Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
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x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2017.
OR
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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)
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| | |
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, a smaller reporting company or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act:
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Large accelerated filer | x | | Accelerated filer | o |
Non-accelerated filer | o | | Smaller reporting company | o |
| | | Emerging growth company | o |
(Do not check if a smaller reporting company)
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
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
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Class | | Outstanding at July 26, 2017 |
Common Stock, $0.001 par value | | 232,728,449 shares |
MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
INDEX
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PART I. FINANCIAL INFORMATION | |
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PART II. OTHER INFORMATION | |
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CERTIFICATIONS | |
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EXHIBITS | |
MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
(unaudited)
| |
Item1. | Financial Statements |
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| | | | | | | |
ASSETS | June 30, 2017 | | March 31, 2017 |
Cash and cash equivalents | $ | 773,036 |
| | $ | 908,684 |
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Short-term investments | 457,210 |
| | 394,088 |
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Accounts receivable, net | 528,954 |
| | 478,373 |
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Inventories | 426,843 |
| | 417,202 |
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Prepaid expenses | 43,778 |
| | 41,354 |
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Assets held for sale | — |
| | 6,459 |
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Other current assets | 68,941 |
| | 58,880 |
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Total current assets | 2,298,762 |
| | 2,305,040 |
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Property, plant and equipment, net | 693,995 |
| | 683,338 |
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Long-term investments | 420,458 |
| | 107,457 |
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Goodwill | 2,299,009 |
| | 2,299,009 |
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Intangible assets, net | 2,026,575 |
| | 2,148,092 |
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Long-term deferred tax assets | 74,065 |
| | 68,870 |
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Other assets | 75,027 |
| | 75,075 |
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Total assets | $ | 7,887,891 |
| | $ | 7,686,881 |
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LIABILITIES AND STOCKHOLDERS' EQUITY | | | |
Accounts payable | $ | 171,857 |
| | $ | 149,233 |
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Accrued liabilities | 244,533 |
| | 212,450 |
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Deferred income on shipments to distributors | 308,797 |
| | 292,815 |
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Current portion of long-term debt | 11,256 |
| | 49,952 |
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Total current liabilities | 736,443 |
| | 704,450 |
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Long-term debt | 2,983,908 |
| | 2,900,524 |
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Long-term income tax payable | 187,255 |
| | 184,945 |
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Long-term deferred tax liability | 347,216 |
| | 409,045 |
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Other long-term liabilities | 220,515 |
| | 217,206 |
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Stockholders' equity: | | | |
Preferred stock, $0.001 par value; authorized 5,000,000 shares; no shares issued or outstanding | — |
| | — |
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Common stock, $0.001 par value; authorized 450,000,000 shares; 252,698,952 shares issued and 232,726,199 shares outstanding at June 30, 2017; 249,463,733 shares issued and 229,093,658 shares outstanding at March 31, 2017 | 233 |
| | 229 |
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Additional paid-in capital | 2,583,575 |
| | 2,537,344 |
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Common stock held in treasury: 19,972,753 shares at June 30, 2017; 20,370,075 shares at March 31, 2017 | (719,180 | ) | | (731,884 | ) |
Accumulated other comprehensive loss | (19,133 | ) | | (14,378 | ) |
Retained earnings | 1,567,059 |
| | 1,479,400 |
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Total stockholders' equity | 3,412,554 |
| | 3,270,711 |
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Total liabilities and stockholders' equity | $ | 7,887,891 |
| | $ | 7,686,881 |
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See accompanying notes to condensed consolidated financial statements
MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
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| | | | | | | |
| Three Months Ended |
| June 30, |
| 2017 | | 2016 |
Net sales | $ | 972,141 |
| | $ | 799,411 |
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Cost of sales (1) | 387,702 |
| | 450,921 |
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Gross profit | 584,439 |
| | 348,490 |
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Research and development (1) | 130,480 |
| | 147,883 |
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Selling, general and administrative (1) | 114,272 |
| | 157,505 |
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Amortization of acquired intangible assets | 120,845 |
| | 80,171 |
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Special (income) charges and other, net | (2,756 | ) | | 22,035 |
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Operating expenses | 362,841 |
| | 407,594 |
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Operating income (loss) | 221,598 |
| | (59,104 | ) |
Losses on equity method investment | (55 | ) | | (56 | ) |
Other income (expense): | | | |
Interest income | 3,526 |
| | 819 |
|
Interest expense | (49,490 | ) | | (34,416 | ) |
Loss on settlement of convertible debt | (13,826 | ) | | — |
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Other income, net | 4,452 |
| | 2,010 |
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Income (loss) before income taxes | 166,205 |
| | (90,747 | ) |
Income tax (benefit) provision | (4,382 | ) | | 18,478 |
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Net income (loss) from continuing operations | 170,587 |
| | (109,225 | ) |
Discontinued operations: | | | |
Loss from discontinued operations | — |
| | (5,473 | ) |
Income tax benefit | — |
| | (1,335 | ) |
Net loss from discontinued operations | — |
| | (4,138 | ) |
| | | |
Net income (loss) | $ | 170,587 |
| | $ | (113,363 | ) |
| | | |
Basic net income (loss) per common share | | | |
Net income (loss) from continuing operations | $ | 0.74 |
| | $ | (0.51 | ) |
Net loss from discontinued operations | — |
| | (0.02 | ) |
Net income (loss) | $ | 0.74 |
| | $ | (0.53 | ) |
Diluted net income (loss) per common share | | | |
Net income (loss) from continuing operations | $ | 0.70 |
| | $ | (0.51 | ) |
Net loss from discontinued operations | — |
| | (0.02 | ) |
Net income (loss) | $ | 0.70 |
| | $ | (0.53 | ) |
Dividends declared per common share | $ | 0.3615 |
| | $ | 0.3595 |
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Basic common shares outstanding | 229,429 |
| | 214,345 |
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Diluted common shares outstanding | 242,902 |
| | 214,345 |
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(1) Includes share-based compensation expense as follows: | | | |
Cost of sales | $ | 3,394 |
| | $ | 7,897 |
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Research and development | 10,289 |
| | 17,517 |
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Selling, general and administrative | 8,725 |
| | 34,165 |
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See accompanying notes to condensed consolidated financial statements
MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
(unaudited)
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| Three Months Ended |
| June 30, |
| 2017 | | 2016 |
Net income (loss) | $ | 170,587 |
| | $ | (113,363 | ) |
Components of other comprehensive income (loss): | | | |
Available-for-sale securities: | | | |
Unrealized holding losses, net of tax effect | (844 | ) | | (1,325 | ) |
Reclassification of realized transactions, net of tax effect | — |
| | 82 |
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Defined benefit plans: | | | |
Actuarial losses related to defined benefit pension plans, net of tax benefit of $926 and $3,003, respectively | (4,114 | ) | | (6,805 | ) |
Reclassification of realized transactions, net of tax effect | 203 |
| | — |
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Change in net foreign currency translation adjustment | — |
| | (3,023 | ) |
Other comprehensive income (loss), net of tax effect | (4,755 | ) | | (11,071 | ) |
Comprehensive income (loss) | $ | 165,832 |
| | $ | (124,434 | ) |
See accompanying notes to condensed consolidated financial statements
MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
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| Three Months Ended |
| June 30, |
| 2017 | | 2016 |
Cash flows from operating activities: | | | |
Net income (loss) | $ | 170,587 |
| | $ | (113,363 | ) |
Adjustments to reconcile net income to net cash provided by operating activities: | | | |
Depreciation and amortization | 151,801 |
| | 113,141 |
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Deferred income taxes | (21,878 | ) | | 32,906 |
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Share-based compensation expense related to equity incentive plans | 22,408 |
| | 59,579 |
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Loss on settlement of convertible debt | 13,826 |
| | — |
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Amortization of debt discount on convertible debt | 25,953 |
| | 12,106 |
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Amortization of debt issuance costs | 1,621 |
| | 1,057 |
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Losses on equity method investments | 55 |
| | 56 |
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Gains on sale of assets | (4,565 | ) | | (61 | ) |
Losses on write-down of fixed assets | 48 |
| | 269 |
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Impairment of intangible assets | 128 |
| | 1,984 |
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Realized losses on available-for-sale investment | — |
| | 82 |
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Realized gains on equity method investment | — |
| | (468 | ) |
Amortization of premium on available-for-sale investments | 476 |
| | 13 |
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Changes in operating assets and liabilities, excluding impact of acquisitions: | | | |
(Increase) in accounts receivable | (50,581 | ) | | (9,901 | ) |
(Increase) decrease in inventories | (9,904 | ) | | 121,102 |
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Increase in deferred income on shipments to distributors | 15,982 |
| | 29,739 |
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Increase (decrease) in accounts payable and accrued liabilities | 36,331 |
| | (18,000 | ) |
Change in other assets and liabilities | (7,296 | ) | | (12,270 | ) |
Operating cash flows related to discontinued operations | — |
| | 5,996 |
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Net cash provided by operating activities | 344,992 |
| | 223,967 |
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Cash flows from investing activities: | |
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Purchases of available-for-sale investments | (487,435 | ) | | (25 | ) |
Sales and maturities of available-for-sale investments | 110,000 |
| | 470,551 |
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Sale of equity method investment | — |
| | 468 |
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Acquisition of Atmel, net of cash acquired | — |
| | (2,747,516 | ) |
Investments in other assets | (1,933 | ) | | (765 | ) |
Proceeds from sale of assets | 10,226 |
| | 52 |
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Capital expenditures | (22,130 | ) | | (18,494 | ) |
Net cash used in investing activities | (391,272 | ) | | (2,295,729 | ) |
Cash flows from financing activities: (1) | |
| | |
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Repayments of revolving loan under credit facility | (60,000 | ) | | (602,000 | ) |
Proceeds from borrowings on revolving loan under credit facility | 60,000 |
| | 1,280,000 |
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Payment of cash dividends | (82,928 | ) | | (77,237 | ) |
Proceeds from sale of common stock | 4,474 |
| | 4,630 |
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Tax payments related to shares withheld for vested restricted stock units | (10,719 | ) | | (25,183 | ) |
Capital lease payments | (195 | ) | | (195 | ) |
Net cash (used in) provided by financing activities | (89,368 | ) | | 580,015 |
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Effect of foreign exchange rate changes on cash and cash equivalents | — |
| | (478 | ) |
Net decrease in cash and cash equivalents | (135,648 | ) | | (1,492,225 | ) |
Cash and cash equivalents at beginning of period | 908,684 |
| | 2,092,751 |
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Cash and cash equivalents at end of period | $ | 773,036 |
| | $ | 600,526 |
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Schedule of significant non-cash financing activity:
(1) During the three months ended June 30, 2017, the Company issued $111.3 million principal amount of 2017 Junior Notes and 3.2 million shares of common stock in exchange for $111.3 million principal amount of 2007 Junior Notes. Refer to Note 13 Debt and Credit Facility for further discussion.
See accompanying notes to condensed consolidated financial statements
Note 1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements include the accounts of Microchip Technology Incorporated and its majority-owned and controlled subsidiaries (the Company). All intercompany balances and transactions have been eliminated in consolidation.
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (US GAAP), pursuant to the rules and regulations of the Securities and Exchange Commission (the SEC). The information furnished herein reflects all adjustments which are, in the opinion of management, of a normal recurring nature and necessary for a fair statement of the results for the interim periods reported. Certain information and footnote disclosures normally included in audited consolidated financial statements have been condensed or omitted pursuant to such SEC rules and regulations. It is suggested that these condensed consolidated financial statements be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 2017. The results of operations for the three months ended June 30, 2017 are not necessarily indicative of the results that may be expected for the fiscal year ending March 31, 2018 or for any other period.
Note 2. Recently Issued Accounting Pronouncements
Recently Adopted Accounting Pronouncements
During the three months ended June 30, 2017, the Company adopted ASU 2015-11-Simplifying the Measurement of Inventory. This standard requires that entities measure inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. ASU 2015-11 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2016 and is applied prospectively. The adoption of this standard did not have a material impact on the Company's financial statements.
In March 2017, the Financial Accounting Standards Board (FASB) issued ASU 2017-07-Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. This standard improves the presentation of net periodic pension cost and net periodic postretirement benefit cost. The amendment will require the employer to report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit cost will be presented separately in the income statement from the service cost component outside of income from operations. The amendment is effective for fiscal years beginning after December 15, 2017. Early adoption is permitted at the beginning of an annual period (in the first interim period) for which financial statements have not yet been issued. During the three months ended June 30, 2017, the Company elected to early adopt ASU 2017-07 and the adoption of this standard did not have a material impact on its financial statements.
Recently Issued Accounting Pronouncements Not Yet Adopted
In January 2017, the FASB issued ASU 2017-04-Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which simplifies the accounting for goodwill impairment. The guidance removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. A goodwill impairment will now be the amount by which a reporting unit's carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. The amendment is effective for annual periods and interim periods within those annual periods, beginning after December 15, 2019, and early adoption is permitted. The Company does not expect this standard to have an impact on its consolidated financial statements.
