Item 1. BUSINESS
Microchip Technology Incorporated, a Delaware corporation ("Microchip" or the "Company"), develops, manufactures and markets 8-bit microcontrollers, application-specific standard products (ASSPs) and related memory products for high-volume embedded control applications in the consumer, automotive, office automation, communications and industrial markets. The Company provides highly cost-effective embedded control products for a wide variety of applications and believes that its PIC(R) product family is a price/performance leader in the worldwide 8-bit microcontroller market. Microchip's embedded control products also offer the advantages of a small footprint and low voltage operation along with ease of development, enabling timely and cost-effective product integration by its customers. The Company's ASSP products include a variety of specialized integrated circuits, including its family of KEELOQ(R) security products. The Company's memory products are primarily comprised of Serial EEPROMs, which are used primarily to provide non-volatile memory storage in embedded control systems.
Except as noted below, references to the Company include the Company and its subsidiaries. The Company's executive offices are located at 2355 West Chandler Boulevard, Chandler, Arizona 85224-6199 and its telephone number is (602) 786-7200.
The following discussion of the Company's business contains certain risk factors that may affect future operating results. For further discussion on certain risk factors that may affect the Company's future operating results, see "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operation," below.
This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Exchange Act of 1933 and Section 21E of the Securities Exchange Act of 1934 which involve risks and uncertainties, including statements regarding the Company's strategy, financial performance, and revenue sources. The Company's actual results could differ materially from the results anticipated in these forward-looking statements as a result of certain factors including those set forth under "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this report.
Industry Background
Competitive pressures increasingly require manufacturers to expand product functionality and provide differentiation while maintaining or reducing cost. To address these requirements, manufacturers increasingly use integrated circuit-based embedded control systems which provide an integrated solution for application-specific control requirements. Embedded control systems enable manufacturers to differentiate their products, replace less efficient electromechanical control devices, add product functionality and significantly reduce product costs. In addition, embedded control systems facilitate the emergence of complete new classes of products. Embedded control systems have been incorporated into thousands of products and subassemblies in a wide variety of markets worldwide, including automotive air bag systems, remote control devices, handheld tools, appliances, portable computers, cordless and cellular telephones, motor controls and security systems.
Embedded control systems typically incorporate a microcontroller as the principal active, and sometimes sole, component. A microcontroller is a self-contained computer-on-a-chip consisting of a central processing unit, non-volatile program memory, RAM memory for data storage and various input/output functions. In addition to the microcontroller, a complete embedded control system incorporates application-specific software and may include specialized peripheral device controllers and external non-volatile memory components, such as EEPROMs, to store additional program software.
The increasing demand for embedded control has made the market for microcontrollers one of the largest segments of the semiconductor logic market. Microcontrollers are currently available in 4-bit through 32-bit architectures. Although 4-bit microcontrollers are relatively inexpensive, typically costing under $1.00 each, they generally lack the minimum performance and features required by today's design engineers for product differentiation and are typically used only to produce basic functionality in products. While 16- and 32-bit architectures provide very high performance, they are prohibitively expensive for most high-volume embedded control applications, typically costing over $5.00 each. As a result, manufacturers of competitive, high-volume products have increasingly found 8-bit microcontrollers, that typically cost $1.00 to $8.00 each, to be the most cost-effective embedded control solution. For example, a typical new automobile may include one 32-bit microcontroller for engine control, three 16-bit microcontrollers for transmission control, audio systems and anti-lock braking, and up to 50 8-bit microcontrollers to provide other embedded control functions, such as door locking,
automatic windows, sun roof, adjustable seats, electric mirrors, air bags, fuel pump, speedometer, and the security and climate control systems.
Most microcontrollers available today are ROM-based and must be programmed by the semiconductor supplier during manufacturing, resulting in six-to-20 week lead times for delivery of such microcontrollers. In addition to delayed product introduction, these long lead times can result in potential inventory obsolescence and factory shutdowns when changes to the firmware are required. To address time-to-market constraints, some suppliers have made EPROM-, EEPROM-, or Flash Memory-based programmable microcontrollers available for prototyping and preproduction runs. However, these microcontrollers have been relatively expensive, and manufacturers have still been required to send program code to the semiconductor factory for ROM programming as product changes are made. As a result, the long lead times for production volume microcontrollers have not been significantly reduced by traditional approaches.
Products
Microchip's strategic focus is on embedded control products, including microcontrollers, ASSPs, related memory products and application development systems.
Microcontrollers
Microchip offers a broad family of proprietary 8-bit microcontrollers under the PIC(R) name and has shipped approximately 600 million PIC(R) microcontrollers to customers worldwide since 1990. The Company's PIC(R) products are designed for applications requiring high performance and low cost. They feature a variety of memory configurations, low voltage and power, small footprint and ease of use. Microchip believes this product family is currently a price/performance leader in the 8-bit microcontroller marketplace. Microchip's performance results from an exclusive RISC-based architecture that provides significant speed advantages over the alternative 8-bit CISC architectures. In addition to providing up to 40 MHz performance, this architecture offers up to a 2:1 software compaction advantage, thereby significantly reducing software development time. RISC architectures also have the advantage of being more easily scaled to higher internal clock speeds in future products. Prices for Microchip's 8-bit microcontrollers range from approximately $.49 to $12.00 per unit.
Microchip's original market focus was in the lowest cost segment of the 8-bit microcontroller marketplace. With its baseline 8-bit products, the Company built its current market position as the leading supplier of field programmable microcontrollers. Over the past three years, Microchip has introduced more than 100 new 8-bit microcontrollers targeted at baseline, mid-range and high-end segments of the 8-bit microcontroller marketplace, as well as the lower end of the 16-bit microcontroller market. In addition, with its 8-pin, 8-bit microcontroller, introduced in the first quarter of fiscal 1997, the Company has also targeted a portion of the large 4-bit microcontroller marketplace. The Company believes that these additional segments represent a significant opportunity for future sales growth.
Microchip has used its manufacturing experience and design and process technology to bring additional enhancements and manufacturing efficiencies to the development and production of its PIC(R) family of microcontroller products. This extensive experience base has enabled the Company to develop its advanced, low cost user programmability feature by incorporating non-volatile memory (EPROM, EEPROM and Flash Memory) into the microcontroller in addition to masked ROM program memory.
Development Systems
The Company offers a comprehensive set of low cost and easy-to-learn application development tools. These tools enable system designers to quickly and easily program a PIC(R) microcontroller for specific applications and are a key factor for obtaining design wins. Microchip's family of development tools operates in the standard Windows environment on standard PC hardware. Entry-level systems, which include an assembler and programmer hardware, are priced at less than $200. A fully configured system, which also provides in-circuit emulation hardware, performance simulators and software debuggers, is priced at approximately $3,700. Customers moving from entry-level designs to those requiring real-time emulation are able to preserve their investment in software tools as they migrate to future PIC(R) devices since all the product families are assembly- and C- language compatible.
Many independent companies also develop and market application development tools and systems which support Microchip's standard microcontroller product architecture. The Company believes that familiarity with and adoption of the Company's, and third-party, development systems by an increasing number of product designers will be an important factor
in the future selection of Microchip's embedded control products. These development tools allow design engineers to develop thousands of application-specific products from Microchip's standard microcontrollers. Currently, there are more than 120 third-party tool suppliers worldwide whose products support the Company's proprietary microcontroller architecture.
ASSPs (Application-Specific Standard Products)
Microchip's application-specific standard products are specialized products designed to perform specific end-user applications as opposed to the Company's other products which are more general purpose in nature. The Company's ASSP device families currently include the KEELOQ(R) family of secure data transmission products, as well as other specialized integrated circuit devices. KEELOQ(R) security products are designed for low cost, secure, uni-directional communications and verification purposes. Applications include automotive remote keyless entry systems, automotive immobilizer systems, automatic garage and gate openers and smart cards.
Memory Products
Microchip's memory products consist primarily of Serial EEPROMs. The Company sells these devices primarily into the embedded control market and is the third largest supplier of such devices worldwide. EEPROM (electrically erasable programmable read only memory) products are used for non-volatile program and data storage in systems where such data must be modified frequently. Serial EEPROMs have a very low I/O pin requirement, permitting production of very small devices. As a result, Serial EEPROMs are widely used to supply non-volatile memory in space-sensitive applications such as portable computers, cellular and cordless telephones, pagers and remote control devices.
