one, two, three, or six-month interest periods) plus a spread of 1.25% to 2.25%, in each case with such spread being determined based on the consolidated leverage ratio for the preceding four fiscal quarters (in the case of the 2018 tranche revolving loans) or the consolidated senior leverage ratio (in the case of the 2020 tranche revolving loans). The base rate means the highest of JPMorgan Chase Bank, N.A.'s prime rate, the federal funds rate plus a margin equal to 0.50% and the adjusted LIBOR rate for a 1-month interest period plus a margin equal to 1.00%. Swingline loans accrue interest at a per annum rate based on the base rate plus the applicable margin for base rate loans. Base rate loans may only be made in U.S. Dollars. The Company is also obligated to pay other customary administration fees and letter of credit fees for a credit facility of this size and type.

Interest is due and payable in arrears quarterly for loans bearing interest at the base rate and at the end of an interest period (or at each three-month interval in the case of loans with interest periods greater than three months) in the case of loans bearing interest at the adjusted LIBOR rate. Interest expense related to the credit agreement was approximately $12.0 million and $23.6 million in the three and six months ended September 30, 2016, respectively, and $4.9 million and $8.5 million for the three and six months ended September 30, 2015, respectively. Principal, together with all accrued and unpaid interest, is due and payable on the respective tranche maturity date, which is June 27, 2018 and February 4, 2020. The weighted average interest rate on borrowings outstanding at September 30, 2016 related to the credit agreement was 2.55%. The Company also pays a quarterly commitment fee on the available but unused portion of its line of credit which is calculated on the average daily available balance during the period. The Company may prepay the loans and terminate the commitments, in whole or in part, at any time without premium or penalty, subject to certain conditions including minimum amounts in the case of commitment reductions and reimbursement of certain costs in the case of prepayments of LIBOR loans.


23
Table of Contents


The Company's obligations under the credit agreement are guaranteed by certain of its subsidiaries meeting materiality thresholds set forth in the credit agreement. To secure the Company's obligations under the credit agreement, the Company and its domestic subsidiaries are required to pledge the equity securities of certain of their respective material subsidiaries, subject to certain exceptions and limitations.

The credit agreement contains customary affirmative and negative covenants, including covenants that limit or restrict the Company and its subsidiaries' ability to, among other things, incur subsidiary indebtedness, grant liens, merge or consolidate, dispose of assets, make investments, make acquisitions, enter into certain transactions with affiliates, pay dividends or make distributions, repurchase stock, enter into restrictive agreements and enter into sale and leaseback transactions, in each case subject to customary exceptions for a credit facility of this size and type. The Company is also required to maintain compliance with consolidated senior and total leverage ratios and a consolidated interest coverage ratio. At September 30, 2016, the Company was in compliance with these covenants.

The credit agreement includes customary events of default that include, among other things, non-payment defaults, inaccuracy of representations and warranties, covenant defaults, cross default to material indebtedness, bankruptcy and insolvency defaults, material judgment defaults, ERISA defaults and a change of control default. The occurrence of an event of default could result in the acceleration of the obligations under the credit agreement. Under certain circumstances, a default interest rate will apply on all obligations during the existence of an event of default under the credit agreement at a per annum rate equal to 2.00% above the applicable interest rate for any overdue principal and 2.00% above the rate applicable for base rate loans for any other overdue amounts.

Note 18.     Pension Plans

In connection with its acquisition of Atmel, the Company assumed unfunded defined benefit pension plans that cover certain French and German employees. Plan benefits are provided in accordance with local statutory requirements. Benefits are based on years of service and employee compensation levels. Pension liabilities and charges are based upon various assumptions, updated annually, including discount rates, future salary increases, employee turnover, and mortality rates. The Company’s French pension plan provides for termination benefits paid to covered French employees only at retirement, and consists of approximately one to five months of salary. The Company's German pension plan provides for defined benefit payouts for covered German employees following retirement.

The aggregate net pension expense relating to these two plans are as follows (amounts in thousands):

 
September 30, 2016
 
Three Months Ended
 
Six Months Ended
Service costs
$
363

 
$
727

Interest costs
241

 
484

Amortization of actuarial loss
64

 
129

Settlements
—

 
231

Net pension period cost
$
668

 
$
1,571



24
Table of Contents


The change in projected benefit obligation and the accumulated benefit obligation, were as follows (amounts in thousands):

Projected benefit obligation at April 4, 2016
$
40,313

Service cost
727

Interest cost
484

Settlements
231

Actuarial losses (gains)
12,060

Benefits paid
(216
)
Foreign currency exchange rate changes
(55
)
Projected benefit obligation at September 30, 2016
$
53,544

Accumulated benefit obligation at September 30, 2016
48,130


As the defined benefit plans are unfunded, the liability recognized on the condensed consolidated balance sheets as of September 30, 2016 was $53.5 million of which $0.6 million is included in accrued liabilities and $52.9 million is included in other long-term liabilities.

Actuarial assumptions used to determine benefit obligations for the plans were as follows at September 30, 2016:

Assumed discount rate
0.77% - 1.14%
Assumed compensation rate of increase
3.00%

The discount rate is based on the quarterly average yield for Euros treasuries with a duration of 30 years, plus a supplement for corporate bonds (Euros, AA rating).

Future estimated expected benefit payments for the remainder of fiscal 2017 through 2026 are as follows (amounts in thousands):

Fiscal Year Ending March 31,
Expected Benefit Payments
2017
$
483

2018
792

2019
985

2020
913

2021
1,198

2022 through 2026
9,185

Total
$
13,556


The Company's pension liability represents the present value of estimated future benefits to be paid.

Actuarial losses (gains) for the three and six months ended September 30, 2016 is comprised of a $2.3 million loss and a $12.8 million loss, respectively, recognized due to declines in the discount rates used to calculate the present value of pension obligation and a $0.7 million settlement gain for the six months ended September 30, 2016. Net actuarial losses (gains) will be recognized as a component of net periodic pension cost during fiscal 2018, which is included in accumulated other comprehensive loss in the condensed consolidated balance sheets as of September 30, 2016.

The Company's net periodic pension cost for fiscal 2017 is expected to be approximately $2.9 million. Cash funding for benefits paid was $0.1 million and $0.2 million for the three and six months ended September 30, 2016, respectively. The Company expects total contributions to these plans to be approximately $0.5 million in fiscal 2017.




25
Table of Contents


Note 19.
Contingencies

In the ordinary course of the Company's business, it is exposed to various liabilities as a result of contracts, product liability, customer claims 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 and disputes relating to the semiconductor industry are not uncommon, and the Company is, from time to time, subject to such litigation and disputes.  As a result, no assurances can be given with respect to the extent or outcome of any such litigation or disputes in the future.

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 September 30, 2016, the Company's estimate of the aggregate potential liability that is possible but not probable is approximately $100 million in excess of amounts accrued.

The Company's technology license agreements generally include an indemnification clause that indemnifies the licensee against liability and damages (including legal defense costs) arising from any claims of patent, copyright, trademark or trade secret infringement by the Company's proprietary technology.  The terms of these indemnification provisions approximate the terms of the outgoing technology license agreements, which are typically perpetual unless terminated by either party for breach. The possible amount of future payments the Company could be required to make based on agreements that specify indemnification limits, if such indemnifications were required on all of these agreements, is approximately $147 million. There are some licensing agreements in place that do not specify indemnification limits.  The Company had not recorded any liabilities related to these indemnification obligations as of September 30, 2016.

Note 20.
Derivative Instruments
 
Foreign Currency Exchange Rate Risk

The Company has international operations and is thus subject to foreign currency rate fluctuations.  Approximately 98% of the Company's sales are U.S. dollar denominated.  However, a significant amount of the Company's expenses and liabilities are denominated in foreign currencies and subject to foreign currency rate fluctuations.  To help manage the risk of changes in foreign currency rates, the Company periodically enters into derivative contracts comprised of foreign currency forward contracts to hedge its asset and liability foreign currency exposure and a portion of its foreign currency operating expenses.   Net losses due to foreign exchange rate fluctuations after the effects of hedging activity were $2.9 million and $2.2 million during the three and six month periods ended September 30, 2016, respectively, compared to net losses of $1.6 million and $1.2 million during the three and six-month periods ended September 30, 2015, respectively.  As of September 30, 2016 and March 31, 2016, the Company had no foreign currency forward contracts outstanding. The Company recognized an immaterial amount of net realized gains and losses on foreign currency forward contracts in each of the three and six months ended September 30, 2016 and 2015. Gains and losses from changes in the fair value of these foreign currency forward contracts and foreign currency exchange rate fluctuations are credited or charged to other income (expense) on the condensed consolidated statements of operations. The Company does not apply hedge accounting to its foreign currency derivative instruments.



