10-Q: Quarterly report pursuant to Section 13 or 15(d)
Published on February 12, 1999
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
( X ) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended DECEMBER 31, 1998.
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________ to _____________.
Commission File Number: 0-21184
MICROCHIP TECHNOLOGY INCORPORATED
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 86-0629024
(State or Other Jurisdiction of (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
----- -----
The number of shares outstanding of the issuer's common stock, as of January 29,
1998:
COMMON STOCK, $.001 PAR VALUE: 50,712,393 SHARES
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MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
INDEX
PAGE
PART I. FINANCIAL INFORMATION.
Item 1. Financial Statements
Condensed Consolidated Balance Sheets - December
31, 1998 and March 31, 1998 ...................................3
Condensed Consolidated Statements of Income -
Three and Nine Months Ended December 31, 1998
and December 31, 1997 .........................................4
Condensed Consolidated Statements of Cash Flows -
Nine Months Ended December 31, 1998 and
December 31, 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 6. Exhibits and Reports on Form 8-K .............................19
SIGNATURES ..................................................................20
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)
Nine Months Ended
December 31,
------------------------
1998 1997
--------- ---------
Cash flows from operating activities: (Unaudited)
Net income $ 48,191 $ 50,141
Adjustments to reconcile net income to
net cash provided by operating
activities:
Provision for doubtful accounts 216 456
Provision for inventory valuation 1,567 669
Provision for pension accrual 708 954
Special charges -- 5,000
Depreciation and amortization 48,978 39,055
Amortization of purchased technology 225 225
Deferred income taxes (4,594) (4,368)
Increase in accounts receivable (102) (1,407)
Increase in inventories (7,383) (2,598)
Increase (decrease) in accounts payable
and accrued liabilities (15,933) 25,749
Change in other assets and liabilities (1,689) 11,413
--------- ---------
Net cash provided by operating activities 70,184 125,289
--------- ---------
Cash flows from investing activities:
Capital expenditures (29,680) (123,359)
--------- ---------
Net cash used in investing activities (29,680) (123,359)
--------- ---------
Cash flows from financing activities:
Net proceeds from lines of credit 18,800 --
Payments on long-term debt (1,835) (1,967)
Payments on capital lease obligations (1,828) (2,941)
Repurchase of common stock (70,324) (7,519)
Proceeds from sale of stock and put options 7,456 9,342
--------- ---------
Net cash used in financing activities (47,731) (3,085)
--------- ---------
Net decrease in cash and cash equivalents (7,227) (1,155)
Cash and cash equivalents at beginning of period 32,188 42,999
--------- ---------
Cash and cash equivalents at end of period $ 24,961 $ 41,844
========= =========
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 nine
months ended December 31, 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 estimated to be between $8,000,000 and
$15,000,000. The measurement period is the six-month period ending March 31,
1999, based upon an election which was made by the seller.
6
(4) ACCOUNTS RECEIVABLE
Accounts receivable consists of the following (amounts in thousands):
December 31, March 31,
1998 1998
------------ ------------
(unaudited)
Trade accounts receivable $ 58,294 $ 57,922
Other 421 790
------------ ------------
58,712 58,712
Less allowance for doubtful accounts 2,509 2,392
------------ ------------
$ 56,206 $ 56,320
============ ============
(5) INVENTORIES
The components of inventories are as follows (amounts in thousands):
December 31, March 31,
1998 1998
---------------------------
(unaudited)
Raw materials $ 4,852 $ 5,795
Work in process 47,277 40,000
Finished goods 30,906 30,021
------------ ------------
83,035 75,816
Less allowance for inventory valuation 10,926 9,523
------------ ------------
$ 72,109 $ 66,293
============ ============
(6) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following (amounts in
thousands):
December 31, March 31,
1998 1998
---------------------------
(unaudited)
Land $ 11,545 $ 11,749
Building and building improvements 78,570 59,725
Machinery and equipment 371,941 322,624
Projects in process 41,173 82,528
------------ ------------
503,229 476,626
Less accumulated depreciation
and amortization 196,635 150,734
------------ ------------
$ 306,594 $ 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 (5.624% at December 31,
1998) plus .325%, expiring in October 2000. At December 31, 1998 and at March
31, 1998, the Company had utilized $28,000,000 and $7,000,000, respectively, 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 December 31, 1998.
