2014.09.30. 10Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
|
| |
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2014.
OR
|
| |
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from __________ to __________
Commission File Number: 0-21184
MICROCHIP TECHNOLOGY INCORPORATED
(Exact Name of Registrant as Specified in Its Charter)
|
| | |
Delaware | | 86-0629024 |
(State or Other Jurisdiction of Incorporation or Organization) | | (IRS Employer Identification No.) |
2355 W. Chandler Blvd., Chandler, AZ 85224-6199
(480) 792-7200
(Address, Including Zip Code, and Telephone Number,
Including Area Code, of Registrant's
Principal Executive Offices)
Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act:
|
| | | | |
Large accelerated filer | x | | Accelerated filer | o |
Non-accelerated filer | o | | Smaller reporting company | o |
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). (Check One)
Yes o No x
Shares Outstanding of Registrant's Common Stock
|
| | |
Class | | Outstanding at October 31, 2014 |
Common Stock, $0.001 par value | | 200,965,645 shares |
MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
INDEX
|
| | |
| | Page |
| | |
PART I. FINANCIAL INFORMATION | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
PART II. OTHER INFORMATION | |
| | |
| | |
| | |
| | |
| | |
| | |
| |
| |
| |
CERTIFICATIONS | |
| |
EXHIBITS | |
| |
Item1. | Financial Statements |
MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
(unaudited)
|
| | | | | | | |
ASSETS | September 30, 2014 | | March 31, 2014 |
Cash and cash equivalents | $ | 481,439 |
| | $ | 466,603 |
|
Short-term investments | 801,670 |
| | 878,182 |
|
Accounts receivable, net | 287,473 |
| | 242,405 |
|
Inventories | 275,746 |
| | 262,725 |
|
Prepaid expenses | 34,350 |
| | 31,756 |
|
Deferred tax assets | 62,411 |
| | 67,490 |
|
Other current assets | 35,876 |
| | 20,238 |
|
Total current assets | 1,978,965 |
| | 1,969,399 |
|
Property, plant and equipment, net | 585,102 |
| | 531,967 |
|
Long-term investments | 841,277 |
| | 798,712 |
|
Goodwill | 557,965 |
| | 276,097 |
|
Intangible assets, net | 599,025 |
| | 445,499 |
|
Other assets | 48,293 |
| | 45,956 |
|
Total assets | $ | 4,610,627 |
| | $ | 4,067,630 |
|
LIABILITIES AND STOCKHOLDERS' EQUITY | | | |
Accounts payable | $ | 94,402 |
| | $ | 74,050 |
|
Accrued liabilities | 113,997 |
| | 96,731 |
|
Short-term borrowings | 17,500 |
| | 17,500 |
|
Deferred income on shipments to distributors | 159,585 |
| | 147,798 |
|
Total current liabilities | 385,484 |
| | 336,079 |
|
Junior convertible debentures | 376,729 |
| | 371,873 |
|
Long-term line of credit | 624,375 |
| | 300,000 |
|
Long-term borrowings, net | 322,767 |
| | 331,385 |
|
Long-term income tax payable | 139,343 |
| | 179,966 |
|
Long-term deferred tax liability | 469,370 |
| | 375,316 |
|
Other long-term liabilities | 40,351 |
| | 37,550 |
|
Stockholders' equity: | | | |
Preferred stock, $0.001 par value; authorized 5,000,000 shares; no shares issued or outstanding | — |
| | — |
|
Common stock, $0.001 par value; authorized 450,000,000 shares; 218,789,994 shares issued and 200,962,463 shares outstanding at September 30, 2014; 218,789,994 shares issued and 200,002,736 shares outstanding at March 31, 2014 | 201 |
| | 200 |
|
Additional paid-in capital | 1,248,841 |
| | 1,244,583 |
|
Common stock held in treasury: 17,827,531 shares at September 30, 2014; 18,787,258 shares at March 31, 2014 | (548,879 | ) | | (577,382 | ) |
Accumulated other comprehensive income | (4,657 | ) | | 1,051 |
|
Retained earnings | 1,507,915 |
| | 1,467,009 |
|
Microchip Technology stockholders' equity | 2,203,421 |
| | 2,135,461 |
|
Noncontrolling interests | 48,787 |
| | — |
|
Total stockholders' equity | 2,252,208 |
| | 2,135,461 |
|
Total liabilities and stockholders' equity | $ | 4,610,627 |
| | $ | 4,067,630 |
|
See accompanying notes to condensed consolidated financial statements
MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
(unaudited)
|
| | | | | | | | | | | | | | | |
| Three Months Ended | | Six Months Ended |
| September 30, | | September 30, |
| 2014 | | 2013 | | 2014 | | 2013 |
Net sales | $ | 546,243 |
| | $ | 492,669 |
| | $ | 1,075,119 |
| | $ | 955,461 |
|
Cost of sales (1) | 238,789 |
| | 203,806 |
| | 461,146 |
| | 400,024 |
|
Gross profit | 307,454 |
| | 288,863 |
| | 613,973 |
| | 555,437 |
|
Operating expenses: | |
| | |
| | |
| | |
|
Research and development (1) | 88,814 |
| | 78,254 |
| | 173,184 |
| | 151,339 |
|
Selling, general and administrative (1) | 71,114 |
| | 69,368 |
| | 140,369 |
| | 135,078 |
|
Amortization of acquired intangible assets | 45,433 |
| | 23,744 |
| | 82,077 |
| | 51,421 |
|
Special charges (income) | 775 |
| | (11 | ) | | 1,079 |
| | 1,690 |
|
| 206,136 |
| | 171,355 |
| | 396,709 |
| | 339,528 |
|
| | | | | | | |
Operating income | 101,318 |
| | 117,508 |
| | 217,264 |
| | 215,909 |
|
Losses on equity method investments | (35 | ) | | (101 | ) | | (67 | ) | | (361 | ) |
Other income (expense): | | | | | | | |
Interest income | 4,531 |
| | 4,010 |
| | 9,273 |
| | 7,935 |
|
Interest expense | (14,019 | ) | | (12,354 | ) | | (27,697 | ) | | (24,210 | ) |
Other (expense) income, net | (1,091 | ) | | 2,143 |
| | (1,078 | ) | | 2,269 |
|
Income before income taxes | 90,704 |
| | 111,206 |
| | 197,695 |
| | 201,542 |
|
Income tax (benefit) provision | (1,334 | ) | | 11,400 |
| | 15,748 |
| | 23,157 |
|
Net income | 92,038 |
| | 99,806 |
| | 181,947 |
| | 178,385 |
|
Less: Net loss attributable to noncontrolling interests | 1,603 |
| | — |
| | 1,603 |
| | — |
|
Net income attributable to Microchip Technology | $ | 93,641 |
| | $ | 99,806 |
| | $ | 183,550 |
| | $ | 178,385 |
|
Basic net income per common share attributable to Microchip Technology stockholders | $ | 0.47 |
| | $ | 0.50 |
| | $ | 0.92 |
| | $ | 0.90 |
|
Diluted net income per common share attributable to Microchip Technology stockholders
| $ | 0.42 |
| | $ | 0.46 |
| | $ | 0.82 |
| | $ | 0.83 |
|
Dividends declared per common share | $ | 0.3560 |
| | $ | 0.3540 |
| | $ | 0.7115 |
| | $ | 0.7075 |
|
Basic common shares outstanding | 200,629 |
| | 197,825 |
| | 200,408 |
| | 197,388 |
|
Diluted common shares outstanding | 225,284 |
| | 216,475 |
| | 224,906 |
| | 214,371 |
|
(1) Includes share-based compensation expense as follows: | | | | | | | |
Cost of sales | $ | 2,640 |
| | $ | 1,864 |
| | $ | 4,695 |
| | $ | 3,833 |
|
Research and development | 7,261 |
| | 6,931 |
| | 13,570 |
| | 12,621 |
|
Selling, general and administrative | 5,372 |
| | 6,205 |
| | 10,329 |
| | 11,202 |
|
See accompanying notes to condensed consolidated financial statements
MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
(unaudited)
|
| | | | | | | | | | | | | | | |
| Three Months Ended | | Six Months Ended |
| September 30, | | September 30, |
| 2014 | | 2013 | | 2014 | | 2013 |
Net income | $ | 92,038 |
| | $ | 99,806 |
| | $ | 181,947 |
| | $ | 178,385 |
|
Less: Net loss attributable to noncontrolling interests | 1,603 |
| | — |
| | 1,603 |
| | — |
|
Net income attributable to Microchip Technology | 93,641 |
| | 99,806 |
| | 183,550 |
| | 178,385 |
|
| | | | | | | |
Components of other comprehensive (loss) income: | | | | | | | |
Available-for-sale securities: | | | | | | | |
Unrealized holding (losses) gains, net of tax effect of $0, ($11), $12 and $497, respectively | (3,465 | ) | | 1,928 |
| | (405 | ) | | (8,070 | ) |
Reclassification of realized transactions, net of tax effect of $0, $776, $12 and $776, respectively | (62 | ) | | (1,340 | ) | | (84 | ) | | (1,390 | ) |
Change in net foreign currency translation adjustment | (6,234 | ) | | — |
| | (6,234 | ) | | — |
|
Other comprehensive (loss) income, net of taxes | (9,761 | ) | | 588 |
| | (6,723 | ) | | (9,460 | ) |
Less: Other comprehensive loss attributable to noncontrolling interests | 1,015 |
| | — |
| | 1,015 |
| | — |
|
Other comprehensive (loss) income attributable to Microchip Technology | (8,746 | ) | | 588 |
| | (5,708 | ) | | (9,460 | ) |
| | | | | | | |
Comprehensive income | 82,277 |
| | 100,394 |
| | 175,224 |
| | 168,925 |
|
Less: Comprehensive loss attributable to noncontrolling interests | 2,618 |
| | — |
| | 2,618 |
| | — |
|
Comprehensive income attributable to Microchip Technology | $ | 84,895 |
| | $ | 100,394 |
| | $ | 177,842 |
| | $ | 168,925 |
|
See accompanying notes to condensed consolidated financial statements
MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited) |
| | | | | | | |
| Six Months Ended |
| September 30, |
| 2014 | | 2013 |
Cash flows from operating activities: | | | |
Net income | $ | 181,947 |
| | $ | 178,385 |
|
Adjustments to reconcile net income to net cash provided by operating activities: | | | |
Depreciation and amortization | 131,809 |
| | 98,462 |
|
Deferred income taxes | (4,497 | ) | | 11,872 |
|
Share-based compensation expense related to equity incentive plans | 28,594 |
| | 27,656 |
|
Excess tax benefit from share-based compensation | (982 | ) | | — |
|
Convertible debt derivatives - revaluation and amortization | 46 |
| | (248 | ) |
Amortization of debt discount on convertible debentures | 4,810 |
| | 4,396 |
|
Amortization of debt issuance costs | 1,088 |
| | 872 |
|
Losses on equity method investments | 67 |
| | 361 |
|
Impairment of intangible assets | 556 |
| | 350 |
|
Amortization of premium on available-for-sale investments | 5,066 |
| | 5,568 |
|
Special charge | — |
| | (237 | ) |
Changes in operating assets and liabilities: | | | |
Increase in accounts receivable | (29,429 | ) | | (693 | ) |
Decrease (increase) in inventories | 32,052 |
| | (32,103 | ) |
Increase in deferred income on shipments to distributors | 11,787 |
| | 12,097 |
|
Decrease in accounts payable and accrued liabilities | (15,817 | ) | | (2,006 | ) |
Change in other assets and liabilities | 10,737 |
| | 20,191 |
|
Net cash provided by operating activities | 357,834 |
| | 324,923 |
|
Cash flows from investing activities: | |
| | |
|
Purchases of available-for-sale investments | (350,598 | ) | | (715,765 | ) |
Sales and maturities of available-for-sale investments | 547,037 |
| | 370,806 |
|
Acquisition of ISSC, net of cash acquired | (252,469 | ) | | — |
|
Purchase of additional controlling interest in ISSC | (1,765 | ) | | — |
|
Acquisition of Supertex, net of cash acquired | (375,365 | ) | | — |
|
Other business acquisitions, net of cash acquired | — |
| | (2,174 | ) |
Investments in other assets | (3,659 | ) | | (2,951 | ) |
Proceeds from sale of assets | — |
| | 16,200 |
|
Capital expenditures | (83,372 | ) | | (55,206 | ) |
Net cash used in investing activities | (520,191 | ) | | (389,090 | ) |
Cash flows from financing activities: | |
| | |
|
Repayments of revolving loan under previous credit facility | — |
| | (650,000 | ) |
Repayments of revolving loan under new credit facility | (308,500 | ) | | (70,000 | ) |
Proceeds from borrowings on revolving loan under previous credit facility | — |
| | 30,000 |
|
Proceeds from borrowings on revolving loan under new credit facility | 632,875 |
| | 360,000 |
|
Proceeds from issuance of long-term borrowings | — |
| | 350,000 |
|
Repayments of long-term borrowings | (8,750 | ) | | — |
|
Deferred financing costs | — |
| | (7,515 | ) |
Payment of cash dividends | (142,644 | ) | | (139,768 | ) |
Proceeds from sale of common stock | 14,035 |
| | 32,888 |
|
Tax payments related to shares withheld for vested restricted stock units | (10,306 | ) | | (10,692 | ) |
Contingent consideration payment | — |
| | (14,700 | ) |
Capital lease payments | (298 | ) | | (178 | ) |
Excess tax benefit from share-based compensation | 982 |
| | — |
|
Net cash provided by (used in) financing activities | 177,394 |
| | (119,965 | ) |
Effect of foreign exchange rate changes on cash and cash equivalents | (201 | ) | | — |
|
Net increase (decrease) in cash and cash equivalents | 14,836 |
| | (184,132 | ) |
Cash and cash equivalents at beginning of period | 466,603 |
| | 528,334 |
|
Cash and cash equivalents at end of period | $ | 481,439 |
| | $ | 344,202 |
|
See accompanying notes to condensed consolidated financial statements
MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The accompanying unaudited condensed consolidated financial statements include the accounts of Microchip Technology Incorporated and its majority-owned subsidiaries (the Company). The Company owns 100% of the outstanding stock in all of its subsidiaries with the exception of its recent acquisition of ISSC Technologies Corporation (ISSC) as further discussed in Note 2. The noncontrolling interests in our net income from ISSC have been excluded from net income attributable to the Company in our condensed consolidated statements of income. 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). The information furnished herein reflects all adjustments which are, in the opinion of management, of a normal recurring nature and necessary for a fair statement of the results for the interim periods reported. Certain information and footnote disclosures normally included in audited consolidated financial statements have been condensed or omitted pursuant to such SEC rules and regulations. It is suggested that these condensed consolidated financial statements be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 2014. The results of operations for the six months ended September 30, 2014 are not necessarily indicative of the results that may be expected for the fiscal year ending March 31, 2015 or for any other period.