26
Table of Contents


Note 21.
Comprehensive Income (Loss)

The following table presents the changes in the components of accumulated other comprehensive income (loss) (AOCI), net of tax, for the six months ended September 30, 2016 (amounts in thousands):
 
Unrealized
holding gains (losses)
available-for-sale securities
 
Defined benefit pension plans
 
Foreign
Currency
 
Total
Accumulated other comprehensive income (loss) at March 31, 2016
$
348

 
$
44

 
$
(3,749
)
 
$
(3,357
)
Other comprehensive loss before reclassifications
(1,729
)
 
(8,330
)
 
(2,569
)
 
(12,628
)
Amounts reclassified from accumulated other comprehensive loss
89

 
—

 
—

 
89

Net other comprehensive loss
(1,640
)
 
(8,330
)
 
(2,569
)
 
(12,539
)
Accumulated other comprehensive loss at September 30, 2016
$
(1,292
)
 
$
(8,286
)
 
$
(6,318
)
 
$
(15,896
)

The table below details where reclassifications of realized transactions out of AOCI are recorded on the condensed consolidated statements of operations (amounts in thousands):
 
 
Three Months Ended
 
Six Months Ended
 
 
 
 
September 30,
 
September 30,
 
 
Description of AOCI Component
 
2016
 
2015
 
2016
 
2015
 
Related Statement
 of Income Line
Unrealized (losses) gains on available-for-sale securities
 
$
(7
)
 
$
6

 
$
(89
)
 
$
13,965

 
Other income

Note 22.
Share-Based Compensation
 
The following table presents the details of the Company's share-based compensation expense (amounts in thousands):
 
Three Months Ended
 
Six Months Ended
 
 
September 30,
 
September 30,
 
 
2016
 
2015
 
2016
 
2015
 
Cost of sales
$
4,100

(1) 
$
2,398

(1) 
$
11,997

(1) 
$
4,055

(1) 
Research and development
10,171

 
8,670

 
27,688

 
15,768

 
Selling, general and administrative
10,119

 
11,958

 
44,284

 
17,315

 
Pre-tax effect of share-based compensation
24,390

 
23,026

 
83,969

 
37,138

 
Income tax benefit
8,358

 
8,574

 
29,246

 
12,106

 
Net income effect of share-based compensation
$
16,032

 
$
14,452

 
$
54,723

 
$
25,032

 

(1) During the three and six months ended September 30, 2016, $2.7 million and $5.5 million, respectively, of share-based compensation expense was capitalized to inventory. The amount of share-based compensation included in cost of sales during the three months ended September 30, 2016 included $4.1 million of previously capitalized share-based compensation expense in inventory that was sold. The amount of share-based compensation included in cost of sales during the six months ended September 30, 2016 included $7.8 million of previously capitalized share-based compensation expense in inventory that was sold and $4.2 million of share-based compensation expense related to the Company's acquisition of Atmel that was not previously capitalized to inventory.  During the three and six months ended September 30, 2015, $1.8 million and $3.6 million, respectively, of share-based compensation expense was capitalized to inventory and $2.4 million and $4.1 million, respectively, of previously capitalized share-based compensation expense in inventory was sold.


27
Table of Contents


Atmel Acquisition-related Equity Awards

    In connection with its acquisition of Atmel, the Company assumed certain restricted stock units (RSUs) granted by Atmel. The assumed awards were measured at the acquisition date based on the estimated fair value, which was a total of $95.9 million. A portion of that fair value, $7.5 million, which represented the pre-acquisition vested service provided by employees to Atmel, was included in the total consideration transferred as part of the acquisition. As of the acquisition date, the remaining portion of the fair value of those awards was $88.4 million, representing post-acquisition share-based compensation expense that will be recognized as these employees provide service over the remaining vesting periods. During the three months ended September 30, 2016, the Company recognized $6.2 million of share-based compensation expense in connection with the acquisition of Atmel. During the six months ended September 30, 2016, the Company recognized $49.4 million of share-based compensation expense in connection with the acquisition of Atmel, of which $37.2 million was due to the accelerated vesting of outstanding equity awards upon termination of certain Atmel employees.

Note 23.
Net Income (Loss) Per Common Share From Continuing Operations Attributable to Microchip Technology Stockholders
 
The following table sets forth the computation of basic and diluted net income (loss) per common share from continuing operations attributable to Microchip Technology stockholders (in thousands, except per share amounts):
 
Three Months Ended
 
Six Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Net income (loss) from continuing operations attributable to Microchip Technology
$
35,574

 
$
64,899

 
$
(73,651
)
 
$
195,566

Weighted average common shares outstanding
215,524

 
204,275

 
214,935

 
203,254

Dilutive effect of stock options and RSUs
4,465

 
3,065

 
—

 
3,228

Dilutive effect of 2037 junior subordinated convertible debentures
13,971

 
9,759

 
—

 
10,451

Weighted average common and potential common shares outstanding
233,960

 
217,099

 
214,935

 
216,933

Basic net income (loss) per common share from continuing operations attributable to Microchip Technology stockholders
$
0.17

 
$
0.32

 
$
(0.34
)
 
$
0.96

Diluted net income (loss) per common share from continuing operations attributable to Microchip Technology stockholders
$
0.15

 
$
0.30

 
$
(0.34
)
 
$
0.90


The Company computed basic net income (loss) per common share from continuing operations attributable to its stockholders using net income (loss) from continuing operations available to common stockholders and the weighted average number of common shares outstanding during the period. The Company computed diluted net income (loss) per common share from continuing operations attributable to its stockholders using net income (loss) from continuing operations available to common stockholders and the weighted average number of common shares outstanding plus potentially dilutive common shares outstanding during the period.

Potentially dilutive common shares from employee equity incentive plans are determined by applying the treasury stock method to the assumed exercise of outstanding stock options and the assumed vesting of outstanding RSUs. For the six months ended September 30, 2016, the calculation of diluted net loss per common share excluded 4,312,066 common shares from employee equity incentive plans as the related impact would have been anti-dilutive as the Company generated a net loss. Weighted average common shares exclude the effect of option shares which are not dilutive.  There were no anti-dilutive option shares for the three months ended September 30, 2016. For the three and six months ended September 30, 2015, the number of option shares that were antidilutive was 182,848 and 47,296, respectively.

Diluted net income per common share attributable to stockholders for the three months ended September 30, 2016, includes 13,971,278 shares issuable upon the exchange of the Company's 2.125% junior subordinated convertible debentures due December 15, 2037 (see Note 16). For the six months ended September 30, 2016, the calculations of diluted net loss per common share excluded 13,068,545 shares issuable upon the exchange of the Company's 2.125% junior subordinated convertible debentures as the related impact would have been anti-dilutive as the Company generated a loss. Diluted net income per common share from continuing operations attributable to stockholders for the three and six months ended September 30, 2015 includes 9,759,393 shares and 10,451,083 shares, respectively, issuable upon the exchange of the

28
Table of Contents


Company's 2.125% junior subordinated convertible debentures.  The debentures have no impact on diluted net income per common share unless the average price of the Company's common stock exceeds the conversion price because the principal amount of the debentures will be settled in cash upon conversion.  Prior to conversion, the Company will include, in the diluted net income per common share calculation, the effect of the additional shares that may be issued when the Company's common stock price exceeds the conversion price using the treasury stock method.  The weighted average conversion price per share used in calculating the dilutive effect of the convertible debt for the three and six-month periods ended September 30, 2016 was $24.07 and $24.15, respectively. The weighted average conversion price per share used in calculating the dilutive effect of the convertible debt for the three and six months ended September 30, 2015 was $24.87 and $24.94, respectively.

There were no shares issuable upon the exchange of the Company's 1.625% senior subordinated convertible debentures due February 15, 2025 (see Note 15). The debentures have no impact on diluted net income per common share unless the average price of the Company's common stock exceeds the conversion price because the principal amount of the debentures will be settled in cash upon conversion.  Prior to conversion, the Company will include, in the diluted net income per common share calculation, the effect of the additional shares that may be issued when the Company's common stock price exceeds the conversion price using the treasury stock method.  The weighted average conversion price per share used in calculating the dilutive effect of the convertible debt for the three and six-month periods ended September 30, 2016 was $65.38 and $65.60, respectively. The weighted average conversion price per share used in calculating the dilutive effect of the convertible debt for the three and six-month periods ended September 30, 2015 was $67.55 and $67.75, respectively.

Note 24. Stock Repurchase

In December 2007, the Company announced that its Board of Directors had authorized the repurchase of up to 10.0 million shares of its common stock in the open market or in privately negotiated transactions.  As of March 31, 2015, the Company had repurchased 7.5 million shares under this authorization for $234.7 million.  In May 2015, the Company's Board of Directors authorized an increase to the existing share repurchase program to 20.0 million shares of common stock from the approximately 2.5 million shares remaining under the prior authorization. During fiscal 2016, the Company purchased 8.6 million shares of its common stock for a total of $363.8 million. In January 2016, the Company's Board of Directors authorized an increase to the existing share repurchase program to 15.0 million shares of common stock from the approximately 11.4 million shares remaining under the prior authorization. There were no repurchases of common stock during the three and six months ended September 30, 2016. There is no expiration date associated with this repurchase program. As of September 30, 2016, approximately 21.5 million shares remained as treasury shares with the balance of the shares being used to fund share issuance requirements under the Company's equity incentive plans.

Note 25.
Dividends

A quarterly cash dividend of $0.3600 per share was paid on September 6, 2016 in the aggregate amount of $77.7 million.  Through the first six months of fiscal 2017, cash dividends of $0.7195 per share have been paid in the aggregate amount of $154.9 million. A quarterly cash dividend of $0.3605 per share was declared on November 7, 2016 and will be paid on December 5, 2016 to stockholders of record as of November 21, 2016. The Company expects the December payment of its quarterly cash dividend to be approximately $80.0 million.

