10-Q: Quarterly report pursuant to Section 13 or 15(d)
Published on November 9, 1998
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
( X ) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 1998.
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to .
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Commission File Number: 0-21184
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MICROCHIP TECHNOLOGY INCORPORATED
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 86-0629024
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
2355 W. CHANDLER BLVD., CHANDLER, AZ 85224-6199
(602) 786-7200
(Address, Including Zip Code, and Telephone Number,
Including Area Code, of Registrant's
Principal Executive Offices)
The registrant (1) has filed all reports required to be filed by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to the filing requirements for the past 90 days.
Yes X No
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The number of shares outstanding of the issuer's common stock, as of October 30,
1998:
COMMON STOCK, $.001 PAR VALUE: 51,352,935 SHARES
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MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
INDEX
PAGE
PART I. FINANCIAL INFORMATION.
Item 1. Financial Statements
Condensed Consolidated Balance Sheets -
September 30, 1998 and March 31, 1998..........................3
Condensed Consolidated Statements of Income -
Three and Six Months Ended September 30, 1998
and September 30, 1997.........................................4
Condensed Consolidated Statements of Cash Flows -
Six Months Ended September 30, 1998 and September 30, 1997.....5
Notes to Condensed Consolidated Financial Statements................6
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations................10
PART II. OTHER INFORMATION.
Item 4. Submission of Matters to a Vote of Security Holders.............18
Item 6. Exhibits and Reports on Form 8-K................................18
SIGNATURES...................................................................19
EXHIBITS
3.1 By-Laws of Registrant as Amended through August 10, 1998
3.2 Modification Agreement dated as of November 4, 1998 to the Credit
Agreement dated as of October 28, 1997 among Registrant, the Banks
named therein, Bank One, Arizona, N.A., as Administrative Agent and
The First National Bank of Chicago, as Documentation Agent
2
MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands except share amounts)
See accompanying notes to condensed consolidated financial statements
3
MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share amounts)
See accompanying notes to condensed consolidated financial statements
4
MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
See accompanying notes to condensed consolidated financial statements
5
MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements include
the accounts of Microchip Technology Incorporated and its wholly owned
subsidiaries (the "Company"). All intercompany balances and transactions have
been eliminated in consolidation.
The accompanying financial statements have been prepared in accordance
with generally accepted accounting principles, pursuant to the rules and
regulations of the Securities and Exchange Commission. In the opinion of the
Company, the accompanying financial statements include all adjustments of a
normal recurring nature which are necessary for a fair presentation of the
results for the interim periods presented. Certain information and footnote
disclosures normally included in financial statements have been condensed or
omitted pursuant to such rules and regulations. It is suggested that these
financial statements be read in conjunction with the consolidated financial
statements and the notes thereto included in the Company's Annual Report on Form
10-K for the year ended March 31, 1998. The results of operations for the six
months ended September 30, 1998 are not necessarily indicative of the results to
be expected for the full fiscal year.
(2) SPECIAL CHARGE
During the quarter ended June 30, 1998, the Company recognized a
special charge of $5,500,000 which was comprised of three elements: a $3,300,000
legal settlement with another company involving an intellectual property
dispute; a $1,700,000 write-off of products obsoleted by the introduction of
newer products; and a $500,000 charge associated with the restructuring of a
portion of the Company's sales organization.
(3) ACQUISITIONS
KEELOQ(R) HOPPING CODE
On November 17, 1995, the Company acquired the Keeloq(R) hopping code
technology and patents developed by Nanoteq Ltd. of the Republic of South
Africa, and the marketing rights related thereto (the "Keeloq Acquisition"). The
Keeloq Acquisition was treated as an asset purchase for accounting purposes. The
amount paid for the Keeloq Acquisition, including all related costs, was
$12,948,000. The Company has written off a substantial portion of the purchase
price that relates to in-process research and development costs, which is
consistent with the Company's ongoing treatment of research and development
costs, as well as all Keeloq Acquisition-related costs. The special charge
associated with the Keeloq Acquisition was $11,448,000, with the balance treated
as purchased technology and amortized on a straight line basis over five years.
Under the terms of the Keeloq Acquisition, the Company agreed to make a
secondary payment, the amount of which will be determined by a formula based on
the net sales and gross margin results of the Company's Keeloq product division
for a six month measurement period. Any such secondary payment is based on
future performance and is currently not determinable. The measurement period
will be either the six month period ending December 31, 1998 or the six month
period ending March 31, 1999, depending upon an election which can be made
either by the Company or the seller. As of the date hereof, neither the Company
nor the seller has made the election, and the measurement period has not yet
therefore been determined. It is currently anticipated that any such payment
would be expensed in the quarter the amount is determined. The impact of the
Keeloq Acquisition to the Company's reported financial position and results of
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operations is immaterial, therefore, pro-forma information illustrating the
combined results after the Keeloq Acquisition has not been provided.