As further discussed in Note 2, on July 17, 2014, the Company completed its acquisition of a controlling interest in ISSC and the Company's second quarter fiscal 2015 financial results include ISSC's results beginning as of the acquisition date.
Acquisition of ISSC
On July 17, 2014, the Company acquired an 83.5% interest in Taiwan based ISSC Technologies Corporation (ISSC), a leading provider of low power Bluetooth and advanced wireless solutions for the Internet of Things (IoT) market. The total purchase price paid for the 83.5% interest was approximately $267.6 million and was financed with existing cash and investment balances. The Company's primary reason for this acquisition was to expand the Company's range of solutions, products and capabilities in the wireless and IoT areas by extending its served available market. The Company acquired the 83.5% ownership interest through a tender offer process and expects to acquire the remaining shares through a follow-on merger which is expected to close in the second half of fiscal 2015.
The acquisition was accounted for under the acquisition method of accounting, with the Company identified as the acquirer, and the operating results of ISSC have been included in the Company's condensed consolidated financial statements as of the closing date of the acquisition with the noncontrolling interest deducted to arrive at net income. Under the acquisition method of accounting, the aggregate amount of consideration paid by the Company was allocated to ISSC's net tangible assets and intangible assets based on their estimated fair values as of July 17, 2014. The excess of the purchase price over the value of the net tangible assets and intangible assets was recorded to goodwill. The factors contributing to the recognition of goodwill were based upon the Company's conclusion that there are strategic and synergistic benefits that are expected to be realized from the acquisition. The goodwill has been allocated to the Company's semiconductor products reporting segment. None of the goodwill related to the ISSC acquisition is deductible for tax purposes. The fair value of the noncontrolling interest was calculated based on the expected purchase price of the remaining shares available. The Company retained an independent third-party appraiser to assist management in its valuation; however, the purchase price allocation has not been finalized. This could result in adjustments to the carrying value of the assets acquired and liabilities assumed, the useful lives of intangible assets and the residual amount allocated to goodwill. The preliminary allocation of the purchase price is based on the best estimates of management and is subject to revision based on the final valuations and estimates of useful lives.
The table below represents the preliminary allocation of the purchase price to the net assets acquired based on their estimated fair values as of July 17, 2014, as well as the associated estimated useful lives of the acquired intangible assets at that date (amounts in thousands):
|
| | | |
Assets acquired | July 17, 2014 |
Cash and cash equivalents | $ | 15,120 |
|
Short-term investments | 27,063 |
|
Accounts receivable, net | 8,792 |
|
Inventories | 19,160 |
|
Prepaid expenses and other current assets | 2,501 |
|
Property, plant and equipment, net | 2,637 |
|
Goodwill | 152,243 |
|
Purchased intangible assets | 147,800 |
|
Other assets | 1,370 |
|
Total assets acquired | 376,686 |
|
| |
Liabilities assumed | |
Accounts payable | (9,860 | ) |
Other current liabilities | (16,997 | ) |
Long-term income tax payable | (4,402 | ) |
Deferred tax liability | (25,126 | ) |
Other long-term liabilities | (245 | ) |
Total liabilities assumed | (56,630 | ) |
Net assets acquired including noncontrolling interest | 320,056 |
|
Less: noncontrolling interest | (52,467 | ) |
Net assets acquired | $ | 267,589 |
|
The amount of cash paid by the Company, net of cash and short-term investments acquired from ISSC of approximately $42.2 million, was $225.4 million.
|
| | | | | |
Purchased Intangible Assets | Useful Life | | April 1, 2014 |
| (in years) | | (in thousands) |
Core/developed technology | 10 | | $ | 68,900 |
|
In-process technology | 10 | | 27,200 |
|
Customer-related | 3 | | 51,100 |
|
Backlog | 1 | | 600 |
|
| | | $ | 147,800 |
|
Purchased intangible assets include core and developed technology, in-process research and development, customer-related intangibles and acquisition-date backlog. The estimated fair values of the core and developed technology and in-process research and development were determined based on the present value of the expected cash flows to be generated by the respective existing technology or future technology. The core and developed technology intangible assets are being amortized commensurate with the expected cash flows used in the initial determination of fair value. In-process technology is capitalized until such time the related projects are completed or abandoned at which time the capitalized amounts will begin to be amortized or written off.
Customer-related intangible assets consist of ISSC's contractual relationships and customer loyalty related to its distributor and end-customer relationships, and the fair values of the customer-related intangibles were determined based on ISSC's projected revenues. An analysis of expected attrition and revenue growth for existing customers was prepared from ISSC's historical customer information. Customer relationships are being amortized in a manner consistent with the estimated cash flows associated with the existing customers and anticipated retention rates. Backlog relates to the value of orders not yet shipped by ISSC at the acquisition date, and the preliminary fair values were based on the estimated profit associated with those orders. Backlog related assets are being recognized commensurate with recognition of the revenue for the orders on which the backlog intangible assets were determined. Amortization expense associated with acquired intangible assets is not deductible for tax purposes. Thus, approximately $25.1 million was established as a net deferred tax liability for the future amortization of the intangible assets.
The amount of ISSC net sales and net loss attributable to the Company included in the Company's condensed consolidated statements of income for the three and six months ended September 30, 2014 was approximately $16.9 million and $8.2 million, respectively.
The following unaudited pro-forma consolidated results of operations for the three and six months ended September 30, 2014 and 2013 assume the ISSC acquisition occurred as of April 1, 2013. The pro-forma results of operations are presented for informational purposes only and are not indicative of the results of operations that would have been achieved if the acquisition had taken place on April 1, 2013 or of results that may occur in the future (amounts in thousands):
|
| | | | | | | | | | | | | | | |
| Three Months Ended | | Six Months Ended |
| September 30, | | September 30, |
| 2014 | | 2013 | | 2014 | | 2013 |
Net sales | $ | 547,543 |
| | $ | 512,150 |
| | $ | 1,097,473 |
| | $ | 993,191 |
|
Net income attributable to Microchip Technology | 95,261 |
| | 92,527 |
| | 178,729 |
| | 161,602 |
|
Net income attributable to Microchip Technology common stockholders per share - basic | $ | 0.47 |
| | $ | 0.47 |
| | $ | 0.89 |
| | $ | 0.82 |
|
Net income attributable to Microchip Technology common stockholders per share - diluted
| $ | 0.42 |
| | $ | 0.43 |
| | $ | 0.79 |
| | $ | 0.75 |
|
Acquisition of Supertex
On April 1, 2014, the Company acquired Supertex, a publicly traded company based in Sunnyvale, California, for $33.00 per share and the exchange of certain share-based payment awards, for a total of $391.8 million. The Company financed the transaction using borrowings under its existing credit agreement. As a result of the acquisition, Supertex became a wholly owned subsidiary of the Company. Supertex is a leader in high voltage analog and mixed signal technologies, with a strong position in the medical, lighting and industrial control markets. The Company's primary reason for this acquisition was to expand the Company's range of solutions, products and capabilities in these areas by extending its served available market.
The acquisition was accounted for under the acquisition method of accounting, with the Company identified as the acquirer, and the operating results of Supertex have been included in the Company's condensed consolidated financial statements as of the closing date of the acquisition. Under the acquisition method of accounting, the aggregate amount of consideration paid by the Company was allocated to Supertex's net tangible assets and intangible assets based on their estimated fair values as of April 1, 2014. The excess of the purchase price over the value of the net tangible assets and intangible assets was recorded to goodwill. The factors contributing to the recognition of goodwill were based upon the Company's conclusion that there are strategic and synergistic benefits that are expected to be realized from the acquisition. The goodwill has been allocated to the Company's semiconductor products reporting segment. None of the goodwill related to the Supertex acquisition is deductible for tax purposes. The Company retained an independent third-party appraiser to assist management in its valuation; however, the purchase price allocation has not been finalized. This could result in adjustments to the carrying value of the assets acquired and liabilities assumed, the useful lives of intangible assets and the residual amount allocated to goodwill. The preliminary allocation of the purchase price is based on the best estimates of management and is subject to revision based on the final valuations and estimates of useful lives.