Note 26. Subsequent Event

The Company announced on November 1, 2016, that it had entered into an agreement to sell certain mobile touch business assets to Solomon Systech (International) Limited ("Solomon Systech"), a Hong Kong based semiconductor company. The transaction included the sale of certain semiconductor products, equipment and patents; and a license to certain other intellectual property and patents related to the Company's mobile touch product line. The Company also agreed to provide certain transition services to Solomon Systech. This transaction is expected to close in mid November 2016 upon the satisfaction of certain customary closing conditions. The business which is being sold to Solomon Systech was reflected as discontinued operations and assets held for sale on the Company's condensed financial statements for the three and six months ended September 30, 2016.


29
Table of Contents


Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations
 
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," "continue," "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 49 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;
•
Our expectation that in the future we will acquire additional businesses that we believe will complement our existing businesses;
•
Our expectation that in the future we will enter into joint development agreements or other business or strategic relationships with other companies;
•
The level of orders that will be received and shipped within a quarter;
•
Our expectation that our days of inventory levels will be down one day to up 11 days, excluding impacts from the sell through of acquired inventory fair value mark-up, in the September 2016 quarter compared to the June 2016 quarter and that it will allow us to maintain competitive lead times and provide strong delivery performance to our customers;
•
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;
•
That the Atmel 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 and that our determinations with respect to the tax consequences of the acquisition are reasonable;

30
Table of Contents


•
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;
•
That 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;
•
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 the probability 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;
•
That when the UK leaves the EU, we may lose our ability to import and export products tax-free throughout Europe which may increase the costs to us for the import and sale of our products to our customers, result in a decrease in sales to certain of our customers or disrupt our operations and product shipments;
•
Our belief that the expiration of any tax holidays will not have a material impact on our overall tax expense or effective tax rate;
•
Our belief that the estimates used in preparing our consolidated financial statements are reasonable;
•
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;
•
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 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.  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 six months ended September 30, 2016 compared to the three and six months ended September 30, 2015.  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 embedded control solutions, including general purpose and specialized microcontrollers, development tools and related software, high-performance linear, mixed-signal, power management, thermal management, radio frequency (RF), timing, safety, security, wired connectivity and wireless connectivity devices, as well as serial EEPROMs, SuperFlash memories, Parallel Flash memories and serial SRAM memories. 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 our SuperFlash technology and other technologies to wafer foundries, integrated device manufacturers and design partners throughout the world for use in the manufacture of advanced microcontroller products, gate array, RF and analog products that require embedded non-volatile memory.
 
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. 


31
Table of Contents


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 wafer fabrication facilities and 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 manufacturing requirements to third parties.

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, 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 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 client engagement managers (CEMs), embedded system engineers (ESEs), and sales management personnel 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 ESE team is to provide technical assistance to strategic accounts and to conduct periodic training sessions for CEMs and distributor sales teams.  ESEs 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.

See "Our operating results are impacted by both seasonality and the wide fluctuation of supply and demand in the semiconductor industry," on page 53 for discussion of the impact of seasonality on our business.
 
Acquisition of Atmel

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 held by certain of our foreign subsidiaries, approximately $0.94 billion from additional borrowings under our existing line of credit agreement and approximately $486.1 million by issuing an aggregate of 10.1 million shares 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 of approximately $39.3 million. Atmel is a worldwide leader in the design and manufacture of microcontrollers, capacitive touch solutions, advanced logic, mixed-signal, nonvolatile memory and RF components. Atmel has offices, manufacturing and research facilities in North America, Europe and Asia.



32
Table of Contents


Critical Accounting Policies and Estimates
 
General
 
Our discussion and analysis of our 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, senior and 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-user, 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.

As a result of our acquisitions of Atmel and Micrel, we acquired certain distributor relationships where revenue is recognized upon shipment to the distributors. With respect to the distributor relationships acquired in the Atmel acquisition, revenue recognition will change in the quarter ending December 31, 2016 and will be consistent with the accounting for our other distributors which will result in the deferral of revenue recognition until the distributor sells the product to their customers. With respect to the distributor relationships acquired in the Micrel acquisition, in the December 2015 quarter, we changed substantially all of these distributor contracts to be consistent with those of our other distributors which resulted in the deferral of revenue recognition under such contracts until the distributor sells the product to their customers.
 
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 distributor's 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 distributors 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

33
Table of Contents


deferred income on shipments to distributors and accounts receivable when incurred, which is generally at the time the distributor sells the product.  At September 30, 2016, we had approximately $350.6 million of deferred revenue and $127.4 million in deferred cost of sales recognized as $223.2 million of deferred income on shipments to distributors.  At March 31, 2016, we had approximately $267.2 million of deferred revenue and $83.8 million in deferred cost of sales recognized as $183.4 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 $142.9 million at September 30, 2016 and $102.9 million at March 31, 2016.  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 products 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 operations.  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 distributors 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.

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 the fair value of assets acquired and liabilities assumed requires significant judgment.  The valuation of intangible assets and acquired investments, 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. Under the acquisition method of accounting, the aggregate amount of consideration we pay for a company is allocated to net tangible assets and intangible assets based on their estimated fair values as of the acquisition date.  The excess of the purchase price over the value of the net tangible assets and intangible assets is recorded to goodwill. On an annual basis, we test goodwill for impairment and, through September 30, 2016, we have never recorded an impairment charge against our goodwill balance.

34
Table of Contents


Share-based Compensation
 
We measure at fair value and recognize compensation expense for all share-based payment awards, including grants of employee stock options, restricted stock units (RSUs) 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 six months ended September 30, 2016 was $84.0 million, of which $72.0 million was reflected in operating expenses.  Total share-based compensation included in cost of sales during the six months ended September 30, 2016 was $12.0 million.  Total share-based compensation included in our inventory balance was $8.0 million at September 30, 2016.
 
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, 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 most 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.  During the six months ended September 30, 2016, we elected to early adopt ASU 2016-09, Compensation - Stock Compensation, Improvements to Employee Share-Based Payment Accounting (Topic 718). Under this standard, entities are permitted to make an accounting policy election to either estimate forfeitures on share-based payment awards, as previously required, or to recognize forfeitures as they occur. We have elected to recognize forfeitures as they occur.
 
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 or we assume unvested equity awards in connection with acquisitions.
 
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 upon 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 12-month demand. Estimates for projected 12-month demand are generally 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.  There was no charge to cost of sales for reduced production levels in each of the three and six month periods ended September 30, 2016 and 2015.

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

35
Table of Contents


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 September 30, 2016, the valuation allowances totaled $199.5 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 September 30, 2016, our deferred tax asset, net of valuation allowances, was $68.8 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.  We are 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. 

Senior and Junior Subordinated Convertible Debentures

We separately account for the liability and equity components of our senior and 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 operations.  Lastly, we include the dilutive effect of the shares of our common stock issuable upon conversion of the outstanding senior and junior subordinated convertible debentures in our diluted income per share calculation regardless of whether the market price triggers or other contingent conversion features have been met.  We apply the treasury stock method as we have the intent and have adopted an accounting policy to settle the principal amount of the senior and 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 prices per share which were $65.17 and $23.99 for our senior and junior subordinated convertible debentures, respectively, at September 30, 2016 and adjusts as dividends are recorded in the future.
 
Contingencies
 
In the ordinary course of our business, we are exposed to various liabilities as a result of contracts, product liability, customer claims and other matters.  Additionally, we are involved in a limited number of legal actions, both as plaintiff and defendant.  Consequently, we could incur uninsured liability in any of those actions.  We also periodically receive 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 we are a party and other claims, although the outcomes are generally not 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 and disputes relating to the semiconductor industry are not uncommon, and we are, from time to time, subject to such litigation and disputes.  As a result, no assurances can be given with respect to the extent or outcome of any such litigation or disputes in the future.

We accrue for claims and contingencies when losses become probable and reasonably estimable. As of the end of each applicable reporting period, we review each of our matters and, where it is probable that a liability has been or will be incurred, we accrue for all probable and reasonably estimable losses. Where we can reasonably estimate a range of losses we may incur regarding such a matter, we record an accrual for the amount within the range that constitutes our best estimate. If we can reasonably estimate a range but no amount within the range appears to be a better estimate than any other, we use the amount that is the low end of such range.



36
Table of Contents


Results of Continuing Operations
 
The following table sets forth certain operational data as a percentage of net sales for the periods indicated:

Three Months Ended
 
Six Months Ended

September 30,
 
September 30,

2016
 
2015
 
2016
 
2015
Net sales
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%
Cost of sales
52.9

 
44.4

 
54.6

 
43.3

Gross profit
47.1

 
55.6

 
45.4

 
56.7

Research and development
15.8

 
17.6

 
17.1

 
16.7

Selling, general and administrative
13.8

 
14.8

 
16.6

 
13.7

Amortization of acquired intangible assets
9.2

 
8.1

 
9.6

 
7.3

Special charges, net
1.1

 
1.3

 
1.9

 
0.7

Operating income
7.2
%
 
13.8
%
 
0.2
%
 
18.3
%

Net Sales
 
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 distributors and original equipment manufacturers, referred to as 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 typically provided by letters of credit.
 