Within this market, Microchip has emphasized providing Serial EEPROMs to customers that require features such as highly compact packaging, low operating voltage, reduced power consumption, extended data retention and high endurance. The Company addresses these requirements by offering products with extremely small package sizes and very low operating voltage for both read and write functions (1.8 volts in contrast with the industry standard of 3.3 volts), together with a wide operating voltage range (1.8 to 5.5 volts). High performance circuitry and microcode are also available to reduce power consumption when a device is not in use, while permitting immediate operating capability when required. The products also feature long data retention and high erase/write endurance.
Microchip currently offers a complete Serial EEPROM family, which meets three principal industry bus interface standards and is available in most standard density, configuration and packaging alternatives. The Company's Smart Serials(TM) line of specialized Serial EEPROMs with user-configurable architecture and other advanced features targets applications such as cellular telephones and data communications.
Manufacturing
Microchip's ownership of its manufacturing resources is an important component of its business strategy, enabling it to maintain a high level of manufacturing control and to be one of the lowest cost producers in the embedded control industry. By owning its wafer fabrication and the majority of its test operations, and by employing proprietary statistical process control techniques, the Company has been able to achieve high production yields. Direct control over wafer fabrication also allows Microchip to shorten the Company's design and production cycles and to capture the manufacturing and a portion of the testing profit margin. Wafer fabrication and wafer test facilities are located in Chandler ("Fab 1") and Tempe ("Fab 2"), Arizona. The Company performs product test at its facilities in Kaohsiung, Taiwan and Chachoengsao, Thailand, located near Bangkok.
Wafers are produced in Class 10 fabrication modules in Fab 1 and Fab 2. Fab 1 currently contains approximately 27,000 square feet. Fab 2 has approximately 50,000 square feet of useable clean room space of which approximately 40,000 square feet are used to support current production requirements. Fab 1 currently produces 5-inch and 6-inch wafers, while Fab 2 currently produces 6-inch and 8-inch wafers. Wafer sort is performed in an 8,000 square foot, Class 10,000 clean room, equipped with automated wafer handlers and test equipment. The two wafer fabrication sites are managed by the same management team and utilize similar production techniques.
The Company is continuing the process of transitioning products to smaller geometries and to larger wafer sizes. The Company has transitioned a portion of its products to a 0.7 micron process and has commenced development of its next generation process technology. Other companies in the industry have experienced difficulty in effecting transitions to
smaller geometry processes and to larger wafers and, consequently, have experienced 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, particularly gross profit margins, could be adversely affected if the Company's transition is substantially delayed or inefficiently implemented.
Microchip currently employs proprietary design and manufacturing processes in developing its microcontroller and memory products. The Company believes its processes afford it both cost-effective designs in existing and derivative products and greater functionality in new product designs. While many of the Company's competitors develop and optimize separate processes for their logic and memory product lines, Microchip uses a common process technology for both microcontroller and non-volatile memory products. This allows Microchip to more fully absorb its process research and development costs and to deliver new products to market more rapidly. Microchip engineers utilize advanced CAD tools and software to perform circuit design, simulation and layout. The Company's in-house photomask and wafer fabrication facilities enable it to rapidly verifiy design techniques by processing test wafers quickly and efficiently.
The Company's Taiwan and Thailand subsidiaries test the majority of the products produced in Fab 1 and Fab 2. Currently, the 150,000 square foot Chachoengsao test facility has the capacity to handle up to 30 million units per month. If required, the Chachoengsao facility could be expanded in the future to more than double its current capacity. The 88,700 square foot Kaohsiung facility has a monthly capacity of 19 million plastic packages. Final test and burn-in functions are handled by advanced automated equipment. The Company uses third-party contractors in Bangkok, Thailand to assemble a significant portion of its products. The balance of Microchip's assembly and test requirements are fulfilled by several third-party assembly and test contractors in Thailand, the Philippines, People's Republic of China, and several other countries in Asia and the Pacific Rim.
Over the last several years, Microchip shifted its assembly operations from Company-owned facilities to third-party contractors in order to meet increased product shipment requirements. At March 31, 1998, all assembly was conducted by third-party contractors. The Company will continue to use third-party contractors to provide a majority of its assembly services. Reliance on third parties involves some reduction in the Company's level of control over the assembly and test portion of its business. While the Company reviews the quality, delivery and cost performance of these third-party contractors, there can be no assurance that increased reliance on third-party contractors will not adversely impact results in future reporting periods if any third-party contractor is unable to maintain assembly and test yields and costs at approximately their current levels. See also "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Gross Profit," below.
The Company's reliance on facilities in Taiwan, Thailand, the Philippines and other foreign countries, and maintenance of substantially all of its finished goods in 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. Microchip currently employs the Alphatec Electronics Public Company Limited group of companies ("Alphatec") headquartered in Bangkok, Thailand for a significant portion of its product assembly volume. While Alphatec's assembly operations have performed reliably for the Company for several years, Alphatec has experienced financing issues in connection with some of its joint ventures involving semiconductor fabrication facilities in Thailand. Such financing difficulties have not impacted Alphatec's assembly facilities nor its provision of services to the Company. However, there can be no assurance that assembly operations will not be affected in the future. Microchip currently has second sources for product assembly for most of its package types and can shift additional wafer output to other factories, if necessary. However, there can be no assurance that such action would not result in short-term disruption including possible temporary product shortages. 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.
Due to the high fixed cost inherent in semiconductor manufacturing, increased manufacturing yields can have significant positive effects on gross profits and overall operating results. During fiscal 1998, the Company continued to focus on manufacturing productivity, and maintained average wafer fab line yields in excess of 90%. The yields are primarily driven by a comprehensive implementation of statistical process control, extensive employee training and selective upgrading of the Company's manufacturing facilities and equipment. Maintenance of manufacturing productivity and yields are important factors in the achievement of the Company's operating results. As is typical in the semiconductor industry, the Company has from time to time experienced lower than anticipated manufacturing yields. The Company's operating results would be adversely affected if it were unable to maintain yields at approximately the current levels.
The raw materials and equipment used in the production of the Company's integrated circuits currently are available from a number of suppliers, and the Company is not materially dependent on any single source of supply. Although the Company has not experienced any material difficulty to date in obtaining raw materials or equipment, the interruption of certain components or ingredients of certain raw materials could reduce the availability or increase the cost of raw materials used by the Company. The manufacture and assembly of integrated circuits, particularly non-volatile, erasable CMOS memory and logic devices such as those produced by the Company, is a highly complex process and sensitive to a wide variety of factors, including the level of contaminants in the manufacturing environment, impurities in the materials used and the performance of the fabrication equipment.
Research and Development
The Company's current research and development activities focus on the design of new microcontroller and memory products, ASSPs, new development systems, and software and application-specific software libraries. The Company is also developing new design and process technology to achieve further cost reductions and performance improvements in existing products. As of April 26, 1998, 277 employees were engaged in research and development. In fiscal 1998, 1997 and 1996, the Company's research and development expenses were $38.4 million, $32.1 million and $27.5 million, respectively. The Company expects that it will continue to spend substantial funds on research and development activities.
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 compete effectively on the basis of price and performance and which address customer requirements. If the Company were unable to design, develop and introduce competitive products on a timely basis, its future operating results would be adversely affected.
Sales and Distribution
The Company markets its products worldwide through a direct sales organization and through distributors. In fiscal 1998, the Company derived approximately 47% of its net sales from direct sales to OEM customers and 53% from sales through distributors.
The Company's direct sales force, currently consisting of 166 people, focuses on three geographical markets: the Americas, Europe and Asia. In the Americas, the Company currently has Technical Support Centers in San Jose, Los Angeles, Dallas, Dayton, Chicago, Atlanta, Boston, New York and Toronto. Microchip also maintains Technical Support Centers in Tokyo, London, Munich, Paris, Milan, Taipei, Seoul, Singapore, Hong Kong, Shanghai, and Bangalore, India. Microchip's direct sales force is augmented by a worldwide network of national distributors and regional distributors in North and South America. Microchip's distribution effort also includes a network of manufacturer's representatives in North America and Europe.
