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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 December 31, 2002.
OR
( ) 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
MICROCHIP TECHNOLOGY INCORPORATED
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 86-0629024
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) 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)
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 [ ]
The registrant is an accelerated filer (as defined by Rule 12b-2 of the
Securities Exchange Act of 1934.
Yes [X] No [ ]
Number of shares of common stock, $.001 par value, outstanding as of January 31,
2003: 203,448,669 SHARES.
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MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
INDEX
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets -
December 31, 2002 and March 31, 2002.................................3
Condensed Consolidated Statements of Income -
Three and Nine Months Ended December 31, 2002
and December 31, 2001................................................4
Condensed Consolidated Statements of Cash Flows -
Nine Months Ended December 31, 2002 and
December 31, 2001....................................................5
Notes to Condensed Consolidated Financial Statements -
December 31, 2002....................................................6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.......................11
Item 3. Quantitative and Qualitative Disclosures about Market Risk..........30
Item 4. Controls and Procedures.............................................31
PART II. OTHER INFORMATION
Item 1. Legal Proceedings...................................................31
Item 6. Exhibits and Reports on Form 8-K....................................31
SIGNATURES....................................................................32
CERTIFICATIONS................................................................33
EXHIBITS
2
MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands except share amounts)
ASSETS
December 31, March 31,
2002 2002
------------ ------------
(Unaudited) (Note 1)
Cash and cash equivalents $ 198,231 $ 280,647
Accounts receivable, net 93,375 80,747
Inventories 93,961 88,615
Prepaid expenses 7,736 6,154
Deferred tax assets 120,731 83,980
Other current assets 72,842 9,033
------------ ------------
Total current assets 586,876 549,176
Property, plant and equipment, net 777,753 715,960
Goodwill 30,746 --
Intangible assets, net 5,133 --
Other assets 9,945 10,464
------------ ------------
Total assets $ 1,410,453 $ 1,275,600
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $ 36,621 $ 38,292
Accrued liabilities 114,669 88,506
Deferred income on shipments to distributors 46,240 40,800
------------ ------------
Total current liabilities 197,530 167,598
Pension accrual 1,059 1,091
Deferred tax liability 36,616 31,132
Stockholders' equity:
Preferred stock, $.001 par value; authorized 5,000,000 shares;
no shares issued or outstanding -- --
Common stock, $.001 par value; authorized 450,000,000 shares;
issued and outstanding 203,469,181 shares at December 31, 2002;
issued 200,802,633 and outstanding 200,629,908 shares at March 31, 2002 203 201
Additional paid-in capital 490,826 459,303
Retained earnings 684,219 619,254
Less shares of common stock held in treasury at cost; 172,725 shares
at March 31, 2002 -- (2,979)
------------ ------------
Net stockholders' equity 1,175,248 1,075,779
------------ ------------
Total liabilities and stockholders' equity $ 1,410,453 $ 1,275,600
============ ============
See accompanying notes to condensed consolidated financial statements
3
MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
December 31, December 31,
---------------------- ----------------------
2002 2001 2002 2001
--------- --------- --------- ---------
Net sales $ 170,998 $ 141,857 $ 500,491 $ 422,413
Cost of sales 77,071 70,718 231,158 210,999
--------- --------- --------- ---------
Gross profit 93,927 71,139 269,333 211,414
Operating expenses:
Research and development 22,323 21,409 66,220 61,111
Selling, general and administrative 22,430 19,869 67,498 61,477
Special charges -- -- 50,800 --
--------- --------- --------- ---------
44,753 41,278 184,518 122,588
Operating income 49,174 29,861 84,815 88,826
Other income (expense):
Interest income 681 1,187 3,155 3,733
Interest expense (114) (111) (372) (443)
Other, net (27) 86 160 449
--------- --------- --------- ---------
Income before income taxes 49,714 31,023 87,758 92,565
Income tax provision 12,677 7,446 18,732 24,067
--------- --------- --------- ---------
Net income $ 37,037 $ 23,577 $ 69,026 $ 68,498
========= ========= ========= =========
Basic net income per share $ 0.18 $ 0.12 $ 0.34 $ 0.34
========= ========= ========= =========
Diluted net income per share $ 0.18 $ 0.11 $ 0.33 $ 0.33
========= ========= ========= =========
Weighted average common
shares outstanding 203,109 200,273 202,152 198,881
========= ========= ========= =========
Weighted average common and potential
common shares outstanding 210,929 209,810 210,484 208,124
========= ========= ========= =========
See accompanying notes to condensed consolidated financial statements
4
MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
Nine Months Ended
December 31,
----------------------
2002 2001
--------- ---------
Cash flows from operating activities:
Net income $ 69,026 $ 68,498
Adjustments to reconcile net income to net cash provided by operating
activities:
Provision for doubtful accounts 45 43
Provision for inventory valuation 4,750 4,735
Provision for pension accrual 34 87
Gain on sale of fixed assets -- (240)
Fab 3 impairment charge 41,500 --
Loss on write-down of fixed assets 2,146 --
In-process research and development charge 9,300 --
Depreciation and amortization 82,895 82,588
Deferred income taxes (24,178) 17,103
Tax benefit from exercise of stock options 17,417 15,488
(Increase) decrease in accounts receivable (11,553) 12,000
Increase in inventories (9,597) (1,292)
Increase (decrease) in accounts payable and accrued liabilities 21,820 (47,655)
Change in other assets and liabilities (106) (39,830)
--------- ---------
Net cash provided by operating activities 203,499 111,525
--------- ---------
Cash flows from investing activities:
PowerSmart acquisition, net of cash acquired (50,674) --
Proceeds from sale of assets -- 1,029
Purchase of Fab 4 (184,717) --
Capital expenditures (62,918) (36,257)
--------- ---------
Net cash used in investing activities (298,309) (35,228)
--------- ---------
Cash flows from financing activities:
Proceeds from lines of credit -- 2,138
Payment of cash dividend (4,061) --
Purchase of treasury stock (7,473) --
Proceeds from sale of stock 23,928 37,051
--------- ---------
Net cash provided by financing activities 12,394 39,189
--------- ---------
Net (decrease) increase in cash and cash equivalents (82,416) 115,486
Cash and cash equivalents at beginning of period 280,647 129,909
--------- ---------
Cash and cash equivalents at end of period $ 198,231 $ 245,395
========= =========
See accompanying notes to condensed consolidated financial statements
5
MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002
(UNAUDITED)
(1) BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
include the accounts of Microchip Technology Incorporated and its wholly owned
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, pursuant to the rules and regulations of the
Securities and Exchange Commission (the "SEC"). In the opinion of management,
all adjustments of a normal recurring nature which are necessary for a fair
presentation have been included. 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 year ended March
31, 2002. The results of operations for the nine months ended December 31, 2002
are not necessarily indicative of the results that may be expected for the year
ending March 31, 2003 or for any other period.
Certain reclassifications have been made to conform the prior year amounts
to the current period presentation.
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 141 ("SFAS 141"), BUSINESS COMBINATIONS, and
No. 142 ("SFAS 142"), GOODWILL AND OTHER INTANGIBLE ASSETS, effective for fiscal
years beginning after December 15, 2001. In accordance with SFAS Nos. 141 and
142, goodwill and intangible assets deemed to have indefinite lives will no
longer be amortized, but will be subject to annual impairment tests. Other
intangible assets will continue to be amortized over their useful lives.
Goodwill will be subject to impairment tests annually, or earlier if indicators
of potential impairment exist, using a fair-value-based approach. The Company
adopted the new rules on accounting for goodwill and other intangible assets
beginning in the first quarter of fiscal 2003 and such rules were applied to the
acquisition of PowerSmart, Inc. The annual impairment tests will be performed in
the fourth quarter of each fiscal year. As of December 31, 2002, no impairment
of goodwill has been recognized. Future goodwill impairment tests may result in
a charge to earnings.
(2) ACQUISITION OF GRESHAM, OREGON WAFER FABRICATION FACILITY
On August 23, 2002, the Company completed its acquisition of a
semiconductor manufacturing complex in Gresham, Oregon. The Company acquired the
facility for $183.5 million in cash plus direct acquisition costs of
approximately $1.2 million. The facility is situated on an approximately
140-acre campus east of Portland and comprises approximately 826,500 square
feet, including approximately 200,000 square feet of clean room space. The
facility came equipped with approximately 350 process tools and 170 support
tools. The Company plans to initially produce 8-inch wafers on its 0.5 micron
and 0.35 micron process technologies at the Gresham facility. The facility also
houses offices, meeting rooms and support functions. The facility is expected to
be placed into production in the second quarter of fiscal 2004, at which time
depreciation will commence.
6
(3) SPECIAL CHARGES
FAB 3 IMPAIRMENT CHARGE
In August 2001, the FASB issued Statement of Financial Accounting Standards
No. 144 ("SFAS 144"), ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED
ASSETS, which is applicable to financial statements for fiscal years beginning
after December 15, 2001. SFAS 144 provides a single accounting model for
long-lived assets to be disposed of and significantly changes the criteria that
would have to be met to classify an asset as held-for-sale. Classification as
held-for-sale is an important distinction since such assets are not depreciated
and are stated at the lower of book value or fair value less cost to sell. SFAS
144 was effective for the Company as of April 1, 2002. In accordance with SFAS
144, the Company recorded a $41.5 million asset impairment charge during the
quarter ended September 30, 2002, as described below.
The Company acquired a semiconductor manufacturing facility in Puyallup,
Washington, referred to as Fab 3, in July 2000. The original purchase consisted
of semiconductor manufacturing facilities and real property. It was the
Company's intention to bring Fab 3 to productive readiness and commence volume
production of 8-inch wafers using its 0.7 and 0.5 micron process technologies by
August 2001. The Company delayed its intended production start up at Fab 3 due
to deteriorating business conditions in the semiconductor industry. Fab 3 has
never been brought to productive readiness.
As described above in Note 2, in August 2002 the Company acquired a
semiconductor manufacturing facility in Gresham, Oregon, referred to as Fab 4.
After the acquisition of Fab 4 was completed, the Company undertook an analysis
of the potential production capacity at Fab 4. The results of the analysis led
the Company to determine that Fab 3's capacity would not be needed in the
foreseeable future and during the second quarter the Company committed to a plan
to sell Fab 3. The Company has retained a third party broker to market Fab 3 on
its behalf. Accordingly, Fab 3 was classified as an asset held-for-sale as of
September 30, 2002 and maintained that classification at December 31, 2002.
The Company retained an independent third party firm, other than its
independent auditors, to complete a fair value appraisal of Fab 3. The
independent third party used the market approach and considered sales of
comparable properties in determining the fair value of Fab 3. The comparable
sales included eight properties, including the subject property from the
Company's prior purchase in 2000. Based on the results of this appraisal, the
Company recorded an asset impairment charge on Fab 3 of $36.9 million, including
estimated costs to sell. The remaining value of $60.2 million was classified as
an asset held-for-sale and is included as a component of other current assets at
December 31, 2002.