The Company has an additional unsecured line of credit with various
Taiwan financial institutions for up to $32,800,000 (U.S. Dollar equivalent).
These borrowings are predominantly denominated in New Taiwan Dollars, bearing
interest at SIBOR (5.125% at December 31, 1998) plus 0.60%, and expiring on
various dates through November 1999. At December 31, 1998 and March 31, 1998 the
Company had utilized $13,800,000 and $16,000,000, respectively, of this line of
credit.
(8) STOCKHOLDERS' EQUITY
STOCK PURCHASE AND OPTION ACTIVITY. As of March 31, 1998, the Company
held 1,010,953 shares in treasury stock. During the nine months ended December
31, 1998, the Company's Board of Directors authorized the purchase of up to
4,000,000 shares of Common Stock and the sale of put options covering an
additional 500,000 shares of Common Stock. In connection with the stock purchase
program, during the nine months ended December 31, 1998, the Company purchased a
total of 2,847,500 shares of the Company's Common Stock in open market
activities at a total cost of $70,324,000. For the nine month period ended
December 31, 1998, the Company had reissued 958,942 of purchased shares through
stock option exercises, the Company's employee stock purchase plan and
settlements related to the Company's net share settled forward contract. As of
December 31, 1998, the Company held 3,230,086 shares in treasury stock.
Also in connection with the stock purchase program, during the nine
months ended December 31, 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 nine months ended December 31, 1998, the Company purchased put options for
100,000 shares. The net proceeds from the sale and purchase of such put options,
in the amount of $2,231,000 for the nine months ended December 31, 1998, were
charged to additional paid-in capital. As of December 31, 1998, the Company had
outstanding put options covering 850,000 shares of Common Stock which have
expiration dates ranging from January 29, 1999 to September 13, 1999, at prices
ranging from $22.30 to $37.88 per share.
Also in connection with the stock purchase program, during the nine
months ended December 31, 1998, the Company completed a costless collar
transaction involving the purchase of call options covering 500,000 shares of
Common Stock priced at $25.95 and the sale of put options covering 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 purchase program, during the
nine months ended December 31, 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 stock purchase program.
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
INTRODUCTION AND FOURTH QUARTER OUTLOOK
The current environment in the semiconductor industry continues to be
characterized by flat to negative sales growth, extremely low order visibility
and declining inventory levels at customers and throughout the distribution
channel. Over the past twelve months Microchip's sales in dollars have remained
relatively flat overall, while the Company has experienced moderate growth in
its core 8-bit microcontroller product line and has continued to gain market
share in that market. Microchip anticipates an industry-wide return to growth
during the second half of this calendar year and has taken a variety of measures
to optimally position the Company for such an upturn.
The Company has decided to implement two restructuring actions to
position the Company for future cost effective growth. During the March 1999
quarter, the Company will complete closure of its 5-inch wafer line which
represents the Company's least flexible and least cost-effective productive
capacity. In eliminating the 5-inch production capacity, the Company's
productive capacity will be reduced by approximately 20%. The Company intends to
replace this capacity with 6-inch and 8-inch wafer production, but intends to
delay this action until inventories have been reduced in both net dollars and
days' sales of inventories. The Company also plans to restructure its assembly
and test operations over the next two quarters, migrating more of its test and a
portion of its assembly to lower-cost, Company-owned facilities. Based on these
two restructuring actions, the Company expects to incur a special restructuring
charge in the March 1999 quarter of $15 to $17 million.
Additionally, as indicated in Footnote (3) in the Notes to Condensed
Consolidated Financial Statements, under the terms of the Keeloq Acquisition,
the Company expects to make the final acquisition payment based upon the
performance of the Company's Keeloq(R) products during the measurement period
ending March 31, 1999. This payment is currently estimated to be between $8
million and $15 million.