The table below represents the preliminary allocation of the purchase price, including adjustments to the purchase price allocation from the previously reported figures at June 30, 2014, to the net assets acquired based on their estimated fair values as of April 1, 2014 (amounts in thousands):
|
| | | | | | | | | | | |
Assets acquired | Previously Reported June 30, 2014 | | Adjustments | | September 30, 2014 |
Cash and cash equivalents | $ | 14,790 |
| | $ | — |
| | $ | 14,790 |
|
Short-term investments | 140,984 |
| | — |
| | 140,984 |
|
Accounts receivable, net | 7,047 |
| | — |
| | 7,047 |
|
Inventories | 27,630 |
| | — |
| | 27,630 |
|
Prepaid expenses | 1,493 |
| | — |
| | 1,493 |
|
Deferred tax assets | 3,997 |
| | — |
| | 3,997 |
|
Other current assets | 16,113 |
| | — |
| | 16,113 |
|
Property, plant and equipment, net | 15,679 |
| | — |
| | 15,679 |
|
Goodwill | 133,713 |
| | (1,205 | ) | | 132,508 |
|
Purchased intangible assets | 89,600 |
| | — |
| | 89,600 |
|
Other assets | 325 |
| | — |
| | 325 |
|
Total assets acquired | 451,371 |
| | (1,205 | ) | | 450,166 |
|
| | | | | |
Liabilities assumed | | | | | |
Accounts payable | (8,481 | ) | | — |
| | (8,481 | ) |
Accrued liabilities | (19,345 | ) | | (25 | ) | | (19,370 | ) |
Long-term income tax payable | (3,796 | ) | | — |
| | (3,796 | ) |
Deferred tax liability | (27,972 | ) | | 1,230 |
| | (26,742 | ) |
Total liabilities assumed | (59,594 | ) | | 1,205 |
| | (58,389 | ) |
Net assets acquired | $ | 391,777 |
| | $ | — |
| | $ | 391,777 |
|
The total purchase price allocated of $391.8 million includes approximately $1.6 million of non cash consideration for the exchange of certain share-based payment awards of Supertex for stock awards of the Company. The amount of cash paid by the Company, net of cash and short-term investments acquired from Supertex of approximately $155.8 million, was $234.4 million.
|
| | | | | |
Purchased Intangible Assets | Useful Life | | April 1, 2014 |
| (in years) | | (in thousands) |
Core/developed technology | 10 | | $ | 68,900 |
|
In-process technology | 10 | | 1,900 |
|
Customer-related | 2 | | 17,700 |
|
Backlog | 1 | | 1,100 |
|
| | | $ | 89,600 |
|
Purchased intangible assets include core and developed technology, in-process research and development, customer-related intangibles and acquisition-date backlog. The estimated fair values of the core and developed technology and in-process research and development were determined based on the present value of the expected cash flows to be generated by the respective existing technology or future technology. The core and developed technology intangible assets are being amortized commensurate with the expected cash flows used in the initial determination of fair value. In-process technology is capitalized until such time the related projects are completed or abandoned at which time the capitalized amounts will begin to be amortized or written off.
Customer-related intangible assets consist of Supertex's contractual relationships and customer loyalty related to its distributor and end-customer relationships, and the fair values of the customer-related intangibles were determined based on Supertex's projected revenues. An analysis of expected attrition and revenue growth for existing customers was prepared from Supertex's historical customer information. Customer relationships are being amortized in a manner consistent with the estimated cash flows associated with the existing customers and anticipated retention rates. Backlog relates to the value of orders not yet shipped by Supertex at the acquisition date, and the preliminary fair values were based on the estimated profit associated with those orders. Backlog related assets are being recognized commensurate with recognition of the revenue for the orders on which the backlog intangible assets were determined. Amortization expense associated with acquired intangible assets is not deductible for tax purposes. Thus, approximately $22.8 million was established as a net deferred tax liability for the future amortization of the intangible assets.
The amount of Supertex net sales included in the Company's condensed consolidated statements of income for the three months ended September 30, 2014 was approximately $16.6 million. The amount of Supertex net sales included in the Company's condensed consolidated statements of income for the six months ended September 30, 2014 was approximately $34.4 million. The operations of Supertex were fully integrated into the Company's operations as of July 1, 2014 and as such, cost of sales and operating expenses were no longer segregated in the three months ended September 30, 2014.
The following unaudited pro-forma consolidated results of operations for the three months ended June 30, 2014 and 2013 assume the Supertex acquisition occurred as of April 1, 2013. The pro-forma results of operations are presented for informational purposes only and are not indicative of the results of operations that would have been achieved if the acquisition had taken place on April 1, 2013 or of results that may occur in the future (amounts in thousands):
|
| | | | | | | | | | | | | | | |
| Three Months Ended | | Six Months Ended |
| September 30, | | September 30, |
| 2014 | | 2013 | | 2014 | | 2013 |
Net sales | $ | 546,243 |
| | $ | 510,418 |
| | $ | 1,077,588 |
| | $ | 986,939 |
|
Net income | 98,391 |
| | 91,271 |
| | 203,896 |
| | 152,235 |
|
Basic earnings per share | $ | 0.49 |
| | $ | 0.46 |
| | $ | 1.02 |
| | $ | 0.77 |
|
Diluted earnings per share | $ | 0.44 |
| | $ | 0.42 |
| | $ | 0.91 |
| | $ | 0.71 |
|
| |
(3) | Recently Issued Accounting Pronouncements |
In June 2014, the FASB issued ASU No. 2014-12, Compensation - Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could be Achieved after the Requisite Service Period. The amendments in this ASU provide explicit guidance on whether a performance target contained in a share-based payment award that could be achieved after the requisite service period should be treated (i) as a performance condition that affects vesting or (ii) as a nonvesting condition that affects the grant-date fair value of the award. The amendments require that a performance target that affects vesting, and that could be achieved after the requisite service period, be treated as a performance condition rather than as a nonvesting condition. Accordingly, such performance targets are not reflected in the estimation of the grant date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. If the performance target becomes probable of being achieved before the end of the requisite service period, the remaining unrecognized compensation cost should be recognized prospectively over the remaining service period. The total amount of compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest and should be adjusted to reflect those awards that ultimately vest. The amendments in this update are effective for annual periods beginning after December 15, 2015, and interim periods within those annual periods. Early adoption is permitted. The Company does not anticipate adoption of this ASU will have a material impact on its consolidated financial statements.
In July 2013, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (ASU 2013-11) to provide guidance on the presentation of unrecognized tax benefits. ASU 2013-11 requires an entity to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows: to the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a
liability and should not be combined with deferred tax assets. ASU 2013-11 is effective for the Company's first quarter of fiscal 2015 with earlier adoption permitted. ASU 2013-11 should be applied prospectively with retroactive application permitted. There was no income statement impact to the Company as a result of adopting this accounting standard.
In May 2014, the FASB issued Accounting Standard Update 2014-09-Revenue from Contracts with Customers, which will supersede nearly all existing revenue recognition guidance under US GAAP. The standard's core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. The Company is carefully evaluating its existing revenue recognition policies to determine whether any contracts in the scope of the guidance will be materially affected by the new requirements. The effects may include identifying performance obligations in existing arrangements, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. The new standard is effective beginning the first quarter of the Company's 2018 fiscal year. Early adoption is not permitted. The standard allows for either "full retrospective" adoption, meaning the standard is applied to all of the periods presented, or "modified retrospective" adoption, meaning the standard is applied only to the most current period presented in the financial statements. The Company is currently evaluating the transition method that will be elected.
The Company incurred special charges related to severance, office closing and other costs associated with its acquisition activity of $0.8 million and $1.1 million for the three and six months ended September 30, 2014, respectively, and $1.7 million for the six months ended September 30, 2013.
The Company's reportable segments are semiconductor products and technology licensing. The Company does not allocate operating expenses, interest income, interest expense, other income or expense, or provision for or benefit from income taxes to these segments for internal reporting purposes, as the Company does not believe that allocating these expenses is beneficial in evaluating segment performance. Additionally, the Company does not allocate assets to segments for internal reporting purposes as it does not manage its segments by such metrics.
The following table represents net sales and gross profit for each segment for the three and six months ended September 30, 2014 (amounts in thousands):
|
| | | | | | | | | | | | | | | |
| Three Months Ended | | Six Months Ended |
| September 30, 2014 | | September 30, 2014 |
| Net Sales | | Gross Profit | | Net Sales | | Gross Profit |
Semiconductor products | $ | 523,659 |
| | $ | 284,870 |
| | $ | 1,032,098 |
| | $ | 570,952 |
|
Technology licensing | 22,584 |
| | 22,584 |
| | 43,021 |
| | 43,021 |
|
| $ | 546,243 |
| | $ | 307,454 |
| | $ | 1,075,119 |
| | $ | 613,973 |
|
The following table represents net sales and gross profit for each segment for the three and six months ended September 30, 2013 (amounts in thousands):
|
| | | | | | | | | | | | | | | |
| Three Months Ended | | Six Months Ended |
| September 30, 2013 | | September 30, 2013 |
| Net Sales | | Gross Profit | | Net Sales | | Gross Profit |
Semiconductor products | $ | 467,843 |
| | $ | 264,037 |
| | $ | 908,117 |
| | $ | 508,093 |
|
Technology licensing | 24,826 |
| | 24,826 |
| | 47,344 |
| | 47,344 |
|
| $ | 492,669 |
| | $ | 288,863 |
| | $ | 955,461 |
| | $ | 555,437 |
|
The Company's investments are intended to establish a high-quality portfolio that preserves principal, meets liquidity needs, avoids inappropriate concentrations, and delivers an appropriate yield in relationship to the Company's investment guidelines and market conditions. The following is a summary of available-for-sale securities at September 30, 2014 (amounts in thousands):
|
| | | | | | | | | | | | | | | |
| Available-for-sale Securities |
| Adjusted Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Estimated Fair Value |
Government agency bonds | $ | 668,639 |
| | $ | 129 |
| | $ | (2,560 | ) | | $ | 666,208 |
|
Municipal bonds | 41,097 |
| | 66 |
| | (2 | ) | | 41,161 |
|
Auction rate securities | 9,825 |
| | — |
| | — |
| | 9,825 |
|
Time deposits (1) | 20,160 |
| | — |
| | — |
| | 20,160 |
|
Corporate bonds and debt | 904,243 |
| | 2,150 |
| | (800 | ) | | 905,593 |
|
| $ | 1,643,964 |
| | $ | 2,345 |
| | $ | (3,362 | ) | | $ | 1,642,947 |
|
(1) Time deposits in various financial institutions with maturities greater than three months that will mature within one year.
The following is a summary of available-for-sale securities at March 31, 2014 (amounts in thousands):
|
| | | | | | | | | | | | | | | |
| Available-for-sale Securities |
| Adjusted Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Estimated Fair Value |
Government agency bonds | $ | 684,451 |
| | $ | 114 |
| | $ | (3,171 | ) | | $ | 681,394 |
|
Municipal bonds | 41,622 |
| | 101 |
| | (14 | ) | | 41,709 |
|
Auction rate securities | 9,825 |
| | — |
| | — |
| | 9,825 |
|
Corporate bonds and debt | 941,524 |
| | 3,247 |
| | (805 | ) | | 943,966 |
|
| $ | 1,677,422 |
| | $ | 3,462 |
| | $ | (3,990 | ) | | $ | 1,676,894 |
|
At September 30, 2014, the Company's available-for-sale debt securities are presented on the condensed consolidated balance sheets as short-term investments of $801.7 million and long-term investments of $841.3 million. At March 31, 2014, the Company's available-for-sale debt securities are presented on the condensed consolidated balance sheets as short-term investments of $878.2 million and long-term investments of $798.7 million.
At September 30, 2014, the Company evaluated its investment portfolio and noted unrealized losses of $3.4 million on its debt securities with an aggregated fair value of $833.3 million, which were due primarily to higher interest rates and resulting declines in market prices. Management does not believe any of the unrealized losses represent an other-than-temporary impairment based on its evaluation of available evidence as of September 30, 2014 and the Company's intent is to hold these investments until these assets are no longer impaired, except for certain auction rate securities (ARS). For those debt securities not scheduled to mature until after September 30, 2015, such recovery is not anticipated to occur in the next year and these investments have been classified as long-term investments.