During the quarter ended September 30, 2002, the Company also recorded an
asset impairment charge of $4.6 million to write-down certain excess
manufacturing equipment located at Fab 3 to its net realizable value of
$212,000. This manufacturing equipment became "excess" as a result of duplicate
equipment acquired in the purchase of Fab 4. The net realizable value for the
excess manufacturing equipment was determined based on management estimates.
Substantially all of the other manufacturing equipment located at Fab 3 has been
transferred to and will be used in the Company's other wafer fabrication
facilities located in Chandler, Arizona (Fab 1), Tempe, Arizona (Fab 2) and
Gresham, Oregon (Fab 4).
If actual market conditions are less favorable than those estimated in the
appraisal, or if future market conditions deteriorate, the net proceeds from the
assets held-for-sale could be less than the amount estimated in the financial
statements and additional charges could result prior to or at the time of the
sale of Fab 3.
POWERSMART IN-PROCESS RESEARCH AND DEVELOPMENT CHARGE
On June 5, 2002, the Company completed the acquisition of PowerSmart, Inc.
in which Microchip acquired all of PowerSmart's outstanding capital stock and
assumed certain stock options for consideration of $54.0 million in cash. The
purchase price was allocated among PowerSmart's tangible and intangible assets,
7
in-process research and development and goodwill based on an independent
valuation analysis performed by a firm other than the Company's independent
auditors.
The acquisition was accounted for as a purchase business combination in
accordance with SFAS No. 141, BUSINESS COMBINATIONS, and accordingly, the
results of PowerSmart's operations are included in the Company's consolidated
results from the date of the acquisition. The acquisition was not considered
significant under the rules and regulations of the SEC (Rule 3-05 of Regulation
S-X).
The amount paid in excess of the fair value of the net tangible assets has
been allocated to separately identifiable intangible assets based upon an
independent valuation analysis. An allocation of $9.3 million of the purchase
price was assigned to in-process research and development and was written off at
the date of the acquisition in accordance with FASB Interpretation No. 4,
"Applicability of FASB Statement No. 2, BUSINESS COMBINATIONS ACCOUNTED FOR BY
THE PURCHASE METHOD."
An allocation of approximately $30.7 million of the purchase price was made
to goodwill related to the acquisition in accordance with SFAS No. 142, GOODWILL
AND OTHER INTANGIBLE ASSETS. Goodwill related to the Powersmart acquisition will
not be amortized but will be subject to periodic impairment tests. None of the
goodwill is expected to be deductible for tax purposes.
An allocation of $5.6 million of the purchase price was made to core
technology and other identifiable intangible assets and will be amortized over
their estimated useful lives of seven years.
(4) ACCOUNTS RECEIVABLE
Accounts receivable consists of the following (amounts in thousands):
December 31, March 31,
2002 2002
---------- ----------
Trade accounts receivable $ 96,183 $ 84,336
Other 1,112 348
---------- ----------
97,295 84,684
Less allowance for doubtful accounts 3,920 3,937
---------- ----------
$ 93,375 $ 80,747
========== ==========
(5) INVENTORIES
The components of inventories consist of the following (amounts in
thousands):
December 31, March 31,
2002 2002
---------- ----------
Raw materials $ 9,620 $ 7,187
Work in process 56,507 61,724
Finished goods 27,834 19,704
---------- ----------
$ 93,961 $ 88,615
========== ==========
Provisions for inventory valuation 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.
8
(6) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following (amounts in
thousands):
December 31, March 31,
2002 2002
---------- ----------
Land $ 11,538 $ 23,685
Building and building improvements 190,937 191,186
Machinery and equipment 756,118 722,049
Projects in process 323,193 211,098
---------- ----------
1,281,786 1,148,018
Less accumulated depreciation
and amortization 504,033 432,058
---------- ----------
$ 777,753 $ 715,960
========== ==========
Depreciation and amortization expense attributed to property and equipment
was $82.9 million and $82.6 million for the nine months ended December 31, 2002
and December 31, 2001, respectively.
(7) LINES OF CREDIT
The Company has an unsecured revolving credit facility with a syndicate of
banks totaling $100,000,000, bearing interest at LIBOR plus 0.625%. The Company
can elect to increase the facility to $150,000,000, subject to certain
conditions set forth in the credit agreement. This facility has a termination
date of May 31, 2003. The Company had no borrowings against this line of credit
as of December 31, 2002. The credit facility requires the Company to achieve
certain financial ratios and operating results to maintain the credit facility.
The Company's ability to fully utilize this credit facility is dependent on it
being in compliance with such covenants and ratios. The Company was in
compliance with these covenants as of December 31, 2002.
The Company has an additional unsecured short-term line of credit with
various financial institutions in Asia totaling $20,000,000 (U.S. Dollar
equivalent). These borrowings are predominantly denominated in U.S. Dollars,
bearing interest at the Singapore Interbank Offering Rate (SIBOR) of 1.4525% at
December 31, 2002 plus 0.75% (average) and expiring on various dates through
November 2003. There were no borrowings against this line of credit as of
December 31, 2002, and an allocation of $855,000 of the available line was made,
relating to import guarantees associated with the Company's business in
Thailand. There are no covenants related to the foreign line of credit.
9
(8) NET INCOME PER SHARE
The following table sets forth the computation of basic and diluted net
income per share (in thousands, except per share amounts):
Three Months Ended Nine Months Ended
December 31, December 31,
----------------------- -----------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
Net income $ 37,037 $ 23,577 $ 69,026 $ 68,498
Weighted average common
shares outstanding 203,109 200,273 202,152 198,881
Dilutive effect of stock options 7,820 9,537 8,332 9,243
---------- ---------- ---------- ----------
Weighted average common
and potential common shares
outstanding 210,929 209,810 210,484 208,124
========== ========== ========== ==========
Basic net income per share $ 0.18 $ 0.12 $ 0.34 $ 0.34
========== ========== ========== ==========
Diluted net income per share $ 0.18 $ 0.11 $ 0.33 $ 0.33
========== ========== ========== ==========
(9) STOCK REPURCHASE
On August 7, 2002, the Company's Board of Directors authorized the Company
to repurchase up to 2,500,000 shares of its common stock in the open market or
in privately negotiated transactions. During the nine months ended December 31,
2002, the Company purchased 393,700 shares of its common stock for $7,473,040.
All of the purchased shares were reissued by December 31, 2002 to fund stock
option exercises and purchases under the Company's employee stock purchase plan.
The timing and amount of any future repurchases will depend upon market
conditions and corporate considerations.
(10) DIVIDEND PAYMENTS
On October 28, 2002, the Company announced that its Board of Directors had
approved and instituted a quarterly cash dividend on its common stock. The
initial quarterly dividend of $0.02 per share was paid on December 6, 2003 in
the amount of $4,060,766. A second quarterly dividend payment was declared on
January 21, 2003 in the amount of $0.02 per share and will be paid on February
28, 2003 to shareholders of record as of February 7, 2003. The Company expects
its second quarterly dividend payment to be approximately $4.1 million.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
The following table sets forth certain operational data as a percentage of
net sales for the periods indicated:
Three Months Ended Nine Months Ended
December 31, December 31,
(Unaudited) (Unaudited)
----------------- -----------------
2002 2001 2002 2001
------ ------ ------ ------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 45.1% 49.9% 46.2% 50.0%
------ ------ ------ ------
Gross profit 54.9% 50.1% 53.8% 50.0%
Research and development 13.0% 15.1% 13.2% 14.5%
Selling, general and
administrative 13.1% 14.0% 13.5% 14.5%
Special charges 0.0% 0.0% 10.2% 0.0%
------ ------ ------ ------
Operating income 28.8% 21.0% 16.9% 21.0%
====== ====== ====== ======
NET SALES
We operate in one industry segment and engage primarily in the design,
development, manufacture and marketing of semiconductor products. We sell our
products to distributors and original equipment manufacturers, referred to as
OEMs, in a broad range of market segments, perform on-going credit evaluations
of our customers and generally require no collateral.
Our net sales for the quarter ended December 31, 2002 were $171.0 million,
an increase of 0.7% from the previous quarter's sales of $169.7 million, and an
increase of 20.5% from net sales of $141.9 million in the quarter ended
December 31, 2001.
Our net sales for the nine months ended December 31, 2002 were $500.5
million, an increase of 18.5% from net sales of $422.4 million for the nine
months ended December 31, 2001.
The increases in net sales for the three and nine-month periods ended
December 31, 2002, compared to the three and nine-month periods ended
December 31, 2001, were primarily due to increased demand, predominantly for our
proprietary microcontroller and analog and interface products. Key factors in
our success in achieving these increases in net sales during the three and
nine-month periods ended December 31, 2002 include:
* continued market share gains
* increasing semiconductor content in our customers' products
* our new product offerings that have increased our served available
market, and
* increasing demand for our programmable products.
11
Sales by product line for the three and nine-month periods ended December
31, 2002 and December 31, 2001 were as follows (in thousands):
Three Months Ended Nine Months Ended
December 31, December 31,
(Unaudited) (Unaudited)
---------------------------------------- ----------------------------------------
2002 % 2001 % 2002 % 2001 %
-------- ------- -------- ------- -------- ------- -------- -------
Microcontrollers $137,227 80.3% $110,384 77.8% $393,678 78.7% $326,439 77.3%
Memory products 20,755 12.1% 21,725 15.3% 68,750 13.7% 64,167 15.2%
Analog and
interface products 13,016 7.6% 9,748 6.9% 38,063 7.6% 31,807 7.5%
-------- ------- -------- ------- -------- ------- -------- -------
Total sales $170,998 100.0% $141,857 100.0% $500,491 100.0% $422,413 100.0%
======== ======= ======== ======= ======== ======= ======== =======
Certain reclassifications have been made to conform the prior period
amounts to the current period presentation.
MICROCONTROLLERS
Our microcontroller product line represents the largest component of our
total net sales. Microcontrollers and associated application development systems
accounted for approximately 80% of our total net sales for the three-month
period ended December 31, 2002, and approximately 79% of our total net sales for
the nine-month period ended December 31, 2002.
Microcontrollers and associated applicable development systems accounted
for approximately 78% of our total net sales for the three-month period ended
December 31, 2001, and approximately 77% of our total net sales for the
nine-month period ended December 31, 2001.
Net sales of our microcontroller products increased approximately 24% in
the three-month period ended December 31, 2002, and 21% in the nine-month period
ended December 31, 2002, compared to the three and nine-month periods ended
December 31, 2001. These sales increases were primarily due to increased demand
for our microcontroller products in end markets, driven principally by market
share gains and those factors described above at page 11. The end markets that
we serve include the automotive, communications, computing, consumer and
industrial control markets.