In November 2016, the FASB issued ASU 2016-18-Statement of Cash Flows: Restricted Cash. This standard requires that the statement of cash flows explain the change during the period in total cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU 2016-18 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. The standard is to be applied using a retrospective transition method to each period presented. The Company does not expect this standard to have a material impact on its consolidated financial statements.
In October 2016, the FASB issued ASU 2016-16-Intra-Entity Transfers of Assets Other Than Inventory. This standard addresses the recognition of current and deferred income taxes resulting from an intra-entity transfer of any asset other than inventory. Prior to the adoption of ASU 2016-16, a company will defer for financial reporting purposes the income tax expense resulting from an intra-entity asset transfer, including the taxes currently payable or paid. Upon adoption of ASU 2016-16, a company will recognize current and deferred income taxes that result from such transfers in the period in which they occur. ASU 2016-16 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017 and is applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The Company is currently evaluating the impact the adoption of this standard will have on its condensed consolidated financial statements but expects to recognize its previously deferred tax related to intra-entity transfers upon adoption of ASU 2016-16 as of April 1, 2018 with a cumulative-effect reduction to retained earnings.
In June 2016, the FASB issued ASU 2016-13-Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments. This standard requires entities to use a current lifetime expected credit loss methodology to measure impairments of certain financial assets. Using this methodology will result in earlier recognition of losses than under the current incurred loss approach, which requires waiting to recognize a loss until it is probable of having been incurred. The amendments in ASU 2016-13 broaden the information that an entity must consider in developing its expected credit loss estimate for assets measured either collectively or individually and can include forecasted information. There are other provisions within the standard affecting how impairments of other financial assets may be recorded and presented, as well as expanded disclosures. ASU 2016-13 is effective for interim and annual periods beginning after December 15, 2019, and permits early adoption, but not before December 15, 2018. The standard is to be applied using a modified retrospective approach. The Company is currently evaluating the impact the adoption of this standard will have on its condensed consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02-Leases. This standard requires lessees to recognize a lease liability and a right-of-use asset on the balance sheet and aligns many of the underlying principles of the new lessor model with those in Accounting Standards Codification Topic 606, Revenue from Contracts with Customers. ASU 2016-02 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2018, with early adoption permitted. The standard is to be applied using the modified retrospective approach to all periods presented. The Company is currently evaluating the impact the adoption of this standard will have on its condensed consolidated financial statements.
In January 2016, the FASB issued ASU 2016-01-Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. This standard addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. ASU 2016-01 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is not permitted. The Company is currently evaluating the impact the adoption of this standard will have on its condensed consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09-Revenue from Contracts with Customers (Topic 606), which will supersede nearly all existing revenue recognition guidance under US GAAP. In July 2015, the FASB issued ASU 2015-14-Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which delayed the effective date of the new standard by one year to December 15, 2017, for annual and interim reporting periods beginning after that date. In accordance with the delay, the new standard will be effective for the Company beginning no later than April 1, 2018. The standard's core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. The new standard allows for the amendment to be applied either retrospectively to each prior reporting period presented or retrospectively as a cumulative-effect adjustment as of the date of adoption. In March 2016, the FASB issued ASU 2016-08 - Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net), which clarifies the implementation guidance on principal versus agent considerations. In April 2016, the FASB issued ASU 2016-10 - Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, which clarifies the implementation guidance on identifying performance obligations. In May 2016, the FASB issued ASU 2016-12 - Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients, which addresses implementation issues that were raised by stakeholders and discussed by the Revenue Recognition Transition Resource Group. As described in the Company's significant accounting policies, the Company currently defers the revenue and cost of sales on shipments to distributors until the distributor sells the product to their end customer. Upon adoption of ASU 2014-09, ASU 2015-14, ASU 2016-08, ASU 2016-10 and ASU 2016-12, the Company will no longer defer revenue until sale by the distributor to the end customer, but rather, will be required to estimate the effects of returns and allowances provided to distributors and record revenue at the time of sale to the distributor. The Company is currently evaluating the impact that the adoption of the standards will have on its condensed consolidated financial statements. The Company currently expects to
adopt the standard under the full retrospective method. The final adoption method will depend on the results of the Company's ongoing assessment of the standard, which is expected to be completed later in fiscal 2018.
Note 3. Business Acquisitions
Acquisition of Atmel
On April 4, 2016, the Company acquired Atmel, a publicly traded company based in San Jose, California. The Company paid an aggregate of approximately $2.98 billion in cash and issued an aggregate of 10.1 million shares of its common stock to Atmel stockholders valued at $486.1 million based on the closing price of the Company's common stock on April 4, 2016 and incurred transaction and other fees of approximately $14.9 million. The total consideration transferred in the acquisition, including approximately $7.5 million of non-cash consideration for the exchange of certain share-based payment awards of Atmel for stock awards of the Company, was approximately $3.47 billion. In addition to the consideration transferred, the Company recognized in its consolidated financial statements $653.1 million in liabilities of Atmel consisting of debt, taxes payable and deferred, pension obligations, restructuring, and contingent and other liabilities. The Company financed the cash portion of the purchase price using approximately $2.04 billion of cash held by certain of its foreign subsidiaries and approximately $0.94 billion from additional borrowings under its existing credit agreement. As a result of the acquisition, Atmel became a wholly owned subsidiary of the Company. Atmel is a worldwide leader in the design and manufacture of microcontrollers, capacitive touch solutions, advanced logic, mixed-signal, nonvolatile memory and radio frequency components. The Company's primary reason for this acquisition was to expand the Company's range of solutions, products and capabilities by extending its served available market.
The acquisition was accounted for under the acquisition method of accounting, with the Company identified as the acquirer, and the operating results of Atmel have been included in the Company's consolidated financial statements as of the closing date of the acquisition. Under the acquisition method of accounting, the aggregate amount of consideration paid by the Company was allocated to Atmel's net tangible assets and intangible assets based on their estimated fair values as of April 4, 2016. The excess of the purchase price over the value of the net tangible assets and intangible assets was recorded to goodwill. The factors contributing to the recognition of goodwill were based upon the Company's conclusion that there are strategic and synergistic benefits that are expected to be realized from the acquisition. The goodwill has been allocated to the Company's semiconductor products reporting segment. None of the goodwill related to the Atmel acquisition is deductible for tax purposes. The Company retained independent third-party appraisers to assist management in its valuation.
The table below represents the allocation of the final purchase price to the net assets acquired based on their estimated fair values, as well as the associated estimated useful lives of the acquired intangible assets (amounts in thousands).
|
| | | | |
Assets acquired | | |
Cash and cash equivalents | | $ | 230,266 |
|
Accounts receivable | | 141,359 |
|
Inventories | | 335,163 |
|
Prepaid expenses and other current assets | | 28,360 |
|
Assets held for sale | | 32,006 |
|
Property, plant and equipment | | 129,884 |
|
Goodwill | | 1,286,371 |
|
Purchased intangible assets | | 1,888,392 |
|
Long-term deferred tax assets | | 46,700 |
|
Other assets | | 7,535 |
|
Total assets acquired | | 4,126,036 |
|
| | |
Liabilities assumed | | |
Accounts payable | | (55,686 | ) |
Other current liabilities | | (120,955 | ) |
Long-term line of credit | | (192,000 | ) |
Deferred tax liabilities | | (27,552 | ) |
Long-term income tax payable | | (115,177 | ) |
Other long-term liabilities | | (141,688 | ) |
Total liabilities assumed | | (653,058 | ) |
Purchase price allocated | | $ | 3,472,978 |
|
|
| | | | | |
Purchased Intangible Assets | Weighted Average | | |
| Useful Life | | |
| (in years) | | (in thousands) |
Core and developed technology | 11 | | $ | 1,074,987 |
|
In-process research and development | — | | 140,700 |
|
Customer-related | 6 | | 630,600 |
|
Backlog | 1 | | 40,300 |
|
Other | 5 | | 1,805 |
|
Total purchased intangible assets | | | $ | 1,888,392 |
|
Purchased intangible assets include core and developed technology, in-process research and development, customer-related intangibles, acquisition-date backlog and other intangible assets. The estimated fair values of the core and developed technology and in-process research and development were determined based on the present value of the expected cash flows to be generated by the respective existing technology or future technology. The core and developed technology intangible assets are being amortized in a manner based on the expected cash flows used in the initial determination of fair value. In-process research and development is capitalized until such time as the related projects are completed or abandoned at which time the capitalized amounts will begin to be amortized or written off. Customer-related intangible assets consist of Atmel's contractual relationships and customer loyalty related to its distributor and end-customer relationships, and the fair values of the customer-related intangibles were determined based on Atmel's projected revenues. An analysis of expected attrition and revenue growth for existing customers was prepared from Atmel's historical customer information. Customer relationships are being amortized in a manner based on the estimated cash flows associated with the existing customers and anticipated retention rates. Backlog relates to the value of orders not yet shipped by Atmel at the acquisition date, and the fair values were based on the
estimated profit associated with those orders. Backlog related assets had a one year useful life and were being amortized on a straight-line basis over that period. The total weighted average amortization period of intangible assets acquired as a result of the Atmel transaction is 9 years. Amortization expense associated with acquired intangible assets is not deductible for tax purposes. Thus, approximately $178.1 million was established as a net deferred tax liability for the future amortization of the intangible assets.
Note 4. Discontinued Operations
Discontinued operations include the mobile touch operations that the Company acquired as part of its acquisition of Atmel. The mobile touch assets had been marketed for sale since the Company's acquisition of Atmel on April 4, 2016 based on management's decision that it was not a strategic fit for the Company's product portfolio. On November 10, 2016, the Company completed the sale of the mobile touch assets to Solomon Systech (Limited) International, a Hong Kong based semiconductor company. The transaction included the sale of certain semiconductor products, equipment, customer list, backlog, patents, and a license to certain other intellectual property and patents related to the Company's mobile touch product line. The Company also agreed to provide certain transition services to Solomon Systech, which were substantially complete as of March 31, 2017. For financial statement purposes, the results of operations for this discontinued business have been segregated from those of the continuing operations and are presented in the Company's condensed consolidated financial statements as discontinued operations.
As the Company completed the sale of the mobile touch assets on November 10, 2016, there are no discontinued operations for the three months ended June 30, 2017. The results of discontinued operations for the three months ended June 30, 2016 are as follows (amounts in thousands):
|
| | | |
| Three Months Ended |
| June 30, |
| 2016 |
Net sales | $ | 9,376 |
|
Cost of sales | 8,424 |
|
Operating expenses | 6,425 |
|
Income tax benefit | (1,335 | ) |
Net loss from discontinued operations | $ | (4,138 | ) |
Note 5. Special (Income) Charges and Other, Net
The following table summarizes activity included in the "special (income) charges and other, net" caption on the Company's condensed consolidated statements of operations (amounts in thousands):
|
| | | | | | | |
| Three Months Ended |
| June 30, |
| 2017 | | 2016 |
Restructuring | | | |
Employee separation costs | $ | 1,086 |
| | $ | 19,616 |
|
Gain on sale of assets | (4,447 | ) | | — |
|
Impairment charges | 100 |
| | 1,961 |
|
Contract exit costs | 586 |
| | 38 |
|
Other | (81 | ) | | 420 |
|
Total | $ | (2,756 | ) | | $ | 22,035 |
|
The Company continuously evaluates its existing operations in an attempt to identify and realize cost savings opportunities and operational efficiencies. This same approach is applied to businesses that are acquired by the Company and often the operating models of acquired companies are not as efficient as the Company's operating model which enables the Company to realize significant savings and efficiencies. As a result, following an acquisition, the Company will from time to
time incur restructuring expenses; however, the Company is often not able to estimate the timing or amount of such costs in advance of the period in which they occur. The primary reason for this is that the Company regularly reviews and evaluates each position, contract and expense against the Company's strategic objectives, long-term operating targets and other operational priorities. Decisions related to restructuring activities are made on a "rolling basis" during the course of the integration of an acquisition whereby department managers, executives and other leaders work together to evaluate each of these expenses and make recommendations. As a result of this approach, at the time of an acquisition, the Company is not able to estimate the total amount of expected employee separation or exit costs that it will incur in connection with its restructuring activities.
The Company's restructuring expenses during fiscal 2017 were related to the Company's recent business combinations, including the acquisitions of Atmel and Micrel, and resulted from workforce, property and other operating expense rationalizations as well as combining product roadmaps and manufacturing operations. These expenses were for employee separation costs, contract exit costs, other operating expenses and intangible asset impairment losses. At March 31, 2017, these activities were substantially complete; however, the Company may continue to incur additional costs in the future as additional synergies or operational efficiencies are identified. The Company is not able to estimate the amount of such future expenses, if any, at this time.