The amortized cost and estimated fair value of the available-for-sale securities at September 30, 2014, by contractual maturity, excluding corporate debt of $6.2 million, which has no contractual maturity, are shown below (amounts in thousands). Expected maturities can differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties, and the Company views its available-for-sale securities as available for current operations.
|
| | | | | | | | | | | | | | | |
| Adjusted Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Estimated Fair Value |
Available-for-sale | | | | | | | |
Due in one year or less | $ | 250,615 |
| | $ | 742 |
| | $ | (5 | ) | | $ | 251,352 |
|
Due after one year and through five years | 1,264,898 |
| | 1,552 |
| | (2,227 | ) | | 1,264,223 |
|
Due after five years and through ten years | 112,436 |
| | 51 |
| | (1,130 | ) | | 111,357 |
|
Due after ten years | 9,825 |
| | — |
| | — |
| | 9,825 |
|
| $ | 1,637,774 |
| | $ | 2,345 |
| | $ | (3,362 | ) | | $ | 1,636,757 |
|
The Company had no material realized gains or losses from the sale of available-for-sale marketable equity securities or debt securities during each of the three and six-month periods ended September 30, 2014 and 2013.
| |
(7) | Fair Value Measurements |
Accounting rules for fair value clarify that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, the Company utilizes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:
| |
Level 1- | Observable inputs such as quoted prices in active markets; |
| |
Level 2- | Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and |
| |
Level 3- | Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions. |
Marketable Debt Instruments
Marketable debt instruments include instruments such as corporate bonds and debt, government agency bonds, bank deposits, municipal bonds, and money market mutual funds. When the Company uses observable market prices for identical securities that are traded in less active markets, the Company classifies its marketable debt instruments as Level 2. When observable market prices for identical securities are not available, the Company prices its marketable debt instruments using non-binding market consensus prices that are corroborated with observable market data; quoted market prices for similar instruments; or pricing models, such as a discounted cash flow model, with all significant inputs derived from or corroborated with observable market data. Non-binding market consensus prices are based on the proprietary valuation models of pricing providers or brokers. These valuation models incorporate a number of inputs, including non-binding and binding broker quotes; observable market prices for identical or similar securities; and the internal assumptions of pricing providers or brokers that use observable market inputs and, to a lesser degree, unobservable market inputs. The Company corroborates non-binding market consensus prices with observable market data using statistical models when observable market data exists. The discounted cash flow model uses observable market inputs, such as LIBOR-based yield curves, currency spot and forward rates, and credit ratings.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
Assets measured at fair value on a recurring basis at September 30, 2014 are as follows (amounts in thousands):
|
| | | | | | | | | | | | | | | |
| Quoted Prices in Active Markets for Identical Instruments (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) | | Total Balance |
Assets | | | | | | | |
Money market mutual funds | $ | 95,464 |
| | $ | — |
| | $ | — |
| | $ | 95,464 |
|
Corporate bonds and debt | — |
| | 899,403 |
| | 6,190 |
| | 905,593 |
|
Time deposits (1) | — |
| | 20,160 |
| | — |
| | 20,160 |
|
Government agency bonds | — |
| | 666,208 |
| | — |
| | 666,208 |
|
Deposit accounts | — |
| | 385,975 |
| | — |
| | 385,975 |
|
Municipal bonds | — |
| | 41,161 |
| | — |
| | 41,161 |
|
Auction rate securities | — |
| | — |
| | 9,825 |
| | 9,825 |
|
Total assets measured at fair value | $ | 95,464 |
| | $ | 2,012,907 |
| | $ | 16,015 |
| | $ | 2,124,386 |
|
(1) Time deposits in various financial institutions with maturities greater than three months that will mature within one year.
Assets measured at fair value on a recurring basis at March 31, 2014 are as follows (amounts in thousands):
|
| | | | | | | | | | | | | | | |
| Quoted Prices in Active Markets for Identical Instruments (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) | | Total Balance |
Assets | | | | | | | |
Money market mutual funds | $ | 192,159 |
| | $ | — |
| | $ | — |
| | $ | 192,159 |
|
Corporate bonds and debt | — |
| | 937,776 |
| | 6,190 |
| | 943,966 |
|
Government agency bonds | — |
| | 681,394 |
| | — |
| | 681,394 |
|
Deposit accounts | — |
| | 274,444 |
| | — |
| | 274,444 |
|
Municipal bonds | — |
| | 41,709 |
| | — |
| | 41,709 |
|
Auction rate securities | — |
| | — |
| | 9,825 |
| | 9,825 |
|
Total assets measured at fair value | $ | 192,159 |
| | $ | 1,935,323 |
| | $ | 16,015 |
| | $ | 2,143,497 |
|
There were no transfers between Level 1 and Level 2 during the three and six-month periods ended September 30, 2014 or the year ended March 31, 2014.
At September 30, 2014 and at March 31, 2014, the Company's ARS for which recent auctions were unsuccessful are made up of securities related to the insurance industry valued at $9.8 million with a par value of $22.4 million. The Company estimated the fair value of its ARS, which are classified as Level 3 securities, based on the following: (i) the underlying structure of each security; (ii) the present value of future principal and interest payments discounted at rates considered to reflect current market conditions; (iii) consideration of the probabilities of default, auction failure, or repurchase at par for each period; and (iv) estimates of the recovery rates in the event of default for each security. The significant unobservable inputs used in the fair value measurement of the insurance sector ARS as of September 30, 2014 were estimated risk free discount rates, liquidity risk premium, and the liquidity horizon. The risk free discount rate applied to these securities was 2% to 2.5% adjusted for the liquidity risk premium which ranged from 9.1% to 29.5%. The anticipated liquidity horizon ranged from 7 to 10 years. A significant increase in the liquidity premium or discount rate, in isolation, would lead to a significantly lower fair value measurement. A significant increase in the liquidity horizon, in isolation, would lead to a significantly lower fair value measurement. Each quarter the Company investigates material changes in the fair value measurements of its ARS.
The following tables present a reconciliation for all assets and liabilities measured at fair value on a recurring basis, excluding accrued interest components, using significant unobservable inputs (Level 3) for the year ended March 31, 2014 (amounts in thousands):
|
| | | | | | | | | | | | | | | | |
Year ended March 31, 2014 | | Auction Rate Securities | | Corporate Debt | | Contingent Consideration | | Total Gains (Losses) |
Balance at March 31, 2013 | | $ | 33,791 |
| | $ | 6,190 |
| | $ | (19,100 | ) | | $ | — |
|
Total gains (losses) (realized and unrealized): | | | | | | | | |
Included in earnings | | 1,101 |
| | — |
| | (1,370 | ) | | (269 | ) |
Included in other comprehensive income | | (332 | ) | | — |
| | — |
| | (332 | ) |
Purchases, sales, issuances, and settlements, net | | (24,735 | ) | | — |
| | 20,470 |
| | — |
|
Balance at March 31, 2014 | | $ | 9,825 |
| | $ | 6,190 |
| | $ | — |
| | $ | (601 | ) |
Gains and losses recognized in earnings using Level 3 inputs for ARS are credited or charged to Other Income (Expense) on the condensed consolidated statements of income. Gains and losses recognized in earnings using Level 3 inputs related to the revaluation of contingent consideration are credited or charged to Special Charges on the condensed consolidated statements of income.
Assets measured at fair value on a recurring basis are presented/classified on the condensed consolidated balance sheets at September 30, 2014 as follows (amounts in thousands):
|
| | | | | | | | | | | | | | | |
| Quoted Prices in Active Markets for Identical Instruments (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) | | Total Balance |
Assets | | | | | | | |
Cash and cash equivalents | $ | 95,464 |
| | $ | 385,975 |
| | $ | — |
| | $ | 481,439 |
|
Short-term investments | — |
| | 801,670 |
| | — |
| | 801,670 |
|
Long-term investments | — |
| | 825,262 |
| | 16,015 |
| | 841,277 |
|
Total assets measured at fair value | $ | 95,464 |
| | $ | 2,012,907 |
| | $ | 16,015 |
| | $ | 2,124,386 |
|
Assets measured at fair value on a recurring basis are presented/classified in the condensed consolidated balance sheets at March 31, 2014 as follows (amounts in thousands):
|
| | | | | | | | | | | | | | | |
| Quoted Prices in Active Markets for Identical Instruments (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) | | Total Balance |
Assets | | | | | | | |
Cash and cash equivalents | $ | 192,159 |
| | $ | 274,444 |
| | $ | — |
| | $ | 466,603 |
|
Short-term investments | — |
| | 878,182 |
| | — |
| | 878,182 |
|
Long-term investments | — |
| | 782,697 |
| | 16,015 |
| | 798,712 |
|
Total assets measured at fair value | $ | 192,159 |
| | $ | 1,935,323 |
| | $ | 16,015 |
| | $ | 2,143,497 |
|
Financial Assets Not Recorded at Fair Value on a Recurring Basis
The Company's non-marketable equity and cost-method investments are not recorded at fair value on a recurring basis. These investments are monitored on a quarterly basis for impairment charges. The investments will only be recorded at fair value when an impairment charge is recognized. There were no impairment charges recognized on these investments during the three and six-month periods ended September 30, 2014 and September 30, 2013.
| |
(8) | Fair Value of Financial Instruments |
The carrying amount of cash equivalents approximates fair value because their maturity is less than three months. Management believes the carrying amount of the equity and cost-method investments materially approximated fair value at September 30, 2014 based upon unobservable inputs. The fair values of these investments have been determined as Level 3 fair value measurements. The fair values of the Company's line of credit and short-term and long-term borrowings are estimated using discounted cash flow analyses, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements and approximate carrying value. Based on the borrowing rates currently available to the Company for bank loans with similar terms and average maturities, the fair value of the Company's line of credit and long-term borrowings at September 30, 2014 approximated book value and are considered Level 2 in the fair value hierarchy described in Note 7. The carrying amount of accounts receivable, accounts payable and accrued liabilities approximates fair value due to the short-term maturity of the amounts. The fair value of the Company's junior subordinated convertible debentures was $2.137 billion at September 30, 2014 and $2.138 billion at March 31, 2014 based on observable market prices for these debentures, which are traded in less active markets and are therefore classified as Level 2 securities.