Microchip believes that a strong technical service presence is essential to the continued development of the embedded control market. The majority of Microchip's field sales engineers (FSEs), field application engineers (FAEs) and sales management have technical degrees and have been previously employed in an engineering environment. The Company believes the technical knowledge of its sales force is a key competitive advantage in the sale of field programmable products. Currently, Microchip has at least one dedicated application engineer in every Technical Support Center. The primary mission of the FAE team is to provide technical assistance to OEM customers and to conduct periodic training sessions for FSEs, manufacturer's representatives and distributor sales teams. The FAEs also conduct frequent technical seminars in major cities around the world. FAEs also work closely with the Company's distributors and manufacturer's representatives to provide technical assistance in end-user support and to assist in the sales process.
As is common in the semiconductor industry, the Company grants price protection to distributors. Under this policy, distributors receive a credit for the difference, at the time of a price reduction, between the price they were originally charged for products in inventory and the reduced price which the Company subsequently charges distributors. From time to time, distributors also receive credit on an individual basis for Company-approved price reductions on specific transactions. The Company also grants some distributors limited rights to return products. The Company defers recognition of net sales and profit on sales to distributors that have rights of return and price protection until those distributors have resold the products to end-customers.
Foreign sales, primarily in Asia and Europe, represented approximately 68%, 66% and 65% of consolidated net sales in fiscal years 1998, 1997 and 1996, respectively. International sales are predominately billed in U.S. Dollars. Although
foreign sales are subject to certain government export restrictions, the Company has not experienced any material difficulties as a result of export restrictions to date.
The Company's policy is to hedge its net foreign currency positions in the normal course of business to reduce its exposure to fluctuations in foreign exchange rates. Foreign exchange gains and losses were not material during fiscal years 1996 through 1998.
Backlog
As of April 26, 1998, the Company's backlog was approximately $76.7 million as compared to $93.7 million as of April 27, 1997. The Company includes in its backlog all purchase orders scheduled for delivery within the subsequent 12 months.
Microchip produces standard products that can be shipped from inventory within a short time after receipt of an order. The Company's business and, to a large extent, that of the entire semiconductor industry is characterized by short-term orders and shipment schedules. Orders constituting the Company's current backlog are subject to changes in delivery schedules or to cancellation at the option of the purchaser without significant penalty. Accordingly, although useful for scheduling production, backlog as of any particular date may not be a reliable measure of sales for any future period. Turns orders (orders received in a quarter for shipment in that quarter) have become an increasingly important component of the Company's quarterly operating results. See "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations - Net Sales," below.
Competition
The semiconductor industry is intensely competitive and has been characterized by price erosion, rapid technological change and foreign competition with respect to many products. The Company competes with major domestic and international semiconductor companies, many of which have greater market recognition and substantially greater financial, technical, marketing, distribution and other resources than the Company with which to pursue engineering, manufacturing, marketing and distribution of their products. Emerging companies are also increasing their participation in the market for embedded control applications. 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. The Company expects to continue to experience increased pricing competition and declining prices for memory products. 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. In addition, the Company's ability to compete successfully depends on a number of factors both within and outside its control, including the quality, performance, reliability, features, ease of use, pricing and diversity of its products; the quality of its customer service and its ability to address the needs of its customers; its success in designing and manufacturing new products including those implementing new technologies; efficiency of production, adequate sources of raw materials and other supplies at acceptable prices; protection of the Company's products and processes by effective utilization of intellectual property laws; the rate at which customers incorporate the Company's products into their own products; product introductions by the Company's competitors; the number, nature and success of its competitors in a given market; and general market and economic conditions. Furthermore, capacity in the semiconductor industry is increasing over time and such increased capacity or improved product availability could adversely affect the Company's competitive position.
The Company currently competes principally on the basis of the technical innovation and performance of its embedded control products, including their speed, functionality, density, power consumption, reliability and packaging alternatives, as well as on price and product availability. The Company believes that other important competitive factors in the embedded control market include ease of use, functionality of application development systems and technical service and support. The Company believes that it competes favorably with other companies on all of these factors, although there is no assurance that the Company will continue to be able to compete successfully in the future.
Patents, Licenses and Trademarks
The Company's success depends in part on its ability to obtain patents, licenses and other intellectual property rights covering its products and manufacturing processes, and to protect its proprietary information. As of March 31, 1998, the Company owned 60 U.S. patents and 11 foreign patents, expiring on various dates between 1997 and 2015, and had an additional 78 U.S. patent applications and 55 foreign patent applications pending. The Company intends to continue to seek patents on its inventions used in its products and manufacturing processes. However, the Company believes that its continued success depends primarily on such factors as the technological skills and innovative abilities of its personnel rather than on its patents. There can be no assurance the Company's existing patents or any new patents that are issued will be of sufficient scope or strength to provide meaningful protection or other commercial advantage to the Company.
The Company has entered into certain intellectual property licenses and cross-licenses with other companies related to semiconductor products and manufacturing processes. As is typical in the semiconductor industry, the Company has from time to time received, and may in the future receive, communications alleging possible infringement of patents or other intellectual property rights of others. The Company investigates all such notices and responds as it believes is appropriate. The Company is currently in discussions with several other companies regarding intellectual property licenses of such other companies' semiconductor patents and technology. Based on industry practice, the Company believes that in most cases it could obtain any necessary licenses or other rights on commercially reasonable terms. However, no assurance can be given that licenses would be on acceptable terms, that litigation would not ensue, that damages for any past infringement would not be assessed or that the Company would not be forced to pay royalties on future sales. Litigation, which could result in substantial cost to the Company and diversion of management effort, may be necessary to enforce patents or other intellectual property rights of the Company or to defend the Company against claimed infringement of the rights of others. See "Item 3 - Legal Proceedings."
Environmental Regulation
The Company is subject to a variety of federal, state and local governmental regulations related to the use, storage, discharge and disposal of toxic, volatile or otherwise hazardous chemicals used in its manufacturing processes, including the Resource Conversation and Recovery Act, the Comprehensive Environmental Response, Compensation and Liability Act, the Superfund Amendment and Reauthorization Act, the Clean Air Act and the Water Pollution Control Act. The Company believes it has obtained all necessary environmental permits to conduct its business. Although the Company believes that its activities conform to presently applicable environmental regulations, the failure to comply with present or future regulations could result in fines being imposed on the Company, suspension of production or a cessation of operations. While the Company has not experienced any materially adverse effects on its operations from governmental regulations, there can be no assurance that changes in such regulations will not require the Company to acquire costly equipment or to incur other significant expenses to comply with environmental regulations. Any failure by the Company to control the use of or adequately restrict the discharge of hazardous substances could subject it to future liabilities. There can be no assurance that environmental problems will not occur in the future which could subject the Company to future costs or liabilities.
Employees
As of April 26, 1998, the Company had 2,153 employees, including 1,555 in manufacturing, 277 in research and development, 196 in sales and marketing and 125 in finance and administration. Approximately 41% of the Company's employees work at the final test facilities located in Kaohsiung, Taiwan and Chachoengsao, Thailand. No employees in the U.S. or Thailand are represented by a labor organization. All employees in the Kaohsiung facility, except for certain management employees, are represented by a labor organization. The Company has never had a work stoppage and believes that its employee relations are good.
Executive Officers
The following sets forth certain information regarding the Company's executive officers as of April 26, 1998:
Mr. Sanghi is currently, and has been since August, 1990, President of the Company, since October, 1991, Chief Executive Officer and since October, 1993, Chairman of the Board of Directors. He has served as a director of the Company since August, 1990. He served as the Company's Chief Operating Officer from August, 1990 through October, 1991 and as Senior Vice President of Operations from February, 1990 through August, 1990. Mr. Sanghi holds an M.S. degree in Electrical and Computer Engineering from the University of Massachusetts and a B.S. degree in Electronics and Communication from Punjab University, India. Mr. Sanghi is also a director of ADFlex Solutions, Inc., a U.S. supplier of flexible circuit-based interconnect solutions.
Mr. Billington has served as Vice President, Manufacturing Operations since October, 1994 and was Vice President, Process Development and Manufacturing Operations from April, 1991 until October, 1994. Prior to his appointment as Vice President, Mr. Billington served as Director of Wafer Fabrication from November, 1990 to April, 1991 and Wafer Fabrication Manager from June, 1989 to November, 1990. Mr. Billington holds a B.S. degree in marketing from Abilene Christian University.
Mr. Chapman has served as the Company's Vice President and Chief Financial Officer since joining the Company in September, 1992 and as Secretary of the Company since December, 1992. Mr. Chapman holds an M.B.A. from the Harvard Graduate School of Business Administration and B.A. degrees in Accounting and Managerial Finance from the University of California.