Historically, average selling prices in the semiconductor industry decrease
over the life of any particular product. The overall average selling prices of
our microcontroller products have remained relatively constant over time due to
the proprietary nature of these products. We have experienced, and expect to
continue to experience, moderate pricing pressure in certain microcontroller
product lines, primarily due to competitive conditions. We have been able to in
the past, and expect to be able to in the future, moderate average selling price
declines in our microcontroller product lines by introducing new products with
more features and higher prices. We may be unable to maintain average selling
prices for our microcontroller products as a result of increased pricing
pressure in the future, which would adversely affect our operating results.
MEMORY PRODUCTS
Sales of our memory products accounted for approximately 12% of our total
net sales for the three-month period ended December 31, 2002, and approximately
14% of our total net sales for the nine-month period ended December 31, 2002.
12
Sales of our memory products accounted for approximately 15% of our total
net sales in each of the three and nine-month periods ended December 31, 2001.
Net sales of our memory products decreased approximately 5% in the
three-month period ended December 31, 2002, and increased approximately 7% in
the nine-month period ended December 31, 2002, compared to the three and
nine-month periods ended December 31, 2001. These sales fluctuations were driven
primarily by customer demand conditions within the Serial EEPROM market, which
products comprise substantially all of our memory product net sales.
Serial EEPROM product pricing has historically been cyclical in nature,
with steep price declines followed by periods of relative price stability,
driven by changes in industry capacity at different stages of the business
cycle. During the periods covered by this report, we have experienced several
Serial EEPROM product pricing trends due to market conditions. We experienced
significant competitive downward pricing pressures in our Serial EEPROM product
lines during the first half of fiscal 2002, returning to modest pricing declines
in the second half of fiscal 2002. Serial EEPROM pricing was essentially flat
during first half of fiscal 2003, and down approximately 9% in the quarter ended
December 31, 2002. We have experienced, and expect to continue to experience,
varying degrees of competitive pricing pressures in our Serial EEPROM products.
We may be unable to maintain the average selling prices of our Serial EEPROM
products as a result of increased pricing pressure in the future, which would
adversely affect our operating results.
ANALOG AND INTERFACE PRODUCTS
Sales of our analog and interface products accounted for approximately 8%
of our total net sales in each of the three and nine-month periods ended
December 31, 2002 and December 31, 2001.
Net sales of our analog and interface products increased approximately 34%
in the three-month period ended December 31, 2002, and 20% in the nine-month
period ended December 31, 2002, compared to the three and nine-month periods
ended December 31, 2001. These sales increases were driven primarily by new
proprietary design wins, supply and demand conditions within the market and our
ability to gain market share.
Analog and interface products can be proprietary or non-proprietary in
nature. Currently, we consider approximately 45% of our analog and interface
product mix to be proprietary in nature, where prices are relatively stable,
similar to the pricing stability experienced in our microcontroller products.
The non-proprietary portion of our analog and interface business will experience
price fluctuations, driven primarily by the current supply and demand for those
products. During the three-month period ended December 31, 2002, pricing of our
non-proprietary analog and interface products was approximately flat compared to
the three-month period ended September 30, 2002. During the nine-month period
ended December 31, 2002, pricing of our non-proprietary analog and interface
products was approximately flat compared to the three-month period ended
March 31, 2002. We have experienced, and expect to continue to experience,
moderate pricing pressure in certain analog and interface product lines,
primarily due to competitive conditions. We may be unable to maintain the
average selling prices of our analog and interface products as a result of
increased pricing pressure in the future, which would adversely affect our
operating results. We anticipate the proprietary portion of our analog and
interface products to increase over time.
TURNS ORDERS
Our net sales in any given quarter depend upon a combination of shipments
from backlog and orders received in that quarter for shipment in that quarter,
which we refer to as turns orders. We measure turns orders at the beginning of a
quarter based on the orders needed to meet the revenue target that we set
entering the quarter. We emphasize our ability to respond quickly to customer
orders as part of our competitive strategy, resulting in customers placing
orders with short delivery schedules. Turns orders directly correlate to product
lead times, which are generally three weeks or less for the majority of our
products, essentially unchanged from lead times a year ago. Shorter lead times
generally mean that turns orders as a percentage of our business are relatively
13
high in any particular quarter and reduces our visibility on future product
shipments. With current lead times for the majority of our products being three
weeks or less, generally, customers do not place orders beyond their immediate
requirements.
The percentage of turns orders in any given quarter is dependent on overall
semiconductor industry conditions and product lead times. As such, our
percentage of turns orders has fluctuated over the last three fiscal years
between 20% and 63%. At October 1, 2002, we required turns orders of
approximately 60% in order to achieve our revenue for the third quarter of
fiscal 2003.
Turns orders are difficult to predict, and we may not experience the
combination of turns orders and shipments from backlog in a quarter that would
be sufficient to achieve anticipated net sales. If we do not achieve a
sufficient level of turns orders in a particular quarter, our net sales and
operating results will suffer.
THE FOREGOING STATEMENTS REGARDING COMPETITIVE PRICING PRESSURE IN OUR
MICROCONTROLLER, SERIAL EEPROM AND ANALOG AND INTERFACE PRODUCT LINES, OUR
ABILITY TO MODERATE FUTURE AVERAGE SELLING PRICE DECLINES IN OUR MICROCONTROLLER
PRODUCT LINES AND THE PROPRIETARY PORTION OF OUR ANALOG AND INTERFACE PRODUCT
LINES INCREASING OVER TIME ARE FORWARD-LOOKING STATEMENTS. ACTUAL RESULTS COULD
DIFFER MATERIALLY BECAUSE OF THE FOLLOWING FACTORS, AMONG OTHERS: THE LEVEL OF
ORDERS THAT ARE RECEIVED AND CAN BE SHIPPED IN A QUARTER; CHANGES IN DEMAND FOR
OUR PRODUCTS AND THE PRODUCTS OF OUR CUSTOMERS; THE LEVEL AT WHICH PREVIOUS
DESIGN WINS BECOME ACTUAL ORDERS AND SALES; INVENTORY MIX AND TIMING OF CUSTOMER
ORDERS; CUSTOMERS' INVENTORY LEVELS, ORDER PATTERNS AND SEASONALITY; LEVEL OF
SELL-THROUGH OF OUR PRODUCTS THROUGH DISTRIBUTION IN ANY PARTICULAR FISCAL
PERIOD; POSSIBLE DISRUPTIONS TO OUR CUSTOMERS' OPERATIONS OCCASIONED BY ANY SLOW
DOWN OR CESSATION IN INTERNATIONAL TRANSPORT OR DELIVERY CAUSED BY LABOR STRIKES
OR WORK STOPPAGES AT INTERNATIONAL PORTS OF DELIVERY IN THE UNITED STATES OR
ELSEWHERE WHICH COULD RESULT IN REDUCED CUSTOMER PURCHASES RELATIVE TO OUR
EXPECTATIONS; OUR ABILITY TO RAMP PRODUCTS INTO VOLUME PRODUCTION; COMPETITION
AND COMPETITIVE PRESSURES ON PRICING AND PRODUCT AVAILABILITY; DISRUPTIONS IN
COMMERCIAL ACTIVITIES, OR INTERNATIONAL TRANSPORT OR DELIVERY OCCASIONED BY
TERRORIST ACTIVITY, ARMED CONFLICT, WAR OR AN UNEXPECTED INCREASE IN THE PRICE
OF, OR DECREASE IN THE SUPPLY OF, OIL RESULTING IN REDUCED END-USER PURCHASES
RELATIVE TO EXPECTATIONS; IMPACT OF EVENTS OUTSIDE THE UNITED STATES, SUCH AS
THE BUSINESS IMPACT OF FLUCTUATING CURRENCY RATES OR UNREST OR POLITICAL
INSTABILITY; THE CYCLICAL NATURE OF BOTH THE SEMICONDUCTOR INDUSTRY AND THE
MARKETS ADDRESSED BY OUR PRODUCTS; MARKET ACCEPTANCE OF OUR NEW PRODUCTS AND
THOSE OF OUR CUSTOMERS; THE FINANCIAL CONDITION OF OUR CUSTOMERS; FLUCTUATIONS
IN PRODUCTION YIELDS, PRODUCTION EFFICIENCIES AND OVERALL CAPACITY UTILIZATION;
CHANGES IN PRODUCT MIX; ABSORPTION OF FIXED COSTS, LABOR AND OTHER FIXED
MANUFACTURING COSTS; AND GENERAL INDUSTRY, ECONOMIC AND POLITICAL CONDITIONS.
DISTRIBUTION
Distributors accounted for approximately 57% of our net sales in the
three-month period ended December 31, 2002, and 60% of our net sales in the
three-month period ended December 31, 2001. Distributors accounted for
approximately 59% of our net sales in the nine-month period ended December 31,
2002, and 61% of our net sales in the nine-month period ended December 31, 2001.
Our largest distributor accounted for approximately 11% of our net sales in
the three-month period ended December 31, 2002, and 12% of our total net sales
in the three-month period ended December 31, 2001. Our largest distributor
accounted for approximately 11% of our total net sales in the nine-month period
ended December 31, 2002, and 12% of our total net sales in the nine-month period
ended December 31, 2001.
Generally, we do not have long-term agreements with our distributors, and
we or our distributors may terminate their relationships with us with little or
no advanced notice. The loss of, or the disruption in the operations of, one or
more of our distributors could reduce our future net sales in a given quarter
and could result in an increase in inventory returns.
14
SALES BY GEOGRAPHY
Sales by geography for the three and nine-month periods ended December 31,
2002 and 2001 were as follows (in thousands):
Three Months Ended Nine Months Ended
December 31, December 31,
(Unaudited) (Unaudited)
---------------------------------------- ----------------------------------------
2002 % 2001 % 2002 % 2001 %
-------- ------- -------- ------- -------- ------- -------- -------
Americas $ 57,321 33.5% $ 47,467 33.5% $169,038 33.8% $143,937 34.1%
Europe 42,217 24.7% 43,188 30.4% 129,827 25.9% 132,799 31.4%
Asia 71,460 41.8% 51,202 36.1% 201,626 40.3% 145,677 34.5%
-------- ------- -------- ------- -------- ------- -------- -------
Total Sales $170,998 100.0% $141,857 100.0% $500,491 100.0% $422,413 100.0%
======== ======= ======== ======= ======== ======= ======== =======
Our sales to foreign customers have been predominately in Asia and Europe,
which we attribute to the manufacturing strength in those areas for automotive,
communications, computing, consumer and industrial control products. Americas
sales include sales to customers in the United States, Canada, Central America
and South America.
Sales to foreign customers accounted for approximately 71% of our net sales
in the three and nine months ended December 31, 2002 and approximately 69% of
our net sales in the three and nine months ended December 31, 2001. The majority
of our foreign sales are U.S. Dollar denominated.