All of the Company's restructuring activities occurred in its semiconductor products segment. The Company incurred $52.2 million since the start of fiscal 2015 in connection with employee separation activities, of which $1.1 million and $19.6 million was incurred during the first quarter of fiscal 2018 and fiscal 2017, respectively. These employee separation activities are now substantially complete and any future amounts are not expected to be material. The Company has incurred $45.3 million in connection with contract exit activities since the start of fiscal 2015 of which $0.6 million was incurred during the first quarter of fiscal 2018 and an immaterial amount in the first quarter of fiscal 2017. These contract exit activities are now substantially complete and any future amounts are not expected to be material.
In the three months ended June 30, 2017, the Company completed the sale of an asset it acquired as part of its acquisition of Micrel for proceeds of $10.0 million and the gain is included in the gain on sale of assets in the above table. As of March 31, 2017, these assets consisting of property, plant and equipment were presented as held for sale in the Company's consolidated financial statements. The impairment losses were recognized as a result of changes in the combined product roadmaps after the acquisition of Atmel that affected the use and life of these assets. The following is a rollforward of accrued restructuring charges from April 1, 2017 to June 30, 2017 (amounts in thousands):
|
| | | | | | | | | | | |
| Employee Separation Costs | | Exit Costs | | Total |
Balance at April 1, 2017 - Restructuring Accrual | $ | 5,474 |
| | $ | 34,751 |
| | $ | 40,225 |
|
Charges | 1,086 |
| | 586 |
| | 1,672 |
|
Payments | (2,995 | ) | | (2,896 | ) | | (5,891 | ) |
Non-cash - Other | (220 | ) | | (76 | ) | | (296 | ) |
Foreign exchange gains | 170 |
| | — |
| | 170 |
|
Balance at June 30, 2017 - Restructuring Accrual | $ | 3,515 |
| | $ | 32,365 |
| | $ | 35,880 |
|
The restructuring liability of $35.9 million is included in accrued liabilities and other long-term liabilities on the Company's condensed consolidated balance sheet as of June 30, 2017.
Note 6. Segment Information
The Company's reportable segments are semiconductor products and technology licensing. The Company does not allocate operating expenses, interest income, interest expense, other income or expense, or provision for or benefit from income taxes to these segments for internal reporting purposes, as the Company does not believe that allocating these expenses is beneficial in evaluating segment performance. Additionally, the Company does not allocate assets to segments for internal reporting purposes as it does not manage its segments by such metrics.
The following table represents net sales and gross profit for each segment for the three months ended June 30, 2017 (amounts in thousands):
|
| | | | | | | |
| Three Months Ended |
| June 30, 2017 |
| Net Sales | | Gross Profit |
Semiconductor products | $ | 947,106 |
| | $ | 559,404 |
|
Technology licensing | 25,035 |
| | 25,035 |
|
Total | $ | 972,141 |
| | $ | 584,439 |
|
The following table represents net sales and gross profit for each segment for the three months ended June 30, 2016 (amounts in thousands):
|
| | | | | | | |
| Three Months Ended |
| June 30, 2016 |
| Net Sales | | Gross Profit |
Semiconductor products | $ | 778,823 |
| | $ | 327,902 |
|
Technology licensing | 20,588 |
| | 20,588 |
|
Total | $ | 799,411 |
| | $ | 348,490 |
|
Note 7. Investments
The Company's investments are intended to establish a high-quality portfolio that preserves principal, meets liquidity needs, avoids inappropriate concentrations, and delivers an appropriate yield in relationship to the Company's investment guidelines and market conditions. The following is a summary of available-for-sale securities at June 30, 2017 (amounts in thousands):
|
| | | | | | | | | | | | | | | |
| Available-for-sale Securities |
| Adjusted Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Estimated Fair Value |
Government agency bonds | $ | 544,638 |
| | $ | 5 |
| | $ | (1,125 | ) | | $ | 543,518 |
|
Municipal bonds - tax-exempt | 9,920 |
| | — |
| | — |
| | 9,920 |
|
Municipal bonds - taxable | 10,000 |
| | 5 |
| | — |
| | 10,005 |
|
Corporate bonds and debt | 312,668 |
| | 64 |
| | (246 | ) | | 312,486 |
|
Marketable equity securities | 707 |
| | 1,032 |
| | — |
| | 1,739 |
|
Total | $ | 877,933 |
| | $ | 1,106 |
| | $ | (1,371 | ) | | $ | 877,668 |
|
The following is a summary of available-for-sale securities at March 31, 2017 (amounts in thousands):
|
| | | | | | | | | | | | | | | |
| Available-for-sale Securities |
| Adjusted Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Estimated Fair Value |
Government agency bonds | $ | 227,089 |
| | $ | 3 |
| | $ | (227 | ) | | $ | 226,865 |
|
Municipal bonds - tax-exempt | 55,289 |
| | — |
| | (10 | ) | | 55,279 |
|
Municipal bonds - taxable | 10,000 |
| | 43 |
| | — |
| | 10,043 |
|
Corporate bonds and debt | 207,888 |
| | 53 |
| | (169 | ) | | 207,772 |
|
Marketable equity securities | 707 |
| | 879 |
| | — |
| | 1,586 |
|
Total | $ | 500,973 |
| | $ | 978 |
| | $ | (406 | ) | | $ | 501,545 |
|
At June 30, 2017, the Company's available-for-sale securities are presented on the condensed consolidated balance sheets as short-term investments of $457.2 million and long-term investments of $420.5 million. At March 31, 2017, the Company's available-for-sale securities are presented on the condensed consolidated balance sheets as short-term investments of $394.1 million and long-term investments of $107.5 million.
The Company had no proceeds from sales of available-for-sale investments during the three months ended June 30, 2017. The Company sold available-for-sale investments for proceeds of $470.6 million during the three months ended June 30, 2016 to finance a portion of the purchase price of its Atmel acquisition which closed on April 4, 2016. The Company had no material realized gains from the sale of available-for-sale securities during the three months ended June 30, 2017 and 2016. The Company determines the cost of available-for-sale debt securities sold on a FIFO basis at the individual security level for sales from multiple lots. For sales of marketable equity securities, the Company uses an average cost basis at the individual security level. Gains and losses recognized in earnings are credited or charged to other income (expense) on the consolidated statements of operations.
The following tables show all investments in an unrealized loss position for which an other-than-temporary impairment has not been recognized and the related gross unrealized losses and fair value, aggregated by investment category and the length of time that the individual securities have been in a continuous unrealized loss position (amounts in thousands):
|
| | | | | | | | | | | | | | | | | | | | | | | |
| June 30, 2017 |
| Less than 12 Months | | 12 Months or Greater | | Total |
| Fair Value | | Unrealized Loss | | Fair Value | | Unrealized Loss | | Fair Value | | Unrealized Loss |
Government agency bonds | $ | 500,561 |
| | $ | (1,125 | ) | | $ | — |
| | $ | — |
| | $ | 500,561 |
| | $ | (1,125 | ) |
Municipal bonds - tax exempt | — |
| | — |
| | — |
| | — |
| | — |
| | — |
|
Corporate bonds and debt | 192,708 |
| | (246 | ) | | — |
| | — |
| | 192,708 |
| | (246 | ) |
Total | $ | 693,269 |
| | $ | (1,371 | ) | | $ | — |
| | $ | — |
| | $ | 693,269 |
| | $ | (1,371 | ) |
|
| | | | | | | | | | | | | | | | | | | | | | | |
| March 31, 2017 |
| Less than 12 Months | | 12 Months or Greater | | Total |
| Fair Value | | Unrealized Loss | | Fair Value | | Unrealized Loss | | Fair Value | | Unrealized Loss |
Government agency bonds | $ | 196,875 |
| | $ | (227 | ) | | $ | — |
| | $ | — |
| | $ | 196,875 |
| | $ | (227 | ) |
Municipal bonds | 55,279 |
| | (10 | ) | | — |
| | — |
| | 55,279 |
| | (10 | ) |
Corporate bonds and debt | 132,820 |
| | (169 | ) | | — |
| | — |
| | 132,820 |
| | (169 | ) |
Total | $ | 384,974 |
| | $ | (406 | ) | | $ | — |
| | $ | — |
| | $ | 384,974 |
| | $ | (406 | ) |
Management does not believe any of the unrealized losses represent an other-than-temporary impairment based on its evaluation of available evidence as of June 30, 2017 and the Company's intent is to hold these investments until these assets are no longer impaired.
The amortized cost and estimated fair value of the available-for-sale securities at June 30, 2017, by contractual maturity, excluding marketable equity securities of $1.7 million, which have 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 | $ | 400,654 |
| | $ | 5 |
| | $ | (306 | ) | | $ | 400,353 |
|
Due after one year and through five years | 476,572 |
| | 69 |
| | (1,065 | ) | | 475,576 |
|
Due after five years and through ten years | — |
| | — |
| | — |
| | — |
|
Due after ten years | — |
| | — |
| | — |
| | — |
|
Total | $ | 877,226 |
| | $ | 74 |
| | $ | (1,371 | ) | | $ | 875,929 |
|
Note 8. Fair Value Measurements
Accounting rules for fair value clarify that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, the Company utilizes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:
| |
Level 1- | Observable inputs such as quoted prices in active markets; |
| |
Level 2- | Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and |
| |
Level 3- | Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions. |
Marketable Debt Instruments
Marketable debt instruments include instruments such as corporate bonds and debt, government agency bonds, bank deposits, municipal bonds, and money market mutual funds. When the Company uses observable market prices for identical securities that are traded in less active markets, the Company classifies its marketable debt instruments as Level 2. When observable market prices for identical securities are not available, the Company prices its marketable debt instruments using non-binding market consensus prices that are corroborated with observable market data; quoted market prices for similar instruments; or pricing models, such as a discounted cash flow model, with all significant inputs derived from or corroborated with observable market data. Non-binding market consensus prices are based on the proprietary valuation models of pricing providers or brokers. These valuation models incorporate a number of inputs, including non-binding and binding broker quotes; observable market prices for identical or similar securities; and the internal assumptions of pricing providers or brokers that use observable market inputs and, to a lesser degree, unobservable market inputs. The Company corroborates non-binding market consensus prices with observable market data using statistical models when observable market data exists. The discounted cash flow model uses observable market inputs, such as LIBOR-based yield curves, currency spot and forward rates, and credit ratings.
Assets Measured at Fair Value on a Recurring Basis
Assets measured at fair value on a recurring basis at June 30, 2017 are as follows (amounts in thousands):
|
| | | | | | | | | | | |
| Quoted Prices in Active Markets for Identical Instruments (Level 1) | | Significant Other Observable Inputs (Level 2) | | Total Balance |
Assets | | | | | |
Cash and cash equivalents: | | | | | |
Money market mutual funds | $ | 111,766 |
| | $ | — |
| | $ | 111,766 |
|
Deposit accounts | — |
| | 661,270 |
| | 661,270 |
|
Short-term investments: | | | | | |
Marketable equity securities
| 1,739 |
| | — |
| | 1,739 |
|
Corporate bonds and debt | — |
| | 235,856 |
| | 235,856 |
|
Government agency bonds | — |
| | 199,689 |
| | 199,689 |
|
Municipal bonds - tax exempt | — |
| | 9,920 |
| | 9,920 |
|
Municipal bonds - taxable | | | 10,005 |
| | 10,005 |
|
Long-term investments: | | | | | |
Corporate bonds and debt | — |
| | 76,630 |
| | 76,630 |
|
Government agency bonds | — |
| | 343,829 |
| | 343,829 |
|
Total assets measured at fair value | $ | 113,505 |
| | $ | 1,537,199 |
| | $ | 1,650,704 |
|
Assets measured at fair value on a recurring basis at March 31, 2017 are as follows (amounts in thousands):
|
| | | | | | | | | | | |
| Quoted Prices in Active Markets for Identical Instruments (Level 1) | | Significant Other Observable Inputs (Level 2) | | Total Balance |
Assets | | | | | |
Cash and cash equivalents: | | | | | |
Money market mutual funds | $ | 343,815 |
| | $ | — |
| | $ | 343,815 |
|
Deposit accounts | — |
| | 564,869 |
| | 564,869 |
|
Short-term investments: | | | | | |
Marketable equity securities | 1,586 |
| | — |
| | 1,586 |
|
Corporate bonds and debt | — |
| | 165,207 |
| | 165,207 |
|
Government agency bonds | — |
| | 161,973 |
| | 161,973 |
|
Municipal bonds - non-taxable | — |
| | 55,279 |
| | 55,279 |
|
Municipal bonds - taxable | | | 10,043 |
| | 10,043 |
|
Long-term investments: | | | | | |
Corporate bonds and debt | — |
| | 42,565 |
| | 42,565 |
|
Government agency bonds | — |
| | 64,892 |
| | 64,892 |
|
Total assets measured at fair value | $ | 345,401 |
| | $ | 1,064,828 |
| | $ | 1,410,229 |
|
There were no transfers between Level 1 and Level 2 during the three months ended June 30, 2017 or the fiscal year ended March 31, 2017. There were no assets measured at fair value on a recurring basis classified as Level 3 at June 30, 2017 or March 31, 2017.