Accounts receivable consists of the following (amounts in thousands):
|
| | | | | | | |
| September 30, 2014 | | March 31, 2014 |
Trade accounts receivable | $ | 288,091 |
| | $ | 243,383 |
|
Other | 2,319 |
| | 1,940 |
|
| 290,410 |
| | 245,323 |
|
Less allowance for doubtful accounts | 2,937 |
| | 2,918 |
|
| $ | 287,473 |
| | $ | 242,405 |
|
The components of inventories consist of the following (amounts in thousands):
|
| | | | | | | |
| September 30, 2014 | | March 31, 2014 |
Raw materials | $ | 14,013 |
| | $ | 9,734 |
|
Work in process | 186,499 |
| | 179,692 |
|
Finished goods | 75,234 |
| | 73,299 |
|
| $ | 275,746 |
| | $ | 262,725 |
|
Inventories are valued at the lower of cost or market using the first-in, first-out method. Inventory impairment charges establish a new cost basis for inventory and charges are not subsequently reversed to income even if circumstances later suggest that increased carrying amounts are recoverable.
| |
(11) | Property, Plant and Equipment |
Property, plant and equipment consists of the following (amounts in thousands):
|
| | | | | | | |
| September 30, 2014 | | March 31, 2014 |
Land | $ | 69,895 |
| | $ | 55,624 |
|
Building and building improvements | 418,525 |
| | 411,149 |
|
Machinery and equipment | 1,538,405 |
| | 1,465,255 |
|
Projects in process | 73,955 |
| | 68,991 |
|
| 2,100,780 |
| | 2,001,019 |
|
Less accumulated depreciation and amortization | 1,515,678 |
| | 1,469,052 |
|
| $ | 585,102 |
| | $ | 531,967 |
|
Depreciation expense attributed to property, plant and equipment was $24.3 million and $47.6 million for the three and six months ended September 30, 2014, respectively, and $23.0 million and $44.4 million for the three and six months ended September 30, 2013, respectively.
| |
(12) | Noncontrolling Interests |
The following table presents the changes in the components of noncontrolling interests for the six months ended September 30, 2014 (amounts in thousands):
|
| | | |
| Noncontrolling Interests |
Balance at March 31, 2014 | $ | — |
|
Additions due to acquisition of controlling interest in ISSC | 52,467 |
|
Net loss attributable to noncontrolling interests | (1,603 | ) |
Other comprehensive loss attributable to noncontrolling interests | (1,015 | ) |
Purchase of additional interests | (1,817 | ) |
Other | 755 |
|
Balance at September 30, 2014 | $ | 48,787 |
|
(13) Intangible Assets and Goodwill
Intangible assets consist of the following (amounts in thousands):
|
| | | | | | | | | | | | |
| | September 30, 2014 |
| | Gross Amount | | Accumulated Amortization | | Net Amount |
Developed technology | | $ | 559,828 |
| | $ | (161,145 | ) | | $ | 398,683 |
|
Customer-related | | 263,805 |
| | (147,489 | ) | | 116,316 |
|
Trademarks and trade names | | 15,730 |
| | (8,323 | ) | | 7,407 |
|
Backlog | | 26,302 |
| | (25,331 | ) | | 971 |
|
In-process technology | | 75,280 |
| | — |
| | 75,280 |
|
Distribution rights | | 5,585 |
| | (5,217 | ) | | 368 |
|
Covenants not to compete | | 400 |
| | (400 | ) | | — |
|
| | $ | 946,930 |
| | $ | (347,905 | ) | | $ | 599,025 |
|
|
| | | | | | | | | | | | |
| | March 31, 2014 |
| | Gross Amount | | Accumulated Amortization | | Net Amount |
Developed technology | | $ | 402,669 |
| | $ | (117,222 | ) | | $ | 285,447 |
|
Customer-related | | 195,800 |
| | (109,170 | ) | | 86,630 |
|
Trademarks and trade names | | 15,730 |
| | (7,118 | ) | | 8,612 |
|
Backlog | | 24,610 |
| | (24,610 | ) | | — |
|
In-process technology | | 64,396 |
| | — |
| | 64,396 |
|
Distribution rights | | 5,585 |
| | (5,171 | ) | | 414 |
|
Covenants not to compete | | 400 |
| | (400 | ) | | — |
|
| | $ | 709,190 |
| | $ | (263,691 | ) | | $ | 445,499 |
|
The Company amortizes intangible assets over their expected useful lives, which range between 1 and 15 years. During the six months ended September 30, 2014, $24.4 million of in-process technology reached technological feasibility and was reclassified as developed technology and began being amortized over its estimated useful life. The following is an expected amortization schedule for the intangible assets for the remainder of fiscal 2015 through fiscal 2019, absent any future acquisitions or impairment charges (amounts in thousands):
|
| |
Year ending March 31, | Projected Amortization Expense |
2015 | $99,063 |
2016 | 150,298 |
2017 | 92,227 |
2018 | 73,926 |
2019 | 65,650 |
Amortization expense attributed to intangible assets was $46.5 million and $84.2 million for the three and six months ended September 30, 2014, respectively. Amortization expense attributed to intangible assets was $25.1 million and $54.0 million for the three and six months ended September 30, 2013, respectively. In the three and six months ended September 30, 2014, approximately $1.0 million and $2.0 million was charged to cost of sales, respectively, and approximately $45.5 million and $82.2 million was charged to operating expenses, respectively. In the three months and six months ended September 30, 2013, approximately $1.3 million and $2.5 million was charged to cost of sales, respectively, and approximately $23.8 million and $51.5 million was charged to operating expenses, respectively. The Company recognized impairment charges of $0.2 million and $0.6 million in the three and six months ended September 30, 2014, respectively. The Company recognized impairment charges of $0.4 million in the three and six months ended September 30, 2013.
Goodwill activity for the six months ended September 30, 2014 was as follows (amounts in thousands):
|
| | | | | | | |
| Semiconductor Products Reporting Unit | | Technology Licensing Reporting Unit |
Balance at March 31, 2014 | $ | 256,897 |
| | $ | 19,200 |
|
Additions due to the acquisition of Supertex | 132,508 |
| | — |
|
Additions due to acquisition of controlling interest in ISSC | 152,243 |
| | — |
|
Adjustments due to other acquisitions | 625 |
| | — |
|
Foreign currency translation adjustments | (3,508 | ) | | — |
|
Balance at September 30, 2014 | $ | 538,765 |
| | $ | 19,200 |
|
At September 30, 2014, $538.8 million of goodwill was recorded in the Company's semiconductor products reporting unit and $19.2 million was recorded in the Company's technology licensing reporting unit. At March 31, 2014, the Company applied a qualitative goodwill impairment screen to its two reporting units, concluding it was not more likely than not that goodwill was impaired. Through September 30, 2014, the Company had never recorded an impairment charge against its goodwill balance.
The provision for income taxes reflects tax on foreign earnings and federal and state tax on U.S. earnings. The Company had an effective tax rate of 8.0% for the six-month period ended September 30, 2014 and 11.5% for the six-month period ended September 30, 2013. The Company's effective tax rate for six-month period ended September 30, 2014 is lower compared to the prior year primarily due to closure of statute of limitations, certain audit settlements with taxing authorities and a change in judgment regarding certain state valuation allowances. During the three-month period ended September 30, 2014, approximately $6.8 million of prior year tax positions were released which increased each of the basic and diluted net income per common share for the three-month period ended September 30, 2014 by approximately $0.03. During the six-month period ended September 30, 2014, approximately $7.4 million of prior year tax positions were released which increased the basic and diluted net income per common share for the six-month period ended September 30, 2014 by approximately $0.04 and $0.03, respectively. The Company's effective tax rate is lower than statutory rates in the U.S. due primarily to its mix of earnings in foreign jurisdictions with lower tax rates.
At September 30, 2014, the Company had $212.1 million of unrecognized tax benefits. Unrecognized tax benefits increased by $32.1 million compared to March 31, 2014 primarily as a result of unrecognized tax benefits from the Company's acquisitions of Supertex and ISSC, the ongoing accrual for uncertain tax positions and the accrual of deficiency interest on these positions. The majority of the increase in the uncertain tax position does not result in a change in the Company's effective tax rate. The Company evaluated the impact of the adoption of ASU 2013-11 on its condensed consolidated financial statements and determined that $72.7 million of unrecognized tax benefits can be presented as a reduction to deferred tax assets for net operating loss carryforward and other tax credit carryforwards. There was no income statement impact as a result of adopting this accounting standard.
The Company files U.S. federal, U.S. state, and foreign income tax returns. For U.S. federal, and in general for U.S. state tax returns, the fiscal 2011 and later tax years remain open for examination by tax authorities. The U.S. Internal Revenue Service (IRS) is currently auditing Microchip's and Standard Microsystems Corporation's (SMSC) 2011 and 2012 tax years. The IRS is also currently auditing Supertex's 2013 tax year. For foreign tax returns, the Company is generally no longer subject to income tax examinations for years prior to fiscal 2006.
The Company recognizes liabilities for anticipated tax audit issues in the U.S. and other domestic and international tax jurisdictions based on its estimate of whether, and the extent to which, additional tax payments are more likely than not. The Company believes that it has appropriate support for the income tax positions taken and to be taken on its tax returns and that its accruals for tax liabilities are adequate for all open years based on an assessment of many factors including past experience and interpretations of tax laws applied to the facts of each matter.
The Company believes it maintains appropriate reserves to offset any potential income tax liabilities that may arise upon final resolution of matters for open tax years. If such reserve amounts ultimately prove to be unnecessary, the resulting reversal of such reserves would result in tax benefits being recorded in the period the reserves are no longer deemed necessary. If such amounts prove to be less than an ultimate assessment, a future charge to expense would be recorded in the period in which the assessment is determined. Although the timing of the resolution and/or closure of audits is highly uncertain, the Company does not believe it is reasonably possible that the unrecognized tax benefits would materially change in the next 12 months.
| |
(15) | 2.125% Junior Subordinated Convertible Debentures |
The Company's $1.15 billion principal amount of 2.125% junior subordinated convertible debentures due December 15, 2037, are subordinated in right of payment to any future senior debt of the Company and are effectively subordinated in right of payment to the liabilities of the Company's subsidiaries. The debentures are convertible, subject to certain conditions, into shares of the Company's common stock at an initial conversion rate of 29.2783 shares of common stock per $1,000 principal amount of debentures, representing an initial conversion price of approximately $34.16 per share of common stock. As of September 30, 2014, the holders of the debentures have the right to convert their debentures between October 1, 2014 and December 31, 2014 because for at least 20 trading days during the 30 consecutive trading day period ending on September 30, 2014, the Company's common stock had a last reported sale price greater than 130% of the conversion price. As of September 30, 2014, a holder could realize more economic value by selling its debentures in the over the counter market than from converting its debentures. As a result of cash dividends paid since the issuance of the debentures, the conversion rate has been adjusted to 39.2544 shares of common stock per $1,000 of principal amount of debentures, representing a conversion price of approximately $25.47 per share of common stock. The debentures include a contingent interest mechanism that begins in December 2017. The terms of the contingent interest include a 0.25% interest rate if the debentures are trading at less than $40 and 0.5% if the debentures are trading at greater than $150. Based on the current trading price of the debentures, the contingent interest rate in calendar year 2017 would be 0.5%.
As the debentures can be settled in cash upon conversion, for accounting purposes, the debentures were bifurcated into a liability component and an equity component, which are both initially recorded at fair value. The carrying value of the equity component at September 30, 2014 and at March 31, 2014 was $822.4 million. The estimated fair value of the liability component of the debentures at the issuance date was $327.6 million, resulting in a debt discount of $822.4 million. The unamortized debt discount was $772.4 million at September 30, 2014 and $777.2 million at March 31, 2014. The carrying value of the debentures was $376.7 million at September 30, 2014 and $371.9 million at March 31, 2014. The remaining period over which the unamortized debt discount will be recognized as non-cash interest expense is 23.25 years. In the three and six months ended September 30, 2014, the Company recognized $2.4 million and $4.8 million, respectively, in non-cash interest expense related to the amortization of the debt discount. In the three and six months ended September 30, 2013, the Company recognized $2.2 million and $4.4 million, respectively, in non-cash interest expense related to the amortization of the debt discount. The Company recognized $6.1 million and $12.2 million of interest expense related to the 2.125% coupon on the debentures in each of the three and six-month periods ended September 30, 2014 and September 30, 2013.
On June 27, 2013, the Company entered into a $2.0 billion credit agreement among the Company, the lenders from time to time that are parties thereto and JPMorgan Chase Bank, N.A., as administrative agent (the Credit Agreement). The Credit Agreement provides for a $350 million term loan and a $1.65 billion revolving credit facility, with a $125 million foreign currency sublimit, a $35 million letter of credit sublimit and a $25 million swingline loan sublimit, terminating on June 27, 2018 (the Maturity Date). The Credit Agreement also contains an increase option permitting the Company, subject to certain requirements, to arrange with existing lenders and/or new lenders for them to provide up to an aggregate of $300 million in additional commitments, which may be for revolving loans or term loans. Proceeds of loans made under the Credit Agreement may be used for working capital and general corporate purposes. The Credit Agreement replaced another credit agreement the Company had in place since August 2011. At September 30, 2014, $965.6 million of borrowings were outstanding under the Credit Agreement consisting of $624.4 million of a revolving line of credit and $341.2 million of a term loan, net of $1.0 million of debt discount resulting from amounts paid to the lenders.