(4) ACCOUNTS RECEIVABLE
Accounts receivable consists of the following (amounts in thousands):
September 30, March 31,
1998 1998
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(unaudited)
Trade accounts receivable $ 65,974 $ 57,922
Other 445 790
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66,419 58,712
Less allowance for doubtful accounts 2,494 2,392
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$ 63,925 $ 56,320
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(5) INVENTORIES
The components of inventories are as follows (amounts in thousands):
September 30, March 31,
1998 1998
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(unaudited)
Raw materials $ 5,722 $ 5,795
Work in process 45,880 40,000
Finished goods 30,255 30,021
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81,857 75,816
Less allowance for inventory valuation 10,517 9,523
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$ 71,340 $ 66,293
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(6) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following (amounts in
thousands):
September 30, March 31,
1998 1998
-----------------------------
(unaudited)
Land $ 11,749 $ 11,749
Building and building improvements 77,659 59,725
Machinery and equipment 355,404 322,624
Projects in process 53,356 82,528
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498,168 476,626
Less accumulated depreciation
and amortization 180,456 150,734
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$ 317,712 $ 325,892
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(7) LINES OF CREDIT
The Company has an unsecured line of credit with a syndicate of U.S.
banks for up to $90,000,000, bearing interest at LIBOR (5.52% at September 30,
1998) plus .325%, expiring in October 2000. At September 30, 1998, the Company
had utilized $45,000,000 of this line of credit. At March 31, 1998, the Company
had utilized $7,000,000 of the line of credit. The agreement between the Company
and the syndicate of banks requires the Company to achieve certain financial
ratios and operating results. The Company was in compliance with these covenants
as of September 30, 1998.
The Company has an additional unsecured line of credit with various
Taiwan financial institutions for up to $29,800,000 (U.S. Dollar equivalent).
These borrowings are predominantly denominated in New Taiwan Dollars, bearing
interest at SIBOR (5.43% at September 30, 1998) plus 0.75%, and expiring on
various dates through November 1999. At September 30, 1998, the Company had
utilized $1,800,000 of this line of credit. At March 31, 1998, the Company had
utilized $16,000,000 of this line of credit.
(8) STOCKHOLDERS' EQUITY
STOCK REPURCHASE AND OPTION ACTIVITY. During the six months ended
September 31, 1998, the Company's Board of Director's authorized the repurchase
of up to 4,000,000 shares of Common Stock and the sale of put options for an
additional 500,000 shares of Common Stock. In connection with the stock
repurchase program, during the six months ended September 30, 1998, the Company
purchased a total of 2,222,500 shares of the Company's Common Stock in open
market activities at a total cost of $57,890,000. As of September 30, 1998, the
Company had reissued 796,276 of these shares through stock option exercises, the
Company's employee stock purchase plan and settlements related to the Company's
net share settled forward contract. Subsequent to September 30, 1998, the
Company purchased 625,000 shares of the Company's Common Stock in open market
activities at a total cost of $12,430,000.
Also in connection with the stock repurchase program, during the six
months ended September 30, 1998, the Company sold put options covering 500,000
shares of Common Stock at prices ranging from $22.30 to $23.75 per share. During
the six months ended September 30, 1998, the Company repurchased put options for
50,000 shares. The net proceeds from the sale and repurchase of such put
options, in the amount of $1,650,000 for the six months ended September 30,
1998, has been credited to additional paid-in capital. As of September 30, 1998,
the Company had outstanding put options covering 950,000 shares of Common Stock
which have expiration dates ranging from October 23, 1998 to September 13, 1999
at prices ranging from $22.30 to $38.81 per share. Subsequent to September 30,
1998, the Company repurchased put options for 100,000 shares. The cost of this
transaction, $3,881,000, was charged to additional paid-in capital.
Also in connection with the stock repurchase program, during the six
months ended September 30, 1998, the Company completed a costless collar
transaction involving the purchase of call options for 500,000 shares of Common
Stock priced at $25.95 and the sale of put options for 665,000 shares of Common
Stock priced at $25.19. The expiration date of the transaction is April 1999.
Also in connection with the stock repurchase program, during the six months
ended September 30, 1998, the Company completed a net share settled forward
contract for 2,000,000 shares of Common Stock at an average price of $29.24. The
expiration date of this transaction is May 2000, with quarterly interim
settlement dates.
The Company expects from time to time to purchase shares of Common
Stock in connection with its authorized Common Stock repurchase plan.
8
(9) NET INCOME PER SHARE
The following table sets forth the computation of basic and diluted net
income per share (in thousands except per share amounts):
(10) COMPREHENSIVE INCOME
In June 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Standards (SFAS) No. 130, "Reporting Comprehensive
Income." SFAS No. 130 establishes requirements for disclosure of comprehensive
income and is effective for both interim and annual periods beginning after
December 15, 1997. Comprehensive income is defined as the change in equity from
transactions involving non-owner sources. The Company has no transactions
involving non-owner sources.