GROSS PROFIT
Our gross profit was $93.9 million in the three months ended December 31,
2002, and $71.1 million in the three months ended December 31, 2001. Our gross
profit was $269.3 million in the nine months ended December 31, 2002, and $211.4
million in the nine months ended December 31, 2001.
Gross profit as a percent of sales was 54.9% in the three months ended
December 31, 2002, and 50.1% in the three months ended December 31, 2001. Gross
profit as a percent of sales was 53.8% in the nine months ended December 31,
2002, and 50.0% in the nine months ended December 31, 2001.
The most significant factors affecting gross profit percentage in the
periods covered by this report were:
* higher levels of manufacturing capacity utilization in fiscal 2003,
compared to fiscal 2002
* continued cost reductions in wafer fabrication and assembly and test
manufacturing
* our ability to maintain average selling prices for our microcontroller
products where moderate downward pricing pressures have been offset by
introduction of new products with more features and higher selling
prices
* varying factors impacting the average selling prices of our Serial
EEPROM products
* fluctuations in the product mix of proprietary microcontroller and
analog products and related Serial EEPROM products
* the sale of inventory that was previously reserved for, and
* one-week plant shutdowns in each quarter of fiscal 2002.
During fiscal 2002, we operated at approximately 70% of our cumulative
total Fab 1 (Chandler, Arizona) and Fab 2 (Tempe, Arizona) capacity due to the
capacity reductions implemented in the March 2001 quarter and one-week plant
shutdowns in each quarter of fiscal 2002. Our overall gross margins in fiscal
2002 were negatively impacted by these actions due to the relatively high fixed
15
costs inherent in our wafer fabrication manufacturing. Capacity utilization
increased to approximately 83% in the first quarter of fiscal 2003, 84% in the
second quarter of fiscal 2003, and 86% in the third quarter of fiscal 2003,
which favorably impacted gross margins, compared to the gross margins attained
in fiscal 2002.
Our overall inventory levels were $93.9 million as of December 31, 2002,
compared to $88.6 million at March 31, 2002. We maintained 111 days of inventory
on our balance sheet as of December 31, 2002, compared to 110 days as of
March 31, 2002. The highest number of days of inventory that we experienced in
either fiscal 2002 or fiscal 2003 was 127 days as of September 30, 2001.
As of December 31, 2002, Fab 3 (Puyallup, Washington) was not an active
operating asset. We are currently holding Fab 3 as an asset held-for-sale and
are maintaining it at minimal operating cost. See "Special Charges - Fab 3
Impairment Charge," below at page 18, for a discussion of the status of Fab 3.
Fabs 1 and 2 currently utilize various manufacturing process technologies,
but predominantly utilize our 1.0 to 0.5-micron processes. We continue to
transition products to more advanced process technologies to reduce future
manufacturing costs. In fiscal 2002 and the first three-quarters of fiscal 2003,
approximately 80% of our production was on 8-inch wafers.
We anticipate that gross margins will fluctuate over time, driven primarily
by the overall product mix of microcontroller, analog and interface and memory
products and the percentage of net sales of each of these products in a
particular quarter, as well as manufacturing yields, fixed cost absorption,
wafer fab loading levels and competitive and economic conditions.
THE FOREGOING STATEMENTS RELATING TO OUR TRANSITION TO ADVANCED PROCESS
TECHNOLOGIES TO REDUCE FUTURE MANUFACTURING COSTS AND THE FLUCTUATION OF GROSS
MARGINS OVER TIME ARE FORWARD-LOOKING STATEMENTS. ACTUAL RESULTS COULD DIFFER
MATERIALLY BECAUSE OF THE FOLLOWING FACTORS, AMONG OTHERS: CHANGES IN DEMAND FOR
OUR PRODUCTS AND THE PRODUCTS OF OUR CUSTOMERS; FLUCTUATIONS IN PRODUCTION
YIELDS, PRODUCTION EFFICIENCIES AND OVERALL CAPACITY UTILIZATION; CHANGES IN
CAPACITY UTILIZATION; ABSORPTION OF FIXED COSTS, LABOR AND OTHER DIRECT
MANUFACTURING COSTS; COMPETITION AND COMPETITIVE PRESSURE ON PRICING; POSSIBLE
DISRUPTIONS TO OUR CUSTOMERS' OPERATIONS OCCASIONED BY ANY SLOW DOWN OR
CESSATION IN INTERNATIONAL TRANSPORT OR DELIVERY CAUSED BY LABOR STRIKES OR WORK
STOPPAGES AT INTERNATIONAL PORTS OF DELIVERY IN THE UNITED STATES OR ELSEWHERE
WHICH COULD RESULT IN REDUCED CUSTOMER PURCHASES RELATIVE TO OUR EXPECTATIONS;
DISRUPTIONS IN COMMERCIAL ACTIVITIES, OR INTERNATIONAL TRANSPORT OR DELIVERY
OCCASIONED BY TERRORIST ACTIVITY, ARMED CONFLICT, WAR OR AN UNEXPECTED INCREASE
IN THE PRICE OF, OR DECREASE IN THE SUPPLY OF, OIL RESULTING IN REDUCED END-USER
PURCHASES RELATIVE TO EXPECTATIONS; IMPACT OF EVENTS OUTSIDE THE UNITED STATES,
SUCH AS THE BUSINESS IMPACT OF FLUCTUATING CURRENCY RATES OR UNREST OR POLITICAL
INSTABILITY; OUR ABILITY TO INCREASE MANUFACTURING CAPACITY AS NEEDED; COST AND
AVAILABILITY OF RAW MATERIALS; CHANGES IN PRODUCT MIX; AND OTHER GENERAL
INDUSTRY, ECONOMIC AND POLITICAL CONDITIONS.
At December 31, 2002, approximately 76% of our assembly requirements were
being performed in our Thailand facility, compared to approximately 50% as of
December 31, 2001. Third-party contractors located throughout Asia perform the
balance of our assembly operations. Substantially all of our test requirements
were being performed in our Thailand facility as of December 31, 2002 and
December 31, 2001. We believe that the assembly and test operations performed at
our Thailand facility provide us with significant cost savings when compared to
third-party contractor assembly and test costs, as well as increased control
over these portions of the manufacturing process.
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.
16
Our reliance on foreign operations, maintenance of substantially all of our
finished goods in inventory at foreign locations, and significant foreign sales
exposes us to foreign political and economic risks, including:
* political, social and economic instability
* trade restrictions and changes in tariffs
* import and export license requirements and restrictions
* difficulties in staffing and managing international operations
* employment regulations
* disruptions in international transport or delivery
* fluctuations in currency exchange rates
* difficulties in collecting receivables
* economic slowdown in the worldwide markets served by us, and
* potentially adverse tax consequences.
To date, we have not experienced any significant interruptions in our
foreign business operations. If any of these risks materialize, our sales could
decrease and our operating results could suffer.
RESEARCH AND DEVELOPMENT
Research and development (R&D) expenses for the three months ended
December 31, 2002 were $22.3 million, or 13.0% of sales, compared to $21.4
million, or 15.1% of sales, for the three months ended December 31, 2001. R&D
expenses for the nine months ended December 31, 2002 were $66.2 million, or
13.2% of sales, compared to $61.1 million, or 14.5% of sales, for the nine
months ended December 31, 2001.
We are committed to investing in new and enhanced products, including
development systems software, and in our design and manufacturing process
technologies. We believe these investments are significant factors in
maintaining our competitive position. We expense all R&D costs as incurred. R&D
expenses include expenditures for 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 $0.9 million, or 4.3%, for the three months ended
December 31, 2002, compared to the three months ended December 31, 2001. R&D
expenses increased $5.1 million, or 8.4%, for the nine months ended December 31,
2002, compared to the nine months ended December 31, 2001. The primary reasons
for the dollar increases in R&D costs in each of these periods was increased
labor and professional service costs associated with expanding our technical
resources and the ongoing R&D expenses acquired as part of the acquisition of
PowerSmart, Inc. described below on page 19. R&D expenses were essentially flat
in the three months ended December 31, 2002, compared to the three months ended
September 30, 2002.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses for the three months ended
December 31, 2002 were $22.4 million, or 13.1% of sales, compared to $19.9
million, or 14.0% of sales, for the three months ended December 31, 2001.
Selling, general and administrative expenses for the nine months ended
December 31, 2002 were $67.5 million, or 13.5% of sales, compared to $61.5
million, or 14.6% of sales, for the nine months ended December 31, 2001.
Selling, general and administrative expenses include salary expenses
related to field sales, marketing and administrative personnel, advertising and
promotional expenditures and legal expenses. Selling, general and administrative
expenses also include costs related to our direct sales force and field
applications engineers who work in sales offices worldwide to stimulate demand
by assisting customers in the selection and use of our products.
17
Selling, general and administrative expenses increased $2.6 million, or
12.9%, for the three months ended December 31, 2002, compared to the three
months ended December 31, 2001. Selling, general and administrative expenses
increased $6.0 million, or 9.8%, for the nine months ended December 31, 2002,
compared to the nine months ended December 31, 2001. The primary reason for the
dollar increase in selling, general and administrative costs in these periods
relate to increased labor costs. Selling, general and administrative expenses
decreased $0.7 million, or 3.0%, for the three months ended December 31, 2002,
compared to the three months ended September 30, 2002 as a result of a variety
of reductions in administrative costs.
Selling, general and administrative expenses are a component of operating
expenses that fluctuate over time, primarily due to revenue and operating
expense investment levels.
SPECIAL CHARGES
FAB 3 IMPAIRMENT CHARGE
In August 2001, the FASB issued Statement of Financial Accounting Standards
No. 144 ("SFAS 144"), "ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED
ASSETS," which is applicable to financial statements for fiscal years beginning
after December 15, 2001. SFAS 144 provides a single accounting model for
long-lived assets to be disposed of and significantly changes the criteria that
would have to be met to classify an asset as held-for-sale. Classification as
held-for-sale is an important distinction because assets held-for-sale are not
depreciated and are stated at the lower of book value or fair value less cost to
sell. SFAS 144 is effective for all of our financial statements issued in fiscal
2003. In accordance with SFAS 144, we recorded a $41.5 million asset impairment
charge during the quarter ended September 30, 2002, as described below.
We acquired Fab 3, a semiconductor manufacturing facility in Puyallup,
Washington, in July 2000. The original purchase consisted of semiconductor
manufacturing facilities and real property. It was the our intention to bring
Fab 3 to productive readiness and commence volume production of 8-inch wafers
using our 0.7 and 0.5 micron process technologies by August 2001. We delayed our
production start up at Fab 3 due to deteriorating business conditions in the
semiconductor industry. Fab 3 has never been brought to productive readiness.