Our net sales for the quarter ended September 30, 2016 were $871.4 million, an increase of 9.0% from the previous quarter's net sales of $799.4 million, and an increase of 60.9% from net sales of $541.4 million in the quarter ended September 30, 2015. Our net sales for the six months ended September 30, 2016 were $1,670.8 million, an increase of 55.4% from net sales of $1,075.3 million in the six months ended September 30, 2015. The amount of reported net sales for the quarter ended June 30, 2016 was lower by $37.7 million as GAAP prohibits the recognition of revenue related to inventory that was in the distributor channel as of the date of the Atmel acquisition. The increase in net sales in the quarter ended September 30, 2016 over the previous quarter was primarily a result of this requirement as well as growth in our business driven by general economic and semiconductor industry conditions. The increases in net sales in the three and six months ended September 30, 2016 compared to the three and six months ended September 30, 2015 were due primarily to our acquisitions of Atmel and Micrel, and also by growth in our historical business driven by general economic and semiconductor industry conditions. Average selling prices for our semiconductor products were up approximately 1% for the three-month period ended September 30, 2016 and approximately flat for the six-month period ended September 30, 2016 compared to the corresponding periods of the previous fiscal year. The average selling price per unit was primarily impacted by the mix of our products sold and overall semiconductor market conditions.  The number of units of our semiconductor products sold was up approximately 61% and 57% for the three and six-month periods ended September 30, 2016, respectively, over the corresponding periods of the previous fiscal year. The unit volumes were primarily impacted by our acquisitions of Atmel and Micrel and overall semiconductor market conditions.  Key factors related to the amount of net sales during the three and six-month periods ended September 30, 2016 compared to the three and six-month periods ended September 30, 2015 include:

•
our acquisition of Atmel which closed on April 4, 2016;
•
our acquisition of Micrel which closed on August 3, 2015;
•
global economic conditions in the markets we serve;
•
semiconductor industry conditions;
•
our new product offerings that have increased our served available market;
•
customers' increasing needs for the flexibility offered by our programmable solutions;
•
inventory holding patterns of our customers;
•
increasing semiconductor content in our customers' products; and
•
continued market share gains in the segments of the markets we address.


37
Table of Contents


Net sales by product line for the three and six months ended September 30, 2016 and 2015 were as follows (dollars in thousands):
 
Three Months Ended
 
Six Months Ended
 
September 30,
 
September 30,
 
(unaudited)
 
(unaudited)
 
2016
 
%
 
2015
 
%
 
2016
 
%
 
2015
 
%
Microcontrollers
$
551,805

 
63.4

 
$
334,255

 
61.7

 
$
1,050,115

 
62.9

 
$
682,425

 
63.5

Analog, interface, mixed signal and timing products
225,078

 
25.8

 
147,214

 
27.2

 
437,413

 
26.2

 
274,269

 
25.5

Memory products
46,487

 
5.3

 
30,240

 
5.6

 
92,401

 
5.5

 
62,013

 
5.8

Technology licensing
23,670

 
2.7

 
23,175

 
4.3

 
44,258

 
2.6

 
46,438

 
4.3

Multi-market and other
24,324

 
2.8

 
6,507

 
1.2

 
46,588

 
2.8

 
10,198

 
0.9

Total sales
$
871,364

 
100.0
%
 
$
541,391

 
100.0
%
 
$
1,670,775

 
100.0
%
 
$
1,075,343

 
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 63.4% of our net sales for the three-month period ended September 30, 2016 and approximately 62.9% of our net sales for the six-month period ended September 30, 2016 compared to approximately 61.7% of our net sales for the three-month period ended September 30, 2015 and approximately 63.5% of our net sales for the six-month period ended September 30, 2015.

Net sales of our microcontroller products increased approximately 65.1% in the three-month period ended September 30, 2016 and increased approximately 53.9% in the six-month period ended September 30, 2016 compared to the three and six-month periods ended September 30, 2015. These sales increases were driven primarily by our acquisition of Atmel, 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.
 
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, Mixed Signal and Timing Products
 
Sales of our analog, interface, mixed signal and timing products accounted for approximately 25.8% of our net sales for the three-month period ended September 30, 2016 and approximately 26.2% of our net sales for the six-month period ended September 30, 2016 compared to approximately 27.2% of our net sales for the three-month period ended September 30, 2015 and approximately 25.5% of our net sales for the six-month period ended September 30, 2015.
 
Net sales of our analog, interface, mixed signal and timing products increased approximately 52.9% in the three-month period ended September 30, 2016 and increased approximately 59.5% in the six-month period ended September 30, 2016 compared to the three and six-month periods ended September 30, 2015. These sales increases were driven primarily by our acquisitions of Micrel and Atmel and market share gains achieved within the analog, interface, mixed signal and timing market.
 

38
Table of Contents


Analog, interface, mixed signal and timing products can be proprietary or non-proprietary in nature.  Currently, we consider a majority of our analog, interface, mixed signal and timing products 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 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, 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 Products
 
Sales of our memory products accounted for approximately 5.3% of our net sales for the three-month period ended September 30, 2016 and approximately 5.5% of our net sales for the six-month period ended September 30, 2016 compared to approximately 5.6% of our net sales for the three-month period ended September 30, 2015 and approximately 5.8% of our net sales for the six-month period ended September 30, 2015.
 
Net sales of our memory products increased approximately 53.7% in the three-month period ended September 30, 2016 and increased approximately 49.0% in the six-month period ended September 30, 2016 compared to the three and six-month periods ended September 30, 2015. The increases in net sales of our memory products over these periods were driven primarily by our acquisition of Atmel and market share gains achieved within the memory market.
 
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 and fees for engineering services.  Technology licensing accounted for approximately 2.7% of our net sales for the three-month period ended September 30, 2016 and approximately 2.6% of our net sales for the six-month period ended September 30, 2016 compared to approximately 4.3% of our net sales for each of the three and six-month periods ended September 30, 2015.

Net sales related to our technology licensing increased approximately 2.1% in the three-month period ended September 30, 2016 and decreased approximately 4.7% in the six-month period ended September 30, 2016 compared to the three and six-month periods ended September 30, 2015. 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

Our Multi-Market and Other (MMO) product line consists of manufacturing services (wafer foundry and assembly and test subcontracting), legacy application specific IC's (ASIC's), complex programmable logic devices (CPLD's), and aerospace products. Revenue from this product line accounted for approximately 2.8% of our net sales for each of the three and six-month periods ended September 30, 2016 compared to approximately 1.2% of our net sales for the three-month period ended September 30, 2015 and approximately 0.9% of our net sales for the six-month period ended September 30, 2015. The increase in net sales in our MMO product line over these periods was primarily driven by our acquisition of Atmel.
 
Distribution
 
Distributors accounted for approximately 56.1% of our net sales in the three-month period ended September 30, 2016 and approximately 52.4% of our net sales in the three-month period ended September 30, 2015. Distributors accounted for approximately 56.0% of our net sales in the six-month period ended September 30, 2016 and approximately 52.3% of our net sales in the six-month period ended September 30, 2015. 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.
 

39
Table of Contents


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 September 30, 2016, our distributors maintained 31 days of inventory of our products compared to 32 days of inventory at our distributors at March 31, 2016.  Over the past five 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 the vast majority of our distributors.
 
Sales by Geography
 
Sales by geography for the three and six months ended September 30, 2016 and 2015 were as follows (dollars in thousands):
 
Three Months Ended
 
Six Months Ended
 
September 30,
 
September 30,
 
(unaudited)
 
(unaudited)
 
2016
 
%
 
2015
 
%
 
2016
 
%
 
2015
 
%
Americas
$
162,496

 
18.7

 
$
100,229

 
18.5

 
$
305,171

 
18.2

 
$
204,773

 
19.0

Europe
199,622

 
22.9

 
110,889

 
20.5

 
382,087

 
22.9

 
225,567

 
21.0

Asia
509,246

 
58.4

 
330,273

 
61.0

 
983,517

 
58.9

 
645,003

 
60.0

Total sales
$
871,364

 
100.0
%
 
$
541,391

 
100.0
%
 
$
1,670,775

 
100.0
%
 
$
1,075,343

 
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 84% of our total net sales in the three-month period ended September 30, 2016 and approximately 85% of our total net sales in the six-month period ended September 30, 2016 compared to approximately 85% of our total net sales in the three-month period ended September 30, 2015 and approximately 84% of our total net sales in the six-month period ended September 30, 2015. 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 $410.6 million in the three-month period ended September 30, 2016 and $301.0 million in the three-month period ended September 30, 2015. Our gross profit was $759.1 million in the six-month period ended September 30, 2016 and $610.0 million in the six-month period ended September 30, 2015. Gross profit as a percentage of sales was 47.1% in the three-month period ended September 30, 2016 and 55.6% in the three-month period ended September 30, 2015. Gross profit as a percentage of sales was 45.4% in the six-month period ended September 30, 2016 and 56.7% in the six-month period ended September 30, 2015.