Assets and Liabilities Measured and Recorded at Fair Value on a Non-Recurring Basis
The Company's non-marketable equity, cost method investments, certain acquired liabilities and non-financial assets, such as intangible assets, assets held for sale and property, plant and equipment, are recorded at fair value on a non-recurring basis. These assets are subject to fair value adjustments in certain circumstances, for example, when there is evidence of impairment.
The Company's non-marketable and cost method investments are monitored on a quarterly basis for impairment charges. The fair values of these investments have been determined as Level 3 fair value measurements because the valuations use unobservable inputs that require management's judgment due to the absence of quoted market prices. There were no impairment charges recognized on these investments during each of the three-month periods ended June 30, 2017 and June 30, 2016. These investments are included in other assets on the condensed consolidated balance sheet.
The fair value measurements related to the Company's non-financial assets, such as intangible assets, assets held for sale and property, plant and equipment are based on available market prices at the measurement date based on transactions of similar assets and third-party independent appraisals, less costs to sell where appropriate. The Company classifies these measurements as Level 2.
Note 9. Fair Value of Financial Instruments
The carrying amount of cash equivalents approximates fair value because their maturity is less than three months. Management believes the carrying amount of the equity and cost-method investments materially approximated fair value at June 30, 2017 based upon unobservable inputs. The fair values of these investments have been determined as Level 3 fair value measurements. The carrying amount of accounts receivable, accounts payable and accrued liabilities approximates fair value due to the short-term maturity of the amounts and are considered Level 2 in the fair value hierarchy.
Fair Value of Subordinated Convertible Debt
The Company measures the fair value of its senior and junior subordinated convertible debt for disclosure purposes. These fair values are based on observable market prices for this debt, which is traded in less active markets and are therefore classified as a Level 2 fair value measurement.
The following table shows the carrying amounts and fair values of the Company's senior and junior subordinated convertible debt as of June 30, 2017 and March 31, 2017 (amounts in thousands). As of June 30, 2017 and March 31, 2017, the carrying amounts of the Company's senior and junior subordinated convertible debt have been reduced by debt issuance costs of $37.0 million and $38.3 million, respectively.
|
| | | | | | | | | | | | | | | |
| June 30, 2017 | | March 31, 2017 |
| Carrying Amount | | Fair Value | | Carrying Amount | | Fair Value |
2017 Senior Debt | $ | 1,397,808 |
| | $ | 2,187,907 |
| | $ | 1,384,914 |
| | $ | 2,106,225 |
|
2015 Senior Debt | $ | 1,273,559 |
| | $ | 2,591,002 |
| | $ | 1,261,787 |
| | $ | 2,481,708 |
|
2017 Junior Debt | $ | 320,254 |
| | $ | 718,662 |
| | $ | 262,298 |
| | $ | 586,609 |
|
2007 Junior Debt | $ | 11,256 |
| | $ | 110,356 |
| | $ | 49,952 |
| | $ | 445,142 |
|
| |
Note 10. | Other Financial Statement Details |
Accounts Receivable
Accounts receivable consists of the following (amounts in thousands):
|
| | | | | | | |
| June 30, 2017 | | March 31, 2017 |
Trade accounts receivable | $ | 525,101 |
| | $ | 473,238 |
|
Other | 5,991 |
| | 7,219 |
|
Total accounts receivable, gross | 531,092 |
| | 480,457 |
|
Less allowance for doubtful accounts | 2,138 |
| | 2,084 |
|
Total accounts receivable, net | $ | 528,954 |
| | $ | 478,373 |
|
Inventories
The components of inventories consist of the following (amounts in thousands):
|
| | | | | | | |
| June 30, 2017 | | March 31, 2017 |
|
Raw materials | $ | 16,274 |
| | $ | 14,430 |
|
Work in process | 279,192 |
| | 268,281 |
|
Finished goods | 131,377 |
| | 134,491 |
|
Total inventories | $ | 426,843 |
| | $ | 417,202 |
|
Inventories are valued at the lower of cost and net realizable value 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.
Property, Plant and Equipment
Property, plant and equipment consists of the following (amounts in thousands):
|
| | | | | | | |
| June 30, 2017 | | March 31, 2017 |
Land | $ | 73,504 |
| | $ | 73,447 |
|
Building and building improvements | 501,476 |
| | 499,668 |
|
Machinery and equipment | 1,801,169 |
| | 1,774,920 |
|
Projects in process | 114,023 |
| | 104,318 |
|
Total property, plant and equipment, gross | 2,490,172 |
| | 2,452,353 |
|
Less accumulated depreciation and amortization | 1,796,177 |
| | 1,769,015 |
|
Total property, plant and equipment, net | $ | 693,995 |
| | $ | 683,338 |
|
Depreciation expense attributed to property, plant and equipment was $29.0 million and $30.6 million for the three months ended June 30, 2017 and 2016, respectively.
Note 11. Intangible Assets and Goodwill
Intangible assets consist of the following (amounts in thousands):
|
| | | | | | | | | | | | |
| | June 30, 2017 |
| | Gross Amount | | Accumulated Amortization | | Net Amount |
Core and developed technology | | $ | 1,938,816 |
| | $ | (474,650 | ) | | $ | 1,464,166 |
|
Customer-related | | 716,945 |
| | (186,694 | ) | | 530,251 |
|
Trademarks and trade names | | 11,700 |
| | (10,152 | ) | | 1,548 |
|
In-process research and development | | 29,379 |
| | — |
| | 29,379 |
|
Distribution rights | | 5,578 |
| | (5,357 | ) | | 221 |
|
Other | | 1,449 |
| | (439 | ) | | 1,010 |
|
Total | | $ | 2,703,867 |
| | $ | (677,292 | ) | | $ | 2,026,575 |
|
|
| | | | | | | | | | | | |
| | March 31, 2017 |
| | Gross Amount | | Accumulated Amortization | | Net Amount |
Core and developed technology | | $ | 1,932,329 |
| | $ | (419,468 | ) | | $ | 1,512,861 |
|
Customer-related | | 716,945 |
| | (123,616 | ) | | 593,329 |
|
Trademarks and trade names | | 11,700 |
| | (9,636 | ) | | 2,064 |
|
In-process research and development | | 38,511 |
| | — |
| | 38,511 |
|
Distribution rights | | 5,578 |
| | (5,346 | ) | | 232 |
|
Other | | 1,449 |
| | (354 | ) | | 1,095 |
|
Total | | $ | 2,706,512 |
| | $ | (558,420 | ) | | $ | 2,148,092 |
|
The Company amortizes intangible assets over their expected useful lives, which range between 1 and 15 years. During the three months ended June 30, 2017, $8.9 million of in-process research and development reached technological feasibility and was reclassified as core and developed technology and began being amortized over its estimated useful life. The following is an expected amortization schedule for the intangible assets for the remainder of fiscal 2018 through fiscal 2022, absent any future acquisitions or impairment charges (amounts in thousands):
|
| |
Fiscal Year Ending March 31, | Projected Amortization Expense |
2018 | $367,731 |
2019 | 362,023 |
2020 | 313,447 |
2021 | 257,054 |
2022 | 190,017 |
Amortization expense attributed to intangible assets was $122.8 million and $82.5 million for the three months ended June 30, 2017 and 2016, respectively. In the three months ended June 30, 2017, approximately $2.0 million was charged to cost of sales, and approximately $120.8 million was charged to operating expenses. In the three months ended June 30, 2016, approximately $0.9 million was charged to cost of sales, and approximately $81.6 million was charged to operating expenses. The Company recognized an immaterial amount of intangible asset impairment charges in the three months ended June 30, 2017. In connection with its acquisition of Atmel, the Company recognized intangible asset impairment charges of $2.0 million for the three months ended June 30, 2016. The impairment losses were recognized as a result of changes in the combined product roadmaps after the acquisition of Atmel that affected the use and life of these assets.
The following shows the goodwill balance as of June 30, 2017 and March 31, 2017 by segment (amounts in thousands):
|
| | | | | | | |
| Semiconductor Products Reporting Unit | | Technology Licensing Reporting Unit |
Goodwill | $ | 2,279,809 |
| | $ | 19,200 |
|
At March 31, 2017, the Company applied a qualitative goodwill impairment test to its two reporting units, concluding it was not more likely than not that goodwill was impaired. Through June 30, 2017, the Company has 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 a negative effective tax rate of 2.6% for the three months ended June 30, 2017 and a negative effective tax rate of 20.4% for the three months ended June 30, 2016. The Company's effective tax rate for the three months ended June 30, 2017 is higher compared to the prior year primarily due to acquisition related expenses in the prior year. The Company's effective tax rate is lower than statutory rates in the U.S. due primarily to its mix of earnings in foreign jurisdictions with lower tax rates as well as numerous tax holidays it receives related to its Thailand manufacturing operations based on its investment in property, plant and equipment in Thailand. The Company's tax holiday periods in Thailand expire at various times in the future, however, the Company actively seeks to obtain new tax holidays. The Company does not expect the future expiration of any of its tax holiday periods in Thailand to have a material impact on its effected tax rate. The material components of foreign income taxed at a rate lower than the U.S. are earnings accrued in Thailand and Ireland, and earnings accrued by the Company's offshore technology company which is resident in the Cayman Islands.
The Company files U.S. federal, U.S. state, and foreign income tax returns. For U.S. federal, and in general for U.S. state tax returns, the fiscal 2005 and later tax years remain effectively open for examination by tax authorities. For foreign tax returns, the Company is generally no longer subject to income tax examinations for years prior to fiscal 2007.
The Company recognizes liabilities for anticipated tax audit issues in the U.S. and other domestic and international tax jurisdictions based on its estimate of whether, and the extent to which, additional tax payments are more likely than not. The Company believes that it has appropriate support for the income tax positions taken and to be taken on its tax returns and that its accruals for tax liabilities are adequate for all open years based on an assessment of many factors including past experience and interpretations of tax laws applied to the facts of each matter.
The Company believes it maintains appropriate reserves to offset any potential income tax liabilities that may arise upon final resolution of matters for open tax years. If such reserve amounts ultimately prove to be unnecessary, the resulting reversal of such reserves would result in tax benefits being recorded in the period the reserves are no longer deemed necessary. If such amounts prove to be less than an ultimate assessment, a future charge to expense would be recorded in the period in which the assessment is determined. Although the timing of the resolution or closure of audits is highly uncertain, the Company does not believe it is reasonably possible that the unrecognized tax benefits would materially change in the next 12 months.
| |
Note 13. | Debt and Credit Facility |
Debt obligations included in the consolidated balance sheets consisted of the following (in millions):
|
| | | | | | | | | | | | | | |
| | Coupon Interest Rate | | Effective Interest Rate | | Fair Value of Liability Component at Issuance (1) | | |
| | | | | June 30, 2017 | | March 31, 2017 |
Senior Indebtedness | | | | | | | | | | |
Credit Facility | | | | | | | | $ | — |
| | $ | — |
|
Senior Subordinated Convertible Debt - Principal Outstanding | | | | | | |
2017 Senior Debt, maturing February 15, 2027 (2017 Senior Debt) | | 1.625% | | 6.0% | | $1,396.3 | | $ | 2,070.0 |
| | $ | 2,070.0 |
|
2015 Senior Debt, maturing February 15, 2025 (2015 Senior Debt) | | 1.625% | | 5.9% | | 1,160.1 | | 1,725.0 |
| | 1,725.0 |
|
Junior Subordinated Convertible Debt - Principal Outstanding | | | | | | |
2017 Junior Debt, maturing February 15, 2037 (2017 Junior Debt) | | 2.250% | | 7.4% | | 321.1 | | 686.3 |
| | 575 |
|
2007 Junior Debt, maturing December 15, 2037 (2007 Junior Debt) | | 2.125% | | 9.1% | | 11.5 | | 32.5 |
| | 143.8 |
|
Total Convertible Debt | | | | | | | | 4,513.8 |
| | 4,513.8 |
|
| | | | | | | | | | |
Gross long-term debt including current maturities | | | | | | | | 4,513.8 |
| | 4,513.8 |
|
Less: Debt discount (2) | | | | | | | | (1,473.9 | ) | | (1,516.5 | ) |
Less: Debt issuance costs (3) | | | | | | | | (44.7 | ) | | (46.8 | ) |
Net long-term debt including current maturities | | | | | | | | 2,995.2 |
| | 2,950.5 |
|
Less: Current maturities (4) | | | | | | | | (11.3 | ) | | (50.0 | ) |
Net long-term debt | | | | | | | | $ | 2,983.9 |
| | $ | 2,900.5 |
|
| | | | | | | | | | |
(1) As each of the convertible instruments may be settled in cash upon conversion, for accounting purposes, they were bifurcated into a liability component and an equity component, which are both initially recorded at fair value. The amount allocated to the equity component is the difference between the principal value of the instrument and the fair value of the liability component at issuance. The resulting debt discount is being amortized to interest expense at the respective effective interest rate over the contractual term of the debt.