THE FOREGOING STATEMENTS RELATING TO ANTICIPATED INDUSTRY-WIDE RETURN
TO GROWTH, THE COMPANY'S POSITIONING FOR AN INDUSTRY-WIDE UPTURN, THE AMOUNT OF
RESTRUCTURING CHARGES FOR THE QUARTER ENDING MARCH 31, 1999 AND THE AMOUNT OF
THE FINAL PAYMENT FOR THE KEELOQ ACQUISITION ARE FORWARD-LOOKING STATEMENTS.
ACTUAL RESULTS COULD DIFFER MATERIALLY BECAUSE OF THE FOLLOWING FACTORS, AMONG
OTHERS; MARKET CONDITIONS IN THE SEMICONDUCTOR INDUSTRY AND DEMAND FOR THE
COMPANY'S PRODUCTS; DELAY IN THE FACILITATION OF THE COMPANY'S IN-HOUSE ASSEMBLY
AND TEST OPERATIONS; FLUCTUATIONS IN PRODUCTION YIELDS AND PRODUCTION
EFFICIENCIES; OVERALL CAPACITY UTILIZATION; COST AND AVAILABILITY OF RAW
MATERIALS; ABSORPTION OF FIXED COSTS, LABOR AND OTHER DIRECT MANUFACTURING
COSTS; CHANGES IN PRODUCT MIX; AND SALES OF KEELOQ(R)-RELATED PRODUCTS DURING
THE SIX MONTHS ENDING MARCH 31, 1999.
10
RESULTS OF OPERATIONS
The following table sets forth certain operational data as a percentage
of net sales for the periods indicated:
Three Months Ended Nine Months Ended
December 31, December 31,
1998 1997 1998 1997
--------------------------------------
Net sales ......................... 100.0% 100.0% 100.0% 100.0%
Cost of sales ..................... 49.4% 51.9% 50.1% 50.2%
----- ----- ----- -----
Gross profit ...................... 50.6% 48.1% 49.9% 49.8%
Research and development .......... 10.1% 9.7% 10.2% 9.4%
Selling, general and administrative 15.4% 16.6% 15.7% 16.7%
Special charge .................... -- 4.8% 1.8% 1.6%
----- ----- ----- -----
Operating income .................. 25.1% 17.0% 22.2% 22.1%
===== ===== ===== =====
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 December 31, 1998 were
$100.2 million, a decrease of 3.3% over sales of $103.6 million for the
corresponding quarter of the previous fiscal year, and a decrease of 3.5% from
the previous quarter's sales of $103.8 million. Net sales for the nine months
ended December 31, 1998 were $303.4 million, flat with sales of $303.8 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 76% and 67% of net sales in the
three months ended December 31, 1998 and 1997, respectively. A related component
of the Company's product sales consists primarily of Serial EEPROM memories
which accounted for 24% and 33% of net sales in the three months ended December
31, 1998 and 1997, respectively. Microcontroller and associated application
development systems accounted for 75% and 68% of net sales in the nine months
ended December 31, 1998 and 1997, respectively, while the related component
consisting of primarily Serial EEPROM memories accounted for 25% and 32%,
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
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
11
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 nine
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. 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 71.0% of net sales in both the three months
ended December 31, 1998 and 1997 and 68.0% and 70.0% for the nine months ended
December 31, 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.
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
12
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 $50.6 million and $49.8 million in the
three months ended December 31, 1998 and 1997, respectively, and $151.4 million
and $151.3 million in the nine months ended December 31, 1998 and 1997,
respectively. Gross profit as a percent of sales was 50.6% and 48.1% in the
three months ended December 31, 1998 and 1997, respectively, and 49.9% and 49.8%
in the nine months ended December 31, 1998 and 1997, respectively. Gross margins
improved during the quarter ended December 31, 1998, influenced primarily by
improved product mix between microcontrollers and Serial EEPROMS and the
Company's ongoing cost reduction programs. The Company anticipates that its
gross product margins will fluctuate over time, driven primarily by the product
mix of 8-bit microcontroller products and related memory products, wafer fab
loading levels, ongoing cost reduction efforts, manufacturing yields and
competitive and economic conditions.