The most significant factors affecting our gross profit percentage in the periods covered by this Form 10-Q were:
 
•
charges of approximately $84.3 million and $174.8 million in the three and six month periods ended September 30, 2016, respectively, and approximately $9.0 million in each of the three and six month periods ended September 30, 2015 related to the recognition of acquired inventory at fair value as a result of our acquisitions which increased the value of our acquired inventory and subsequently increased our cost of sales and reduced our gross margins when the related revenue was recognized;
•
for each of the three and six-month periods ended September 30, 2016 and September 30, 2015, inventory write-downs being higher than the gross margin impact of sales of inventory that was previously written down; and
•
fluctuations in the product mix of microcontrollers, analog, interface, mixed signal and timing products, memory products and technology licensing.


40
Table of Contents


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 six month periods ended September 30, 2016 and 2015, 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 0.22 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%. As a result of our acquisition of Atmel, we acquired a 6-inch wafer fabrication facility in Colorado Springs, Colorado (Fab 5) that currently utilizes processes between 0.25 micron and 1.0 micron. We consider normal capacity at Fab 5 to be 70% to 75%. As a result of our acquisition of Micrel in August 2015, we acquired a 6-inch wafer fabrication facility in San Jose, California and are in the process of providing last time inventory for our customers as we transition those products into our Fab 2 and Fab 4 facilities. We intend to start decommissioning the San Jose Fab in late fiscal 2017.
 
Our overall inventory levels were $424.7 million at September 30, 2016, compared to $306.8 million at March 31, 2016.  We maintained 84 days of inventory on our balance sheet at September 30, 2016 compared to 110 days of inventory at March 31, 2016.  The primary reason for the decrease in our days of inventory at September 30, 2016 compared to March 31, 2016 is the recognition of acquired inventory at fair value as a result of our acquisitions which increased the value of our acquired inventory and subsequently increased our cost of sales. The impact of this additional cost lowered days of inventory by 19 days. We expect our days of inventory levels in the December 2016 quarter to be down one day to up 11 days from the September 2016 levels, excluding the impact from the sell through of acquired inventory fair value mark-up. We believe our existing level of inventory will allow us to maintain competitive lead times and provide strong delivery performance to our customers.
 
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 and, as a result of our acquisition of Atmel, we acquired a test facility in Calamba, Philippines. During the three months ended September 30, 2016, approximately 36% of our assembly requirements were performed in our Thailand facilities compared to approximately 53% during the three months ended September 30, 2015.  The percentage of our assembly work that is performed internally fluctuates over time based on supply and demand conditions in the semiconductor industry, our internal capacity capabilities and our acquisition activities.  Third-party contractors located primarily in Asia perform the balance of our assembly operations.  During the three months ended September 30, 2016, approximately 63% of our test requirements were performed in our Thailand and Philippines facilities compared to approximately 82% of our test requirements performed in our Thailand facilities during the three months ended September 30, 2015. The primary reasons for the percentage reductions in the assembly and test operations performed internally in the three months ended September 30, 2016 compared to the same period last year are our acquisitions of Atmel and Micrel, which companies outsourced most of these activities. Over time, we intend to migrate a portion of the outsourced assembly and test activities from our Atmel and Micrel acquisitions to our Thailand and Philippines facilities. We believe that the assembly and test operations performed at our internal facilities provide us with significant cost savings compared to contractor assembly and test costs, as well as increased control over these portions of the manufacturing process.
 
We rely on outside wafer foundries for a significant portion of our wafer fabrication requirements. Approximately 42% and 41% of our net sales came from products that were produced at outside wafer foundries in the three and six-months ended September 30, 2016, respectively. In each of the three and six months ended September 30, 2015, approximately 40% of our net sales came from products that were produced at outside wafer foundries.
 

41
Table of Contents


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 September 30, 2016 were $137.8 million, or 15.8% of net sales, compared to $95.3 million, or 17.6% of net sales, for the three months ended September 30, 2015.  R&D expenses for the six months ended September 30, 2016 were $285.7 million, or 17.1% of net sales, compared to $179.9 million, or 16.7% of net sales, for the six months ended September 30, 2015. 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 $42.5 million, or 44.7%, for the three months ended September 30, 2016 over the same period last year.  R&D expenses increased $105.7 million, or 58.8%, for the six months ended September 30, 2016 over the same period last year.  The primary reasons for the increases in R&D costs over these periods were additional costs from our acquisitions of Atmel and Micrel.

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 September 30, 2016 were $120.1 million, or 13.8% of net sales, compared to $80.3 million, or 14.8% of net sales, for the three months ended September 30, 2015.  Selling, general and administrative expenses for the six months ended September 30, 2016 were $277.6 million, or 16.6% of net sales, compared to $147.1 million, or 13.7% of net sales, for the six months ended September 30, 2015. 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, CEMs and ESEs who work in sales offices worldwide to stimulate demand by assisting customers in the selection and use of our products.
 
Selling, general and administrative expenses increased $39.9 million, or 49.7%, for the three months ended September 30, 2016 over the same period last year. Selling, general and administrative expenses increased $130.5 million, or 88.7%, for the six months ended September 30, 2016 over the same period last year.  The primary reasons for the increases in selling, general and administrative expenses over these periods were additional costs from our acquisitions of Atmel and Micrel. Selling, general and administrative expenses for the six months ended September 30, 2016 also includes share-based compensation expense of $25.5 million due to the accelerated vesting of outstanding equity awards upon the termination of certain Atmel employees and approximately $18.5 million of acquisition-related legal and professional service expenses.

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 six months ended September 30, 2016 was $80.4 million and $160.6 million, respectively. Amortization of acquired intangible assets for the three and six months ended September 30, 2015 was $43.8 million and $78.5 million, respectively. The primary reasons for the increases in acquired intangible asset amortization for the three and six months ended September 30, 2016 over the same periods last year were increased amortization from our acquisitions of Atmel and Micrel partially offset by decreased amortization from our customer-related intangible assets from our acquisitions of Standard Microsystems Corporation (SMSC) and ISSC Technologies Corporation (ISSC).


42
Table of Contents


Special Charges

We incurred special charges related to severance, office closing and other costs associated with our acquisition activity
of $9.5 million and $31.6 million for the three and six months ended September 30, 2016, respectively, compared to $6.6 million and $8.2 million in the three and six months ended September 30, 2015, respectively.

Other Income (Expense)
 
Interest income in the three and six months ended September 30, 2016 was $0.4 million and $1.3 million, respectively. Interest income in the three and six months ended September 30, 2015 was $6.4 million and $11.9 million, respectively. The primary reason for the decreases in interest income in the three and six months ended September 30, 2016 compared to the same periods last year relates to lower invested cash balances as we used cash to finance a portion of the purchase price of our acquisition of Atmel.

Interest expense in the three and six months ended September 30, 2016 was $35.1 million and $69.5 million, respectively. Interest expense in the three and six months ended September 30, 2015 was $25.6 million and $49.7 million, respectively. The primary reason for the increases in interest expense in the three and six months ended September 30, 2016 compared to the same periods last year relates to increased borrowings under our credit facility to partially finance our acquisitions of Atmel and Micrel.

Other expense, net in the three and six months ended September 30, 2016 was $2.8 million and $0.8 million, respectively. Other expense, net in the three months ended September 30, 2015 was $1.7 million and other income, net in the six months ended September 30, 2015 was $15.3 million. The primary reasons for the changes in other income (expense) relates to realized gains of $14.0 million from the sale of marketable equity and debt securities and a gain of $2.2 million on the sale of an equity method investment occurring in the 2015 periods.

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 a negative effective tax rate of 12.4% for the six months ended September 30, 2016 and a negative effective tax rate of 12.6% for the six months ended September 30, 2015.  Our effective tax rate for the six months ended September 30, 2016 is lower compared to the prior year primarily due to acquisition-related expenses.

The geographic dispersion of our earnings and losses contributes to the period-to-period changes in our effective tax rates. In fiscal 2016, approximately 20% of our earnings from continuing operations before income taxes was generated in the U.S. at a combined federal and state effective tax rate that is higher than our overall effective tax rate. We are also subject to taxation in many other jurisdictions where 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 statutory tax rates for each of fiscal year 2016 and the first and second quarters of fiscal 2017 were approximately 37%. Our non-U.S. blended statutory tax rates for each of fiscal year 2016 and the first and second quarters of fiscal 2017 were much lower than this. The difference in rates applicable in foreign jurisdictions results from a number of factors, including lower statutory rates, historical loss carry-forwards, 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.

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 2005 and later tax returns remain effectively open for examination by the taxing authorities. Microchip 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.
 

43
Table of Contents


We have significant operations in foreign jurisdictions that have significantly lower effective tax rates than the U.S. 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 is 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.

Results of Discontinued Operations

Discontinued operations represent the mobile touch business that we acquired as part of our acquisition of Atmel. The mobile touch business has been marketed for sale since our acquisition of Atmel closed on April 4, 2016 based on management's decision that such business was not a strategic fit for our product portfolio. For financial statement purposes, the net assets and results of operations for this discontinued business have been segregated from those of our continuing operations and are presented in the our condensed consolidated financial statements as discontinued operations and assets held for sale. At September 30, 2016, assets held for sale related to discontinued operations was $14.1 million. Net loss from discontinued operations for the three and six months ended September 30, 2016 was $1.7 million and $5.8 million, respectively.