On August 23, 2002, we acquired a semiconductor manufacturing facility in
Gresham, Oregon, which we refer to as Fab 4. See Note 2 to the Condensed
Consolidated Financial Statements on page 6, above. We decided to purchase Fab 4
instead of bringing Fab 3 to productive readiness because, among other things,
the cost of the manufacturing equipment needed to ramp production at Fab 3 over
the next several years was significantly higher than the total purchase price of
Fab 4, and the time to bring Fab 4 to productive readiness was significantly
less than the time required to bring Fab 3 to productive readiness.
After the acquisition of Fab 4 was completed, we undertook an analysis of
the potential production capacity at Fab 4. The results of the production
capacity analysis led us to determine that Fab 3's capacity would not be needed
in the foreseeable future and during the second quarter we committed to a plan
to sell Fab 3. We have retained a third party broker to market Fab 3 on our
behalf. Accordingly, Fab 3 was classified as an asset held-for-sale as of
September 30, 2002 and maintained that classification at December 31, 2002.
We retained an independent third party firm, other than our independent
auditors, to complete a fair value appraisal of Fab 3. The independent third
party used the market approach and considered sales of comparable properties in
determining the fair value of Fab 3. The comparable sales included eight
properties, including Fab 3 from our purchase in 2000. Based on the results
of this appraisal, we recorded an asset impairment charge on Fab 3 of
$36.9 million, including estimated costs to sell. The remaining value of
$60.2 million is classified as an asset held-for-sale and is included as a
component of other current assets at December 31, 2002.
During the quarter ended September 30, 2002, we also recorded an asset
impairment charge of $4.6 million to write-down certain excess manufacturing
equipment located at Fab 3 to its net realizable value of $212,000. This
manufacturing equipment became "excess" as a result of duplicate equipment
acquired in the purchase of Fab 4. The net realizable value for the excess
18
manufacturing equipment was determined based on management estimates.
Substantially all of the other manufacturing equipment located at Fab 3 has been
transferred to and will be used in our other wafer fabrication facilities
located in Chandler, Arizona (Fab 1), Tempe, Arizona (Fab 2) and Gresham, Oregon
(Fab 4).
If actual market conditions are less favorable than those estimated in the
appraisal, or if future market conditions deteriorate, the net proceeds from the
assets held-for-sale could be less than the amount estimated in the financial
statements and additional charges could result prior to or at the time of the
sale of the facility.
POWERSMART IN-PROCESS RESEARCH AND DEVELOPMENT CHARGE
During the quarter ended June 30, 2002, purchased in-process research and
development of $9.3 million, associated with our acquisition of PowerSmart, Inc.
was written off at the date of the acquisition (June 5, 2002) in accordance with
FASB Interpretation No. 4, "APPLICABILITY OF FASB STATEMENT NO. 2 BUSINESS
COMBINATIONS ACCOUNTED FOR BY THE PURCHASE METHOD." The value assigned to the
in-process research and development was determined by an independent valuation
analysis performed by a firm other than our independent auditors. As of the
valuation date, there were 15 projects that were considered to be in-process.
The values of the projects were determined based on analyses of cash flows to be
generated by the products that are expected to result from the in-process
projects. These cash flows were estimated by forecasting total revenues expected
from these products then deducting appropriate operating expenses, cash flow
adjustments and contributory asset returns to establish a forecast of net return
on in-process technology. These net returns were substantially reduced to take
into account the time value of money and the risks associated with the inherent
difficulties and uncertainties in achieving commercial readiness. The above
analysis resulted in $9.3 million of value assigned to acquired in-process
research and development, which was expensed on the acquisition date in
accordance with FIN 4. We believe the assumptions used in valuing the in-process
research and development are reasonable, but are inherently uncertain, and no
assurance can be given that the assumptions made will occur. During the nine
months ended December 31, 2002, we incurred development costs of approximately
$2.1 million related to the acquired in-process research and development, and
should the projects continue to move toward commercialization, we estimate that
future expenditures could approximate $2.9 million over the next few years. None
of the in-process research and development projects had been completed as of
December 31, 2002.
There were no such special charges incurred during the three and nine-month
periods ended December 31, 2001.
THE FOREGOING STATEMENT RELATING TO OUR ESTIMATED FUTURE EXPENDITURES ON
THE ACQUIRED IN-PROCESS R&D PROJECTS IS A FORWARD-LOOKING STATEMENT. ACTUAL
RESULTS COULD DIFFER MATERIALLY BECAUSE OF THE FOLLOWING FACTORS, AMONG OTHERS:
DELAYS IN COMPLETION OF A PARTICULAR PROJECT; CHANGES IN OUR PRIORITIZATION OF
PROJECTS; CHANGES IN THE SPECIFICATIONS OF A PARTICULAR PROJECT; UNFORESEEN
ENGINEERING PROBLEMS; AND UNANTICIPATED COSTS.
OTHER INCOME (EXPENSE)
Interest income decreased in the three and nine-month periods ended
December 31, 2002 from the corresponding periods of the previous fiscal year due
to lower invested cash balances as a result of our August 23, 2002 acquisition
of Fab 4 and our June 5, 2002 acquisition of PowerSmart. Additionally, the
interest rates applying to our invested cash balances were lower during the
three and nine-month periods ended December 31, 2002, compared to the rates
applying during the corresponding periods of the previous fiscal year.
INCOME TAXES
Provisions for income taxes reflect tax on foreign earnings and federal and
state tax on U.S. earnings. We had an effective tax rate of 21.3% for the nine
months ended December 31, 2002, and 26.0% for the nine months ended December 31,
2001. During the nine months ended December 31, 2002, our effective tax rate was
lower than it has been historically due to the special charge incurred during
the second quarter of fiscal 2003. Under Accounting Principles Board Opinion
19
No. 28, INTERIM FINANCIAL REPORTING, we provide for an income tax
provision/benefit for special charges in the period in which they occur
separately from our calculation of the estimated effective tax rate for the
remainder of our operations. Given that the special charge in the second quarter
of fiscal 2003 was incurred in the United States, we provided a tax benefit in
the September 30, 2002 quarter based on the 40% U.S. tax rate that we expect to
apply to the special charges. Excluding special charges, our effective tax rate
for the nine months ended December 31, 2002 was 25.5%.
As part of the process of preparing our 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 consolidated
balance sheet. We must then assess the likelihood that our deferred tax asset
will be recovered from future taxable income within the relevant jurisdiction
and, to the extent we believe that recovery is not likely, we must establish a
valuation allowance. We have not provided for a valuation allowance because we
believe that our deferred tax asset will be recovered from future taxable
income. Should we determine that we would not be able to realize all or part of
our net deferred tax asset in the future, an adjustment to the deferred tax
asset would be charged to income in the period such determination was made. At
December 31, 2002, our gross deferred tax asset was $120.7 million. Numerous
taxing authorities in the countries in which we do business are increasing their
scrutiny of various tax structures employed by businesses. We believe that we
maintain adequate tax reserves to offset any potential tax liabilities that may
arise upon audit in the United States and the 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.
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 audit by the U.S. Internal Revenue Service for our fiscal
years ended March 31, 1998, 1999, 2000 and 2001.
THE FOREGOING STATEMENTS REGARDING THE RECOVERABILITY OF OUR DEFERRED TAX
ASSET FROM OUR FUTURE TAXABLE INCOME AND THE ADEQUACY OF OUR TAX RESERVES TO
OFFSET ANY POTENTIAL TAX LIABILITIES THAT MAY ARISE UPON AUDIT ARE
FORWARD-LOOKING STATEMENTS. ACTUAL RESULTS COULD DIFFER MATERIALLY BECAUSE OF
THE FOLLOWING FACTORS, AMONG OTHERS: CURRENT AND FUTURE TAX LAWS AND
REGULATIONS; TAXATION RATES IN GEOGRAPHIC REGIONS WHERE WE HAVE SIGNIFICANT
OPERATIONS; RESULTS OF ANY CURRENT OR FUTURE AUDIT CONDUCTED BY THE U.S.
INTERNAL REVENUE SERVICE OR OTHER TAXING AUTHORITIES IN THE COUNTRIES IN WHICH
WE DO BUSINESS; AND THE LEVEL OF OUR TAXABLE INCOME AND WHETHER OUR TAXABLE
INCOME WILL BE SUFFICIENT TO UTILIZE OUR DEFERRED TAX ASSET.
EURO CONVERSION ISSUES
We operate in the European Market and currently generate approximately
24.7% of our total net sales from customers located in Europe. Our commercial
headquarters in Europe are located in the United Kingdom, which is not currently
one of the 11 member states of the European Union that has converted to the
Euro.
We currently conduct approximately 96.3% of our business in Europe in U.S.
Dollars and approximately 0.2% of our business in Europe in Pounds Sterling. The
balance of our net sales in Europe is conducted in the Euro. We will monitor the
potential commercial impact of conversion of a portion of our current business
to the Euro, but we do not currently anticipate any material impact to our
business or operations based on this transition.
LIQUIDITY AND CAPITAL RESOURCES
We had $198.2 million in cash and cash equivalents at December 31, 2002, a
decrease of $82.4 million from the March 31, 2002 balance. The decrease in cash
and cash equivalents over this time period is primarily attributable to the cash
20
used in our June 5, 2002 acquisition of PowerSmart and our August 23, 2002
acquisition of Fab 4, offset by cash generated from operating activities.
We maintain an unsecured revolving credit facility with a syndicate of
banks totaling $100.0 million. We can elect to increase the facility to $150.0
million, subject to certain conditions set forth in the credit agreement. This
facility has a termination date of May 31, 2003. There were no borrowings
against this line of credit as of December 31, 2002. We are required to achieve
certain financial ratios and operating results to maintain this line of credit
and were in compliance with these requirements at December 31, 2002. During the
fourth quarter of fiscal 2003 we will begin the process of evaluating a new
credit facility to replace the facility that terminates on May 31, 2003.
We also maintain an unsecured short-term line of credit with various
financial institutions in Asia totaling $20.0 million (U.S. Dollar equivalent).
There were no borrowings under the foreign line of credit as of December 31,
2002, but an allocation of approximately $0.9 million of the available line was
made, relating to import guarantees associated with our business in Thailand.
There are no covenants related to the foreign line of credit.
At December 31, 2002, an aggregate of $119.1 million of our credit
facilities was available, subject to financial covenants and ratios with which
we were in compliance. Our ability to fully utilize our credit facilities is
dependent on our remaining in compliance with such covenants and ratios.
During the nine months ended December 31, 2002, we generated $203.5 million
of cash from operating activities, an increase of $92.0 million from the nine
months ended December 31, 2001. The increase in cash flow from operations was
primarily due to the non-cash impact of the $41.5 million Fab 3 impairment
charge and the $9.3 million in-process research and development charge, and the
impact of changes in accounts payable and accrued liabilities and other assets
and liabilities.
During the nine months ended December 31, 2002, net cash used in investing
activities increased $263.1 million, to $298.3 million, from $35.2 million for
the nine months ended December 31, 2001. The increase was due to our
acquisitions of Fab 4 and PowerSmart and increased capital expenditures.