9
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
The following table sets forth certain operational data as a percentage
of net sales for the periods indicated:
For the quarter ended June 30, 1998, the Company recognized a special
charge of $5,500,000 which was comprised of three elements: a $3,300,000 legal
settlement with another company involving an intellectual property dispute; a
$1,700,000 write-off of products obsoleted by the introduction of newer
products; and a $500,000 charge associated with the restructuring of a portion
of the Company's sales organization.
NET SALES
Microchip's net sales for the quarter ended September 30, 1998 were
$103.8 million, an increase of 0.7% over sales of $103.0 million for the
corresponding quarter of the previous fiscal year, and an increase of 4.3% from
the previous quarter's sales of $99.5 million. Net sales for the six months
ended September 30, 1998 were $203.3 million, an increase of 1.5% from sales of
$200.3 million in the corresponding period of the previous fiscal year.
The Company's family of 8-bit microcontrollers represents the largest
component of Microchip's total net sales. Microcontrollers and associated
application development systems accounted for 75% and 69% of net sales in the
three months ended September 30, 1998 and 1997, respectively. A related
component of the Company's product sales consists primarily of Serial EEPROM
memories which accounted for 25% and 31% of net sales in the three months ended
September 30, 1998 and 1997, respectively. Microcontroller and associated
application development systems accounted for 75% and 69% of net sales in the
six months ended September 30, 1998 and 1997, respectively, while the related
component consisting of primarily Serial EEPROM memories accounted for 25% and
31%, respectively, for the same periods.
The Company's net sales in any given quarter are dependent upon a
combination of orders received in that quarter for shipment in that quarter
("turns orders") and shipments from backlog. As part of its competitive
strategy, the Company has emphasized its ability to respond quickly to such
turns orders. This strategy, combined with current industry conditions, results
in customers placing orders with short delivery schedules. The Company has been
experiencing increasing turns orders as a portion of its business over the last
several years and is highly dependent on turns orders. Because turns orders are
10
difficult to predict, there can be no assurance that the combination of turns
orders and shipments from backlog in any quarter will be sufficient to achieve
growth in net sales. If the Company does not achieve a sufficient level of turns
orders in a particular quarter, the Company's revenues and operating results
would be adversely affected.
The Company's overall average selling prices for its microcontroller
products have remained relatively constant, while average selling prices of its
memory products have declined over time. During fiscal 1998 and the first six
months of fiscal 1999, the Company continued to experience increased pricing
pressure on its memory products, primarily due to the less proprietary nature of
these products and increased competition, and the Company expects this to
continue in the future. While average selling prices for microcontrollers have
remained relatively constant, the Company has experienced, and expects to
continue to experience, increasing pricing pressure in certain microcontroller
product lines, due primarily to competitive conditions. The Company has been
able to maintain average selling prices by continuing to introduce new products
with more features and higher prices, thereby offsetting price declines in older
products. There can be no assurance that average selling prices for the
Company's microcontroller or other products can be maintained due to increased
pricing pressure in the future. An increase in pricing pressure could adversely
affect the Company's operating results.
THE FOREGOING STATEMENTS REGARDING TURNS ORDERS, AVERAGE SELLING PRICES
AND PRICING PRESSURES ARE FORWARD LOOKING STATEMENTS. ACTUAL RESULTS COULD
DIFFER MATERIALLY BECAUSE OF THE FOLLOWING FACTORS, AMONG OTHERS: THE LEVEL OF
ORDERS THAT ARE RECEIVED AND CAN BE SHIPPED IN A QUARTER; INVENTORY MIX AND
TIMING OF CUSTOMER ORDERS; COMPETITION AND COMPETITIVE PRESSURES ON PRICING AND
PRODUCT AVAILABILITY; CUSTOMERS' INVENTORY LEVELS, ORDER PATTERNS AND
SEASONALITY; THE CYCLICAL NATURE OF BOTH THE SEMICONDUCTOR INDUSTRY AND THE
MARKETS ADDRESSED BY THE COMPANY'S PRODUCTS; MARKET ACCEPTANCE OF THE PRODUCTS
OF BOTH THE COMPANY AND ITS CUSTOMERS; DEMAND FOR THE COMPANY'S PRODUCTS;
FLUCTUATIONS IN PRODUCTION YIELDS, PRODUCTION EFFICIENCIES AND OVERALL CAPACITY
UTILIZATION; CHANGES IN PRODUCT MIX; AND ABSORPTION OF FIXED COSTS, LABOR AND
OTHER FIXED MANUFACTURING COSTS.