The loans under the Credit Agreement bear interest, at the Company's option, at the base rate plus a spread of 0.25% to 1.25% or an adjusted LIBOR rate (based on one, two, three, or six-month interest periods) plus a spread of 1.25% to 2.25%, in each case with such spread being determined based on the consolidated leverage ratio for the preceding four fiscal quarter period. The base rate means the highest of JPMorgan Chase Bank, N.A.'s prime rate, the federal funds rate plus a margin equal to 0.50% and the adjusted LIBOR rate for a 1-month interest period plus a margin equal to 1.00%. Swingline loans accrue interest at a per annum rate based on the base rate plus the applicable margin for base rate loans. Base rate loans may only be made in U.S. dollars. The Company is also obligated to pay other customary administration fees and letter of credit fees for a credit facility of this size and type.
Interest is due and payable in arrears quarterly for loans bearing interest at the base rate and at the end of an interest period (or at each three-month interval in the case of loans with interest periods greater than three months) in the case of loans bearing interest at the adjusted LIBOR rate. Interest expense related to the Credit Agreement was approximately $5.1 million and $10.1 million in the three and six months ended September 30, 2014, respectively, and approximately $4.0 million and $7.5 million in the three and six months ended September 30, 2013, respectively. Principal, together with all accrued and unpaid interest, is due and payable on the Maturity Date. The weighted average interest rate on short-term borrowings outstanding at September 30, 2014 related to the Credit Agreement was 1.65%. The Company also pays a quarterly commitment fee on the available but unused portion of its line of credit which is calculated on the average daily available balance during the period. The Company may prepay the loans and terminate the commitments, in whole or in part, at any time without premium or penalty, subject to certain conditions including minimum amounts in the case of commitment reductions and reimbursement of certain costs in the case of prepayments of LIBOR loans.
The Company's obligations under the Credit Agreement are guaranteed by certain of its subsidiaries meeting materiality thresholds set forth in the Credit Agreement. To secure the Company's obligations under the Credit Agreement, the Company and its domestic subsidiaries will be required to pledge the equity securities of certain of their respective material subsidiaries, subject to certain exceptions and limitations.
The Credit Agreement contains customary affirmative and negative covenants, including covenants that limit or restrict the Company and its subsidiaries' ability to, among other things, incur subsidiary indebtedness, grant liens, merge or consolidate, dispose of assets, make investments, make acquisitions, enter into certain transactions with affiliates, pay dividends or make distributions, repurchase stock, enter into restrictive agreements and enter into sale and leaseback transactions, in each case subject to customary exceptions for a credit facility of this size and type. The Company is also required to maintain compliance with a consolidated leverage ratio and a consolidated interest coverage ratio. At September 30, 2014, the Company was in compliance with these covenants.
The Credit Agreement includes customary events of default that include, among other things, non-payment defaults, inaccuracy of representations and warranties, covenant defaults, cross default to material indebtedness, bankruptcy and insolvency defaults, material judgment defaults, ERISA defaults and a change of control default. The occurrence of an event of default could result in the acceleration of the obligations under the Credit Agreement. Under certain circumstances, a default interest rate will apply on all obligations during the existence of an event of default under the Credit Agreement at a per annum rate equal to 2.00% above the applicable interest rate for any overdue principal and 2.00% above the rate applicable for base rate loans for any other overdue amounts.
In the ordinary course of the Company's business, it is involved in a limited number of legal actions, both as plaintiff and defendant, and could incur uninsured liability in any one or more of them. The Company also periodically receives notifications from various third parties alleging infringement of patents, intellectual property rights or other matters. With respect to pending legal actions to which the Company is a party, although the outcomes of these actions are not generally determinable, the Company believes that the ultimate resolution of these matters will not have a material adverse effect on its financial position, cash flows or results of operations. Litigation relating to the semiconductor industry is not uncommon, and the Company is, and from time to time has been, subject to such litigation. No assurances can be given with respect to the extent or outcome of any such litigation in the future.
The Company's technology license agreements generally include an indemnification clause that indemnifies the licensee against liability and damages (including legal defense costs) arising from any claims of patent, copyright, trademark or trade secret infringement by the Company's proprietary technology. The terms of these indemnification provisions approximate the terms of the outgoing technology license agreements, which are typically perpetual unless terminated by either party for breach. The possible amount of future payments the Company could be required to make based on agreements that specify indemnification limits, if such indemnifications were required on all of these agreements, is approximately $138 million. There are some licensing agreements in place that do not specify indemnification limits. The Company had not recorded any liabilities related to these indemnification obligations as of September 30, 2014.
At September 30, 2014, the Company had recognized a contingent liability in the amount of $5.7 million recorded in connection with the Company's April 8, 2010 acquisition of Silicon Storage Technology Inc. (SST) as an adverse outcome was determined to be probable and estimable.
| |
(18) | Derivative Instruments |
The Company has international operations and is thus subject to foreign currency rate fluctuations. To help manage the risk of changes in foreign currency rates, the Company periodically enters into derivative contracts comprised of foreign currency forward contracts to hedge its asset and liability foreign currency exposure and a portion of its foreign currency operating expenses. Approximately 99% of the Company's sales are U.S. dollar denominated. To date, the exposure related to foreign exchange rate volatility has not been material to the Company's operating results. As of September 30, 2014 and March 31, 2014, the Company had no foreign currency forward contracts outstanding. The Company recognized an immaterial amount of net realized gains and losses on foreign currency forward contracts in each of the three and six months ended September 30, 2014 and 2013. Gains and losses from changes in the fair value of these foreign currency forward contracts are credited or charged to Other Income (Expense). The Company does not apply hedge accounting to its foreign currency derivative instruments.
The following table presents the changes in the components of accumulated other comprehensive income (AOCI) for the six months ended September 30, 2014 (amounts in thousands):
|
| | | | | | | | | | | | | | | |
| Unrealized holding gains (losses) available-for-sale securities | | Minimum pension liability | | Foreign Currency | | Total |
Balance at March 31, 2014 | $ | (528 | ) | | $ | 140 |
| | $ | 1,439 |
| | $ | 1,051 |
|
Other comprehensive (loss) income before reclassifications | (405 | ) | | — |
| | (5,219 | ) | | (5,624 | ) |
Amounts reclassified from accumulated other comprehensive income (loss) | (84 | ) | | — |
| | — |
| | (84 | ) |
Net other comprehensive (loss) income | (489 | ) | | — |
| | (5,219 | ) | | (5,708 | ) |
Balance at September 30, 2014 | $ | (1,017 | ) | | $ | 140 |
| | $ | (3,780 | ) | | $ | (4,657 | ) |
The table below details where reclassifications of realized transactions out of AOCI are recorded on the condensed consolidated statements of income (amounts in thousands):
|
| | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | Six Months Ended | | |
| | September 30, | | September 30, | | |
Description of AOCI Component | | 2014 | | 2013 | | 2014 | | 2013 | | Related Statement of Income Line |
Unrealized gains on available-for-sale securities | | $ | 62 |
| | $ | 2,116 |
| | $ | 96 |
| | $ | 2,166 |
| | Other income |
Taxes | | — |
| | (776 | ) | | (12 | ) | | (776 | ) | | Provision for income taxes |
Reclassification of realized transactions, net of taxes | | $ | 62 |
| | $ | 1,340 |
| | $ | 84 |
| | $ | 1,390 |
| | Net income |
| |
(20) | Share-Based Compensation |
The following table presents the details of the Company's share-based compensation expense (amounts in thousands):
|
| | | | | | | | | | | | | | | | |
| Three Months Ended | | Six Months Ended | |
| September 30, | | September 30, | |
| 2014 | | 2013 | | 2014 | | 2013 | |
Cost of sales | $ | 2,640 |
| (1) | $ | 1,864 |
| (1) | $ | 4,695 |
| (1) | $ | 3,833 |
| (1) |
Research and development | 7,261 |
| | 6,931 |
| | 13,570 |
| | 12,621 |
| |
Selling, general and administrative | 5,372 |
| | 6,205 |
| | 10,329 |
| | 11,202 |
| |
Pre-tax effect of share-based compensation | 15,273 |
| | 15,000 |
| | 28,594 |
| | 27,656 |
| |
Income tax benefit | 1,833 |
| | 1,589 |
| | 3,253 |
| | 2,991 |
| |
Net income effect of share-based compensation | $ | 13,440 |
| | $ | 13,411 |
| | $ | 25,341 |
| | $ | 24,665 |
| |
(1) During the three and six months ended September 30, 2014, $1.6 million and $3.3 million, respectively, of share-based compensation expense was capitalized to inventory and $2.6 million and $4.7 million, respectively, of previously capitalized share-based compensation expenses in inventory was sold. During the three and six months ended September 30, 2013, $2.4 million and $3.8 million, respectively, of share-based compensation expense was capitalized to inventory and $1.9 million and $3.8 million, respectively, of previously capitalized share-based compensation expense in inventory was sold.
| |
(21) | Net Income Per Common Share Attributable to Microchip Technology Stockholders |
The following table sets forth the computation of basic and diluted net income per common share attributable to Microchip Technology stockholders (in thousands, except per share amounts):
|
| | | | | | | | | | | | | | | |
| Three Months Ended | | Six Months Ended |
| September 30, | | September 30, |
| 2014 | | 2013 | | 2014 | | 2013 |
Net income attributable to Microchip Technology | $ | 93,641 |
| | $ | 99,806 |
| | $ | 183,550 |
| | $ | 178,385 |
|
Weighted average common shares outstanding | 200,629 |
| | 197,825 |
| | 200,408 |
| | 197,388 |
|
Dilutive effect of stock options and RSUs | 3,767 |
| | 4,144 |
| | 3,780 |
| | 3,908 |
|
Dilutive effect of convertible debt | 20,888 |
| | 14,506 |
| | 20,718 |
| | 13,075 |
|
Weighted average common and potential common shares outstanding | 225,284 |
| | 216,475 |
| | 224,906 |
| | 214,371 |
|
Basic net income per common share attributable to Microchip Technology stockholders | $ | 0.47 |
| | $ | 0.50 |
| | $ | 0.92 |
| | $ | 0.90 |
|
Diluted net income per common share attributable to Microchip Technology stockholders | $ | 0.42 |
| | $ | 0.46 |
| | $ | 0.82 |
| | $ | 0.83 |
|
The Company computed basic earnings per common share attributable to its stockholders using net income available to common stockholders and the weighted average number of common shares outstanding during the period. The Company computed diluted earnings per common share attributable to its stockholders using net income available to stockholders and the weighted average number of common shares outstanding plus potentially dilutive common shares outstanding during the period.
Potentially dilutive common shares from employee equity incentive plans are determined by applying the treasury stock method to the assumed exercise of outstanding stock options and the assumed vesting of outstanding RSUs.
Diluted net income per common share attributable to stockholders for the three and six months ended September 30, 2014 includes 20,887,608 shares and 20,717,720 shares, respectively, issuable upon the exchange of debentures (see Note 15). Diluted net income per common share attributable to stockholders for the three and six months ended September 30, 2013 includes 14,506,100 shares and 13,075,168 shares, respectively, issuable upon the exchange of debentures. The debentures have no impact on diluted net income per common share unless the average price of the Company's common stock exceeds the conversion price because the principal amount of the debentures will be settled in cash upon conversion. Prior to conversion, the Company will include, in the diluted net income per common share calculation, the effect of the additional shares that may be issued when the Company's common stock price exceeds the conversion price using the treasury stock method. The weighted average conversion price per share used in calculating the dilutive effect of the convertible debt for the three and six-month periods ended September 30, 2014 was $25.58 and $25.67, respectively. The weighted average conversion price per share used in calculating the dilutive effect of the convertible debt for the three and six-month periods ended September 30, 2013 was $26.42 and $26.54, respectively.