We enter into hedging transactions from time to time in an attempt to
minimize our exposure to currency rate fluctuations. Although none of the
countries in which we conduct significant foreign operations have had a highly
inflationary economy in the last five years, there is no assurance that
inflation rates or fluctuations in foreign currency rates in countries where we
conduct operations will not adversely affect our operating results in the
future.
On August 7, 2002, our Board of Directors authorized the repurchase up to
2,500,000 shares of our common stock in the open market or in privately
negotiated transactions. As of December 31, 2002, we had repurchased 393,700
shares of common stock for $7,473,040. As of December 31, 2002, all of the
purchased shares had been reissued to fund stock option exercises and purchases
under our employee stock purchase plan. The timing and amount of any future
repurchases will depend upon market conditions and corporate considerations.
Our level of capital expenditures varies from time to time as a result of
actual and anticipated business conditions. Capital expenditures in the nine
months ended December 31, 2002 were $247.6 million, compared to $36.3 million
for the nine months ended December 31, 2001. The primary reasons for the dollar
increase in capital expenditures in the nine-month period ended December 31,
2002 were the purchase of Fab 4, other selective investments to increase our
manufacturing capacity in response to market demand and our continued investment
in R&D equipment. We currently intend to spend approximately $70 million during
the next 12 months to invest in equipment and facilities to maintain, and
selectively increase, capacity to meet our currently anticipated needs.
21
On October 28, 2002, we announced that our Board of Directors had approved
and instituted a quarterly cash dividend on our common stock. The initial
quarterly dividend of $0.02 per share was paid on December 6, 2003 in the amount
of $4,060,766. A second quarterly dividend payment was declared on January 21,
2003 in the amount of $0.02 per share and will be paid on February 28, 2003 to
shareholders of record as of February 7, 2003. We expect our second quarterly
dividend payment to be approximately $4.1 million.
We expect to finance capital expenditures through our existing cash
balances, cash flows from operations, available debt arrangements and other
sources of financing, including possible issuances of equity and debt securities
depending on market conditions. We believe that the capital expenditures
anticipated to be incurred over the next 12 months will provide sufficient
manufacturing capacity to meet our currently anticipated needs.
THE FOREGOING STATEMENTS REGARDING THE ANTICIPATED LEVEL OF CAPITAL
EXPENDITURES OVER THE NEXT 12 MONTHS, THE NATURE OF SUCH EXPENDITURES, THE
FINANCING AND SUFFICIENCY OF OUR CAPITAL EXPENDITURES AND THE BELIEF THAT
CAPITAL EXPENDITURES ANTICIPATED TO BE INCURRED OVER THE NEXT 12 MONTHS WILL
PROVIDE US SUFFICIENT MANUFACTURING CAPACITY TO MEET OUR CURRENTLY ANTICIPATED
NEEDS ARE FORWARD-LOOKING STATEMENTS. ACTUAL RESULTS COULD DIFFER MATERIALLY
BECAUSE OF THE FOLLOWING FACTORS, AMONG OTHERS: CHANGES IN DEMAND FOR OUR
PRODUCTS AND THOSE OF OUR CUSTOMERS; CHANGES IN UTILIZATION OF CURRENT
MANUFACTURING CAPACITY; UNANTICIPATED COSTS IN BRINGING FAB 4 ON-LINE; MARKET
ACCEPTANCE OF OUR PRODUCTS AND OF OUR CUSTOMERS' PRODUCTS; THE CYCLICAL NATURE
OF THE SEMICONDUCTOR INDUSTRY AND THE MARKETS ADDRESSED BY OUR PRODUCTS; THE
AVAILABILITY AND COST OF RAW MATERIALS, EQUIPMENT AND OTHER SUPPLIES; ACTUAL
LEVELS OF CAPITAL EXPENDITURES; THE COSTS AND OUTCOME OF ANY LITIGATION
INVOLVING INTELLECTUAL PROPERTY, CUSTOMER OR OTHER ISSUES; THE FINANCIAL
CONDITION OF OUR CUSTOMERS AND VENDORS; UNINSURED LOSSES; AND THE ECONOMIC,
POLITICAL AND OTHER CONDITIONS IN THE WORLDWIDE MARKETS SERVED BY US.
Net cash provided by financing activities was $12.4 million for the nine
months ended December 31, 2002, compared to $39.2 million for the nine months
ended December 31, 2001. Proceeds from the exercise of stock options and
employee purchases under our employee stock purchase plan were $23.9 million in
the nine months ended December 31, 2002 and $37.1 million in the nine months
ended December 31, 2001.
We had a net shares settled forward contract outstanding as of December 31,
2001. In connection with this contract, we made a net delivery of 572,645 shares
of our common stock during the nine months ended December 31, 2001. We closed
out the net shares settled forward contract in its entirety on January 15, 2002
and made a cash payment of $27.8 million to purchase the remaining 1,610,606
shares outstanding under the contract. The purchased shares were held as
treasury shares and used to fund stock option exercises and purchases under our
employee stock purchase plan through April 9, 2002.
We believe that our existing sources of liquidity combined with cash
generated from operations will be sufficient to meet our currently anticipated
cash requirements for at least the next 12 months. However, the semiconductor
industry is capital intensive. In order to remain competitive, we must
constantly evaluate the need to make significant investments in capital
equipment for both production and research and development. We may seek
additional equity or debt financing during the next 12 months for the capital
expenditures required to maintain or expand our wafer fabrication and product
assembly and test facilities, or other purposes. The timing and amount of any
such financing requirements will depend on a number of factors, including demand
for our products, changes in industry conditions, product mix, and competitive
factors. There can be no assurance that such financing will be available on
acceptable terms, and any additional equity financing would result in
incremental dilution to existing stockholders.
ADDITIONAL FACTORS THAT MAY AFFECT OUR RESULTS OF OPERATIONS
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.
22
OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE DUE TO FACTORS THAT COULD REDUCE
OUR NET SALES AND PROFITABILITY.
Our quarterly operating results are affected by a wide variety of factors
that could reduce our net sales and profitability, many of which are beyond our
control. Some of the factors that may affect our quarterly operating results
include:
* demand for our products in the distribution and OEM channels
* the level at which previous design wins become actual orders and sales
* the level of sell-through of our products through distribution
* the level of orders that are received and can be shipped in a quarter
(turns orders)
* market acceptance of both our products and our customers' products
* customer order patterns and seasonality
* downward pricing pressures in our non-proprietary product lines
* possible disruption in commercial activities or international
transport or delivery caused by terrorist activity, armed conflict,
war or unexpected increases in the price of, or decrease in the supply
of, oil, any of which could result in changes in logistics and
security arrangements, and reduced customer purchases relative to
expectations
* possible disruptions to our customers' operations occasioned by any
slow down or cessation in international transport or delivery caused
by labor strikes or work stoppages at international ports of delivery
in the United States or elsewhere which could result in reduced
customer purchases relative to our expectations
* impact of events outside of the United States, such as the business
impact of fluctuating currency rates or unrest or political
instability
* disruption in the supply of wafers or assembly and testing services
* availability of manufacturing capacity, the extent of effective use of
manufacturing capacity and fluctuations in manufacturing yields
* the availability and cost of raw materials, equipment and other
supplies
* the costs and outcome of any litigation involving intellectual
property, customer and other issues
* uninsured losses, and
* economic, political and other conditions in the worldwide markets
served by us.
We believe that period-to-period comparisons of our operating results are
not necessarily meaningful and that you should not rely upon any such
comparisons as indications of future performance. In future periods our
operating results may fall below the expectations of public market analysts and
investors, which would likely have a negative effect on the price of our common
stock.
OUR OPERATING RESULTS WILL SUFFER IF WE INEFFECTIVELY UTILIZE OUR MANUFACTURING
CAPACITY OR FAIL TO MAINTAIN MANUFACTURING YIELDS.
The manufacture and assembly of integrated circuits, particularly
non-volatile, erasable CMOS memory and logic devices such as those that we
produce, are complex processes. These processes are sensitive to a wide variety
of factors, including the level of contaminants in the manufacturing
environment, impurities in the materials used and the performance of our wafer
fabrication personnel and equipment. 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.
Our operating results are also adversely affected when we operate at less
than optimal capacity as was the case throughout fiscal 2002. Lower capacity
utilization results in certain costs being charged directly to expense and lower
gross margins.
23
IF WE DO NOT BRING OUR FAB 4 (GRESHAM, OREGON) WAFER FABRICATION FACILITY ON
LINE IN A TIMELY MANNER, OUR ANTICIPATED REVENUES MAY BE REDUCED AND WE WOULD
INCUR FIXED EXPENSES THAT WOULD REDUCE OUR GROSS MARGINS IN FUTURE PERIODS.
On August 23, 2002, we acquired a semiconductor facility in Gresham,
Oregon, which we refer to as Fab 4. We currently anticipate that Fab 4 will
commence production in the second quarter of fiscal 2004. Bringing Fab 4 on-line
involves significant risks, including:
* successful implementation of our 0.5 micron manufacturing process at
Fab 4
* effective integration of a variety of hardware and software components
* potential shortages of materials and skilled labor
* unforeseen environmental or engineering problems
* approvals and requirements of governmental and regulatory agencies,
and
* unanticipated costs.
Any one of these risks could delay the equipping and production start-up of
Fab 4, and could involve significant additional costs or reduce our anticipated
revenues.
As a result of these and other factors, Fab 4 may not commence production
when anticipated or within budget. Also, we may be unable to achieve adequate
manufacturing yields in Fab 4 in a timely manner and our revenues may not
increase in proportion to the anticipated increase in manufacturing capacity
associated with Fab 4 which would harm our operating results.
WE DEPEND ON ORDERS THAT ARE RECEIVED AND SHIPPED IN THE SAME QUARTER AND
THEREFORE HAVE LIMITED VISIBILITY OF FUTURE PRODUCT SHIPMENTS.
Our net sales in any given quarter depend upon a combination of shipments
from backlog and orders received in that quarter for shipment in that quarter,
which we refer to as turns orders. We emphasize our ability to respond quickly
to customer orders as part of our competitive strategy, resulting in customers
placing orders with short delivery schedules. Shorter lead times generally means
that turns orders as a percentage of our business is relatively high in any
particular quarter and reduces our visibility on future product shipments. The
percentage of turns orders in any given quarter fluctuates and depends on
overall semiconductor industry conditions and product lead times.
As such, our percentage of turns orders has fluctuated over the last three
fiscal years between approximately 20% and 63%. At October 1, 2002, we required
turns order of approximately 60% in order to achieve our revenue for the third
quarter of fiscal 2003. Because turns orders are difficult to predict, increased
levels of turns orders make our net sales more difficult to forecast.
If we do not achieve a sufficient level of turns orders in a particular
quarter relative to our revenue targets, our revenue and operating results will
suffer.