Foreign sales represented 66% and 68% of net sales in the three months
ended September 30, 1998 and 1997, respectively, and 67% and 69% for the six
months ended September 30, 1998 and 1997, respectively. The Company's foreign
sales have been predominantly in Asia and Europe which the Company attributes to
the manufacturing strength in those areas for consumer, automotive, office
automation, communications and industrial products. The majority of foreign
sales are U.S. Dollar denominated. The Company has entered into, and from time
to time will enter into, hedging transactions in order to minimize exposure to
currency rate fluctuations. Although none of the countries in which the Company
conducts significant foreign operations have had a highly inflationary economy
in the last five years, there is no assurance that inflation rates or
fluctuations in foreign currency rates in countries where the Company conducts
operations will not adversely affect the Company's operating results in the
future.
ADDITIONAL FACTORS AFFECTING OPERATING RESULTS
The Company believes that future growth in net sales of its 8-bit
microcontrollers and other related products will depend largely upon the
Company's success in having its current and new products designed into
high-volume customer applications. Design wins typically precede the Company's
volume shipment of products for such applications by 15 months or more. The
Company also believes that shipment levels of its proprietary application
development systems are an indicator of potential future design wins and
microcontroller sales. The Company continued to achieve a high volume of design
wins and shipped substantial numbers of application development systems. There
can be no assurance that any particular development system shipment will result
in a product design win or that any particular design win will result in future
product sales.
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The Company's operating results are affected by a wide variety of other
factors that could adversely impact its net sales and profitability, many of
which are beyond the Company's control. These factors include the Company's
ability to design and introduce new products on a timely basis, market
acceptance of products of both the Company and its customers, customer order
patterns and seasonality, changes in product mix, whether the Company's
customers buy from a distributor or directly from the Company, product
performance and reliability, product obsolescence, the amount of any product
returns, availability and utilization of manufacturing capacity, fluctuations in
manufacturing yield, the availability and cost of raw materials, equipment and
other supplies, the cyclical nature of both the semiconductor industry and the
markets addressed by the Company's products, technological changes, competition
and competitive pressures on prices, and economic, political or other conditions
in the United States and other worldwide markets served by the Company. The
semiconductor industry is a capital intensive business and the Company's
operating results may be adversely affected if net sales are not sufficient to
offset the high fixed manufacturing costs and operating expenses. The Company's
products are incorporated into a wide variety of consumer, automotive, office
automation, communications and industrial products. A slowdown in demand for
products which utilize the Company's products as a result of economic or other
conditions in the worldwide markets served by the Company could adversely affect
the Company's operating results.
GROSS PROFIT
The Company's gross profit was $51.5 million and $52.1 million in the three
months ended September 30, 1998 and 1997, respectively, and $100.7 million and
$101.5 million in the six months ended September 30, 1998 and 1997,
respectively. Gross profit as a percent of sales was 49.6% and 50.6% in the
three months ended September 30, 1998 and 1997, respectively, and 49.6% and
50.7% in the six months ended September 30, 1998 and 1997, respectively. Gross
margins remained relatively constant during the quarter ended September 30,
1998, with product mix remaining relatively constant and average selling price
reductions, primarily in Serial EEPROMs, being offset by the Company's ongoing
cost reduction programs. The Company is continuing the process of transitioning
products to smaller geometries and to larger wafer sizes to reduce future
manufacturing costs. The Company anticipates that its cost of sales and gross
product margins will fluctuate over time, driven primarily by the product mix of
8-bit microcontroller products and related memory products, manufacturing
yields, wafer fab loading levels and competitive and economic conditions.
As a result of reduced shipments of Serial EEPROMs produced in the Company's
5-inch manufacturing facility, the Company has reduced the manufacturing levels
of this wafer fab by approximately 25%. The Company is also planning a longer
than normal shutdown of its wafer fabrication facilities at the end of December
1998. In order to offset the adverse cost absorption effects related to the
reduced 5-inch loading and the extended shutdown, the Company has instituted a
series of cost reductions in all aspects of its business. Management believes
that there will be no material financial impact from the reduced 5-inch loading
and extended shutdown; however, there can be no assurance that further
reductions in loading related primarily to customer demand will not result in
unabsorbed fixed costs, having an unfavorable impact on operating results and
net income reported by the Company.