(2) The unamortized discount includes the following (in millions):
|
| | | | | | | |
| June 30, | | March 31, |
| 2017 | | 2017 |
2017 Senior Debt | $ | (654.9 | ) | | $ | (667.5 | ) |
2015 Senior Debt | (435.3 | ) | | (446.6 | ) |
2017 Junior Debt | (362.6 | ) | | (309.3 | ) |
2007 Junior Debt | (21.1 | ) | | (93.1 | ) |
Total unamortized discount | $ | (1,473.9 | ) | | $ | (1,516.5 | ) |
(3) Debt issuance costs include the following (in millions):
|
| | | | | | | |
| June 30, | | March 31, |
| 2017 | | 2017 |
Senior Credit Facility | $ | (7.7 | ) | | $ | (8.5 | ) |
2017 Senior Debt | (17.3 | ) | | (17.6 | ) |
2015 Senior Debt | (16.2 | ) | | (16.6 | ) |
2017 Junior Debt | (3.4 | ) | | (3.4 | ) |
2007 Junior Debt | (0.1 | ) | | (0.7 | ) |
Total debt issuance costs | $ | (44.7 | ) | | $ | (46.8 | ) |
(4) Current maturities include the full balance of the 2007 Junior Debt.
Ranking of Indebtedness - The Senior Subordinated Convertible Debt and Junior Subordinated Convertible Debt (collectively, the Convertible Debt) are unsecured obligations which are subordinated in right of payment to the amounts outstanding under the Company's Credit Facility. The Junior Subordinated Convertible Debt is expressly subordinated in right of payment to any existing and future senior debt of the Company (including the Credit Facility and the Senior Subordinated Convertible Debt) and is structurally subordinated in right of payment to the liabilities of the Company's subsidiaries. The Senior Subordinated Convertible Debt is subordinated to the Credit Facility; ranks senior to the Company's indebtedness that is expressly subordinated in right of payment, including the Junior Subordinated Convertible Debt; ranks equal in right of payment to any of the Company's unsubordinated indebtedness that does not provide that it is senior to the Senior Subordinated Convertible Debt; ranks junior in right of payment to any of the Company's secured, unsubordinated indebtedness to the extent of the value of the assets securing such indebtedness; and ranks junior to all indebtedness and other liabilities of the Company's subsidiaries.
Summary of Conversion Features - Each series of Convertible Debt is convertible, subject to certain conditions, into cash, shares of the Company's common stock or a combination thereof, at the Company's election, at specified Conversion Rates (see table below), adjusted for certain events including the declaration of cash dividends. Up until the three-months immediately preceding the maturity date of the applicable series of Convertible Debt, each series of Convertible Debt is convertible only upon the occurrence of (1) the closing price of the Company's common stock exceeds the Conversion Price (see table below) by 130% for 20 days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter or (2) during the 5 business day period after any 10 consecutive trading day period, or the measurement period, in which the trading price per $1,000 principal amount of notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of the Company's common stock and the conversion rate on each such trading day or (3) upon the occurrence of certain corporate events specified in the indenture of such series of Convertible Debt. In addition, for each series other than the 2007 Junior Debt, if at the time of conversion the applicable price of the Company's common stock exceeds the applicable Conversion Price at such time, the applicable Conversion Rate will be increased by up to an additional maximum incremental shares rate, as determined pursuant to a formula specified in the indenture for the applicable series of Convertible Debt, and as adjusted for cash dividends paid since the issuance of such series of Convertible Debt. However, in no event will the applicable Conversion Rate exceed the applicable Maximum Conversion Rate specified in the indenture for the applicable series of Convertible Debt (see table below). The following table sets forth the applicable Conversion Rates adjusted for dividends declared since issuance of such series of Convertible Debt and the applicable Maximum Incremental Share Rate (with the exception of the 2007 Junior Debt) and applicable Conversion Rates as adjusted for dividends paid since the applicable issuance date:
|
| | | | | | | | | | | | |
| Dividend adjusted rates as of June 30, 2017 |
| Conversion Rate, adjusted | | Approximate Conversion Price, adjusted | | Maximum Incremental Rate, adjusted | | Maximum Conversion Rate, adjusted |
2017 Senior Debt | 9.9890 |
| | $ | 100.11 |
| | 4.9945 |
| | 14.2344 |
|
2015 Senior Debt | 15.5772 |
| | $ | 64.20 |
| | 7.7886 |
| | 21.8081 |
|
2017 Junior Debt | 10.1674 |
| | $ | 98.35 |
| | 5.0838 |
| | 14.2344 |
|
2007 Junior Debt | 42.3241 |
| | $ | 23.63 |
| | NA |
| | 48.6727 |
|
As of June 30, 2017, the holders of the 2007 Junior Debt had the right to convert their debentures between July 1, 2017 and September 30, 2017 because the Company's common stock has exceeded the Conversion Price by 130% for the specified period of time during the quarter ended June 30, 2017. In June 2017, the Company received notification from certain holders of the 2007 Junior Debt of their intent to convert $15.2 million in principal value according to the terms of the debt and the Company settled the principal amount in cash and issued 0.5 million shares of its common stock in respect of the conversion value in excess of the principal amount in the second quarter of fiscal 2018. In addition, the Company has the option and intent to call the remaining outstanding 2007 Junior Debt on or after December 15, 2017. Therefore, the 2007 Junior Debt is classified as a current liability on the consolidated balance sheet as of June 30, 2017 and March 31, 2017. If the Company does not call the 2007 Junior Debt in December 2017, additional interest will be due on the notes based on the trading value of the notes of 0.25% if the debentures are trading at less than $400 and a 0.5% additional interest rate if the debentures are trading at greater than $1,500. Based on the current trading price of the debentures, the contingent interest rate beginning in December 2017 would be 0.5% of the average trading price. The if-converted value of the debentures exceeded the principal amount by $73.5 million at June 30, 2017.
As of June 30, 2017, the 2015 Senior Debt is not convertible but had a value if converted above par of $348.9 million.
The Company may not redeem any series of Convertible Debt prior to the relevant maturity date and no sinking fund is provided for any series of Convertible Debt. Upon the occurrence of a fundamental change as defined in the applicable indenture of such series of Convertible Debt, holders of such series may require the Company to purchase all or a portion of their Convertible Debt for cash at a price equal to 100% of the principal amount plus any accrued and unpaid interest.
Interest expense includes the following (in millions):
|
| | | | | | | |
| Three Months Ended June 30, |
| 2017 | | 2016 |
Debt issuance amortization | $ | 0.9 |
| | $ | 0.4 |
|
Amortization of debt discount - non cash interest expense | 25.9 |
| | 12.1 |
|
Coupon interest expense | 19.4 |
| | 10.1 |
|
Total | $ | 46.2 |
| | $ | 22.6 |
|
The remaining period over which the unamortized debt discount will be recognized as non-cash interest expense is 9.63 years, 7.63 years, 19.63 years, 20.46 years for the 2017 Senior Debt, 2015 Senior Debt, 2017 Junior Debt and 2007 Junior Debt, respectively.
Issuances and Settlements - In June 2017, the Company exchanged in privately negotiated transactions $111.3 million aggregate principal amount of its 2007 Junior Debt for (i) $111.3 million principal amount of 2017 Junior Debt with a market value of $119.3 million plus (ii) the issuance of 3.2 million shares of the Company's common stock with a value of $254.6 million, of which $56.3 million was allocated to the fair value of the liability and $321.1 million was allocated to the reacquisition of the equity component for total consideration of $374.0 million. The transaction resulted in a loss on settlement of the 2007 Junior Debt of approximately $13.8 million, which represented the difference between the fair value of the liability component at time of repurchase and the sum of the carrying values of the debt component and any unamortized debt issuance costs. The debt discount on the new 2017 Junior Debt was the difference between the par value and the fair value of the debt resulting in a debt discount of $55.1 million which will be amortized to interest expense using the effective interest method over the term of the debt.
In February 2017, the Company issued the 2017 Senior Debt and 2017 Junior Debt for net proceeds of $2,043.6 million and $567.7 million, respectively. In connection with the issuance of these instruments, the Company incurred issuance costs of $33.7 million, of which $17.8 million and $3.4 million was recorded as debt issuance costs related to the 2017 Senior Debt and 2017 Junior Debt, respectively, and will be amortized using the effective interest method over the term of the debt. The balance of $12.5 million in fees was recorded to equity. Interest on both instruments is payable semi-annually on February 15 and August 15 of each year.
In February 2015, the Company issued the 2015 Senior Debt for net proceeds of approximately $1,694.7 million. In connection with the issuance, the Company incurred issuance costs of $30.3 million, of which $20.4 million was recorded as debt issuance costs and will be amortized using the effective interest method over the term of the debt. The balance of $9.9 million was recorded to equity.
The Company utilized the proceeds from the issuances of the 2017 debt and 2015 debt to reduce amounts borrowed under its Credit Facility and to settle a portion of the 2007 Junior Debt in privately negotiated transactions. In February 2017 and February 2015, the Company settled $431.3 million and $575.0 million, respectively, in aggregate principal of its 2007 Junior Debt. The 2015 repurchase consisted solely of cash. In February 2017, the Company used cash of $431.3 million and an aggregate of 12.0 million in shares of the Company's common stock valued at $862.7 million for total consideration of $1,293.9 million to settle $431.3 million of the 2007 Junior Debt, of which $188.0 million was allocated to the liability component and $1,105.9 million was allocated to the equity component. In addition, in February 2017, there was an inducement fee of $5.0 million which was recorded in the consolidated statement of operations in loss on settlement of convertible debt. The consideration transferred in February 2015 was $1,134.6 million, of which $238.3 million was allocated to the liability component and $896.3 million was allocated to the equity component. In the case of both settlements of the 2007 Junior Debt, the consideration was allocated to the liability and equity components using the equivalent rate that reflected the borrowing rate for a similar non-convertible debt prior to the retirement. The transactions resulted in a loss on settlement of convertible debt of approximately $43.9 million and $50.6 million in fiscal 2017 and fiscal 2015, respectively, which represented, in each case, the difference between the fair value of the liability component at time of repurchase and the sum of the carrying values of the debt component and any unamortized debt issuance costs.
Credit Facility
The Company maintains a $2.774 billion credit facility which is made up of two tranches, one available until February 4, 2020 and another available through June 27, 2018. The Credit Facility was amended in February 2017 and February 2015. The financial covenants include, among others, limits on the Company's consolidated senior ratio and total leverage ratio. The maximum Total Leverage Ratio (capitalized terms not otherwise defined in this Form 10-Q have the meaning of the defined terms in the applicable agreements) cannot exceed 5.00 to 1.00 and is calculated as Consolidated Total Indebtedness, excluding the Junior Debt up to a $700 million maximum, to Consolidated EBIDTA for a period of four quarters. The Total Leverage Ratio may be temporarily increased to 5.50 to 1.00 for a period of four consecutive quarters in conjunction with a Permitted Acquisition occurring during the first four quarters following the acquisition. The Total Leverage Ratio then decreases to 5.25 to 1.00 for three consecutive quarters, finally returning to the stated 5.00 to 1.00 Total Leverage Ratio after a period of seven consecutive fiscal periods. The Company can elect to use this special feature, also referred to as an Adjusted Covenant Period, not more than one time from and after February 8, 2017, the effective date of the February 2017 amendment (discussed below), and may elect to terminate an Adjusted Covenant Period prior to the end of the Adjusted Covenant Period. The Credit Facility also requires that the Senior Leverage Ratio not exceed 3.50 to 1.00, which is calculated as Consolidated Senior Indebtedness to Consolidated EBIDTA for four consecutive quarters. The Company is also required to comply with an Interest Coverage Ratio of less than 3.50 to 1.00, measured quarterly.
In June 2017, in connection with the settlement of the 2007 Junior Debt, the Company amended the Credit Agreement to (i) extend the time period during which the Company is permitted to repurchase, redeem or exchange the 2007 Junior Debt and (ii) amend the maximum total leverage ratio covenant to extend the time period for permitted refinancings or exchanges of the 2007 Junior Debt that may be excluded from the calculation of the ratio, subject to certain conditions.
The Credit Agreement has a $125 million foreign currency sublimit, a $25 million letter of credit sublimit and a $25 million swingline loan sublimit. The Company has the option to obtain additional tranche commitments or additional indebtedness as long as the Senior Leverage Ratio is equal to or less than 2.50 to 1.00.