Liquidity and Capital Resources

We had $490.8 million in cash, cash equivalents and short-term and long-term investments at September 30, 2016, a decrease of $2,073.7 million from the March 31, 2016 balance.  The decrease in cash, cash equivalents and short-term and long-term investments over this period is primarily attributable to $2,747.5 million used for our acquisition of Atmel, net of cash acquired from Atmel and dividend payments of $154.9 million, partially offset by cash generated by operating activities and increases in borrowings under our credit facility.
 
Net cash provided by operating activities was $446.1 million in the six months ended September 30, 2016, compared to $331.4 million in the six months ended September 30, 2015. The increase in net cash provided from operating activities was primarily due to higher net sales in the six months ended September 30, 2016 compared to the prior year resulting primarily from our acquisitions of Atmel and Micrel.

During the six months ended September 30, 2016, net cash used in investing activities was $2,316.3 million compared to $727.9 million in the six months ended September 30, 2015.  The increase in net cash used in investing activities was due primarily to $2,747.5 million of cash consideration, net of $230.3 million of cash and cash equivalents acquired, used to finance our acquisition of Atmel in April 2016, offset by an increase of $786.9 million in cash from our purchases, sales and maturities of available-for-sale securities in the six months ended September 30, 2016 compared to the same period last year and $343.9 million of cash consideration, net of $99.2 million of cash and cash equivalents acquired, used to finance our acquisition of Micrel in August 2015.

Our level of capital expenditures varies from time to time as a result of actual and anticipated business conditions. Capital expenditures in the six months ended September 30, 2016 were $36.6 million compared to $63.6 million in the six months ended September 30, 2015.  Capital expenditures were primarily for the expansion of production capacity and the addition of research and development equipment.  We currently intend to spend approximately $120 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 provided by financing activities was $267.8 million in the six months ended September 30, 2016 compared to $327.7 million in the six months ended September 30, 2015.  We made payments on our borrowings under our credit agreement of $951.5 million and $190.0 million during the six months ended September 30, 2016 and 2015, respectively. Cash received on borrowings under our credit agreement totaled $1,385.0 million and $1,024.5 million during the six months ended September 30, 2016 and 2015, respectively. Cash expended for the repurchase of shares of our common stock was $363.8 million during the six months ended September 30, 2015. No amounts were expended during the six months ended September 30, 2016 for the repurchase of our common stock. We paid cash dividends to our stockholders of $154.9 million in the six months ended September 30, 2016 and $145.0 million in the six months ended September 30, 2015. Proceeds from the exercise of stock options and employee purchases under our employee stock purchase plans were $25.5 million in the six months ended September 30, 2016 and $13.5 million in the six months ended September 30, 2015.
 

44
Table of Contents


In February 2015, we amended our $2.0 billion credit agreement with certain lenders.  As a result of such amendment, the revolving credit facility portion of the agreement was increased from $1,650.0 million to $2,555.0 million and the $350.0 million term loan portion of the agreement was removed. The increase option permitting us, subject to certain requirements, to arrange with existing lenders or new lenders to provide up to an aggregate of $300.0 million in additional commitments, was also adjusted to $249.4 million. In December 2015, we exercised our increase option in our credit agreement to obtain additional revolving commitments of $219.0 million, bringing our total revolving credit facility commitments to $2,774.0 million. Proceeds of loans made under the credit agreement may be used for working capital and general corporate purposes. At September 30, 2016, $1,677.5 million of borrowings were outstanding under the credit agreement. See Note 17 of the notes to condensed 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 $438.0 million at September 30, 2016 and $2,559.3 million at March 31, 2016. 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 September 30, 2016 and March 31, 2016 was approximately $52.9 million and $5.3 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 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. 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.  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 September 30, 2016, 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 held 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 aggregate of 10.1 million shares 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. Although 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.

In May 2015, our Board of Directors authorized the repurchase of up to 20.0 million shares of our common stock in the open market or in privately negotiated transactions.  In January 2016, our Board of Directors authorized an increase in the existing share repurchase program to 15.0 million shares of common stock from the approximately 11.4 million shares remaining under the current authorization. As of March 31, 2016, we had repurchased 8.6 million shares under this authorization for approximately $363.8 million.  There is no expiration date associated with this repurchase program. 

As of September 30, 2016, we held approximately 21.5 million shares of our common stock as treasury shares.


45
Table of Contents


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 $0.3600 per share was paid on September 6, 2016 in the aggregate amount of $77.7 million. A quarterly dividend of $0.3605 per share was declared on November 7, 2016 and will be paid on December 5, 2016 to stockholders of record as of November 21, 2016. We expect the aggregate December cash dividend to be approximately $80.0 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 increase our borrowings 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, 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, 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, 2016, other than those obligations at September 30, 2016 that resulted from our acquisition of Atmel. The following table summarizes our significant contractual obligations at September 30, 2016, and the effect such obligations are expected to have on our liquidity and cash flows in future periods.  This table excludes amounts already recorded on our balance sheet as current liabilities at September 30, 2016 (dollars in thousands):

 
Payments Due by Period
 
Total
 
Less than
1 year
 
1 – 3 years
 
3 – 5 years
 
More than
5 years
Operating lease obligations
$
90,184

 
$
14,173

 
$
43,556

 
$
22,457

 
$
9,998

Capital purchase obligations (1)
21,909

 
21,909

 
—

 
—

 
—

Other purchase obligations and commitments (2)
87,705

 
78,384

 
7,296

 
1,783

 
242

Borrowings under credit agreement outstanding as of September 30, 2016 - principal and interest (3)
1,820,088

 
21,388

 
85,553

 
1,713,147

 
—

1.625% senior convertible debentures - principal and interest on 1.625% coupon (4)
1,959,763

 
14,016

 
56,063

 
56,063

 
1,833,621

2.125% junior convertible debentures – principal and interest on 2.125% coupon (5)
834,139

 
6,109

 
24,438

 
24,438

 
779,154

Pension obligations
13,556

 
483

 
1,777

 
2,111

 
9,185

Total contractual obligations (6)
$
4,827,344

 
$
156,462

 
$
218,683

 
$
1,819,999

 
$
2,632,200

 
(1)  Capital purchase obligations represent commitments for construction or purchases of property, plant and equipment.  These obligations were not recorded as liabilities on our balance sheet as of September 30, 2016, as we have not yet received the related goods or taken title to the property.
 
(2)  Other purchase obligations and commitments include payments due under various types of licenses and outstanding purchase commitments with our wafer foundries of approximately $73.4 million for delivery of wafers subsequent to September 30, 2016.
 
(3)  For purposes of this table we have assumed that the principal of our credit agreement borrowings outstanding at September 30, 2016 will be paid on February 4, 2020, which is the maturity date of such borrowings.

46
Table of Contents


 
(4)  For purposes of this table we have assumed that the principal of our senior convertible debentures will be paid on February 15, 2025, which is the maturity date of such debentures.
 
(5)  For purposes of this table we have assumed that the principal of our junior convertible debentures will be paid on December 15, 2037, which is the maturity date of such debentures.
 
(6)  Total contractual obligations do not include contractual obligations recorded on our balance sheet as current liabilities, or certain purchase obligations as discussed below.

The contractual obligations table above excludes certain estimated tax liabilities of $421.1 million as of September 30, 2016 as it is not practical to estimate the timing of these future tax payments. However, these estimated tax liabilities for uncertain tax positions are included in our condensed consolidated balance sheet. See Note 14 of the notes to condensed consolidated financial statements for more information.

Purchase orders or contracts for the purchase of raw materials and other goods and services, with the exception of commitments to our wafer foundries, are not included in the contractual obligations table above.  We are not able to determine the aggregate amount of such purchase orders that represent contractual obligations, as purchase orders may represent authorizations to purchase rather than binding agreements.  For the purpose of the foregoing table, contractual obligations for the purchase of goods or services are defined as agreements that are enforceable and legally binding on us and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction.  Our purchase orders are based on our current manufacturing needs and are fulfilled by our vendors with short time horizons.  We do not have significant agreements for the purchase of raw materials or other goods specifying minimum quantities or set prices that exceed our expected requirements for three months.  We also enter into contracts for outsourced services; however, the obligations under these contracts were not significant and the contracts generally contain clauses allowing for cancellation without significant penalty.
 
The expected timing of payment of the obligations discussed above is estimated based on current information.  Timing of payments and actual amounts paid may be different depending on the time of receipt of goods or services or changes to agreed-upon amounts for some obligations.

Off-Balance Sheet Arrangements (Including Guarantees)
 
As of September 30, 2016, 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 intended to establish a high-quality portfolio that preserves principal, meets liquidity needs, avoids inappropriate concentrations, and delivers an appropriate yield in relationship to 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 $490.8 million as of September 30, 2016 compared to $2,564.6 million as of March 31, 2016. We sold a significant portion of our available-for-sale investments during the first quarter of fiscal 2017 and the fourth quarter of fiscal 2016 to partially finance the purchase price of our Atmel acquisition which closed on April 4, 2016. As of September 30, 2016, as a result of the sales of securities to partially finance the purchase price of our Atmel acquisition, the maturity date of our outstanding investments was less than three months. 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 have the ability to hold our fixed income investments until maturity and, therefore, we would not expect to recognize any material adverse impact in income or cash flows if market interest rates increase.