THE FOREGOING STATEMENTS RELATING TO ANTICIPATED GROSS MARGINS, COST OF
SALES, THE TRANSITION TO HIGHER YIELDING MANUFACTURING PROCESSES, 5-INCH WAFER
PRODUCTION, AND THE EXTENT AND IMPACT OF OPERATING EXPENSE REDUCTIONS ARE
FORWARD-LOOKING STATEMENTS. ACTUAL RESULTS COULD DIFFER MATERIALLY BECAUSE OF
THE FOLLOWING FACTORS, AMONG OTHERS: FLUCTUATIONS IN PRODUCTION YIELDS,
PRODUCTION EFFICIENCIES AND OVERALL CAPACITY UTILIZATION; COST AND AVAILABILITY
OF RAW MATERIALS; ABSORPTION OF FIXED COSTS, LABOR AND OTHER DIRECT
MANUFACTURING COSTS; THE TIMING AND SUCCESS OF MANUFACTURING PROCESS TRANSITION;
12
DEMAND FOR THE COMPANY'S PRODUCTS; COMPETITION AND COMPETITIVE PRESSURE ON
PRICING OF SERIAL EEPROMS; THE IMPACT OF COST REDUCTIONS AND THE POSSIBLE NEED
FOR FURTHER COST REDUCTIONS; CHANGES IN PRODUCT MIX; COMPETITIVE PRESSURES ON
PRICES; AND OTHER ECONOMIC CONDITIONS.
All of Microchip's assembly operations are currently performed by
third-party contractors in order to meet product shipment requirements. Reliance
on third parties involves some reduction in the Company's level of control over
these portions of its business. While the Company reviews the quality, delivery
and cost performance of these third-party contractors, there can be no assurance
that reliance on third-party contractors will not adversely impact results in
future reporting periods if any third-party contractor is unable to maintain
assembly yields and costs at their current levels. Microchip intends to develop
its own in-house assembly operations over the next twelve months, and will
transition a portion of its assembly requirements from third-party contractors
to fill this capacity. The Company performs test operations at Company
facilities in Taiwan and Thailand.
The Company's reliance on third-party and Company facilities in Taiwan,
Thailand, the Philippines and other foreign countries, and maintenance of
substantially all of its finished goods inventory overseas, entails certain
political and economic risks, including political instability and expropriation,
supply disruption, currency controls and exchange fluctuations, as well as
changes in tax laws, tariff and freight rates. The Company has not experienced
any significant interruptions in its foreign business operations to date.
Nonetheless, the Company's business and operating results could be adversely
affected if foreign operations or international air transportation were
disrupted.
RESEARCH AND DEVELOPMENT
The Company is committed to continued investment in new and enhanced
products, including its development systems software, and in its design and
manufacturing process technology, which are significant factors in maintaining
the Company's competitive position. The dollar investment in research and
development increased by 12.7% in the current quarter as compared to the
corresponding quarter of the previous fiscal year, and by 3.5% from the previous
quarter. The Company will continue to invest in research and development in the
future, including an investment in process and product development associated
with capacity expansion of the Company's fabrication facilities.
The Company's future operating results will depend to a significant
extent on its ability to continue to develop and introduce new products on a
timely basis which can compete effectively on the basis of price and performance
and which address customer requirements. The success of new product
introductions depends on various factors, including proper new product
selection, timely completion and introduction of new product designs,
development of support tools and collateral literature that make complex new
products easy for engineers to understand and use and market acceptance of
customers' end products. Because of the complexity of its products, the Company
has experienced delays from time to time in completing development of new
products. In addition, there can be no assurance that any new products will
receive or maintain substantial market acceptance. If the Company were unable to
design, develop and introduce competitive products on a timely basis, its future
operating results would be adversely affected.
The Company's future success will also depend upon its ability to
develop and implement new design and process technologies. Semiconductor design
and process technologies are subject to rapid technological change, requiring
large expenditures for research and development. Other companies in the industry
have experienced difficulty in effecting transitions to smaller geometry
processes and to larger wafers and, consequently, have suffered reduced
manufacturing yields or delays in product deliveries. The Company believes that
its transition to smaller geometries and to larger wafers will be important for
13
the Company to remain competitive, and operating results could be adversely
affected if the transition is substantially delayed or inefficiently
implemented.
SELLING, GENERAL AND ADMINISTRATIVE
The Company maintained its level of investment in selling, general and
administrative costs at $16.2 million in the current quarter, as compared to
$16.1 million in the immediately proceeding quarter. On similar net sales,
selling, general and administrative costs were lower in the current quarter by
$1.0 million as compared to the corresponding quarter of the previous fiscal
year. As the Company continues to invest in incremental worldwide sales and
technical support resources to promote the Company's embedded control products,
selling, general and administrative costs are expected to increase over time, in
relation to sales.
OTHER INCOME (EXPENSE)
Interest income was maintained at the same level for the three months
ended September 30, 1998 as compared to the prior fiscal quarter and decreased
from the prior fiscal quarter as a result of reduced invested cash balances.
Interest expense in the three months ended September 30, 1998 increased over the
three months ended September 30, 1997 and the prior fiscal quarter,
respectively, due to incremental borrowing levels associated with a stock
repurchase program. Other income represents numerous immaterial non-operating
items. The Company's interest expense could increase in the balance of fiscal
1999 if the Company increases its borrowings, and interest expense could be
adversely impacted by increased interest rates.