Weighted average common shares exclude the effect of option shares which are not dilutive. There were no antidilutive option shares for each of the three and six-month periods ended September 30, 2014 and September 30, 2013.
A quarterly cash dividend of $0.356 per share was paid on September 4, 2014 in the aggregate amount of $71.4 million. Through the first six months of fiscal 2015, cash dividends of $0.7115 per share have been paid in the aggregate amount of $142.6 million. A quarterly cash dividend of $0.3565 per share was declared on October 30, 2014 and will be paid on December 5, 2014 to stockholders of record as of November 21, 2014. The Company expects the December 2014 payment of its quarterly cash dividend to be approximately $71.7 million.
On October 15, 2014, Hua Hong Semiconductor Limited (Hua Hong) effected its initial public offering on the Hong Kong Stock Exchange. The Company owns 27,964,822 shares of Hua Hong with a carrying value of $3.6 million as of September 30, 2014. The Company estimates its shares to be worth approximately $39.2 million based on the closing price of Hong Kong Dollar 10.88 per share (approximately US$1.40 per share) on 10/31/2014. The Company plans to classify this investment as an available-for-sale investment.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
This report, including "Part I – Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Part II - Item 1A Risk Factors" contains certain forward-looking statements that involve risks and uncertainties, including statements regarding our strategy, financial performance and revenue sources. We use words such as "anticipate," "believe," "plan," "expect," "future," "intend" and similar expressions to identify forward-looking statements. Our actual results could differ materially from the results anticipated in these forward-looking statements as a result of certain factors including those set forth under "Risk Factors," beginning at page 41 and elsewhere in this Form 10-Q. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. You should not place undue reliance on these forward-looking statements. We disclaim any obligation to update information contained in any forward-looking statement. These forward-looking statements include, without limitation, statements regarding the following:
| |
• | The effects that adverse global economic conditions and fluctuations in the global credit and equity markets may have on our financial condition and results of operations; |
| |
• | The effects and amount of competitive pricing pressure on our product lines; |
| |
• | Our ability to moderate future average selling price declines; |
| |
• | The effect of product mix, capacity utilization, yields, fixed cost absorption, competition and economic conditions on gross margin; |
| |
• | The amount of, and changes in, demand for our products and those of our customers; |
| |
• | Our expectation that in the future we will acquire additional businesses that we believe will complement our existing businesses; |
| |
• | Our expectation that in the future we will enter into joint development agreements or other business or strategic relationships with other companies; |
| |
• | The level of orders that will be received and shipped within a quarter; |
| |
• | Our expectation that our inventory levels will be up four to 14 days in the December 2014 quarter compared to the September 2014 quarter and that it will allow us to maintain competitive lead times; |
| |
• | The effect that distributor and customer inventory holding patterns will have on us; |
| |
• | Our belief that customers recognize our products and brand name and use distributors as an effective supply channel; |
| |
• | Anticipating increased customer requirements to meet voluntary criteria related to the reduction or elimination of substances in our products; |
| |
• | Our belief that deferred cost of sales are recorded at their approximate carrying value and will have low risk of material impairment; |
| |
• | Our belief that our direct sales personnel combined with our distributors provide an effective means of reaching our customer base; |
| |
• | Our ability to increase the proprietary portion of our analog and interface product lines and the effect of such an increase; |
| |
• | Our belief that our processes afford us both cost-effective designs in existing and derivative products and greater functionality in new product designs; |
| |
• | The impact of any supply disruption we may experience; |
| |
• | Our ability to effectively utilize our facilities at appropriate capacity levels and anticipated costs; |
| |
• | That we adjust capacity utilization to respond to actual and anticipated business and industry-related conditions; |
| |
• | That our existing facilities will provide sufficient capacity to respond to increases in demand with modest incremental capital expenditures; |
| |
• | That manufacturing costs will be reduced by transition to advanced process technologies; |
| |
• | Our ability to maintain manufacturing yields; |
| |
• | Continuing our investments in new and enhanced products; |
| |
• | The cost effectiveness of using our own assembly and test operations; |
| |
• | Our anticipated level of capital expenditures; |
| |
• | Continuation and amount of quarterly cash dividends; |
| |
• | The sufficiency of our existing sources of liquidity to finance anticipated capital expenditures and otherwise meet our anticipated cash requirements, and the effects that our contractual obligations are expected to have on them; |
| |
• | The impact of seasonality on our business; |
| |
• | The accuracy of our estimates used in valuing employee equity awards; |
| |
• | That the resolution of legal actions will not have a material effect on our business, and the accuracy of our assessment of the probability of loss and range of potential loss; |
| |
• | The recoverability of our deferred tax assets; |
| |
• | The adequacy of our tax reserves to offset any potential tax liabilities, having the appropriate support for our income tax positions and the accuracy of our estimated tax rate; |
| |
• | Our belief that the expiration of any tax holidays will not have a material impact on our overall tax expense or effective tax rate; |
| |
• | Our belief that the estimates used in preparing our consolidated financial statements are reasonable; |
| |
• | Our belief that recently issued accounting pronouncements listed in this document will not have a significant impact on our consolidated financial statements; |
| |
• | Our actions to vigorously and aggressively defend and protect our intellectual property on a worldwide basis; |
| |
• | Our ability to obtain patents and intellectual property licenses and minimize the effects of litigation; |
| |
• | The level of risk we are exposed to for product liability claims or indemnification claims; |
| |
• | The effect of fluctuations in market interest rates on our income and/or cash flows; |
| |
• | The effect of fluctuations in currency rates; |
| |
• | Our belief that any of the unrealized losses in our investment portfolio represent an other-than-temporary impairment and that recovery is not anticipated to occur in the next year; |
| |
• | That our offshore earnings are considered to be permanently reinvested offshore and that we could determine to repatriate some of our offshore earnings in future periods to fund stockholder dividends, share repurchases, acquisitions or other corporate activities; |
| |
• | That a significant portion of our future cash generation will be in our foreign subsidiaries; |
| |
• | Our intention to indefinitely reinvest undistributed earnings of certain non-US subsidiaries in those subsidiaries; |
| |
• | Our intent to maintain a high-quality investment portfolio that preserves principal, meets liquidity needs, avoids inappropriate concentrations and delivers an appropriate yield; and |
| |
• | Our ability to collect accounts receivable. |
We begin our Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) with a summary of Microchip's overall business strategy to give the reader an overview of the goals of our business and the overall direction of our business and products. This is followed by a discussion of the Critical Accounting Policies and Estimates that we believe are important to understanding the assumptions and judgments incorporated in our reported financial results. We then discuss our Results of Operations for the three and six months ended September 30, 2014 compared to the three and six months ended September 30, 2013. We then provide an analysis of changes in our balance sheet and cash flows, and discuss our financial commitments in sections titled "Liquidity and Capital Resources," "Contractual Obligations" and "Off-Balance Sheet Arrangements."
Strategy
Our goal is to be a worldwide leader in providing specialized semiconductor products for a wide variety of embedded control applications. Our strategic focus is on the embedded control market, which includes microcontrollers, high-performance linear and mixed signal devices, power management and thermal management devices, connectivity devices, interface devices, Serial EEPROMs, SuperFlash memory products, our patented KeeLoq® security devices and Flash IP solutions. We provide highly cost-effective embedded control products that also offer the advantages of small size, high performance, low voltage/power operation and ease of development, enabling timely and cost-effective embedded control product integration by our customers. We license our SuperFlash and other technologies to wafer foundries, integrated device manufacturers and design partners throughout the world for use in the manufacture of advanced microcontroller products.
We sell our products to a broad base of domestic and international customers across a variety of industries. The principal markets that we serve include consumer, automotive, industrial, office automation and telecommunications. Our business is subject to fluctuations based on economic conditions within these markets.
Our manufacturing operations include wafer fabrication, wafer probe and assembly and test. The ownership of a substantial portion of our manufacturing resources is an important component of our business strategy, enabling us to maintain a high level of manufacturing control resulting in us being one of the lowest cost producers in the embedded control industry. By owning wafer fabrication facilities and our assembly and test operations, and by employing statistical process control techniques, we have been able to achieve and maintain high production yields. Direct control over manufacturing resources allows us to shorten our design and production cycles. This control also allows us to capture a portion of the wafer manufacturing and the assembly and test profit margin. We do outsource a significant portion of our manufacturing requirements to third parties.
We employ proprietary design and manufacturing processes in developing our embedded control products. We believe our processes afford us both cost-effective designs in existing and derivative products and greater functionality in new product designs. While many of our competitors develop and optimize separate processes for their logic and memory product lines, we use a common process technology for both microcontroller and non-volatile memory products. This allows us to more fully leverage our process research and development costs and to deliver new products to market more rapidly. Our engineers utilize advanced computer-aided design (CAD) tools and software to perform circuit design, simulation and layout, and our in-house photomask and wafer fabrication facilities enable us to rapidly verify design techniques by processing test wafers quickly and efficiently.
We are committed to continuing our investment in new and enhanced products, including development systems, and in our design and manufacturing process technologies. We believe these investments are significant factors in maintaining our competitive position. Our current research and development activities focus on the design of new microcontrollers, digital signal controllers, memory, analog and mixed-signal products, Flash-IP systems, development systems, software and application-specific software libraries. We are also developing new design and process technologies to achieve further cost reductions and performance improvements in our products.
We market and sell our products worldwide primarily through a network of direct sales personnel and distributors. Our distributors focus primarily on servicing the product and technical support requirements of a broad base of diverse customers. We believe that our direct sales personnel combined with our distributors provide an effective means of reaching this broad and diverse customer base. Our direct sales force focuses primarily on major strategic accounts in three geographical markets: the Americas, Europe and Asia. We currently maintain sales and support centers in major metropolitan areas in North America, Europe and Asia. We believe that a strong technical service presence is essential to the continued development of the embedded control market. Many of our field sales engineers (FSEs), field application engineers (FAEs), and sales management personnel have technical degrees and have been previously employed in an engineering environment. We believe that the technical knowledge of our sales force is a key competitive advantage in the sale of our products. The primary mission of our FAE team is to provide technical assistance to strategic accounts and to conduct periodic training sessions for FSEs and distributor sales teams. FAEs also frequently conduct technical seminars for our customers in major cities around the world, and work closely with our distributors to provide technical assistance and end-user support.
See "Our operating results are impacted by both seasonality and the wide fluctuations of supply and demand in the semiconductor industry," on page 43 for discussion of the impact of seasonality on our business.
Critical Accounting Policies and Estimates
General
Our discussion and analysis of our financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. We review the accounting policies we use in reporting our financial results on a regular basis. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, business combinations, share-based compensation, inventories, income taxes, junior subordinated convertible debentures and contingencies. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Our results may differ from these estimates due to actual outcomes being different from those on which we based our assumptions. We review these estimates and judgments on an ongoing basis. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements. We also have other policies that we consider key accounting policies, such as our policy regarding revenue recognition to original equipment manufacturers (OEMs); however, we do not believe these policies require us to make estimates or judgments that are as difficult or subjective as our policies described below.
Revenue Recognition - Distributors
Our distributors worldwide generally have broad price protection and product return rights, so we defer revenue recognition until the distributor sells the product to their customer. Revenue is recognized when the distributor sells the product to an end-customer, at which time the sales price becomes fixed or determinable. Revenue is not recognized upon shipment to our distributors since, due to discounts from list price as well as price protection rights, the sales price is not substantially fixed or determinable at that time. At the time of shipment to these distributors, we record a trade receivable for
the selling price as there is a legally enforceable right to payment, relieve inventory for the carrying value of goods shipped since legal title has passed to the distributor, and record the gross margin in deferred income on shipments to distributors on our condensed consolidated balance sheets.