47
Table of Contents


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).  Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 (i) is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.  Our disclosure controls and procedures are designed to provide reasonable assurance that such information is accumulated and communicated to our management.  Our disclosure controls and procedures include components of our internal control over financial reporting. Management's assessment of the effectiveness of our internal control over financial reporting is expressed at the level of reasonable assurance because a control system, no matter how well designed and operated, can provide only reasonable, but not absolute, assurance that the control system's objectives will be met.
 
Changes in Internal Control over Financial Reporting
 
On April 4, 2016, we acquired Atmel which operated under its own set of systems and internal controls. During the three months ended September 30, 2016, we transitioned certain of Atmel's processes to our internal control processes and we expect to transition more of such processes throughout the remainder of fiscal 2017.

Other than with respect to our transition of Atmel to our systems and control environment as described above, during the three months ended September 30, 2016, 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.
 

48
Table of Contents


PART II.  OTHER INFORMATION

Item 1.
Legal Proceedings
 
In the ordinary course of our business, we are involved in a limited number of legal actions, both as plaintiff and defendant. Consequently, we could incur uninsured liability in any of those actions. We also periodically receive 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 we are a party, although the outcomes of these actions are generally not determinable, we believe that the ultimate resolution of these matters will not harm our business and will not have a material adverse effect on our financial position, cash flows or results of operations.  However, if an unfavorable ruling were to occur in any of the legal proceedings described below or in other legal proceedings or matters that were not deemed material to us as of the date hereof, then such legal proceedings or matters could 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, from time to time, subject to such litigation.  As a result, no assurances can be given with respect to the extent or outcome of any such litigation in the future.
As a result of our acquisition of Atmel, which closed April 4, 2016, we became involved with the following lawsuits.
In re: Continental Airbag Products Liability Litigation. On May 11, 2016, an Amended and Consolidated Class Action Complaint ("Complaint") was filed in the United States District Court for the Southern District of Florida (Miami Division) against Atmel, Continental Automotive Systems, Inc., Honda Motor Co., Ltd. and an affiliate, and Daimler AG and an affiliate. The Complaint which includes claims arising under federal law and Florida, California, New Jersey, Michigan and Louisiana state law alleges that class members unknowingly purchased or leased vehicles containing defective airbag control units (incorporating allegedly defective application specific integrated circuits manufactured by our Atmel subsidiary between 2006 and 2010), and thereby suffered financial harm, including a loss in the value of their purchased or leased vehicles. The plaintiffs are seeking, individually and on behalf of a putative class, unspecified compensatory and exemplary damages, statutory penalties, pre- and post-judgment interest, attorneys' fees, and injunctive and other relief. Our Atmel subsidiary intends to contest plaintiffs' claims vigorously.
Southern District of New York Action by LFoundry Rousset ("LFR") and LFR Employees. On March 4, 2014, LFR and Jean-Yves Guerrini, individually and on behalf of a putative class of LFR employees, filed an action in the United States District Court for the Southern District of New York (the "District Court") against our Atmel subsidiary, our French subsidiary, Atmel Rousset S.A.S. ("Atmel Rousset"), and LFoundry GmbH ("LF"), LFR's German parent. The case purports to relate to Atmel Rousset's June 2010 sale of its wafer manufacturing facility in Rousset, France to LF, and LFR's subsequent insolvency, and later liquidation, more than three years later. The District Court dismissed the case on August 21, 2015, and the United States Court of Appeals for the Second Circuit affirmed the dismissal on June 27, 2016. On July 25, 2016, the plaintiffs filed a notice of appeal from the District Court's June 27, 2016 denial of their motion for relief from the dismissal judgment.
Individual Labor Actions by former LFR Employees. In the wake of LFR's insolvency and liquidation, over 500 former employees of LFR have filed individual labor actions against Atmel Rousset in a French labor court. Our Atmel Rousset subsidiary believes that each of these actions is entirely devoid of merit, and, further, that any assertion by any of the Claimants of a co-employment relationship with our Atmel Rousset subsidiary is based substantially on the same specious arguments that the Paris Commercial Court summarily rejected in 2014 in related proceedings. Our Atmel Rousset subsidiary therefore intends to defend vigorously against each of these claims.

Item 1A. Risk Factors
 
When evaluating Microchip and its business, you should give careful consideration to the factors listed below, in addition to the information provided elsewhere in this Form 10-Q and in other documents that we file with the Securities and Exchange Commission. 

Our 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:

49
Table of Contents



•
general economic, industry or political conditions in the U.S. or internationally;
•
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;
•
changes in utilization of our manufacturing capacity and fluctuations in manufacturing yields;
•
our ability to realize the expected benefits of our acquisitions including our recent acquisition of Atmel;
•
changes or fluctuations in customer order patterns and seasonality;
•
our ability to secure sufficient wafer foundry, assembly and testing capacity;
•
the mix of inventory we hold and our ability to satisfy orders from our inventory;
•
levels of inventories held by our customers;
•
risk of excess and obsolete inventories;
•
changes in tax regulations and policies in the U.S. and other countries in which we do business;
•
our ability to ramp our factory capacity to meet customer demand;
•
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;
•
the level of sell-through of our products through distribution;
•
fluctuations in our mix of product sales;
•
announcements of 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 or claims involving intellectual property, customers or other issues;
•
fluctuations in commodity prices; and
•
property damage or other losses, whether or not covered by insurance.

We believe that period-to-period comparisons of our operating results are not necessarily meaningful and that you should not rely upon any such comparisons as indications of 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. Our acquisition of Atmel, adverse global economic conditions, the subsequent economic recovery and uncertainty surrounding the strength and duration of such recovery have caused our operating results to fluctuate significantly and make comparability between periods less meaningful.
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 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. For example, in fiscal 2012 and fiscal 2013 we reduced wafer starts in both Fab 2 and Fab 4, which negatively impacted our gross profit through the March 2013 quarter. We increased wafer starts modestly throughout fiscal 2014 and fiscal 2015. Although we operated at normal capacity levels during the last three quarters of fiscal 2015, the first two quarters of fiscal 2016, the fourth quarter of fiscal 2016, and the first two quarters of fiscal 2017, there can be no assurance that such production levels will be maintained in future periods.


50
Table of Contents


We may not fully realize the anticipated benefits of our completed or future acquisitions or divestitures including our recently completed acquisition of Atmel.

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, we acquired Atmel, which is our largest and most complex acquisition ever. In addition, in August 2015, we completed our acquisition 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. (Supertex); 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 we may be unable to realize the expected synergies and cost savings from the integration. There may be increased risk due to integrating financial reporting and internal control systems. We may have difficulty in developing, manufacturing and marketing the products of a newly acquired company, or in growing 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 acquired companies and other third parties related to the transaction. In particular, as a result of our Atmel acquisition, we became involved with third-party claims, litigation and disputes related to the Atmel business. See "Item 1. Legal Proceedings" for information regarding pending litigation. 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 stock-based compensation expense and other charges that adversely affect our operating results. To fund our acquisition of Atmel, we used a significant portion of our cash balances, increased the borrowings under our existing credit agreement and issued approximately 10.1 million shares of our common stock. Additionally, we may fund future acquisitions of new businesses or strategic alliances by utilizing cash, borrowings under our credit agreement, raising debt, issuing shares of our common stock, or other mechanisms.

Further, if we decide to divest assets or a business, including the Atmel mobile touch business which is classified as a discontinued operation in our financial statements, we may encounter difficulty in finding or completing divestiture opportunities or alternative exit strategies on acceptable terms or in a timely manner. These circumstances could delay the achievement of our strategic objectives or cause us to incur additional expenses with respect to assets or a business that we want to dispose of, or we may dispose of assets or a business at a price or on terms that are less favorable than we had anticipated. Even following a divestiture, we may be contractually obligated with respect to certain continuing obligations to customers, vendors, landlords or other third parties. We may also have continuing obligations for pre-existing liabilities related to the 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.

In February 2015, we amended our credit agreement to increase the revolving credit facility to $2.555 billion and we sold $1.725 billion of principal value of our 1.625% senior subordinated convertible debentures. In August 2015, we increased our borrowings under our credit agreement to finance the purchase price of our Micrel acquisition which closed on August 3, 2015. In December 2015, we exercised our increase option in our credit agreement to obtain additional revolving commitments of $219 million, bringing our total revolving credit facility to $2.774 billion. In connection with the closing of our acquisition of Atmel on April 4, 2016, we increased our borrowings under our credit agreement by approximately $0.94 billion to finance a portion of the purchase price of such acquisition. As a result of such transactions, we have a substantially greater amount of debt than we had maintained in the past. At September 30, 2016, we had $1,677.5 million in outstanding borrowings under our credit agreement. 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 all or a portion of our loans under our credit agreement, our debentures 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.