In February 2017, the Company used $1,682.5 million of the proceeds from the issuance of the 2017 Senior Debt and 2017 Junior Debt to pay off the entire balance on its line of credit. In connection with the February 2017 amendment to the Credit Agreement, the Company incurred $2.1 million of issuance fees which will be amortized over the term of the facility and for which the balance is recorded net of any outstanding Credit Facility balance. At June 30, 2017 and March 31, 2017, there were no outstanding borrowings under the revolving credit facility.
The Company's obligations under the credit agreement are guaranteed by certain of its subsidiaries meeting materiality thresholds set forth in the credit agreement. To secure the Company's obligations under the credit agreement, the Company and its domestic subsidiaries are required to pledge the equity securities of certain of their respective material subsidiaries, subject to certain exceptions and limitations. In addition, in connection with the February 2017 amendment, the Company and the guarantor subsidiaries granted a security interest in substantially all of their personal property to secure the obligations under the credit agreement.
The loans under the credit agreement bear interest, at the Company's option, at the base rate plus a spread of 0.25% to 1.25% or an adjusted LIBOR rate (based on one, two, three, or six-month interest periods) plus a spread of 1.25% to 2.25%, in each case with such spread being determined based on the consolidated leverage ratio for the preceding four fiscal quarters (in the case of the 2018 tranche revolving loans) or the consolidated senior leverage ratio (in the case of the 2020 tranche revolving loans). The base rate means the highest of JPMorgan Chase Bank, N.A.'s prime rate, the federal funds rate plus a margin equal to 0.50% and the adjusted LIBOR rate for a 1-month interest period plus a margin equal to 1.00%. Swingline loans accrue interest at a per annum rate based on the base rate plus the applicable margin for base rate loans. Base rate loans may only be made in U.S. Dollars. The Company is also obligated to pay other customary administration fees and letter of credit fees for a credit facility of this size and type.
Interest is due and payable in arrears quarterly for loans bearing interest at the base rate and at the end of an interest period (or at each three-month interval in the case of loans with interest periods greater than three months) in the case of loans bearing interest at the adjusted LIBOR rate. Interest expense related to the credit agreement was approximately $2.7 million in the three months ended June 30, 2017 and $11.6 million for the three months ended June 30, 2016. Principal, together with all accrued and unpaid interest, is due and payable on the respective tranche maturity date, which is June 27, 2018 and February 4, 2020. The Company 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 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 senior leverage ratio, a total leverage ratio and an interest coverage ratio, all measured quarterly and calculated on a consolidated bases. At June 30, 2017, the Company was in compliance with these covenants.
The credit agreement includes customary events of default that include, among other things, non-payment defaults, inaccuracy of representations and warranties, covenant defaults, cross default to material indebtedness, bankruptcy and insolvency defaults, material judgment defaults, ERISA defaults and a change of control default. The occurrence of an event of default could result in the acceleration of the obligations under the credit agreement. Under certain circumstances, a default interest rate will apply on all obligations during the existence of an event of default under the credit agreement at a per annum rate equal to 2.00% above the applicable interest rate for any overdue principal and 2.00% above the rate applicable for base rate loans for any other overdue amounts.
Note 14. Pension Plans
In connection with its acquisition of Atmel, the Company assumed unfunded defined benefit pension plans that cover certain French and German employees. Plan benefits are provided in accordance with local statutory requirements. Benefits are based on years of service and employee compensation levels. Pension liabilities and charges are based upon various assumptions, updated annually, including discount rates, future salary increases, employee turnover, and mortality rates. The Company's French pension plan provides for termination benefits paid to covered French employees only at retirement, and consists of approximately one to five months of salary. The Company's German pension plan provides for defined benefit payouts for covered German employees following retirement.
The aggregate net pension expense relating to these two plans are as follows (amounts in thousands):
|
| | | | | | | |
| Three Months Ended |
| June 30, |
| 2017 | | 2016 |
Service costs | $ | 353 |
| | $ | 364 |
|
Interest costs | 240 |
| | 243 |
|
Amortization of actuarial loss | 203 |
| | — |
|
Settlements | — |
| | 231 |
|
Net pension period cost | $ | 796 |
| | $ | 838 |
|
Interest costs and amortization of actuarial losses are recorded in the other income, net line item in the statement of operations. The Company's net periodic pension cost for fiscal 2018 is expected to be approximately $2.6 million. Cash funding for benefits paid was $0.1 million for the three months ended June 30, 2017. The Company expects total contributions to these plans to be approximately $0.7 million in fiscal 2018.
In the ordinary course of the Company's business, it is exposed to various liabilities as a result of contracts, product liability, customer claims and other matters. Additionally, the Company is involved in a limited number of legal actions, both as plaintiff and defendant. Consequently, the Company could incur uninsured liability in any of those actions. The Company also periodically receives notifications from various third parties alleging infringement of patents or other intellectual property rights, or from customers requesting reimbursement for various costs. With respect to pending legal actions to which the Company is a party and other claims, although the outcomes are generally not determinable, the Company believes that the ultimate resolution of these matters will not have a material adverse effect on its financial position, cash flows or results of operations. Litigation and disputes relating to the semiconductor industry are not uncommon, and the Company is, from time to time, subject to such litigation and disputes. As a result, no assurances can be given with respect to the extent or outcome of any such litigation or disputes in the future.
As a result of its acquisition of Atmel, which closed April 4, 2016, the Company became involved with the following lawsuits:
In re: Continental Airbag Products Liability Litigation. On May 11, 2016, an Amended and Consolidated Class Action Complaint ("Complaint") was filed in the United States District Court for the Southern District of Florida (Miami Division) against Atmel, Continental Automotive Systems, Inc., Honda Motor Co., Ltd. and an affiliate, and Daimler AG and an affiliate. The Complaint which includes claims arising under federal law and Florida, California, New Jersey, Michigan and Louisiana state law alleges that class members unknowingly purchased or leased vehicles containing defective airbag control units (incorporating allegedly defective application specific integrated circuits manufactured by the Company's Atmel subsidiary between 2006 and 2010), and thereby suffered financial harm, including a loss in the value of their purchased or leased vehicles. The plaintiffs are seeking, individually and on behalf of a putative class, unspecified compensatory and exemplary damages, statutory penalties, pre- and post-judgment interest, attorneys' fees, and injunctive and other relief. The Company's Atmel subsidiary contested plaintiffs' claims vigorously, and on May 23, 2017 the case was ordered to be dismissed.
Continental Claim ICC Arbitration. On December 29, 2016, Continental Automotive GmbH ("Continental") filed a Request for Arbitration with the ICC, naming as respondents the Company's subsidiaries Atmel Corporation, Atmel SARL, Atmel Global Sales Ltd., and Atmel Automotive GmbH (collectively, "Atmel"). The Request alleges that a quality issue affecting Continental airbag control units in certain recalled vehicles stems from allegedly defective Atmel application specific integrated circuits ("ASICs"). The Continental airbag control units, ASICs and vehicle recalls are also at issue in In re: Continental Airbag Products Liability Litigation, described above. Continental seeks to recover from Atmel all related costs and damages incurred as a result of the vehicle manufacturers’ airbag control unit-related recalls, currently alleged to be $61.6 million (but subject to increase). The Company's Atmel subsidiaries intend to defend this action vigorously.
Southern District of New York Action by LFoundry Rousset ("LFR") and LFR Employees. On March 4, 2014, LFR and Jean-Yves Guerrini, individually and on behalf of a putative class of LFR employees, filed an action in the United States District Court for the Southern District of New York (the "District Court") against the Company's Atmel subsidiary, French subsidiary, Atmel Rousset S.A.S. ("Atmel Rousset"), and LFoundry GmbH ("LF"), LFR's German parent. The case purports to relate to Atmel Rousset's June 2010 sale of its wafer manufacturing facility in Rousset, France to LF, and LFR's subsequent insolvency, and later liquidation, more than three years later. The District Court dismissed the case on August 21, 2015, and the United States Court of Appeals for the Second Circuit affirmed the dismissal on June 27, 2016. On July 25, 2016, the plaintiffs filed a notice of appeal from the District Court's June 27, 2016 denial of their motion for relief from the dismissal judgment. On May 19, 2017, the United States Court of Appeals for the Second Circuit affirmed the June 27, 2016 order dismissing the case.
Individual Labor Actions by former LFR Employees. In the wake of LFR's insolvency and liquidation, over 500 former employees of LFR have filed individual labor actions against Atmel Rousset in a French labor court. The Company's Atmel Rousset subsidiary believes that each of these actions is entirely devoid of merit, and, further, that any assertion by any of the Claimants of a co-employment relationship with the Atmel Rousset subsidiary is based substantially on the same specious arguments that the Paris Commercial Court summarily rejected in 2014 in related proceedings. The Company's Atmel Rousset subsidiary therefore intends to defend vigorously against each of these claims.
The Company accrues for claims and contingencies when losses become probable and reasonably estimable. As of the end of each applicable reporting period, the Company reviews each of its matters and, where it is probable that a liability has been or will be incurred, the Company accrues for all probable and reasonably estimable losses. Where the Company can reasonably estimate a range of losses it may incur regarding such a matter, the Company records an accrual for the amount within the range that constitutes its best estimate. If the Company can reasonably estimate a range but no amount within the range appears to be a better estimate than any other, the Company uses the amount that is the low end of such range. As of June 30, 2017, the Company's estimate of the aggregate potential liability that is possible but not probable is approximately $100 million in excess of amounts accrued.
The Company's technology license agreements generally include an indemnification clause that indemnifies the licensee against liability and damages (including legal defense costs) arising from any claims of patent, copyright, trademark or trade secret infringement by the Company's proprietary technology. The terms of these indemnification provisions approximate the terms of the outgoing technology license agreements, which are typically perpetual unless terminated by either party for breach. The possible amount of future payments the Company could be required to make based on agreements that specify indemnification limits, if such indemnifications were required on all of these agreements, is approximately $151.5 million. There are some licensing agreements in place that do not specify indemnification limits. As of June 30, 2017, the Company had not recorded any liabilities related to these indemnification obligations and the Company believes that any amounts that it may be required to pay under these agreements in the future will not have a material adverse effect on its financial position, cash flows or results of operations.
| |
Note 16. | Derivative Instruments |
Freestanding Derivative Forward Contracts
The Company has international operations and is thus subject to foreign currency rate fluctuations. Approximately 99% of the Company's sales are U.S. Dollar denominated. However, a significant amount of the Company's expenses and liabilities are denominated in foreign currencies and subject to foreign currency rate fluctuations. To help manage the risk of changes in foreign currency rates, the Company periodically enters into derivative contracts comprised of foreign currency forward contracts to hedge its asset and liability foreign currency exposure and a portion of its foreign currency operating expenses. Foreign exchange rate fluctuations after the effects of hedging activity resulted in net gains of $4.5 million and $1.4 million during the three month periods ended June 30, 2017 and 2016, respectively. As of June 30, 2017 and March 31, 2017, 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 months ended June 30, 2017 and 2016. Gains and losses from changes in the fair value of these foreign currency forward contracts and foreign currency exchange rate fluctuations are credited or charged to other income (expense). The Company does not apply hedge accounting to its foreign currency derivative instruments.
| |
Note 17. | Comprehensive Income (Loss) |
The following table presents the changes in the components of accumulated other comprehensive income (loss) (AOCI), net of tax, for the three months ended June 30, 2017 (amounts in thousands):
|
| | | | | | | | | | | | | | | |
| Unrealized holding gains (losses) available-for-sale securities | | Defined benefit pension plans | | Foreign Currency | | Total |
Accumulated other comprehensive income (loss) at March 31, 2017 | $ | 312 |
| | $ | (5,263 | ) | | $ | (9,427 | ) | | $ | (14,378 | ) |
Other comprehensive loss before reclassifications | (844 | ) | | (4,114 | ) | | — |
| | (4,958 | ) |
Amounts reclassified from accumulated other comprehensive loss | — |
| | 203 |
| | — |
| | 203 |
|
Net other comprehensive loss | (844 | ) | | (3,911 | ) | | — |
| | (4,755 | ) |
Accumulated other comprehensive loss at June 30, 2017 | $ | (532 | ) | | $ | (9,174 | ) | | $ | (9,427 | ) | | $ | (19,133 | ) |
The table below details where reclassifications of realized transactions out of AOCI are recorded on the condensed consolidated statements of operations (amounts in thousands):
|
| | | | | | | | | | |
| | Three Months Ended | | |
| | June 30, | | |
Description of AOCI Component | | 2017 | | 2016 | | Related Statement of Income Line |
Unrealized (losses) gains on available-for-sale securities | | $ | — |
| | $ | (82 | ) | | Other income |
| |
Note 18. | Share-Based Compensation |
The following table presents the details of the Company's share-based compensation expense (amounts in thousands):
|
| | | | | | | |
| Three Months Ended |
| June 30, |
| 2017 | | 2016 |
Cost of sales (1) | $ | 3,394 |
| | $ | 7,897 |
|
Research and development | 10,289 |
| | 17,517 |
|
Selling, general and administrative | 8,725 |
| | 34,165 |
|
Pre-tax effect of share-based compensation | 22,408 |
| | 59,579 |
|
Income tax benefit (2) | 7,428 |
| | 20,888 |
|
Net income effect of share-based compensation | $ | 14,980 |
| | $ | 38,691 |
|
(1) During the three months ended June 30, 2017, $2.7 million of share-based compensation expense was capitalized to inventory and $3.4 million of previously capitalized share-based compensation expense in inventory was sold. During the three months ended June 30, 2016, $2.8 million of share-based compensation expense was capitalized to inventory. The amount of share-based compensation included in cost of sales during the three months ended June 30, 2016 included $3.7 million of previously capitalized share-based compensation expense in inventory that was sold and $4.2 million of share-based compensation expense related to the Company's acquisition of Atmel that was not previously capitalized to inventory.