PROVISION FOR INCOME TAXES
Provisions for income taxes reflect tax on foreign earnings and federal
and state tax on U.S. earnings. The Company had an effective tax rate of 27% in
each of the six months ended September 30, 1998 and 1997, due to the combination
of U.S. statutory taxes and lower tax rates at its foreign locations. The
Company believes that its tax rate for the foreseeable future will be
approximately 27%.
THE FOREGOING STATEMENT REGARDING THE COMPANY'S ANTICIPATED FUTURE TAX
RATE IS A FORWARD-LOOKING STATEMENT. ACTUAL RESULTS COULD DIFFER MATERIALLY
BECAUSE OF THE FOLLOWING FACTORS, AMONG OTHERS: CURRENT TAX LAWS AND
REGULATIONS; TAXATION RATES IN GEOGRAPHIC REGIONS WHERE THE COMPANY HAS
SIGNIFICANT OPERATIONS; AND CURRENT TAX HOLIDAYS AVAILABLE IN FOREIGN LOCATIONS.
YEAR 2000 ISSUE
The Year 2000 ("Y2K") issue is the result of various computer programs
being written using two digits rather than four to define the year, thus
potentially rendering them incapable of properly managing and manipulating data
that includes 21st century dates. The potential for Y2K issues which could
reasonably affect the Company could arise from any combination of: a) the
Company's own internal information processing and embedded systems, b) external
systems used by providers of critical goods or services to the Company, and c)
Y2K issues arising within the products manufactured by the Company.
THE COMPANY'S CURRENT STATE OF YEAR 2000 READINESS
The Company has implemented a Y2K readiness program and has, as of
September 30, 1998, taken substantial efforts to reasonably ensure that its
operations are not subject to substantial adverse Y2K-related impact. This
program began with a survey of potential sources of Y2K exposure which could
14
reasonably impact the Company's business. As of September 30, 1998, this initial
source identification phase has been completed.
The subsequent step in the program has been to systematically analyze
each identified potential source of Y2K exposure as to its likelihood of
material effect on the Company's operations and the range of available
remediation actions. In the case of identified systems INTERNAL to the Company,
analysis generally involved performing physical tests which simulated
performance of the systems with post-year 2000 dates. For potential sources of
Y2K risk which are EXTERNAL to the Company, such as with the Company's external
vendors and suppliers, the Company has typically relied upon written assurances
of Y2K compliance from those various parties in lieu of physical testing by the
Company's employees. To date, the Company has not identified any Y2K issues
inherent in the products manufactured by the Company. The Company's products,
for the most part, involve hardware integrated circuits which, at the time of
sale to customers, have no inherent date sensitive features. As of September 30,
1998, the analysis phase of the Y2K readiness program has been substantially
completed.
The final phase of the Y2K readiness program involves the modification,
replacement or elimination of systems identified in the prior analysis phase as
being in need of remediation. To date, the Company has completed the remediation
process for the majority of its identified INTERNAL systems, with the primary
effort centered around the total replacement of information systems related to
the Company's sales order process, planning, physical distribution and finance
functions. The majority of this task was completed during the quarter ended
September 30, 1998. As of September 30, 1998, the Company had surveyed and begun
to receive letters of Y2K compliance from approximately 80% of its key EXTERNAL
vendors and suppliers and expects to secure documentation of compliance from
these business partners by September 30, 1999.
COSTS TO ADDRESS THE YEAR 2000 ISSUE
The total cost associated with required modifications to become Y2K
compliant is not expected to be material to the Company's financial position.
The amount expended through September 30, 1998 was approximately $13,000,000,
primarily associated with the total replacement of the information systems
related to the Company's sales order process, planning, physical distribution
and finance functions which was completed during the quarter ended September 30,
1998. The Company had intended to replace such systems in the ordinary cause of
its business and the implementation was not substantially accelerated due to
Y2K. The Company believes that the cost of its Y2K readiness program, as well as
currently anticipated costs to be incurred with respect to Y2K issues of
third-parties, will not exceed $18,000,000, inclusive of the costs described
above. It is anticipated that all such expenditures will be funded from
operating cash flows and absorbed as part of the Company's ongoing operations.
THE FOREGOING STATEMENTS RELATED TO MATERIALITY OF Y2K COSTS, THE COSTS
TO ADDRESS Y2K ISSUES AND THE FUNDING AND ABSORPTION OF SUCH COSTS ARE FORWARD
LOOKING STATEMENTS. ACTUAL RESULTS COULD DIFFER MATERIALLY BECAUSE OF THE
FOLLOWING FACTORS, AMONG OTHERS: THE FAILURE TO CORRECTLY TIMELY IDENTIFY AND
CORRECT Y2K PROBLEMS, EITHER BY THE COMPANY OR ITS KEY SUPPLIERS OR CUSTOMERS.