51
Table of Contents


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. We may be unable to compete successfully in the future, which could harm our business. Our ability to compete successfully depends on a number of factors both within and outside our control, including, but not limited to:

•
the quality, performance, reliability, features, ease of use, pricing and diversity of our products;
•
our success in designing and manufacturing new products including those implementing new technologies;
•
the rate at which customers incorporate our products into their own applications and the success of such applications;
•
the rate at which the markets that we serve redesign and change their own products;
•
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 obtain adequate foundry and assembly and test capacity and supplies of raw materials and other supplies at acceptable prices;
•
our ability to protect our products and processes by effective utilization of intellectual property rights;
•
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.


52
Table of Contents


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 six months of fiscal 2017, approximately 41% of our net sales came from products that were produced at outside wafer foundries. During fiscal 2016, approximately 39% 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 six months of fiscal 2017, approximately 62% of our assembly requirements and 37% of our test requirements were performed by third party contractors compared to approximately 44% of our assembly requirements and 11% of our test requirements during fiscal 2016. 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 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 is subject to seasonally lower 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 acquisitions of Atmel and Micrel) 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 56% of our net sales in the first six months of fiscal 2017 and approximately 53% of our net sales in fiscal 2016. 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 sell-through of our products by 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.


53
Table of Contents


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.

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 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.


54
Table of Contents


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. An interruption of any materials or equipment sources, or the lack of supplier support for a particular piece of equipment, could harm our business.

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 (including the matters described in Part II Item 1. Legal Proceedings of this Form 10-Q). As is typical in the semiconductor industry, we receive notifications from third parties from time to time who believe that we owe them indemnification, defense, reimbursement, 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.

We are subject to customer and third-party claims related to the manufacture, performance or use of our products, or those of an acquired company. 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 into their applications or the insufficient design, application, manufacture, 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;
•
a requirement to pay damages or penalties; and
•
third-party costs, defense costs, and indemnification amounts.

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.


55
Table of Contents


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 six months of fiscal 2017, approximately 85% of our net sales were made to foreign customers, including 32% in China. During fiscal 2016, approximately 84% of our net sales were made to foreign customers, including 30% 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 deliver products to our European customers through our facilities in England. The UK’s EU referendum on June 23, 2016 (called "Brexit" in the press) was in favor of the UK leaving the EU. When the UK does ultimately leave the EU, we may lose our ability to import and export products tax-free throughout Europe. As a result, it may increase the costs to Microchip for the import and sale of our products to our customers, which may result in a decrease in sales to certain of our customers. In order to avoid these costs, we may have to consider alternate methods for delivering product into Europe. In implementing these changes, we may experience a disruption in operations or product shipments.

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. Substantially all 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 a result of our acquisition of Atmel, 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;

56
Table of Contents


•
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.

We do not typically have long-term contracts with our customers, but where we do, certain terms of such contracts expose us to risks and liabilities.

We do not typically enter into long-term contracts with our customers and we cannot be certain about future order levels from our customers. When we do enter into customer contracts, the contract is generally cancelable at the convenience of the customer. Even though we had approximately 115,000 customers and our ten largest direct customers made up approximately 12% of our total revenue for the six month period ended September 30, 2016, cancellation of customer contracts could have an adverse impact on our revenue and profits.

We have entered into contracts with certain customers that differ from our standard terms of sale. Further, as a result of our acquisitions, we have inherited certain customer contracts 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 have committed to supply specific quantities of products on scheduled delivery dates, or extended 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. 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. 

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, 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.

57
Table of Contents


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 as our licenses are based on per unit royalties.

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. Over the past several months, the U.S. dollar has strengthened against the Euro and other major currencies.  Although our business has not been materially adversely impacted by such change in the value of the U.S. dollar, there can be no assurance as to the future impact that the strength of the 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.


58
Table of Contents


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 many 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. We may incur significant decommissioning and clean-up costs and obligations in the event we cease to use, or decide to sell or repurpose a facility that we or an acquired company has used in a manufacturing capacity or that has been exposed to potentially hazardous materials (including the Micrel wafer fabrication facility in San Jose, California). 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.

Potential U.S. tax legislation regarding our foreign earnings could materially and adversely impact our business and financial results.

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. Present U.S. income taxes and foreign withholding taxes have not been provided on undistributed earnings for certain of our non-U.S. subsidiaries, because such earnings are intended to be indefinitely reinvested in the operations of those subsidiaries. In recent years, there have been a number of initiatives proposed by the Obama administration and members of Congress regarding the tax treatment of such undistributed earnings. If adopted, certain of these initiatives would substantially reduce our ability to defer U.S. taxes including repealing the deferral of U.S. taxation of foreign earnings, eliminating utilization of or substantially reducing our ability to claim foreign tax credits, and eliminating various tax deductions until foreign earnings are repatriated to the U.S. Changes in tax law such as these proposals could have a material adverse impact on our financial position and results of operations.

59
Table of Contents



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 26, 2016. 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 products.

A significant portion of our sales are made outside of the U.S. through the exporting and re-exporting of products. In addition to local jurisdictions' export regulations, our U.S.-manufactured products or products based on U.S. technology are subject to U.S. laws and regulations governing international trade and exports, 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 destinations 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 these or other 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 export 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 currently ongoing and future examinations of our income tax returns by the IRS could have an adverse effect on our results of operations.

We are effectively subject to examination of our income tax returns by the IRS and other tax authorities for fiscal 2005 and later. We are currently under IRS audit for fiscal 2011 and fiscal 2012.  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.

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.


60
Table of Contents


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.

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 long-lived 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 and other intangible assets is determined by the excess of the purchase price over the net identifiable assets acquired. Our acquisition of Atmel significantly increased our goodwill and net intangible assets. As of September 30, 2016, we had goodwill of $2,384.7 million and other net intangible assets of $2,322.7 million. We review our long-lived assets, including goodwill and other intangible assets, for impairment annually in the fourth fiscal quarter or whenever events or changes in circumstances indicate that the carrying amount of those assets may not be recoverable.  Factors that may be considered in assessing whether goodwill or intangible assets may not be recoverable 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 or material long-lived asset impairment charges were recorded in fiscal 2016 or the first six months of fiscal 2017.  However, if in future periods, we determine that our long-lived assets, including goodwill or intangible assets, are impaired, we will be required to write down these assets which would have a negative effect on our consolidated financial statements.  

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 acquisition of Atmel, we assumed unfunded defined benefit pension plans that cover certain of our French, German and Philippines employees. Plan benefits are managed in accordance with local statutory requirements. Benefits are based on years of service and employee compensation levels. The projected benefit obligation totaled $53.5 million at September 30, 2016. The plans are unfunded, in compliance with local statutory regulations, and we have no immediate intention of funding these plans. Benefits are paid when amounts become due, commencing when participants retire. We expect to pay approximately $0.5 million in fiscal 2017 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.

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 previously paid to us 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 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 debentures will dilute the ownership interest of existing stockholders, including holders who had previously converted their debentures.

The conversion of some or all of our outstanding debentures will dilute the ownership interest of existing stockholders to the extent we deliver common stock upon conversion of the debentures. Upon conversion, we may satisfy our conversion obligation by delivering cash, shares of common stock or any combination, at our option. If upon conversion we elect 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 the conversion value in excess of the one thousand dollars principal amount (i.e., the conversion spread). There would be no adjustment to the numerator in

61
Table of Contents


the net income per common share computation for the cash settled portion of the debentures 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 debentures could adversely affect prevailing market prices of our common stock. In addition, the existence of the debentures may encourage short selling by market participants because the conversion of the debentures could be used to satisfy short positions, or anticipated conversion of the debentures into shares of our common stock could depress the price of our common stock.

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 Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09 - Revenue from Contracts with Customers (Topic 606), which will supersede nearly all existing revenue guidance under US GAAP and will be effective for us beginning no later than April 1, 2018. 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 adoption, we will no longer defer revenue until the sale by our distributors to end customers, but rather, we will be required to record revenue at the time of sale to the distributor. We are currently evaluating the impact that the adoption of the standard will have on our consolidated financial statements and have not elected a transition method. Refer to Note 2 to our consolidated financial statements for additional information on the new guidance and its potential impact on us.

Climate change regulations and sustained adverse climate change pose regulatory and physical risks that could harm our results of operations or affect the way we conduct business.

Climate change regulations 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 could have an adverse effect on our operating results.

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, Thailand and the Philippines. 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 shares of our common stock in the three months ended September 30, 2016.


62
Table of Contents


Item 6.
Exhibits
10.1
Executive Management Incentive Compensation Plan, as amended (incorporated by reference to the same numbered exhibit to the Company's Current Report on Form 8-K filed on August 18, 2016).
 
 
31.1
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
31.2
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
32
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
101.INS
XBRL Instance Document
 
 
101.SCH
XBRL Taxonomy Extension Schema Document
 
 
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
 
 
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
 
 
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document


63
Table of Contents


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.

 
 
 
MICROCHIP TECHNOLOGY INCORPORATED
 
 
 
 
Date:
 
November 8, 2016
By: /s/ J. Eric Bjornholt                                
 
 
 
J. Eric Bjornholt
 
 
 
Vice President and Chief Financial Officer
 
 
 
(Duly Authorized Officer, and
 
 
 
Principal Financial and Accounting Officer)

64