(2) Amounts exclude excess tax benefits related to share-based compensation of $5.9 million for the three months ended June 30, 2017 and $6.7 million for the three months ended June 30, 2016.
Atmel Acquisition-related Equity Awards
During the three months ended June 30, 2016, the Company recognized $43.2 million of share-based compensation expense in connection with awards assumed in the acquisition of Atmel, of which $37.1 million was due to the accelerated vesting of outstanding equity awards upon termination of certain Atmel employees.
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Note 19. | Net Income (Loss) Per Common Share From Continuing Operations |
The following table sets forth the computation of basic and diluted net income (loss) per common share from continuing operations (in thousands, except per share amounts):
|
| | | | | | | |
| Three Months Ended |
| June 30, |
| 2017 | | 2016 |
Net income (loss) from continuing operations | $ | 170,587 |
| | $ | (109,225 | ) |
Weighted average common shares outstanding | 229,429 |
| | 214,345 |
|
Dilutive effect of stock options and RSUs | 4,514 |
| | — |
|
Dilutive effect of 2007 Junior debt | 4,129 |
| | — |
|
Dilutive effect of 2015 Senior debt | 4,830 |
| | — |
|
Dilutive effect of 2017 Senior debt | — |
| | — |
|
Dilutive effect of 2017 Junior debt | — |
| | — |
|
Weighted average common and potential common shares outstanding | 242,902 |
| | 214,345 |
|
Basic net income (loss) per common share from continuing operations | $ | 0.74 |
| | $ | (0.51 | ) |
Diluted net income (loss) per common share from continuing operations | $ | 0.70 |
| | $ | (0.51 | ) |
The Company computed basic net income (loss) per common share from continuing operations using net income (loss) from continuing operations available to common stockholders and the weighted average number of common shares outstanding during the period. The Company computed diluted net income per common share from continuing operations using net income (loss) from continuing operations available to common stockholders and the weighted average number of common shares outstanding plus potentially dilutive common shares outstanding during the period.
Potentially dilutive common shares from employee equity incentive plans are determined by applying the treasury stock method to the assumed exercise of outstanding stock options and the assumed vesting of outstanding RSUs. Weighted average common shares exclude the effect of option shares which are not dilutive. There were no anti-dilutive option shares for the three months ended June 30, 2017. For the three months ended June 30, 2016, the calculation of diluted net loss per common share excluded 4,159,273 common shares from employee equity incentive plans as the related impact would have been anti-dilutive as the Company generated a net loss.
Diluted net income (loss) per common share from continuing operations for the three months ended June 30, 2017, includes 4,128,673 shares, issuable upon the exchange of the Company's 2007 Junior Debt and 4,829,550 issuable upon the exchange of the Company's 2015 Senior Debt. Diluted net income per common share from continuing operations attributable to stockholders for the three months ended June 30, 2016 excludes 12,165,812 shares issuable upon the exchange of the Company's 2007 Junior Debt as the related impact would have been anti-dilutive as the Company generated a net loss for such period. The convertible debt has 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 following is the weighted average conversion price per share used in calculating the dilutive effect (See Note 13 for details on the convertible debt):
|
| | | | | | | |
| June 30, |
| 2017 | | 2016 |
2007 Junior Debt | $ | 23.69 |
| | $ | 24.23 |
|
2015 Senior Debt | $ | 64.35 |
| | $ | 65.82 |
|
2017 Senior Debt | $ | 100.35 |
| | $ | — |
|
2017 Junior Debt | $ | 98.59 |
| | $ | — |
|
Note 20. Stock Repurchase
The Company's Board of Directors previously approved a share repurchase program under which up to 15.0 million shares of our common stock may be repurchased in the open market or in privately negotiated transactions. There were no repurchases of common stock during the three months ended June 30, 2017. There is no expiration date associated with this repurchase program. As of June 30, 2017, the Company held approximately 20.0 million shares as treasury shares.
A quarterly cash dividend of $0.3615 per share was paid on June 6, 2017 in the aggregate amount of $82.9 million. A quarterly cash dividend of $0.362 per share was declared on August 3, 2017 and will be paid on September 5, 2017 to stockholders of record as of August 21, 2017. The Company expects the September 2017 payment of its quarterly cash dividend to be approximately $84.4 million.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
This report, including "Part I – Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Part II - Item 1A Risk Factors" contains certain forward-looking statements that involve risks and uncertainties, including statements regarding our strategy, financial performance and revenue sources. We use words such as "anticipate," "believe," "plan," "expect," "future," "continue," "intend" and similar expressions to identify forward-looking statements. Our actual results could differ materially from the results anticipated in these forward-looking statements as a result of certain factors including those set forth under "Risk Factors," beginning at page 48 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:
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• | 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; |
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• | The effects and amount of competitive pricing pressure on our product lines; |
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• | Our ability to moderate future average selling price declines; |
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• | The effect of product mix, capacity utilization, yields, fixed cost absorption, competition and economic conditions on gross margin; |
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• | The amount of, and changes in, demand for our products and those of our customers; |
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• | Our expectation that in the future we will acquire additional businesses that we believe will complement our existing businesses; |
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• | Our expectation that in the future we will enter into joint development agreements or other business or strategic relationships with other companies; |
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• | The level of orders that will be received and shipped within a quarter; |
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• | Our expectation that our days of inventory levels in the September 2017 quarter will be flat compared to the June 2017 levels. Our belief that our existing level of inventory will allow us to maintain competitive lead times and provide strong delivery performance to our customers. |
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• | The effect that distributor and customer inventory holding patterns will have on us; |
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• | Our belief that customers recognize our products and brand name and use distributors as an effective supply channel; |
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• | Anticipating increased customer requirements to meet voluntary criteria related to the reduction or elimination of substances in our products; |
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• | Our belief that deferred cost of sales are recorded at their approximate carrying value and will have low risk of material impairment; |
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• | Our belief that our direct sales personnel combined with our distributors provide an effective means of reaching our customer base; |
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• | Our ability to increase the proprietary portion of our analog and interface product lines and the effect of such an increase; |
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• | Our belief that our processes afford us both cost-effective designs in existing and derivative products and greater functionality in new product designs; |
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• | The impact of any supply disruption we may experience; |
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• | Our ability to effectively utilize our facilities at appropriate capacity levels and anticipated costs; |
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• | That we adjust capacity utilization to respond to actual and anticipated business and industry-related conditions; |
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• | That our existing facilities will provide sufficient capacity to respond to increases in demand with modest incremental capital expenditures; |
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• | That manufacturing costs will be reduced by transition to advanced process technologies; |
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• | Our ability to maintain manufacturing yields; |
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• | Continuing our investments in new and enhanced products; |
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• | The cost effectiveness of using our own assembly and test operations; |
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• | Our anticipated level of capital expenditures; |
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• | Continuation and amount of quarterly cash dividends; |
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• | That the Atmel acquisition was structured in a manner that enabled us to utilize a substantial portion of the cash, cash equivalents, short-term investments and long-term investments held by certain of our foreign subsidiaries in a tax efficient manner and that our determinations with respect to the tax consequences of the acquisition are reasonable; |
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• | 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; |
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• | That our U.S. operations and capital requirements are funded primarily by cash generated from U.S. operating activities, which has been and is expected to be sufficient to meet our business needs in the U.S. for the foreseeable future; |
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• | The impact of seasonality on our business; |
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• | The accuracy of our estimates used in valuing employee equity awards; |
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• | 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; |
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• | The recoverability of our deferred tax assets; |
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• | 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; |
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• | Our belief that our determinations with respect to the tax consequences of the Atmel acquisition are reasonable; |
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• | Our belief that the expiration of any tax holidays will not have a material impact on our overall tax expense or effective tax rate; |
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• | Our belief that the estimates used in preparing our consolidated financial statements are reasonable; |
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• | Our actions to vigorously and aggressively defend and protect our intellectual property on a worldwide basis; |
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• | Our ability to obtain patents and intellectual property licenses and minimize the effects of litigation; |
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• | The level of risk we are exposed to for product liability claims or indemnification claims; |
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• | The effect of fluctuations in market interest rates on our income and/or cash flows; |
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• | The effect of fluctuations in currency rates; |
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• | 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; |
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• | That a significant portion of our future cash generation will be in our foreign subsidiaries; |
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• | Our intention to satisfy the lesser of the principal amount or the conversion value of our debentures in cash; |
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• | Our intention to indefinitely reinvest undistributed earnings of certain non-US subsidiaries in those subsidiaries; |
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• | Our intent to maintain a high-quality investment portfolio that preserves principal, meets liquidity needs, avoids inappropriate concentrations and delivers an appropriate yield; and |
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• | Our ability to collect accounts receivable. |
We begin our Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) with a summary of our overall business strategy to give the reader an overview of the goals of our business and the overall direction of our business and products. This is followed by a discussion of the Critical Accounting Policies and Estimates that we believe are important to understanding the assumptions and judgments incorporated in our reported financial results. We then discuss our Results of Operations for the three months ended June 30, 2017 compared to the three months ended June 30, 2016. We then provide an analysis of changes in our balance sheet and cash flows, and discuss our financial commitments in sections titled "Liquidity and Capital Resources," "Contractual Obligations" and "Off-Balance Sheet Arrangements."
Strategy
Our goal is to be a worldwide leader in providing specialized semiconductor products for a wide variety of embedded control applications. Our strategic focus is on embedded control solutions, including general purpose and specialized microcontrollers, development tools and related software, analog, interface, mixed signal and timing products, wired and wireless connectivity products, memory products and technology licensing. We provide highly cost-effective embedded control solutions that also offer the advantages of small size, high performance, extreme low power usage, wide voltage range operation, mixed signal integration and ease of development, thus enabling timely and cost-effective integration of our solutions by our customers in their end products. We license our SuperFlash technology and other technologies to wafer foundries, integrated device manufacturers and design partners throughout the world for use in the manufacture of advanced microcontroller products, gate array, radio frequency (RF) and analog products that require embedded non-volatile memory.
We sell our products to a broad base of domestic and international customers across a variety of industries. The principal markets that we serve include consumer, automotive, industrial, office communication, computing and aerospace. 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 assembly and test operations, and by employing statistical process control techniques, we have been able to achieve and maintain high production yields. Direct control over manufacturing resources allows us to shorten our design and production cycles. This control also allows us to capture a portion of the wafer manufacturing and the assembly and test profit margin. We do outsource a significant portion of our manufacturing requirements to third parties.
We employ proprietary design and manufacturing processes in developing our embedded control products. We believe our processes afford us both cost-effective designs in existing and derivative products and greater functionality in new product designs. While many of our competitors develop and optimize separate processes for their logic and memory product lines, we use a common process technology for both microcontroller and non-volatile memory products. This allows us to more fully leverage our process research and development costs and to deliver new products to market more rapidly. Our engineers utilize advanced computer-aided design (CAD) tools and software to perform circuit design, simulation and layout, and our in-house photomask and wafer fabrication facilities enable us to rapidly verify design techniques by processing test wafers quickly and efficiently.
We are committed to continuing our investment in new and enhanced products, including development systems, and in our design and manufacturing process technologies. We believe these investments are significant factors in maintaining our competitive position. Our current research and development activities focus on the design of new microcontrollers, digital signal controllers, memory, analog and mixed-signal products, Flash-IP systems, development systems, software and application-specific software libraries. We are also developing new design and process technologies to achieve further cost reductions and performance improvements in our products.
We market and sell our products worldwide primarily through a network of direct sales personnel and distributors. Our distributors focus primarily on servicing the product and technical support requirements of a broad base of diverse customers. We believe that our direct sales personnel combined with our distributors provide an effective means of reaching this broad and diverse customer base. Our direct sales force focuses primarily on major strategic accounts in three geographical markets: the Americas, Europe and Asia. We currently maintain sales and support centers in major metropolitan areas in North America, Europe and Asia. We believe that a strong technical service presence is essential to the continued development of the embedded control market. Many of our client engagement managers (CEMs), embedded system engineers (ESEs), and sales management personnel have technical degrees and have been previously employed in an engineering environment. We believe that the technical knowledge of our sales force is a key competitive advantage in the sale of our products. The primary mission of our ESE team is to provide technical assistance to strategic accounts and to conduct periodic training sessions for CEMs and distributor sales teams. ESEs also frequently conduct technical seminars for our customers in major cities around the world, and work closely with our distributors to provide technical assistance and end-user support.