Mr. Rigg has served as Vice President, Advanced Microcontroller and Systems Group since March, 1997. From November, 1995 to March, 1997 he served as Vice President, Advanced Microcontroller and Technology Division. From June, 1989 to November, 1995, he served as Vice President, Logic Products Division. Mr. Rigg holds a B.S. degree in Physics from Manchester University, England.
Mr. Little has served as Vice President, Americas Sales since April, 1998. From November, 1995 to April, 1998 he served as Vice President, Standard Microcontroller and ASSP Division. From September, 1993 to November, 1995, he served as Vice President, Memory Products and ASSP Division. Prior to his appointment as Vice President, Mr. Little served as Division Director for the Company's Memory Products Division from July, 1991 to September, 1993, and as Director of Memory Marketing from November, 1989 to July, 1991. Mr. Little holds a BSET from United Electronics Institute.
Item 2.
Item 2. PROPERTIES
The Company's current headquarters, research and development center and one of its U.S wafer fabrication facilities are located in three buildings totaling approximately 242,000 square feet situated on a 77-acre parcel of land in Chandler, Arizona. A second U.S. manufacturing site consisting of a wafer fabrication facility, office and warehouse facilities and a development systems center, totaling approximately 253,000 square feet, is situated on a 22-acre parcel of land in Tempe, Arizona. The Chandler and Tempe facilities are owned by the Company. Company-owned final test facilities are located in Taiwan and Thailand. The Taiwan operations are housed in a three-story, 88,700 square foot building located in the Kaohsiung Export Processing Zone in Kaohsiung, Taiwan, Republic of China. The Taiwan building is owned by the Company's Taiwan subsidiary and is located on land that is leased to the Company pursuant to leases from the Taiwan government expiring in December, 1998 and 2002. The Company intends to renew the lease that expires in December, 1998. The Company's Thailand final test operations are housed in a 150,000 square foot facility located in the Alphatechnopolis Industrial Park in Chachoengsao, Thailand, near Bangkok. The Thailand facility, owned by the Company's Thailand subsidiary, is situated on land to which the Company expects to acquire title by the end of fiscal 1999, in accordance with an agreement between the Company and the land owner. The Company leases space for 20 Technical Support Centers in San 8
Jose and Los Angeles, California; Dallas, Texas; Dayton, Ohio; Chicago, Illinois; Atlanta, Georgia; Boston, Massachusetts; New York, New York; as well as Toronto, Tokyo, London, Munich, Paris, Milan, Taipei, Seoul, Singapore, Hong Kong, Shanghai and Bangalore, India. The Company's aggregate monthly rental payments for its facilities are approximately $107,000.
The Company currently believes that its existing facilities will be adequate to meet its requirements for the next 12 months.
Item 3.
Item 3. LEGAL PROCEEDINGS
In the ordinary course of its business, the Company is involved in a limited number of legal actions, both as plaintiff and defendant, and could incur uninsured liability in any one or more of them. Although the outcome of these actions is not presently determinable, the Company believes that the ultimate resolution of these matters will not have a material adverse effect on the Company's results of operations or financial conditions. The Company could also be subject to future litigation if it is unable to resolve pending intellectual property and technology licensing discussions. The Company is currently the defendant in one case regarding intellectual property and has commenced litigation against other companies for alleged infringement of the Company's intellectual property rights. The Company does not expect these matters will have a material adverse effect on its business or results of operation. However, the failure to obtain necessary licenses or other rights, or litigation arising out of infringement claims, could have a material adverse effect on the Company's business and results of operations. Litigation relating to the semiconductor industry is not uncommon, and the Company is, and from time to time, has been, subject to such litigation. No assurances can be given with respect to the extent or outcome of any such litigation in the future.
The Securities and Exchange Commission is presently conducting an investigation into matters relating to the Company's disclosure on February 26, 1996 that revenues and earnings for the quarter ended March 31, 1996 would be lower than previously estimated. While the outcome of the investigation, and its effect on the Company, if any, cannot be predicted at the present time, the Company does not believe that the investigation will result in a material adverse effect on the Company.
Microchip Technology Incorporated v. Lucent Technologies Inc. (District of Arizona, CIV97-1502 PHX EHC) On January 13, 1998, the Company finalized a settlement in its patent litigation with Lucent Technologies Inc. and the case was dismissed on January 30, 1998. In connection with this settlement, the Company recorded a $5 million charge during the quarter ended December 31, 1997. See "Item 5 - Market For Registrant's Common Equity and Related Stockholder Matters," below, and Note 2 to the Consolidated Financial Statements.
Item 4.
Item 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders during the fourth quarter of fiscal 1998.
PART II
Item 5.
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the Nasdaq National Market under the symbol "MCHP." The Company's Common Stock has been quoted on the Nasdaq National Market since March 19, 1993. The following table sets forth the quarterly high and low closing prices of the Common Stock as reported by the Nasdaq National Market for the last two years, adjusted to reflect a 3-for-2 stock split effected in January, 1997:
On May 22, 1998, the closing sale price for the Company's Common Stock was $27.125 per share. As of such date, there were approximately 515 holders of record of the Company's Common Stock. This figure does not reflect beneficial ownership of shares held in nominee names.
The Company has not paid cash dividends on its capital stock. The Company currently anticipates that it will retain all available funds for use in the operations of its business and therefore does not anticipate paying any cash dividends in the foreseeable future.
The trading price of the Company's Common Stock has been, and in the future could be, subject to wide fluctuations in response to quarterly variations in operating results of the Company and other semiconductor companies, actual or anticipated announcements of technical innovations or new products by the Company or its competitors, changes in analysts' estimates of the Company's financial performance, general conditions in the semiconductor industry, worldwide economic and financial conditions and other events or factors. In addition, the stock market has experienced significant price and volume fluctuations which have particularly affected the market prices for many high technology companies and which often have been unrelated to the operating performance of such companies. These broad market fluctuations and other factors may adversely affect the market price of the Company's Common Stock.
As of January 13, 1998 and in connection with the settlement of patent infringement litigation, the Company issued a warrant to acquire 300,000 shares of Common Stock at $25.25 per share. The warrant is currently fully exercisable and expires on June 30, 2001. The issuance of the warrant was deemed exempt from registration under the Securities Act of 1933, as amended, in reliance on Section 4(2) of such Act. See "Item 3, Legal Proceedings," above and Note 2 to the Consolidated Financial Statements.
Item 6.
Item 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data for the five-year period ended March 31, 1998 should be read in conjunction with the Company's Consolidated Financial Statements and notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in Item 7
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 years indicated:
Year Ended March 31, 1998 1997 1996 ------------------------
Net sales ......................... 100.0% 100.0% 100.0% Cost of sales ..................... 50.3% 50.1% 48.2% ---- ---- ---- Gross profit ...................... 49.7% 49.9% 51.8% Research and development .......... 9.7% 9.6% 9.6% Selling, general and administrative 17.0% 16.8% 17.0% Special charges ................... 1.2% 2.2% 4.0% ---- ---- ---- Operating income .................. 21.8% 21.3% 21.1% ==== ==== ====
Net Sales
Microchip's net sales of $396.9 million in fiscal 1998 increased by $62.6 million, or 18.7%, over fiscal 1997 and net sales of $334.3 million in fiscal 1997 increased by $48.4 million, or 16.9%, over fiscal 1996.
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 66%, 64% and 59% of total net sales in fiscal 1998, 1997 and 1996, respectively. A related component of the Company's product sales consists primarily of Serial EEPROM memories which accounted for 34%, 36% and 41% of net sales in fiscal 1998, 1997 and 1996, respectively.
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. The Company has emphasized its ability to respond quickly to customer orders as part of its competitive strategy. This strategy, combined with current industry conditions, results in customers placing orders with short delivery schedules. The Company experienced increasing turns orders as a portion of the Company's business in fiscal 1998, as compared to fiscal 1997, which reduced the Company's visibility in projecting net sales levels. 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 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, 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 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 within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the safe harbors created thereby. 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.
Several Asian countries have recently experienced economic difficulties including high rates of loan defaults, business failures and currency devaluations. During the quarters ended December 31, 1997 and March 31, 1998, the Company experienced weakness in the expected level of turns orders and net sales related to its business in Asia. During the fourth fiscal quarter of fiscal 1998, shipments to Asia were lower than the preceding quarter by approximately 30%. The Company derives a substantial portion of its net sales from customers in Asia and there can be no assurance that such economic difficulties will not continue to adversely affect the Company's operating results in future periods.