INTENSE COMPETITION IN OUR MARKETS MAY LEAD TO PRICING PRESSURES, REDUCED SALES
OF OUR PRODUCTS AND 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 with which to pursue
engineering, manufacturing, marketing and distribution of their products.
Emerging companies are also increasing their participation in the market for
embedded control applications. We may be unable to compete successfully in the
future, which could harm our business.
24
Our ability to compete successfully depends on a number of factors both
within and outside our control, including:
* the quality, performance, reliability, features, ease of use, pricing
and diversity of our products
* the quality of our customer service and our ability to address the
needs of our customers
* our success in designing and manufacturing new products including
those implementing new technologies
* the rate at which customers incorporate our products into their own
products
* our level of manufacturing capacity utilization and manufacturing
yields
* our ability to hire and retain qualified engineering and management
personnel
* product introductions by our competitors
* the number, nature and success of our competitors in a given market
* our ability to obtain adequate supplies of raw materials and other
supplies at acceptable prices
* our ability to protect our products and processes by effective
utilization of intellectual property laws, and
* general market and economic conditions.
Historically, average selling prices in the semiconductor industry decrease
over the life of any particular product. The overall average selling prices of
our microcontroller and proprietary analog and interface products have remained
relatively constant, while average selling prices of our Serial EEPROM and
non-proprietary analog and interface products have declined, over time. We have
experienced, and expect to continue to experience, pricing pressure in certain
of our proprietary product lines, due primarily to competitive conditions. We
have been able to moderate average selling price declines in many of our
proprietary product lines by continuing to introduce new products with more
features and higher prices. We have experienced in the past and expect to
continue to experience in the future varying degrees of competitive pricing
pressures in our Serial EEPROM products.
We may be unable to maintain average selling prices for our products as a
result of increased pricing pressure in the future, which would reduce our
operating results.
WE MUST ATTRACT AND RETAIN QUALIFIED PERSONNEL TO BE SUCCESSFUL, AND COMPETITION
FOR QUALIFIED PERSONNEL IS INTENSE IN OUR MARKET.
Our success depends to a significant extent upon the efforts and abilities
of our senior management, engineering and other personnel. The competition for
qualified engineering and management personnel is intense. We may be
unsuccessful in retaining our existing key personnel or in attracting and
retaining additional key personnel that we require. The loss of the services of
one or more of our key personnel or the inability to add key personnel could
harm our business. We have no employment agreements with any member of our
senior management team.
OUR SUCCESS DEPENDS ON OUR ABILITY TO INTRODUCE NEW PRODUCTS ON A TIMELY BASIS.
Our future operating results will depend to a significant extent on our
ability to develop and introduce new products on a timely basis that can compete
effectively on the basis of price and performance and which address customer
requirements. The success of new product introductions depends on various
factors, including:
* proper new product selection
* timely completion and introduction of new product designs
* development of support tools and collateral literature that make
complex new products easy for engineers to understand and use, and
* market acceptance of our customers' end products.
25
Because our products are complex, we have experienced delays from time to
time in completing development of new products. In addition, our new products
may not receive or maintain substantial market acceptance. We may be unable to
design, develop and introduce competitive products on a timely basis, which
could reduce 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.
GENERAL CONDITIONS IN THE INSURANCE INDUSTRY MAY AFFECT OUR COSTS AND INCREASE
THE RISKS TO OUR BUSINESS OPERATIONS.
As conditions in the insurance industry have resulted in decreased
availability of coverage and increased insurance rates over the last two fiscal
years, our liability, property and casualty insurance coverage levels have
decreased and our retained risk exposure from uninsured losses has increased. We
have not made any material change to our operations as a result of the reduced
coverage. Availability and cost of insurance coverage have generally fluctuated
over time as the insurance industry reacts to various market forces and we will
consider changes in our coverage levels based on conditions in the insurance
market.
WE CONTRACT WITH SEVERAL THIRD-PARTY CONTRACTORS IN ASIA TO PERFORM KEY
MANUFACTURING FUNCTIONS FOR US.
We use several third-party contractors located throughout Asia for a
portion of the assembly and testing of our products and for a portion of the
wafer fabrication of our analog products. Although we have reduced our
dependence on third-party contractors over time, the disruption or termination
of any of these sources could harm our business and operating results. Our use
of third parties involves some reduction in our level of control over the
portions of our business that we subcontract. Our future operating results could
suffer if any third-party contractor were to experience financial, operations or
production difficulties, or if they were unable to maintain manufacturing
yields, assembly and test yields and costs at approximately their current
levels.
WE MAY LOSE SALES IF OUR SUPPLIERS OF RAW MATERIALS AND EQUIPMENT FAIL TO MEET
OUR NEEDS.
Our semiconductor manufacturing operations require raw materials and
equipment that must meet exacting standards. We generally have more than one
source for these supplies, but there are only a limited number of suppliers
capable of delivering various raw materials and equipment that meet our
standards. In addition, the raw materials and equipment necessary for our
business could become more difficult to obtain as worldwide use of
semiconductors in product applications increases. We have experienced supply
shortages from time to time in the past, and on occasion our suppliers have told
us they need more time than expected to fill our orders or that they will no
longer support certain equipment with updates or spare and replacements parts.
An interruption of any raw materials or equipment sources, or the lack of
supplier support for a particular piece of equipment, could harm our business.
OUR BUSINESS IS HIGHLY DEPENDENT ON SELLING THROUGH DISTRIBUTORS.
Sales through distributors accounted for 63% of our net sales for the
fiscal year ended March 31, 2002 and 59% of sales in the first nine months of
fiscal 2003. Sales through one distributor accounted for 13% of our net sales in
fiscal 2002 and 11% of our total net sales for the first nine months of fiscal
2003. Generally, we do not have long-term agreements with our distributors, and
we or our distributors may terminate their relationship with us with little or
no advanced notice.
26
The loss of, or a disruption in the operations of, one or more of our
distributors could reduce our net sales in a given quarter and could result in
an increase in inventory returns.
OUR OPERATING RESULTS MAY BE IMPACTED BY THE WIDE FLUCTUATIONS OF SUPPLY AND
DEMAND IN THE SEMICONDUCTOR INDUSTRY.
The semiconductor industry is characterized by wide fluctuations of supply
and demand. Throughout fiscal 2001 and fiscal 2002, the industry experienced a
significant economic downturn, characterized by diminished product demand and
production over-capacity. These conditions continued during the first nine
months of fiscal 2003. We have sought to reduce our exposure to this industry
cyclicality by selling proprietary products, that cannot be easily or quickly
replaced, to a geographically diverse base of customers across a broad range of
market segments. However, we have experienced substantial period-to-period
fluctuations in operating results and may, in the future, experience
period-to-period fluctuations in operating results due to general industry or
economic conditions.
INTELLECTUAL PROPERTY CLAIMS AND LITIGATION COULD SUBJECT US TO SIGNIFICANT
LIABILITY FOR DAMAGES AND COULD INVALIDATE OUR PROPRIETARY RIGHTS.
As is typical in the semiconductor industry, we and our customers have from
time to time received, and may in the future receive, communications from third
parties asserting patent or other intellectual property rights on certain of our
products or technologies. In the event a third party were to make a valid
intellectual property claim and a license or other agreement was not available
on commercially reasonable terms, our operating results could be harmed. We have
in the past been, are currently, and may in the future be, involved in
litigation to defend Microchip against alleged infringement of the rights of
others or to enforce our intellectual property rights. Litigation could result
in substantial cost to us and divert our resources. An unfavorable outcome in
any such suit could harm our business, financial condition or results of
operations.
Our ability to obtain patents, licenses and other intellectual property
rights covering our products and manufacturing processes is important for our
success. To that end, we have acquired certain patents and patent licenses and
intend to continue to seek patents on our inventions and manufacturing
processes. The process of seeking patent protection can be long and expensive,
and patents may not be issued from currently pending or future applications. In
addition, our existing patents and any new patents that are issued may not be of
sufficient scope or strength to provide meaningful protection or any commercial
advantage to us. We may be subject to or may initiate interference proceedings
in the U.S. Patent and Trademark Office, which can require significant financial
and management resources. In addition, the laws of certain foreign countries do
not protect our intellectual property rights to the same extent as the laws of
the United States.
WE DO NOT HAVE LONG-TERM CONTRACTS WITH OUR CUSTOMERS.
We do not typically enter into long-term contracts with our customers and
we cannot be certain as to future order levels from our customers. When we do
enter into customer contracts, the contract is generally cancelable at the
convenience of the customer. In the event of any early termination of a contract
by one of our major customers, it is unlikely that we would be able to rapidly
replace that revenue source which would harm our financial results.
BUSINESS INTERRUPTIONS COULD HARM OUR BUSINESS.
Operations at any of our primary manufacturing facilities, or at any of our
wafer fabrication or test and assembly subcontractors, may be disrupted for
reasons beyond our control, including work stoppages, power loss, incidents of
terrorism, political instability, telecommunications failure, fire, earthquake,
floods, or other natural disasters. If operations at any of our facilities or by
any of our subcontractors are interrupted, we may not be able to shift
production to other facilities on a timely basis. If this occurs, we may
experience delays in shipments of products to our customers and alternate
sources for production may be unavailable on acceptable terms. This could result
27
in reduced revenues and profits and the cancellation of orders or loss of
customers. In addition, business interruption insurance will likely not be
enough to compensate us for any losses that may occur and any losses or damages
incurred by us as a result of business interruptions could significantly harm
our business.
WE ARE HIGHLY DEPENDENT ON FOREIGN SALES AND OPERATIONS, WHICH EXPOSES US TO
FOREIGN POLITICAL AND ECONOMIC RISKS.
Sales to foreign customers account for a substantial portion of our net
sales. During the fiscal year ended March 31, 2002, approximately 69% of our net
sales were made to foreign customers. During the first nine months of fiscal
2003, approximately 71% of our net sales were made to foreign customers. We
purchase a substantial portion of our raw materials and equipment from foreign
suppliers. In addition, we own a product assembly and testing facility located
near Bangkok, Thailand. We also use various third-party contractors located
throughout Asia for a portion of the assembly and testing of our products and
for a portion of the wafer fabrication of our analog products.
Our reliance on foreign operations, maintenance of substantially all of our
finished goods in inventory at foreign locations and significant foreign sales
exposes us to foreign political and economic risks, including:
* political, social and economic instability
* trade restrictions and changes in tariffs
* import and export license requirements and restrictions
* difficulties in staffing and managing international operations
* employment regulations
* disruptions in international transport or delivery
* fluctuations in currency exchange rates
* difficulties in collecting receivables
* economic slowdown in the worldwide markets served by us, and
* potentially adverse tax consequences.
If any of these risks materialize, our sales could decrease and our
operating results could suffer.