See "Our operating results are impacted by both seasonality and the wide fluctuation of supply and demand in the semiconductor industry," on page 52 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, senior and junior subordinated convertible debt 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 which prevent the sales pricing from being fixed or determinable at the time of shipment to our distributors. Therefore, revenue recognition is deferred until the pricing uncertainty is resolved, which generally occurs when the distributor sells the product to their customer. 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.
In connection with our acquisition of Atmel, we acquired certain distributor relationships where revenue was recognized upon shipment to the distributors based on certain contractual terms or prevailing business practices that resulted in the price not being fixed and determinable at such time. Following an acquisition, we undertake efforts to align the contract terms and business practices of the acquired entity with our own. Once these efforts are complete, revenue recognition is changed. With respect to such distributor relationships acquired in the Atmel acquisition, as of October 1, 2016, these business practices were conformed to those of our other distributors resulting in the deferral of revenue recognition until the distributor sells the product to their customers.
Deferred income on shipments to distributors effectively represents the gross margin on the sale to the distributor; however, the amount of gross margin that we recognize in future periods could be less than the deferred margin as a result of credits granted to distributors on specifically identified products and customers to allow the distributors to earn a competitive gross margin on the sale of our products to their end customers and price protection concessions related to market pricing conditions.
We sell the majority of the items in our product catalog to our distributors worldwide at a uniform list price. However, distributors resell our products to end customers at a very broad range of individually negotiated price points. The majority of our distributors' resales require a reduction from the original list price paid. Often, under these circumstances, we remit back to the distributor a portion of their original purchase price after the resale transaction is completed in the form of a credit against the 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. Discounts to a price less than our cost have historically been rare. The effect of granting these credits establishes the net selling price to our distributors for the product and results in the net revenue recognized by us when the product is sold by the distributors to their end customers. Thus, a portion of the "deferred income on shipments to distributors" balance represents the amount of distributors' original purchase price that will be credited back to the distributors in the future. The wide range and variability of negotiated price concessions granted to distributors does not allow us to accurately estimate the portion of the balance in the deferred income on shipments to distributors account that will be credited back to the distributors. Therefore, we do not reduce deferred income on shipments to distributors or accounts receivable by anticipated future concessions; rather, price concessions are typically recorded against deferred income on shipments to distributors and accounts receivable when incurred, which is generally at the time the distributor sells the product. At June 30, 2017, we had approximately $435.7 million of deferred revenue and $126.9 million in
deferred cost of sales recognized as $308.8 million of deferred income on shipments to distributors. At March 31, 2017, we had approximately $418.0 million of deferred revenue and $125.2 million in deferred cost of sales recognized as $292.8 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 $202.7 million at June 30, 2017 and $203.9 million at March 31, 2017. On sales to distributors, our payment terms generally require the distributor to settle amounts owed to us for an amount in excess of their ultimate cost. The sales price to our distributors may be higher than the amount that the distributors will ultimately owe us because distributors often negotiate price reductions after purchasing products from us and such reductions are often significant. It is our practice to apply these negotiated price discounts to future purchases, requiring the distributor to settle receivable balances, on a current basis, generally within 30 days, for amounts originally invoiced. This practice has an adverse impact on the working capital of our distributors. As such, we have entered into agreements with certain distributors whereby we advance cash to the distributors to reduce the distributors' working capital requirements. These advances are reconciled at least on a quarterly basis and are estimated based on the amount of ending inventory as reported by the distributor multiplied by a negotiated percentage. Such advances have no impact on our revenue recognition or our condensed consolidated statements of operations. We process discounts taken by distributors against our deferred income on shipments to distributors' balance and true-up the advanced amounts generally after the end of each completed fiscal quarter. The terms of these advances are set forth in binding legal agreements and are unsecured, bear no interest on unsettled balances and are due upon demand. The agreements governing these advances can be canceled by us at any time.
We reduce product pricing through price protection based on market conditions, competitive considerations and other factors. Price protection is granted to distributors on the inventory they have on hand at the date the price protection is offered. When we reduce the price of our products, it allows the distributor to claim a credit against its outstanding accounts receivable balances based on the new price of the inventory it has on hand as of the date of the price reduction. There is no immediate revenue impact from the price protection, as it is reflected as a reduction of the deferred income on shipments to distributors' balance.
Products returned by distributors and subsequently scrapped have historically been immaterial to our consolidated results of operations. We routinely evaluate the risk of impairment of the deferred cost of sales component of the deferred income on shipments to distributors account. Because of the historically immaterial amounts of inventory that have been scrapped, and historically rare instances where discounts given to a distributor result in a price less than our cost, we believe the deferred costs are recorded at their approximate carrying value.
Recent Updates to Revenue Recognition
In May 2014, the FASB issued ASU 2014-09-Revenue from Contracts with Customers (Topic 606) and in August 2015, the FASB subsequently issued ASU 2015-14 “Deferral of the Effective Date,” which supersedes existing revenue recognition guidance pursuant to US GAAP and will no longer permit us to defer revenue on sales to distributors until the products are sold to the end customer. Upon our adoption of ASU 2014-09 and 2015-14 beginning April 1, 2018, a portion of this deferred revenue will be required to be estimated and recognized upon sale to the distributor rather than upon the sale by the distributor to the end customer. See Note 2 to our condensed consolidated financial statements for additional information on the new guidance.
Business Combinations
All of our business combinations are accounted for at fair value under the acquisition method of accounting. Under the acquisition method of accounting, (i) acquisition-related costs, except for those costs incurred to issue debt or equity securities, will be expensed in the period incurred; (ii) non-controlling interests will be valued at fair value at the acquisition date; (iii) in-process research and development will be recorded at fair value as an intangible asset at the acquisition date and amortized once the technology reaches technological feasibility; (iv) restructuring costs associated with a business combination will be expensed subsequent to the acquisition date; and (v) changes in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date will be recognized through income tax expense or directly in contributed capital. The measurement of the fair value of assets acquired and liabilities assumed requires significant judgment. The valuation of intangible assets, 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. Under the acquisition method of accounting, the aggregate amount of consideration we pay for a company is allocated to net tangible assets and intangible assets based on their estimated fair values as of the acquisition date. The excess of the purchase price over the value of the net tangible assets and intangible assets is recorded to goodwill. On an annual basis, we test goodwill for impairment and, through June 30, 2017, we have never recorded an impairment charge against our goodwill balance.
Share-based Compensation
We measure at fair value and recognize compensation expense for all share-based payment awards, including grants of employee stock options, restricted stock units (RSUs) and employee stock purchase rights, to be recognized in our financial statements based on their respective grant date fair values. For the past several years, we have utilized RSUs as our primary equity incentive compensation instrument for employees. Share-based compensation cost is measured on the grant date based on the fair market value of our common stock discounted for expected future dividends and is recognized as expense straight-line over the requisite service periods. Total share-based compensation during the three months ended June 30, 2017 was $22.4 million, of which $19.0 million was reflected in operating expenses and $3.4 million was reflected in cost of sales. Total share-based compensation included in our inventory balance was $8.0 million at June 30, 2017.
During the fiscal year ended March 31, 2017, we elected to early adopt ASU 2016-09, Compensation - Stock Compensation, Improvements to Employee Share-Based Payment Accounting (Topic 718). Under this standard, entities are permitted to make an accounting policy election to either estimate forfeitures on share-based payment awards, as previously required, or to recognize forfeitures as they occur. We have elected to recognize forfeitures as they occur. Prior to the adoption of ASU 2016-09, we estimated the number of share-based awards to be forfeited due to employee turnover.
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 and net realizable value 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 net realizable value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those we projected, additional inventory write-downs may be required. Inventory impairment charges establish a new cost basis for inventory and charges are not subsequently reversed to income even if circumstances later suggest that increased carrying amounts are recoverable. In estimating our inventory obsolescence, we primarily evaluate estimates of demand over a 12-month period and record impairment charges for inventory on hand in excess of the estimated 12-month demand. Estimates for projected 12-month demand are generally based on the average shipments of the prior three-month period, which are then annualized to adjust for any potential seasonality in our business. The estimated 12-month demand is compared to our most recently developed sales forecast to further reconcile the 12-month demand estimate. Management reviews and adjusts the estimates as appropriate based on specific situations. For example, demand can be adjusted up for new products for which historic sales are not representative of future demand. Alternatively, demand can be adjusted down to the extent any existing products are being replaced or discontinued.
In periods where our production levels are substantially below our normal operating capacity, the reduced production levels of our manufacturing facilities are charged directly to cost of sales. There was no charge to cost of sales for reduced production levels in each of the three month periods ended June 30, 2017 and 2016.
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. 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.
Various taxing authorities in the U.S. and other countries in which we do business scrutinize the tax structures employed by businesses. Companies of our size and complexity are regularly audited by the taxing authorities in the jurisdictions in which they conduct significant operations. We are currently being audited by the tax authorities in various foreign jurisdictions. At this time, we do not know what the outcome of these audits will be. 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.
The accounting model as defined in ASC 740 related to the valuation of uncertain tax positions requires us to presume that the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information and that each tax position will be evaluated without consideration of the possibility of offset or aggregation with other positions. The recognition requirement for the liability exists even if we believe the possibility of examination by a taxing authority or discovery of the related risk matters is remote or where we have a long history of the taxing authority not performing an exam or overlooking an issue. We will record an adjustment to a previously recorded position if new information or facts related to the position are identified in a subsequent period. All adjustments to the positions are recorded through the income statement. Generally, adjustments will be recorded in periods subsequent to the initial recognition if the taxing authority has completed an audit of the period or if the statute of limitation expires. Due to the inherent uncertainty in the estimation process and in consideration of the criteria of the accounting model, amounts recognized in the financial statements in periods subsequent to the initial recognition may significantly differ from the estimated exposure of the position under the accounting model.
Senior and Junior Subordinated Convertible Debt
We separately account for the liability and equity components of our senior and junior subordinated convertible debt in a manner that reflects our nonconvertible debt (unsecured debt) borrowing rate when interest cost is recognized. This results in a bifurcation of a component of the debt, classification of that component in equity and the accretion of the resulting discount on the debt to be recognized as part of interest expense in our condensed consolidated statements of operations. Lastly, we include the dilutive effect of the shares of our common stock issuable upon conversion of the outstanding senior and junior subordinated convertible debt in our diluted income per share calculation regardless of whether the market price triggers or other contingent conversion features have been met. We apply the treasury stock method as we have the intent and have adopted an accounting policy to settle the principal amount of the senior and junior subordinated convertible debentures in cash. This method results in incremental dilutive shares when the average fair value of our common stock for a reporting period exceeds the conversion prices per share and adjusts as dividends are recorded in the future.
Contingencies
In the ordinary course of our business, we are exposed to various liabilities as a result of contracts, product liability, customer claims and other matters. Additionally, we are involved in a limited number of legal actions, both as plaintiff and defendant. Consequently, we could incur uninsured liability in any of those actions. We also periodically receive notifications from various third parties alleging infringement of patents or other intellectual property rights, or from customers requesting reimbursement for various costs. With respect to pending legal actions to which we are a party and other claims, although the outcomes are generally not determinable, we believe that the ultimate resolution of these matters will not have a material adverse effect on our financial position, cash flows or results of operations. Litigation and disputes relating to the semiconductor industry are not uncommon, and we are, from time to time, subject to such litigation and disputes. As a result, no assurances can be given with respect to the extent or outcome of any such litigation or disputes in the future.
We accrue for claims and contingencies when losses become probable and reasonably estimable. As of the end of each applicable reporting period, we review each of our matters and, where it is probable that a liability has been or will be incurred, we accrue for all probable and reasonably estimable losses. Where we can reasonably estimate a range of losses we may incur regarding such a matter, we record an accrual for the amount within the range that constitutes our best estimate. If we can reasonably estimate a range but no amount within the range appears to be a better estimate than any other, we use the amount that is the low end of such range. Contingencies of an acquired company that exist as of the date of the acquisition are measured at fair value if determinable, which generally is based on a probability weighted model. If fair value is not determinable, contingencies of an acquired company are recognized when they become probable and reasonably estimable.
Results of Continuing Operations
The following table sets forth certain operational data as a percentage of net sales for the periods indicated:
|
| | | | | |
| Three Months Ended |
| June 30, |
| 2017 | | 2016 |
Net sales | 100.0 | % | | 100.0 | % |
Cost of sales | 39.9 |
| | 56.4 |
|
Gross profit | 60.1 |
| | 43.6 |
|
| | | |
Research and development | |