Foreign sales represented 68%, 66% and 65% of net sales in fiscal 1998, 1997 and 1996, 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 family of microcontroller products and related memory 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 increased numbers of application development systems in fiscal 1998 compared to previous fiscal years. 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 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 Company believes its ability to continue to increase its manufacturing capacity to meet customer demand and maintain satisfactory delivery schedules will be an important competitive factor. As a result of the increase in fixed costs and operating expenses related to expanding its manufacturing capacity, the Company's operating results may be adversely affected if net sales do not increase sufficiently to offset the increased costs. 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 $197.3 million, $166.9 million and $148.2 million in fiscal 1998, 1997 and 1996, respectively. Gross profit as a percent of sales was 49.7%, 49.9% and 51.8% in fiscal 1998, 1997 and 1996, respectively. The gross profit percentage in fiscal years 1998 and 1997 was down from the fiscal 1996 level, primarily as a result of reduced 5-inch wafer production at one of the Company's wafer fabrication facilities and increased pricing pressure on its non-volatile memory products. The Company is continuing the process of transitioning products to smaller geometries and to larger wafer sizes to reduce future manufacturing costs. Eight-inch wafer production commenced at the Tempe wafer fabrication facility in early fiscal 1998 and the Company is continuing the transitioning of products to its 0.7 micron process. The Company expects that 25% of its products will come from 8-inch wafers during fiscal 1999. 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.
The foregoing statements relating to anticipated gross margins, cost of sales, 8-inch wafer production, and the transition to higher yielding manufacturing processes are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the safe harbors created thereby. 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; changes in product mix; competitive pressures on prices; and other economic conditions.
In the quarter ended June 30, 1997, the Company changed its method of accounting for inventories from the last-in, first-out (LIFO) method to the first-in, first-out (FIFO) method. The change did not have a material effect on the results of operations. The FIFO method is the predominant accounting method used in the semiconductor industry. Prior to this change, the Company's inventory costs did not differ significantly under the two methods. Prior period results of operations have not been restated for this change as the impact is not material.
All of Microchip's assembly operations are 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 approximately their current levels.
The Company's reliance on facilities in Taiwan, Thailand, the Philippines and other foreign countries, and maintenance of substantially all of its finished goods in 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. Microchip currently employs the Alphatec Electronics Public Company Limited group of companies ("Alphatec") headquartered in Bangkok, Thailand for a significant portion of its product assembly volume. While Alphatec's assembly operations have performed reliably for the Company for several years, Alphatec has experienced financing issues in connection with some of its joint ventures involving semiconductor fabrication facilities in Thailand. Such financing difficulties have not impacted Alphatec's assembly facilities nor its provision of services to the Company. However, there can be no assurance that assembly operations will not be affected in the future. Microchip currently has second sources for product assembly for most of its package types and can shift additional wafer output to other factories, if necessary. However, there can be no assurance that such action would not result in short-term disruption including possible temporary product shortages. 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 20% in fiscal 1998 over fiscal 1997, and 17% in fiscal 1997 over fiscal 1996. The Company will continue to invest in research and development in the future, including an investment in process and product development associated with the 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 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 increased its level of investment in selling, general and administrative costs to $67.5 million, $56.2 million and $48.9 million for fiscal years 1998, 1997 and 1996, respectively. The increased costs reflect the requirement to invest in incremental worldwide sales and technical support resources to promote the Company's embedded control products.
Other Income (Expense)
Interest income in fiscal 1998 increased over fiscal 1997 and 1996 as a result of increased invested cash balances, resulting from completion of an equity offering in February, 1997. Interest expense in fiscal 1998 decreased over fiscal 1997 and 1996 due to reductions in borrowing levels associated with the Company's capital equipment additions. Other income represents numerous immaterial non-operating items. The Company's interest expense could increase in fiscal 1999 if the Company increases its borrowings and interest expense would 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 27.0%, 26.4% and 27.0% for the years ended March 31, 1998, 1997 and 1996, respectively, due primarily to 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 within the meaning of section 27A of the Securities Act of 1933, as amended, and section 21E of the Securities Exchange Act of 1934, as amended, and is subject to the safe harbors created thereby. 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 Conversion
The Year 2000 issue is the result of computer programs being written using two digits rather than four to define the year, thus rendering them incapable of properly managing and manipulating data that includes 21st century dates. The Company is currently installing business and financial systems to replace existing software systems to address the Year 2000 compliance issue. The Company is also currently reviewing other aspects of its computer systems, including manufacturing and product development areas. Microchip's products, for the most part, involve hardware integrated circuit devices manufactured by Microchip which, subsequent to their sale, are combined with proprietary application firmware by Microchip's customers. Thus, Microchip believes that its products have no inherent date sensitive features. At this time management is not able to assess the cost of Year 2000 compliance. The Company does not anticipate that the Year 2000 will pose significant operating problems. However, delays in the implementation of new information systems, or a failure to fully identify and resolve all Year 2000 deficiencies in the Company's systems could have a material adverse effect on the Company's future results of operations.
Liquidity and Capital Resources
The Company had $32.2 million in cash and cash equivalents at March 31, 1998, a decrease of $10.8 million from the March 31, 1997 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 March 31, 1998 were $7.0 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 March 31, 1998. The Company also has an unsecured short term line of credit totaling $19.8 million with certain foreign banks. Borrowings under the foreign line of credit as of March 31, 1998 were $16.0 million. There are no covenants related to the foreign line of credit.
At March 31, 1998, an aggregate of $86.8 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 year ended March 31, 1998, the Company generated $136.5 million of cash from operating activities, an improvement of $59.0 million from the year ended March 31, 1997 and an improvement of $63.1 million from the year ended March 31, 1996. The improvement in cash flow from operations was primarily due to increased profitability, the impact of changes in accounts payable, accrued expenses and accounts receivable and an increase in depreciation expense.
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 years ended March 31, 1998, 1997 and 1996 were $145.3 million, $79.0 million and $115.8 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 $55.0 million during the next 12 months for additional capital equipment to increase capacity at its existing wafer fabrication facilities and to expand product test operations. 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 additional manufacturing capacity to meet its currently anticipated needs.
Net cash used in financing activities was $2.1 million for the year ended March 31, 1998. Net cash provided by financing activities was $13.4 million and $27.1 million for the years ended March 31, 1997 and 1996 respectively. Proceeds from sale of stock and put options were $12.5 million, $59.5 million and $9.6 million for the years ended March 31, 1998, 1997 and 1996, respectively. Proceeds from issuance of long-term debt were $2.9 million for the year ended March 31, 1996. Payments on long term debt and capital lease obligations were $6.1 million, $5.7 million and $5.9 million for the years ended March 31, 1998, 1997 and 1996, respectively. Proceeds from lines of credit were $23.0 million and $20.5 million for the years ended March 31, 1998 and 1996 respectively. Repayments on lines of credit were $21.0 million for the year ended March 31, 1997. Cash expended for the purchase of the Company's Common Stock was $31.5 million and $19.5 million for the years ended March 31, 1998 and 1997, respectively.
On January 30, 1998 and July 26, 1997, the Company's Board of Directors authorized the repurchase of 2,500,000 shares and 1,500,000 shares, respectively, in connection with a Common Stock repurchase plan. On July 26, 1997, the Board of Directors also authorized the Company to sell up to 750,000 put options in connection with the same plan. As of March 31, 1998 the Company has purchased 1,277,500 shares of Common Stock at an aggregate cost of $31,481,000 and has outstanding 400,000 put options at prices ranging from $29.63 to $38.81. Subsequent to March 31, 1998 the Company purchased 222,500 shares of Common Stock at an aggregate price of $6,667,000 and sold put options of 100,000 shares of Common Stock at a price of $27.50.
Subsequent to March 31, 1998, the Company completed two transactions in connection with the stock repurchase program. April, 1998 the Company completed a costless collar transaction for 500,000 calls priced at $25.95 and 665,000 puts priced at $25.19. The expiration date of the transaction is April 23, 1999. Also in connection with the stock repurchase program, the Company completed a net share settled forward contract for 2,000,000 shares at an average price of $29.24. The expiration date of this transaction is May, 2000 with quarterly interim settlement dates as determined by the Company.