Deferred income on shipments to distributors effectively represents the gross margin on the sale to the distributor; however, the amount of gross margin that we recognize in future periods could be less than the deferred margin as a result of credits granted to distributors on specifically identified products and customers to allow the distributors to earn a competitive gross margin on the sale of our products to their end customers and price protection concessions related to market pricing conditions.
We sell the majority of the items in our product catalog to our distributors worldwide at a uniform list price. However, distributors resell our products to end customers at a very broad range of individually negotiated price points. The majority of our distributors' resales require a reduction from the original list price paid. Often, under these circumstances, we remit back to the distributor a portion of their original purchase price after the resale transaction is completed in the form of a credit against the distributors' outstanding accounts receivable balance. The credits are on a per unit basis and are not given to the distributor until they provide information to us regarding the sale to their end customer. The price reductions vary significantly based on the customer, product, quantity ordered, geographic location and other factors, and discounts to a price less than our cost have historically been rare. The effect of granting these credits establishes the net selling price to our distributors for the product and results in the net revenue recognized by us when the product is sold by the distributors to their end customers. Thus, a portion of the "deferred income on shipments to distributors" balance represents the amount of distributors' original purchase price that will be credited back to the distributor in the future. The wide range and variability of negotiated price concessions granted to distributors does not allow us to accurately estimate the portion of the balance in the deferred income on shipments to distributors' account that will be credited back to the distributors. Therefore, we do not reduce deferred income on shipments to distributors or accounts receivable by anticipated future concessions; rather, price concessions are typically recorded against deferred income on shipments to distributors and accounts receivable when incurred, which is generally at the time the distributor sells the product. At September 30, 2014, we had approximately $249.0 million of deferred revenue and $89.4 million in deferred cost of sales recognized as $159.6 million of deferred income on shipments to distributors. At March 31, 2014, we had approximately $222.8 million of deferred revenue and $75.0 million in deferred cost of sales recognized as $147.8 million of deferred income on shipments to distributors. The deferred income on shipments to distributors that will ultimately be recognized in our income statement will be lower than the amount reflected on the balance sheet due to additional price credits to be granted to the distributors when the product is sold to their customers. These additional price credits historically have resulted in the deferred income approximating the overall gross margins that we recognize in the distribution channel of our business.
Distributor advances, reflected as a reduction of deferred income on shipments to distributors on our condensed consolidated balance sheets, totaled $101.9 million at September 30, 2014 and $92.8 million at March 31, 2014. On sales to distributors, our payment terms generally require the distributor to settle amounts owed to us for an amount in excess of their ultimate cost. The sales price to our distributors may be higher than the amount that the distributors will ultimately owe us because distributors often negotiate price reductions after purchasing the product from us and such reductions are often significant. It is our practice to apply these negotiated price discounts to future purchases, requiring the distributor to settle receivable balances, on a current basis, generally within 30 days, for amounts originally invoiced. This practice has an adverse impact on the working capital of our distributors. As such, we have entered into agreements with certain distributors whereby we advance cash to the distributors to reduce the distributor's working capital requirements. These advances are reconciled at least on a quarterly basis and are estimated based on the amount of ending inventory as reported by the distributor multiplied by a negotiated percentage. Such advances have no impact on our revenue recognition or our condensed consolidated statements of income. We process discounts taken by distributors against our deferred income on shipments to distributors' balance and true-up the advanced amounts generally after the end of each completed fiscal quarter. The terms of these advances are set forth in binding legal agreements and are unsecured, bear no interest on unsettled balances and are due upon demand. The agreements governing these advances can be canceled by us at any time.
We reduce product pricing through price protection based on market conditions, competitive considerations and other factors. Price protection is granted to distributors on the inventory they have on hand at the date the price protection is offered. When we reduce the price of our products, it allows the distributor to claim a credit against its outstanding accounts receivable balances based on the new price of the inventory it has on hand as of the date of the price reduction. There is no immediate revenue impact from the price protection, as it is reflected as a reduction of the deferred income on shipments to distributors balance.
Products returned by distributors and subsequently scrapped have historically been immaterial to our consolidated results of operations. We routinely evaluate the risk of impairment of the deferred cost of sales component of the deferred income on shipments to distributor's account. Because of the historically immaterial amounts of inventory that have been scrapped, and historically rare instances where discounts given to a distributor result in a price less than our cost, we believe the deferred costs are recorded at their approximate carrying value.
Business Combinations
All of our business combinations are accounted for at fair value under the acquisition method of accounting. Under the acquisition method of accounting, (i) acquisition-related costs, except for those costs incurred to issue debt or equity securities, will be expensed in the period incurred; (ii) non-controlling interests will be valued at fair value at the acquisition date; (iii) in-process research and development will be recorded at fair value as an intangible asset at the acquisition date and amortized once the technology reaches technological feasibility; (iv) restructuring costs associated with a business combination will be expensed subsequent to the acquisition date; and (v) changes in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date will be recognized through income tax expense or directly in contributed capital. The measurement of fair value of assets accrued and liabilities assumed requires significant judgment. The valuation of intangible assets and acquired investments in privately held companies, in particular, requires that we use valuation techniques such as the income approach. The income approach includes the use of a discounted cash flow model, which includes discounted cash flow scenarios and requires the following significant estimates: revenue, expenses, capital spending and other costs, and
discount rates based on the respective risks of the cash flows. The valuation of non-marketable equity investments acquired also takes into account variables such as conditions reflected in the capital markets, recent financing activity by the investees, the investees' capital structure and the terms of the investees' issued interests.
Share-Based Compensation
We measure fair value and recognize compensation expense for all share-based payment awards, including grants of employee stock options, RSUs, stock appreciation rights, and employee stock purchase rights, to be recognized in our financial statements based on their respective grant date fair values. Total share-based compensation during the six months ended September 30, 2014 was $28.6 million, of which $23.9 million was reflected in operating expenses. Total share-based compensation reflected in cost of sales during the six months ended September 30, 2014 was $4.7 million. Total share-based compensation included in our inventory balance was $4.3 million at September 30, 2014.
Determining the appropriate fair-value model and calculating the fair value of share-based awards at the date of grant requires judgment. The fair value of our RSUs is based on the fair market value of our common stock on the date of grant discounted for expected future dividends. We use the Black-Scholes option pricing model to estimate the fair value of employee stock options and rights to purchase shares under our employee stock purchase plans. Option pricing models, including the Black-Scholes model, also require the use of input assumptions, including expected volatility, expected life, expected dividend rate, and expected risk-free rate of return. We use a blend of historical and implied volatility based on options freely traded in the open market as we believe this is more reflective of market conditions and a better indicator of expected volatility than using purely historical volatility. The expected life of the awards is based on historical and other economic data trended into the future. The risk-free interest rate assumption is based on observed interest rates appropriate for the terms of our awards. The dividend yield assumption is based on our history and expectation of future dividend payouts. We estimate the number of share-based awards which will be forfeited due to employee turnover. Quarterly changes in the estimated forfeiture rate can have a significant effect on reported share-based compensation, as the impact on prior period amortization for all unvested awards is recognized in the period the forfeiture estimate is changed. If the actual forfeiture rate is higher or lower than the estimated forfeiture rate, then an adjustment is made to increase or decrease the estimated forfeiture rate, which will result in a decrease or increase to the expense recognized in our financial statements. If forfeiture adjustments are made, they would affect our gross margin, research and development expenses, and selling, general and administrative expenses. The effect of forfeiture adjustments in the second quarter of fiscal 2015 was immaterial.
We evaluate the assumptions used to value our awards on a quarterly basis. If factors change and we employ different assumptions, share-based compensation expense may differ significantly from what we have recorded in the past. If there are any modifications or cancellations of the underlying unvested securities, we may be required to accelerate, increase or cancel any remaining unearned share-based compensation expense. Future share-based compensation expense and unearned share-based compensation will increase to the extent that we grant additional equity awards to employees or we assume unvested equity awards in connection with acquisitions.
Inventories
Inventories are valued at the lower of cost or market using the first-in, first-out method. We write down our inventory for estimated obsolescence or unmarketable inventory in an amount equal to the difference between the cost of inventory and the estimated market value based on assumptions about future demand and market conditions. If actual market conditions are less favorable than those we projected, additional inventory write-downs may be required. Inventory impairment charges establish a new cost basis for inventory and charges are not subsequently reversed to income even if circumstances later suggest that increased carrying amounts are recoverable. In estimating our inventory obsolescence, we primarily evaluate estimates of demand over a 12-month period and record impairment charges for inventory on hand in excess of the estimated 12-month demand. Estimates for projected 12-month demand are based on the average shipments of the prior three-month period, which are then annualized to adjust for any potential seasonality in our business. The estimated 12-month demand is compared to our most recently developed sales forecast to further reconcile the 12-month demand estimate. Management reviews and adjusts the estimates as appropriate based on specific situations. For example, demand can be adjusted up for new products for which historic sales are not representative of future demand. Alternatively, demand can be adjusted down to the extent any existing products are being replaced or discontinued.
In periods where our production levels are below our normal operating capacity, the reduced production levels of our manufacturing facilities are charged directly to cost of sales. Approximately $0.8 million was charged to cost of sales in the six-month period ended September 30, 2014 compared to approximately $5.0 million and $15.4 million in the three and six-month periods ended September 30, 2013, respectively. The was no charge to cost of sales for reduced production levels in the three-month period ended September 30, 2014.
Income Taxes
As part of the process of preparing our condensed consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our condensed consolidated balance sheets. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income within the relevant jurisdiction and to the extent we believe that recovery is not likely, we must establish a valuation allowance. We have provided valuation allowances for certain of our deferred tax assets, including state net operating loss carryforwards, foreign tax credits and state tax credits, where it is more likely than not that some portion, or all of such assets, will not be realized. At September 30, 2014, the valuation allowances totaled $72.5 million. Should we determine that we would not be able to realize all or part of our net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made. At September 30, 2014, our deferred tax asset, net of valuation allowances, was $62.4 million.
Various taxing authorities in the U.S. and other countries in which we do business scrutinize the tax structures employed by businesses. Companies of our size and complexity are regularly audited by the taxing authorities in the jurisdictions in which they conduct significant operations. Microchip and SMSC are currently under IRS audit for fiscal years 2011 and 2012. Supertex is currently under IRS audit for fiscal year 2013. We recognize liabilities for anticipated tax audit issues in the U.S. and other tax jurisdictions based on our estimate of whether, and the extent to which, additional tax payments are probable. We believe that we maintain adequate tax reserves to offset any potential tax liabilities that may arise upon these and other pending audits in the U.S. and other countries in which we do business. If such amounts ultimately prove to be unnecessary, the resulting reversal of such reserves would result in tax benefits being recorded in the period the reserves are no longer deemed necessary. If such amounts ultimately prove to be less than an ultimate assessment, a future charge to expense would be recorded in the period in which the assessment is determined.
Junior Subordinated Convertible Debentures
We separately account for the liability and equity components of our junior subordinated convertible debentures in a manner that reflects our nonconvertible debt (unsecured debt) borrowing rate when interest cost is recognized. This results in a bifurcation of a component of the debt, classification of that component in equity and the accretion of the resulting discount on the debt to be recognized as part of interest expense in our condensed consolidated statements of income. Additionally, we
include the dilutive effect of the shares of our common stock issuable upon conversion of the outstanding junior subordinated convertible debentures in our diluted income per share calculation regardless of whether the market price trigger or other contingent conversion feature has been met. We apply the treasury stock method as we have the intent and have adopted an accounting policy to settle the principal amount of the junior subordinated convertible debentures in cash. This method results in incremental dilutive shares when the average fair value of our common stock for a reporting period exceeds the conversion price per share which was $25.47 at September 30, 2014 and adjusts as dividends are recorded in the future.