During the quarter ended December 31, 1998, the Company reduced the
manufacturing levels of its 5-inch wafer fab by approximately 30%. The Company
also completed a longer than normal holiday shutdown of its wafer fabrication
facilities at the end of December 1998. The Company intends to eliminate its
5-inch wafer line by the end of the current fiscal quarter, primarily due to the
higher cost and lower manufacturing flexibility of this production line. The
Company intends to replace this capacity with 6-inch and 8-inch wafer
production, but intends to delay this action until inventories have been reduced
in both net dollars and days' sales of inventories. The Company also plans to
restructure its assembly and test operations over the next two quarters.
In order to offset the adverse cost absorption effects related to the
elimination of the 5-inch wafer fab, the Company has instituted a series of cost
reductions in all aspects of its business. There can be no assurance that these
restructuring actions and cost reductions will sufficiently reduce fixed
manufacturing costs to enable the Company to maintain gross profit margins. In
addition, these restructuring actions could result in execution problems and
manufacturing yield problems that could adversely impact the Company's gross
profit.
THE FOREGOING STATEMENTS RELATING TO ANTICIPATED GROSS PRODUCT MARGIN,
CLOSURE OF THE COMPANY'S 5-INCH WAFER PRODUCTION LINE, 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; DEMAND FOR THE COMPANY'S PRODUCTS; COMPETITION
AND
13
COMPETITIVE PRESSURE ON PRICING; THE IMPACT OF COST REDUCTIONS AND THE POSSIBLE
NEED FOR FURTHER COST REDUCTIONS; CHANGES IN PRODUCT MIX; 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 currently performs test operations at
Company-owned facilities in Taiwan and Thailand.
THE FOREGOING STATEMENT RELATED TO THE COMPANY'S INTENTION TO DEVELOP
IN-HOUSE ASSEMBLY AND TEST OPERATIONS OVER THE NEXT 12 MONTHS IS A
FORWARD-LOOKING STATEMENT. ACTUAL RESULTS COULD DIFFER MATERIALLY BECAUSE OF THE
FOLLOWING FACTORS, AMONG OTHERS: TIMING AND SUCCESS OF THE TRANSITION FROM THIRD
PARTY ASSEMBLY SERVICES PROVIDERS TO COMPANY-OWNED ASSEMBLY AND TEST OPERATIONS;
DELAY IN THE FACILITATION OF THE COMPANY'S IN-HOUSE ASSEMBLY AND TEST
OPERATIONS; DIFFICULTIES IN THE TRANSITION OF THE ASSEMBLY FUNCTION FROM THIRD
PARTIES TO THE COMPANY; SUPPLY DISRUPTION; LABOR UNREST; CHANGES IN PRODUCT MIX;
COMPETITIVE PRESSURES ON PRICES AND OTHER ECONOMIC CONDITIONS.
The Company's reliance on third-party and Company-owned 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 1.3% in the current quarter as compared to the
corresponding quarter of the previous fiscal year, and decreased by 4.1% from
the previous quarter as a result of the Company's ongoing cost reduction
programs. The Company will continue to invest in research and development in the
future, including an investment in process and product development.
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.
14
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
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 reduced its level of selling, general and administrative
costs to $15.4 million in the current quarter compared to $16.2 million in the
immediately proceeding quarter. This decrease resulted from the Company's
ongoing cost reduction programs. On slightly lower net sales, selling, general
and administrative costs were lower in the current quarter by $1.8 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 December 31, 1998, as compared to the prior fiscal quarter and decreased
from the corresponding quarter of the previous fiscal year as a result of
reduced invested cash balances. Interest expense in the three months ended
December 31, 1998 increased over the three months ended December 31, 1997, due
to incremental borrowing levels associated with the stock repurchase program.
Interest expense in the three months ended December 31, 1998 decreased from the
prior fiscal quarter due to lower borrowings on the Company's lines of credit.