Also subsequent to March 31, 1998 the Company's Board of Directors authorized an additional share repurchase of Common Stock of 2,000,000 shares and to sell up to 500,000 additional put options. 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 financing will be available on acceptable terms, and any additional equity financing could result in additional dilution to existing investors.
Item 7A.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements of the Company listed in the index appearing under Item 14(a)(1) hereof are filed as part of this Annual Report on Form 10-K. See also Index to Financial Statements on page F- I hereof.
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
Item 10.
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to the Company's directors is incorporated herein by reference to the Company's proxy statement for the 1998 annual meeting of stockholders under the caption "Election of Directors."
See Item I, Part I hereof under the caption "Executive Officers" for information with respect to the Company's executive officers. Information with respect to compliance with Section 16(a) of the Securities Exchange Act of 1934, as amended, is incorporated herein by reference to the Company's proxy statement for the 1998 annual meeting of stockholders under the caption "Section16(a) Beneficial Ownership Reporting Compliance."
Item 11.
Item 11. EXECUTIVE COMPENSATION
Information with respect to executive compensation is incorporated herein by reference to the information under the caption "Executive Compensation" in the Company's proxy statement for the 1998 annual meeting of stockholders.
Item 12.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information with respect to security ownership of certain beneficial owners and management of the Company is incorporated herein by reference to the information under the caption "Security Ownership of Principal Stockholders, Directors and Executive Officers" in the Company's proxy statement for the 1998 annual meeting of stockholders.
Item 13.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Not applicable.
PART IV
Item 14.
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Annual Report on Form 10-K:
Page No. (1) Financial Statements:
Independent Auditors' Report
Consolidated Balance Sheets as of March 31, 1998 and 1997
Consolidated Statements of Income for each of the years in the three-year period ended March 31, 1998
Consolidated Statements of Cash Flows for each of the years in the three-year period ended March 31, 1998
Consolidated Statements of Stockholders' Equity for each of the years in the three-year period ended March 31, 1998
Notes to Consolidated Financial Statements
(2) Financial Statement Schedules - Applicable schedules have been omitted because informa- tion is included in the footnotes to the Financial Statements.
(3) The Exhibits which are filed with this report or which are incorporated herein by reference are set forth in the Exhibit Index which appears on page E-1 hereof, which Exhibit Index is incorporated herein by this reference.
(b) No current reports on Form 8-K were filed during the quarter ended March 31, 1998.
(c) See Item 14(a)(3) above.
(d) See "Index to Financial Statements" included under Item 8 to this report.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 (Registrant)
By:/s/ Steve Sanghi ------------------------------------- Steve Sanghi President and Chief Executive Officer
Date: May 26, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Name and Signature Title Date - ------------------ ----- ----
/s/ Steve Sanghi Director, President and May 26, 1998 - --------------------------- Chief Executive Officer Steve Sanghi
Albert J. Hugo-Martinez* Director May 26, 1998
Jon H. Beedle* Director May 26, 1998
L. B. Day* Director May 26, 1998
Matthew W. Chapman* Director May 26, 1998
/s/ C. Philip Chapman Vice President, Chief Financial May 26, 1998 - --------------------------- Officer and Secretary (Principal C. Philip Chapman Financial and Accounting Officer)
*By:/s/ Steve Sanghi Individually and as Attorney-in-fact May 26, 1998 ----------------------- Steve Sanghi
Annual Report on Form 10-K
Item 8, Item 14(a)(1) and (2), (c) and (d)
---------------------------------
CONSOLIDATED FINANCIAL STATEMENTS
EXHIBITS
---------------------------------
YEAR ENDED MARCH 31, 1998
MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CHANDLER, ARIZONA
MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
Index to Consolidated Financial Statements
Page Number -----------
Independent Auditors' Report
Consolidated Balance Sheets as of March 31, 1998 and 1997
Consolidated Statements of Income for each of the years in the three-year period ended March 31, 1998
Consolidated Statements of Cash Flows for each of the years in the three-year period ended March 31, 1998
Consolidated Statements of Stockholders' Equity for each of the years in the three-year period ended March 31, 1998
Notes to Consolidated Financial Statements i
KPMG Peat Marwick LLP
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders Microchip Technology Incorporated:
We have audited the accompanying consolidated balance sheets of Microchip Technology Incorporated and subsidiaries as of March 31, 1998 and 1997, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the years in the three-year period ended March 31, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Microchip Technology Incorporated and subsidiaries as of March 31, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended March 31, 1998, in conformity with generally accepted accounting principles.
/s/ KPMG Peat Marwick LLP
Phoenix, Arizona April 22, 1998, except as to the second and third paragraphs in note 13 which are as of May 18, 1998
MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
(in thousands except share amounts)
See accompanying notes to consolidated financial statements
MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share amounts)
Years Ended March 31, ----------------------------------- 1998 1997 1996 --------- --------- ---------
Net sales $ 396,894 $ 334,252 $ 285,888 Cost of sales 199,538 167,330 137,708 --------- --------- --------- Gross profit 197,356 166,922 148,180
Operating expenses: Research and development 38,362 32,073 27,517 Selling, general and administrative 67,549 56,248 48,903 Special charges 5,000 7,544 11,448 --------- --------- --------- 110,911 95,865 87,868
Operating income 86,445 71,057 60,312
Other income (expense): Interest income 2,635 1,419 2,034 Interest expense (1,130) (3,271) (2,981) Other, net 217 288 569 --------- --------- ---------
Income before income taxes 88,167 69,493 59,934
Income taxes 23,799 18,361 16,182 --------- --------- ---------
Net income $ 64,368 $ 51,132 $ 43,752 ========= ========= =========
Basic net income per share $ 1.21 $ 0.99 $ 0.86 ========= ========= =========
Diluted net income per share $ 1.14 $ 0.94 $ 0.80 ========= ========= =========
Weighted average common shares outstanding 53,376 51,569 50,750 ========= ========= =========
Weighted average common and common equivalent shares outstanding 56,313 54,683 54,533 ========= ========= =========
See accompanying notes to consolidated financial statements
MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
See accompanying notes to consolidated financial statements
MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIAIRES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
See accompanying notes to consolidated financial statements
MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES -------------------------------
Principles of Consolidation The consolidated financial statements include the accounts of Microchip Technology Incorporated and its wholly owned subsidiaries (the "Company"). All significant intercompany accounts and transactions have been eliminated in consolidation.
Cash and Cash Equivalents All highly liquid investments including marketable securities purchased with an original maturity of three months or less are considered to be cash equivalents. At March 31, 1997, the Company had classified marketable securities of $25,964,000, with a maturity of less than three months as cash and cash equivalents. There were no marketable securities at March 31, 1998.
Inventories Inventories are valued at the lower of cost or market using the first-in, first-out (FIFO) method.
Property, Plant and Equipment Property, plant and equipment are stated at cost. Major renewals and improvements are capitalized, while maintenance and repairs are expensed when incurred. Depreciation is provided on a straight-line basis over the estimated useful lives of the related assets which range from three to twenty-five years.
Assets acquired under capital lease arrangements have been recorded at the present value of the future minimum lease payments and are being amortized on a straight-line basis over the estimated useful life of the asset or the lease term, whichever is shorter. Amortization of this equipment is included in depreciation and amortization expense.
Foreign Currency Translation and Forward Contracts The Company's foreign subsidiaries are considered to be extensions of the U.S. company and any translation gains and losses related to these subsidiaries are included in income. As the U.S. Dollar is utilized as the functional currency, gains and losses resulting from foreign currency transactions (transactions denominated in a currency other than the subsidiaries' functional currency) are also included in income. Gains and losses associated with currency rate changes on forward contracts are recorded currently in income.
Revenue Recognition Revenue from product sales to direct customers is recognized upon shipment. The Company defers recognition of net sales and profits on sales to distributors that have rights of return and price protection until the distributors have resold the products.
Income Taxes Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which these temporary differences are expected to be recovered or settled.
Computation of Net Income per Share In 1997, the Financial Accounting Standards Board issued SFAS No. 128, Earnings per Share ("SFAS No. 128"). SFAS No. 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. All earnings per share amounts for all periods have been presented, and where appropriate restated, to conform to the SFAS No. 128 requirements.
Impairment of Long-Lived Assets The Company records impairment losses on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount.