MOST REASONABLY LIKELY WORST CASE SCENARIO(S)
Having reasonably determined that the Company's own hardware and
software systems will be substantially Y2K compliant and that its products
inherently have no date code-related issues, management believes that the worst
case scenarios would most likely involve massive, simultaneous Y2K-related
disruptions from the Company's key external raw material suppliers and/or
service providers. For these worst case scenarios to have maximum adverse impact
on the Company, the vendors
15
in question would either need to be sole-source providers or their peer
companies, who would otherwise be potential second-source suppliers, would also
need to undergo similar Y2K-related disruption. Examples on the material
supplier side would include extended and substantial disruptions of the
Company's key raw material suppliers of: silicon wafers, leadframes, specialty
chemicals and gasses. Examples on the service provider side would include
extended, substantial disruptions of the Company's third-party semiconductor
assembly firms, telecommunications and datacommunications services, airfreight
and delivery services, or the worldwide banking system. The Company believes
that such massive and simultaneous disruptions of the supply of basic goods and
services due to Y2K-related issues are highly unlikely to occur.
CONTINGENCY PLANS
The Company has made no contingency plans for handling Y2K issues
because it believes that the steps it has taken to assess its own hardware and
software systems and those of its key vendors and suppliers are adequate to
ensure minimal disruption to its business processes. In the event of random,
unforeseen Y2K problems (such as the failure of specific pieces of process
equipment, or the temporary inability of certain vendors to provide materials or
services) the Company believes that these types of issues will most likely be
able to be resolved in the normal course of business, including the potential
use of alternate suppliers, in most cases.
LIQUIDITY AND CAPITAL RESOURCES
The Company had $27.8 million in cash and cash equivalents at September
30, 1998, a decrease of $4.4 million from the March 31, 1998 balance. The
Company has an unsecured line of credit with a syndicate of domestic banks
totaling $90.0 million. Borrowings under the domestic line of credit as of
September 30, 1998 were $45.0 million. The domestic line of credit requires the
Company to achieve certain financial ratios and operating results. The Company
was in compliance with these covenants at September 30, 1998. The Company also
has an unsecured short term line of credit totaling $29.8 million with certain
foreign banks. Borrowings under the foreign line of credit as of September 30,
1998 were $1.8 million. There are no covenants related to the foreign line of
credit. At September 30, 1998, an aggregate of $73.0 million of these facilities
was available, subject to financial covenants and ratios with which the Company
was in compliance. The Company's ability to fully utilize these facilities is
dependent on the Company remaining in compliance with such covenants and ratios.
During the six months ended September 30, 1998, the Company generated
$49.3 million of cash from operating activities, a decrease of $42.1 million
from the six months ended September 30, 1997. The decrease in cash flow from
operations was primarily due to a special charge which decreased profitability,
a lower accounts payable balance as a result of lower capital purchases, an
increase in inventories and an increase in accounts receivable.
It is anticipated that the Company's investment in working capital will
continue to grow in line with sales growth. Inventory turns are expected to
remain relatively consistent over the balance of this fiscal year reflecting the
current net sales projection and capacity reductions of the Company's 5-inch
wafer fab. The accounts receivables balance grew in the quarter ending September
30, 1998, primarily due to reduced shipment linearity in the quarter associated
with the implementation of a new information system. It is anticipated that
accounts receivable balances will return to historical levels in future
quarters, in relationship to sales.
THE FOREGOING STATEMENTS REGARDING INVESTMENT IN WORKING CAPITAL,
INVENTORY TURNS AND ACCOUNTS RECEIVABLE BALANCES FOR FUTURE QUARTERS ARE FORWARD
LOOKING STATEMENTS. ACTUAL RESULTS COULD DIFFER
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MATERIALLY BECAUSE OF THE FOLLOWING FACTORS, AMONG OTHERS: THE LEVEL OF ORDERS
THAT ARE RECEIVED AND CAN BE SHIPPED IN A QUARTER; TIMELINESS OF CUSTOMER
INVOICING; INVENTORY MIX AND TIMING OF CUSTOMER ORDERS; COMPETITION AND
COMPETITIVE PRESSURES ON PRICING AND PRODUCT AVAILABILITY; CUSTOMERS' INVENTORY
LEVELS, ORDER PATTERNS AND SEASONALITY; THE CYCLICAL NATURE OF BOTH THE
SEMICONDUCTOR INDUSTRY AND THE MARKETS ADDRESSED BY THE COMPANY'S PRODUCTS;
MARKET ACCEPTANCE OF THE PRODUCTS OF BOTH THE COMPANY AND ITS CUSTOMERS; DEMAND
FOR THE COMPANY'S PRODUCTS; FLUCTUATIONS IN PRODUCTION YIELDS, PRODUCTION
EFFICIENCIES AND OVERALL CAPACITY UTILIZATION; CHANGES IN PRODUCT MIX; AND
ABSORPTION OF FIXED COSTS, LABOR AND OTHER FIXED MANUFACTURING COSTS; AND
COLLECTION OF ACCOUNTS RECEIVABLE AND DAYS OUTSTANDING.