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
Provision 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 nine months ended December 31, 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
15
systems used by providers of critical goods or services to the Company, c)
customer failures resulting from Y2K problems leading to reductions in demand
from the customer and d) 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
December 31, 1998, taken substantial efforts to reasonably insure that its
operations are not subject to substantial adverse Y2K-related impact. This
program began in 1997 with a comprehensive documentation of potential sources of
Y2K exposure which could reasonably impact the Company's business. 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. 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 December 31, 1998, the Company has received letters of
Y2K compliance from approximately 80% of its key EXTERNAL vendors and suppliers
and expects to secure documentation of compliance from the remainder of these
key vendors and suppliers 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 December 31, 1998 was approximately $14,000,000,
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 the
Y2K issue. 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.
16
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 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. Examples on the customer side would include Y2K problems
encountered by such customer adversely impacting that customer's business and
reducing the customer's purchases from the Company. 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.
THE FOREGOING STATEMENTS RELATED TO MATERIALITY OF Y2K COSTS, THE COSTS
TO ADDRESS Y2K ISSUES AND THE FUNDING AND ABSORPTION OF SUCH COSTS, WORST-CASE
SCENARIO(S) AND CONTINGENCY PLANS 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.
EURO CONVERSION ISSUES
The Company operates in the European Market and currently generates
approximately 30% of its net sales from customers located in Europe. The
Company's commercial headquarters in Europe are located in the United Kingdom,
which is not currently one of the eleven member states of the European Union who
are converting to a common currency.
The Company currently conducts 96% of its business in Europe in U.S.
Dollars and 2% of its business in Europe in Pounds Sterling. The balance of its
net sales are conducted in currencies which will eventually be replaced by the
euro. The Company will be monitoring the potential commercial impact of
converting a portion of its current business to the euro, but does not expect
any material impact to its business based on this transition.
The Company does not currently anticipate any material impact to its
business related to euro matters from information technology, derivative
transactions, tax issues and accounting software issues.
17
LIQUIDITY AND CAPITAL RESOURCES
The Company had $25.0 million in cash and cash equivalents at December
31, 1998, a decrease of $7.2 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
December 31, 1998 were $28.0 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 December 31, 1998. The Company also
has an unsecured short-term line of credit totaling $32.8 million with certain
foreign banks. Borrowings under the foreign line of credit as of December 31,
1998 were $13.8 million. There are no covenants related to the foreign line of
credit. At December 31, 1998, an aggregate of $81.0 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 nine months ended December 31, 1998, the Company generated
$70.2 million of cash from operating activities, a decrease of $55.1 million
from the nine months ended December 31, 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 and an
increase in inventories.
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 nine months ended December 31, 1998 and 1997 were $29.7 million and $123.4
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
$70.0 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 $47.7 million for the nine
months ended December 31, 1998. Net cash used in financing activities was $3.1
million for the nine months ended December 31, 1997. Proceeds from sale of stock
and put options were $7.5 million and $9.3 million for the nine months ended
December 31, 1998 and 1997, respectively. Payments on long term debt and capital
lease obligations were $3.7 million and $4.9 million for the nine months ended
December 31, 1998 and 1997, respectively. Proceeds from lines of credit were
$18.8 million for the nine months ended December 31, 1998. Cash expended for the
purchase of the Company's Common Stock was $70.3 million for the nine months
ended December 31, 1998.
During the nine months ended December 31, 1998, the Company purchased
2,847,500 shares of Common Stock at an aggregate cost of $70,324,000 and had
outstanding 850,000 put options at prices ranging from $22.30 to $37.88. The
Company also has 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 purchase plan. The Company
18
will also have cash requirements associated with the restructuring activities
described above and the secondary payment related to the Keeloq Acquisition.
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 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 6. EXHIBITS AND REPORTS ON FORM 8-K.
a) Exhibits.
None.
b) Reports on Form 8-K.
The registrant did not file any reports on Form 8-K during the
quarter ended December 31, 1998.
19
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MICROCHIP TECHNOLOGY INCORPORATED
Date: February 12, 1999 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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