WE ARE SUBJECT TO STRINGENT ENVIRONMENTAL REGULATION, WHICH MAY FORCE US TO
INCUR SIGNIFICANT EXPENSES.
We must comply with many different federal, state and local governmental
regulations related to the use, storage, discharge and disposal of toxic,
volatile or otherwise hazardous chemicals used in our manufacturing processes.
Although we believe that our activities conform to presently applicable
environmental regulations, our failure to comply with present or future
regulations could result in the imposition of fines, suspension of production or
a cessation of operations. Any such regulation could require us to acquire
costly equipment or to incur other significant expenses to comply with
environmental regulations. Any failure by us to control the use of or adequately
restrict the discharge of hazardous substances could subject us to future
liabilities. Environmental problems at our facilities may occur that could
subject us to future costs or liabilities.
In 1993, TelCom Semiconductor, Inc., with whom we merged in January 2001,
acquired the semiconductor manufacturing operations of Teledyne, Inc. previously
conducted at TelCom's Mountain View, California facility. The semiconductor
manufacturing operations conducted by Teledyne at the facility allegedly
contaminated the soil and groundwater of the facility, and the groundwater of
properties located down-gradient of the facility. Although TelCom was
indemnified by Teledyne against, among other things, any liabilities arising
from any such contamination, and although we should be able to benefit from this
indemnification as a successor to TelCom's business, we cannot assure you that
claims will not be made against us or that such indemnification will be
available or will provide meaningful protection at the time any such claim is
brought. To the extent that we are subject to a claim that is not covered by the
indemnity from Teledyne or as to which Teledyne is unable to provide
indemnification, our financial condition or operating results could suffer.
28
OUR FAILURE TO SUCCESSFULLY INTEGRATE BUSINESSES, PRODUCTS OR TECHNOLOGIES WE
ACQUIRE COULD DISRUPT OR HARM OUR ONGOING BUSINESS.
We have from time to time acquired, and may in the future acquire,
additional complementary businesses, products and technologies. Achieving the
anticipated benefits of an acquisition depends upon whether the integration of
the acquired business, products or technology is accomplished efficiently and
effectively. In addition, successful acquisitions in the semiconductor industry
may be more difficult to accomplish than in other industries because such
acquisitions require, among other things, integration of product offerings,
manufacturing operations and coordination of sales and marketing and R&D
efforts. These difficulties can become more challenging due to the need to
coordinate geographically separated organizations, the complexities of the
technologies being integrated, and the necessities of integrating personnel with
disparate business backgrounds and combining two different corporate cultures.
The integration of operations following an acquisition also requires the
dedication of management resources, which may distract attention from our
day-to-day business and may disrupt key R&D, marketing or sales efforts. The
inability of our management to successfully integrate any future acquisition
could harm our business. Furthermore, products acquired in connection with
acquisitions may not gain acceptance in our markets, and we may not achieve the
anticipated or desired benefits of such transaction.
POWERSMART, INC., WHICH WE ACQUIRED ON JUNE 5, 2002, DEPENDED ON THIRD-PARTY
WAFER MANUFACTURERS FOR ALL OF ITS PRODUCT REQUIREMENTS. ANY INABILITY OR
UNWILLINGNESS OF POWERSMART'S WAFER SUPPLIERS TO MEET THESE MANUFACTURING
REQUIREMENTS WOULD SIGNIFICANTLY DELAY OUR ABILITY TO PRODUCE AND SHIP
POWERSMART PRODUCTS.
While Microchip has historically manufactured virtually all of its own
wafers, PowerSmart purchased its wafers primarily from two outside foundries.
Each of these foundries also fabricates wafers for other semiconductor
companies, including some of our competitors. We expect to continue to rely on
one outside foundry to supply a substantial portion of the wafers that are
required to support the PowerSmart business through the first half of fiscal
2004. Such foundry is a direct competitor of ours. We may be unable to acquire
wafers from this foundry if it experiences manufacturing failures, yield
shortfalls or other situations when demand exceeds capacity or for other
reasons. In such case, we may not be able to qualify additional manufacturing
sources for existing PowerSmart products on a timely manner or at all, and such
arrangements, if any, may not be on favorable terms to us.
Although current market conditions in the semiconductor industry indicate
that there is sufficient manufacturing capacity at outside foundries, a
significant increase in demand for PowerSmart products during the remainder of
fiscal 2003 or the first half of fiscal 2004 could result in wafers being in
short supply and prevent us from having an adequate supply to meet our customer
requirements and meet requested delivery dates for customers of our PowerSmart
products.
RECENTLY ENACTED AND PROPOSED CHANGES IN SECURITIES LAWS AND RELATED REGULATIONS
COULD RESULT IN INCREASED COSTS TO US.
Recently enacted and proposed changes in the laws and regulations affecting
public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and
rules proposed by the SEC, Nasdaq and the NYSE, could result in increased costs
to us as we evaluate the implications of any new rules and respond to their
requirements. The new rules could make it more difficult for us to obtain
certain types of insurance, including director and officer liability insurance,
and we may be forced to accept reduced policy limits and coverage or incur
substantially higher costs to obtain the same or similar coverage. In this
regard, during the recent annual renewal of our director and officer liability
insurance policy, we experienced substantially reduced policy limits and terms
at a significant cost increase compared to our prior coverage. The impact of
these events could also make it more difficult for us to attract and retain
qualified persons to serve on our board of directors, on committees of our
29
board of directors, or as executive officers. We are presently evaluating and
monitoring developments with respect to new and proposed rules and cannot
predict or estimate the amount of the additional costs we may incur or the
timing of such costs.
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:
* quarterly variations in our operating results and the operating
results of other technology companies
* actual or anticipated announcements of technical innovations or new
products by us or our competitors
* changes in analysts' estimates of our financial performance or
buy/sell recommendations
* general conditions in the semiconductor industry, and
* worldwide political, economic and financial conditions.
In addition, the stock market has experienced significant price and volume
fluctuations that have particularly affected the market prices for many high
technology companies and that often have been unrelated to the operating
performance of such companies. These broad market fluctuations and other factors
may harm the market price of our common stock.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our investment portfolio, consisting of fixed income securities, was $186.2
million as of December 31, 2002, and $247.6 million as of March 31, 2002. These
securities, like all fixed income instruments, are subject to interest rate risk
and will decline in value if market interest rates increase. If market rates
were to increase immediately and uniformly by 10% from the levels of December
31, 2002 and March 31, 2002, the decline in the fair value of our investment
portfolio would not be material. Additionally, we have the ability to hold our
fixed income investments until maturity and, therefore, we would not expect to
recognize an adverse impact on income or cash flows.
We have international operations and are thus subject to foreign currency
rate fluctuations. To date, our exposure related to exchange rate volatility has
not been significant. If the foreign currency rates fluctuate by 15% from the
rates at December 31, 2002 and March 31, 2002, the effect on our financial
position and results of operations would not be material.
During the normal course of our business, we are routinely subjected to a
variety of market risks, examples of which include, but are not limited to,
interest rate movements and foreign currency fluctuations, as we discuss in this
Item 3, and collectability of accounts receivable. We constantly assess these
risks and have established policies and procedures to protect against the
adverse affects of these other potential exposures. Although we do not
anticipate any material losses in these risk areas, no assurance can be made
that material losses will not be incurred in these areas in the future.
We believe that our market risk, as discussed in this Item 3, has not
materially changed from March 31, 2002.
30
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Our chief executive officer and our chief financial officer, after
evaluating the effectiveness of our "disclosure controls and procedures" (as
defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of
1934, as amended) as of a date within 90 days of our filing of this quarterly
report on Form 10-Q, referred to as the "Evaluation Date," have concluded that,
as of the Evaluation Date, our disclosure controls and procedures were adequate
and effective to ensure the timely collection, evaluation and disclosure of
information relating to us and our consolidated subsidiaries that would
potentially be subject to disclosure under the Securities Exchange Act of 1934,
as amended, and the rules and regulations promulgated thereunder.
CHANGES IN INTERNAL CONTROLS
There were no significant changes in our internal controls or other factors
that could significantly affect our internal controls subsequent to the
Evaluation Date. No significant deficiencies or material weaknesses were
identified in the evaluation of our internal controls and therefore no
corrective actions have been taken.
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
MICROCHIP TECHNOLOGY INCORPORATED V. U.S. PHILIPS CORPORATION, ET AL.
(DISTRICT OF ARIZONA, 01-CV-2090-PGR); U.S. PHILIPS CORPORATION V. ATMEL
CORPORATION, ET AL. (SOUTHERN DISTRICT OF NEW YORK, 01-CV-9178-LAP). As reported
in our annual report on Form 10-K for the fiscal year ended March 31, 2002 and
our quarterly reports on Form 10-Q for the quarters ended June 30, 2002 and
September 30, 2002, on October 26, 2001, we filed an action in federal district
court in Arizona for declaratory relief against U.S. Philips Corporation and
Philips Electronics North America Corp. requesting that the Court declare, among
other matters, that we do not infringe Philips' U.S. Patent Nos. 4,689,740 and
5,559,502. We initiated legal action so that a determination could be made
relating to the validity, enforceability and alleged infringement of, and our
license to, the Philips' patents. In response to our filing the declaratory
judgment action in Arizona, Philips filed an action against us in federal
district court in New York, alleging infringement of the `740 patent and seeking
unspecified damages and injunctive relief. The Arizona court has agreed to
retain jurisdiction, and the New York court recently agreed to transfer the case
in that forum to Arizona. In response to this development, on December 16, 2002,
Philips filed a demand for arbitration in Amsterdam with the International
Chamber of Commerce. We will contend that Philips' demand for arbitration is
untimely, and intend to continue to litigate this matter vigorously. We
currently believe that the outcome of this matter will not have a material
adverse effect on our consolidated financial position or results of operations.
However, the final outcome of this matter is inherently uncertain, and should
the outcome be adverse to us, we may be required to pay damages and other
expenses and may be subjected to injunctive relief. The litigation, even if
resolved in our favor, may also result in diversion of management attention and
significant legal fees.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS.
Exhibit 99.1 Certification of Chief Executive Officer and Chief
Financial Officer Pursuant to 18 U.S.C. Section 1350,
As Adopted Pursuant To Section 906 of the
Sarbanes-Oxley Act of 2002.
31
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: February 7, 2003 By: /s/ Gordon W. Parnell
------------------------------------
Gordon W. Parnell
Vice President and Chief Financial
Officer (Duly Authorized Officer,
and Principal Financial and
Accounting Officer)
32
CERTIFICATION
I, Steve Sanghi, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Microchip Technology
Incorporated;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: February 7, 2003
/s/ Steve Sanghi
----------------------------------------
Steve Sanghi
President and CEO
33
CERTIFICATION
I, Gordon W. Parnell, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Microchip Technology
Incorporated;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: February 7, 2003
/s/ Gordon W. Parnell
----------------------------------------
Gordon W. Parnell
Vice President and CFO
34