Stock Option Plans Prior to April 1, 1996, the Company accounted for its stock option plans in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. As such, compensation expense would be recorded, only if, on the date of grant, the current market price of the underlying stock exceeded the exercise price. On April 1, 1996, the Company adopted SFAS No. I23, Accounting for Stock-Based Compensation, which permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 also allows entities to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants made in fiscal 1996 and future years as if the fair-value-based method defined in SFAS No. 123 had been applied. The Company has elected to continue to apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123.
Use of Estimates The Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates.
Reclassifications Certain 1997 and 1996 fiscal year balances have been reclassified to conform to the fiscal year 1998 presentation.
2. SPECIAL CHARGES ---------------
Legal Settlement With Lucent Technologies Inc. On January 13, 1998, the Company finalized a settlement of its patent litigation with Lucent Technologies Inc. resulting in the Company recording a $5 million special charge during the quarter ended December 31, 1997. Under the terms of the settlement, Microchip made a one-time cash payment to Lucent and issued to Lucent warrants to acquire 300,000 shares of Common Stock of the Company priced at $25.25 per share. The terms of the settlement also provide for the Company to make a contingent payment to Lucent if the Company's earnings per share performance for the three and one-half year period ending June 30, 2001 does not meet certain targeted levels. It is currently anticipated that any contingent payment required under the terms of the settlement would be expensed in the period the amount is determined.
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 a secondary payment which will be determined by a formula based on the net sales and gross margin results of the division for the six month period ended December 31, 1998. Any such secondary payment is based on future performance and is currently not determinable. 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 operations is immaterial, therefore, pro-forma information illustrating the combined results after the Keeloq Acquisition has not been provided.
ASIC Technical Solutions On June 25, 1996, the Company acquired ASIC Technical Solutions, Inc., a fabless provider of quick turn gate array devices (the "ASIC Acquisition"). The ASIC Acquisition was treated as a purchase for accounting purposes. The amount paid for the ASIC Acquisition and related costs was $1,750,000. As part of the ASIC Acquisition, the Company allocated a substantial portion of the purchase price to in-process research and development costs, which is consistent with the Company's on-going treatment of research and development costs. The total special charge associated with the ASIC Acquisition was $1,575,000, with the balance treated as purchased technology related to current products and amortized over five years. The impact of the ASIC Acquisition to the Company's reported financial position and results of operations is immaterial, therefore, pro-forma information illustrating the combined results after the ASIC Acquisition has not been provided.
Restructuring Charges During the quarter ended June 30, 1996, primarily in response to inventory correction activities at the Company's customers, the Company implemented a series of actions to reduce production capacity, curtail the growth of inventories and reduce operating expenses. These actions included delaying capital expansion plans and deferring capital spending, a 15% production cutback in wafer fabrication, a headcount reduction in early April, 1996 representing approximately 3% of the Company's worldwide employees, and a two-week wafer fab shut down in early July, 1996. As a result of these actions, the Company recorded a pre-tax special charge of $5,969,000 in the quarter ended June 30, 1996 to cover costs primarily related to idling part of the Company's 5-inch wafer fab capacity, paying continuing expenses during the wafer fabrication facility shutdown and paying severance costs associated with the April, 1996 headcount reduction.
3. CONTINGENCIES -------------
The Company is subject to lawsuits and other claims arising in the ordinary course of its business. In the Company's opinion, based on consultation with legal counsel, as of March 31, 1998, the effect of such matters will not have a material adverse effect on the Company's financial position.
4. ACCOUNTS RECEIVABLE -------------------
Accounts receivable consists of the following (amounts in thousands):
March 31, 1998 1997 ----------------- Trade accounts receivable $57,922 $62,165 Other 790 1,031 -----------------
58,712 63,196
Less allowance for doubtful accounts 2,392 2,094 -----------------
$56,320 $61,102 =================
5. INVENTORIES -----------
The components of inventories are as follows (amounts in thousands):
March 31, 1998 1997 ----------------- Raw materials $ 5,795 $ 3,365 Work in process 40,000 44,813 Finished goods 30,021 16,966 -----------------
75,816 65,144
Less allowance for inventory valuation 9,523 8,331 -----------------
$66,293 $56,813 =================
In the quarter ended June 30, 1997, the Company changed its method of accounting for inventories from the last-in, first-out (LIFO) method to the first-in, first-out (FIFO) method. The change did not have a material effect on the results of operations. The FIFO method is the predominant accounting method used in the semiconductor industry. Prior to this change, the Company's inventory costs did not differ significantly under the two methods. Prior period results of operations have not been restated for this change as the impact is not material.
6. PROPERTY, PLANT AND EQUIPMENT -----------------------------
Property, plant and equipment consists of the following (amounts in thousands):
March 31, 1998 1997 -------------------
Land $ 11,749 $ 10,837 Building and building improvements 59,725 51,796 Machinery and equipment 322,624 218,284 Projects in process 82,528 52,608 -------- --------
476,626 333,525 Less accumulated depreciation and amortization 150,734 99,467 -------- --------
$325,892 $234,058 ======== ========
7. LONG-TERM DEBT --------------
Long-term debt consists of borrowings (denominated in U.S. Dollars) from three Taiwan financial institutions, secured by equipment financed thereby. Interest rates are at the Singapore Interbank Offering Rate (SIBOR) (5.69% at March 31, 1998) plus 0.75% and at the London Interbank Offering Rate (LIBOR) (5.69% at March 31, 1998) plus .75%. The weighted average interest rate on these borrowings was 5.89% at March 31, 1998. Payments, including interest, are due semi-annually through September 15, 2000. The aggregate annual maturities of long term debt as of March 31, 1998 are $2,196,000, $1,147,000 and $273,000 for the years ending March 31, 1999, 2000 and 2001, respectively.
The Company has an unsecured line of credit with a syndicate of U.S. banks for up to $90,000,000, bearing interest at the LIBOR plus .325% expiring in October, 2000. At March 31, 1998 the Company had utilized $7,000,000 of this line of credit. At March 31, 1997 there were no borrowings against 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 March 31, 1998.
The Company has an additional unsecured line of credit with various Taiwan financial institutions for up to $19,750,000 (U.S. Dollar equivalent). These borrowings are predominantly denominated in New Taiwan Dollars, bearing interest at SIBOR plus .75% and expiring on various dates through November, 1998. At March 31, 1998 the Company had utilized $16,000,000 of this line of credit.
8. EMPLOYEE BENEFIT PLANS ----------------------
The Company maintains a contributory profit-sharing plan for a majority of its domestic employees meeting certain service requirements. The plan qualifies under Section 401(k) of the Internal Revenue Code, and allows employees to contribute up to 15% of their compensation, subject to maximum annual limitations prescribed by the Internal Revenue Service. Company contributions to the plan were at the discretion of the Board of Directors until January 1, 1997, when the employer match was revised to provide for a fixed and discretionary component. The Company shall make a matching contribution of up to 25% of the first 4% of the participant's eligible compensation and may award up to an additional 25% under the discretionary match. All matches are provided on a quarterly basis and require the participant to be an active employee at the end of each quarter. For the fiscal years ended March 31, 1998, 1997 and 1996, the Company contributions to the plan totaled $525,000, $452,000 and $407,000, respectively.
The Company's Employee Stock Purchase Plan (the "Purchase Plan") allows eligible employees of the Company to purchase shares of Common Stock at semi-annual intervals through periodic payroll deductions. The purchase price per share, in general, will be 85% of the lower of the fair market value of the Common Stock on the participant's entry date into the offering period or 85% of the fair market value on the semi-annual purchase date. As of March 31, 1998, 312,772 shares were available for issuance under the Purchase Plan. Since the inception of the Purchase Plan, 3,306,000 shares of Common Stock have been reserved for issuance under the Purchase Plan. During fiscal 1995, a purchase plan was adopted for employees in non-U.S. locations. The plan allows for the purchase price per share to be 100% of the lower of the fair market value of the Common Stock on the beginning or end of the semi-annual purchase plan period.
Effective January 1, 1997, the Company adopted a non-qualified deferred compensation arrangement. This plan is unfunded and is maintained primarily for the purpose of providing deferred compensation for a select group of management as defined in ERISA Sections 201, 301 and 401. There are no Company matching contributions with respect to this plan.
Substantially all employees in foreign locations are covered by a statutory pension plan. Contributions are accrued based on an actuarially determined percentage of compensation and are funded in amounts sufficient to meet statutory requirements. Pension expense amounted to $1,202,000, $1,316,000 and $1,197,000 for the years ended March 31, 1998, 1997 and 1996, respectively.