The Company's level of capital expenditures varies from time to time as
a result of actual and anticipated business conditions. Capital expenditures in
the six months ended September 30, 1998 and 1997 were $24.2 million and $78.6
million, respectively. Capital expenditures were primarily for the expansion of
production capacity and the addition of research and development equipment in
each of these periods. The Company currently intends to spend approximately
$75.0 million during the next 12 months for additional capital equipment to
increase capacity at its existing wafer fabrication facilities to expand product
test operations and to develop in-house assembly capacity. The Company expects
capital expenditures will be financed by cash flow from operations, available
debt arrangements and other sources of financing. The Company believes that the
capital expenditures anticipated to be incurred over the next 12 months will
provide sufficient manufacturing capacity to meet its currently anticipated
needs.
Net cash used in financing activities was $29.5 million for the six
months ended September 30, 1998. Net cash provided by financing activities was
$4.4 million for the six months ended September 30, 1997. Proceeds from sale of
stock and put options were $7.0 million and $7.2 million for the six months
ended September 30, 1998 and 1997, respectively. Payments on long term debt and
capital lease obligations were $2.5 million and $2.7 million for the six months
ended September 30, 1998 and 1997, respectively. Proceeds from lines of credit
were $23.8 million for the six months ended September 30, 1998. Cash expended
for the purchase of the Company's Common Stock was $57.9 million for the six
months ended September 30, 1998.
During the six months ended September 30, 1998, the Company purchased
2,222,500 shares of Common Stock at an aggregate cost of $57,890,000 and had
outstanding 950,000 put options at prices ranging from $22.30 to $38.81.
Subsequent to September 30, 1998, the Company purchased 625,000 shares of Common
Stock at an aggregate cost of $12,430,000. The Company also has outstanding
puts, a costless collar and a net share settled forward contact. See Note 8 to
"Condensed Consolidated Financial Statements." These derivative transactions
could obligate the Company to purchase shares of the Company's Common Stock in
the future if the stock price is below the strike price of the instruments.
The Company expects from time to time to purchase shares of Common
Stock in connection with its authorized Common Stock repurchase plan.
The Company believes that its existing sources of liquidity combined
with cash generated from operations will be sufficient to meet the Company's
currently anticipated cash requirements for at least the next 12 months.
However, the semiconductor industry is capital intensive. In order to remain
competitive, the Company must continue to make significant investments in
capital equipment, for both production and research and development. The Company
may seek additional equity or debt financing during the next 12 months for the
capital expenditures required to maintain or expand the Company's wafer
fabrication and product test facilities or other purposes. The timing and amount
of any such capital requirements will depend on a number of factors, including
demand for the Company's products, product mix, changes in industry conditions
and competitive factors. There can be no assurance that such
17
financing will be available on acceptable terms, and any additional equity
financing could result in additional dilution to existing investors.
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
(a) The Annual Meeting of Stockholders of the Company was held on
August 10, 1998 (the "Meeting").
(b) Steve Sanghi, Albert J. Hugo-Martinez, L.B. Day and Matthew W.
Chapman were elected as Directors at the Meeting.
(c) The results of the vote on the matters voted upon at the
Meeting were as follows:
(i) ELECTION OF DIRECTORS:
(ii) RATIFICATION OF APPOINTMENT OF KPMG PEAT MARWICK LLP
AS THE COMPANY'S INDEPENDENT AUDITORS FOR THE FISCAL
YEAR ENDING MARCH 31, 1999:
FOR AGAINST ABSTAIN
42,398,471 36,271 26,064
The foregoing matters are described in more detail in the Registrant's
definitive proxy statement dated July 6, 1998 relating to the Meeting.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
3.1 By-Laws of Registrant as amended through August 10,
1998.
3.2 Modification Agreement dated as of November 4, 1998
to the Credit Agreement dated as of October 28, 1997
among Registrant, the Banks named therein, Bank One,
Arizona, N.A., as Administrative Agent and The First
National Bank of Chicago, as Documentation Agent
(b) Reports on Form 8-K.
The registrant did not file any reports on Form 8-K during the
quarter ended September 30, 1998.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MICROCHIP TECHNOLOGY INCORPORATED
Date: November 9, 1998 By: /s/ C. Philip Chapman
------------------ --------------------------------
C. Philip Chapman
Vice President, Chief Financial Officer
and Secretary (Duly Authorized Officer, and
Principal Financial and Accounting Officer)
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