The Company has an incentive compensation plan which provides for awards, based on a percentage of base salary, from an incentive pool created from operating profits of the Company, at the discretion of the Board of Directors. During the years ended March 31, 1998, 1997 and 1996, $1,851,000, $2,064,000 and $1,357,000, respectively, was charged against operations for this plan.
The Company also has a plan which provides a cash bonus based on the operating profits of the Company for all employees, at the discretion of the Board of Directors. During the years ended March 31, 1998, 1997 and 1996, $1,746,000, $1,373,000 and $1,025,000, respectively, was charged against operations for this plan.
9. STOCK OPTION PLANS ------------------
Under the Company's stock option plans (the "Plans"), key employees, non-employee directors and consultants may be granted incentive stock options or non-statutory stock options to purchase shares of Common Stock at a price not less than 100% of the fair value of the option shares on the grant date. Options granted under the Plans vest over the period determined by the Board of Directors at the date of grant, at periods ranging from one year to four years.
At March 31, 1998 there were 4,887,709 shares available for grant under the Plans. The per share weighted-average fair value of stock options granted under the Plans for the years ended March 31, 1998, 1997 and 1996 was $15.61, $9.66 and $13.22, respectively, based on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:
Years Ended March 31, 1998 1997 1996 -------------------------
Expected life (years) 3.64 3.50 3.50 Risk-free interest rate 5.75% 6.25% 6.25% Volatility 62% 60% 60% Dividend yield 0% 0% 0%
Under the Plans, 18,897,476 shares of Common Stock had been reserved for issuance since the inception of the Plans.
The stock option activity is as follows:
Options Outstanding Shares Weighted Average Exercise Price ----------------------------------------------- Outstanding at March 31, 1995 7,110,672 $ 7.76
Granted 981,833 23.77 Exercised (1,367,832) 4.01 Canceled (177,366) 10.86 ----------
Outstanding at March 31, 1996 6,547,307 10.88
Granted 2,092,952 17.74 Exercised (1,314,977) 6.16 Canceled (967,610) 21.28 ----------
Outstanding at March 31, 1997 6,357,672 $ 12.50
Granted 1,631,821 27.80 Exercised (778,418) 7.72 Canceled (1,006,781) 25.99 ----------
Outstanding at March 31, 1998 6,204,294 $ 14.84 ==========
The following table summarizes information about the stock options outstanding at March 31, 1998:
At March 31, 1998 and 1997, the number of options exercisable was 2,625,827 and 2,208,808, respectively, and the weighted-average exercise price of those options was $8.94 and $6.60, respectively.
On March 2, 1998, the Board of Directors of the Company approved an option exchange program for options priced in excess of $25.00. Excluding executive officers, corporate officers and directors, employees who were issued stock options in this category and who were active employees on March 2, 1998, could elect to keep their options to buy Common Stock at the original grant price or elect to exchange such options for options priced at $21.50 per share, the fair market value of the Company's Common Stock on March 9, 1998. If the employee elected to exchange the options for options priced at $21.50 per share, the vesting commencement date was extended by 90 days from the original vesting date. There were 534,522 shares exchanged under the option exchange program.
For certain options granted, the Company recognized as compensation expense the excess of the deemed value for accounting purposes of the Common Stock issuable upon exercise of such options over the exercise price of such options. This deferred compensation expense is amortized ratably over the vesting period of each option. During the years ended March 31, 1997 and 1996, the Company recorded compensation expense of $30,000 and $60,000, respectively.
The Company received a tax benefit of $5,332,000, $5,742,000 and $4,130,000 for the years ended March 31, 1998, 1997 and 1996, respectively, on the exercise of non-qualified stock options and the disposition of stock acquired
with incentive stock options or through the Purchase Plan. For financial reporting purposes, the tax effect of this deduction is accounted for as a credit to additional paid-in capital rather than as a reduction of income tax expense.
The Company applies APB Opinion No. 25 in accounting for its various stock plans and, accordingly, no compensation cost has been recognized for the Plans or the Purchase Plan in the financial statements. Had the Company determined compensation cost in accordance with SFAS No. 123, the Company's net income per share would have been reduced to the pro forma amounts indicated below:
Years Ended March 31, 1998 1997 1996 ------------------------------------
Net income As reported $ 64,368 $ 51,132 $ 43,752 Pro forma 58,063 48,202 40,691
Basic net income As reported $ 1.21 $ 0.99 $ 0.86 per share Pro forma 1.09 0.93 0.80
Diluted net income As reported $ 1.14 $ 0.94 $ 0.80 per share Pro forma 1.03 0.88 0.75
Pro forma net income reflects only options granted during the fiscal years ended March 31, 1998, 1997 and 1996. Therefore, the full impact of calculating compensation cost for stock options under SFAS No. 123 is not reflected in pro forma net income amounts presented above because compensation cost is reflected over the options' vested period and compensation cost for options granted prior to April 1, 1995 is not considered.
10. LEASE COMMITMENTS -----------------
The Company leases office space, transportation and other equipment under capital and operating leases which expire at various dates through March, 2007. The future minimum lease commitments under these leases are payable as follows (amounts in thousands):
Year ended Capital Operating March 31, Leases Leases --------- ------ ------
1999 $ 2,319 $ 1,288 2000 363 1,099 2001 -- 806 2002 -- 591 2003 -- 476 Thereafter -- 1,707 ------------------------ Total minimum lease payments $ 2,682 $ 5,967 =======
Less amount representing interest (at rates ranging from 6.7% to 8.5%) (128) -------
Present value of net minimum lease payments 2,554
Less current maturities 2,206 -------
Capital lease obligations $ 348 =======
Rental expense under operating leases totaled $2,811,000, $2,644,000 and $1,675,000 for the years ended March 31, 1998, 1997 and 1996, respectively.
11. INCOME TAXES ------------
The provision for income taxes is as follows (amounts in thousands):
Years Ended March 31, 1998 1997 1996 --------------------------------
Current expense: Federal $ 22,575 $ 13,814 $ 15,923 State 2,508 3,454 4,122 Foreign 8,139 4,093 3,539 -------- -------- --------
33,222 21,361 23,584 -------- -------- --------
Deferred expense (benefit): Federal (6,315) (1,322) (5,922) State (702) (331) (1,480) Foreign (2,406) (1,347) -- -------- -------- --------
(9,423) (3,000) (7,402) -------- -------- --------
$ 23,799 $ 18,361 $ 16,182 ======== ======== ========
The tax benefit associated with the exercise of employee stock options reduced taxes currently payable by $5,332,000, $5,742,000 and $4,130,000 for the years ended March 31, 1998, 1997 and 1996, respectively.
The provision for income taxes differs from the amount computed by applying the statutory federal tax rate to income before income taxes. The sources and tax effects of the differences are as follows (amounts in thousands):
Years Ended March 31, 1998 1997 1996 --------------------------------
Computed expected provision $ 30,858 $ 24,323 $ 20,977 State income taxes, net of federal benefit 1,630 2,245 1,669 Foreign sales corporation benefit (3,707) (2,552) (2,123) Foreign income taxed at lower than the federal rate (4,982) (5,655) (4,341) -------- -------- --------
$ 23,799 $ 18,361 $ 16,182 ======== ======== ========
Pretax income from foreign operations was $39,554,000, $32,172,000 and $29,434,000 for the years ended March 31, 1998, 1997 and 1996, respectively. Unremitted foreign earnings that are considered to be permanently invested outside the United States and on which no deferred taxes have been provided, amounted to approximately $147,874,000 at March 31, 1998.
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows (amounts in thousands):
March 31, 1998 1997 -------------------- Deferred tax assets:
Intercompany profit in inventory $ 15,168 $ 10,408 Deferred income on shipments to distributors 9,398 6,475 Inventory reserves 3,550 2,392 Technology assets 2,798 2,934 Accrued expenses and other 7,662 4,976 -------- -------- Gross deferred tax assets 38,576 27,185 -------- --------
Deferred tax liabilities:
Property, plant and equipment, principally due to differences in depreciation (11,071) (8,479) Other deferred liabilities -- (624) -------- -------- Gross deferred tax liability (11,071) (9,103) -------- -------- Net deferred tax asset $ 27,505 $ 18,082 ======== ========
Management believes that it is more likely than not that the results of future operations will generate sufficient taxable income to realize the deferred tax assets.
The Company has benefited from a partial tax holiday for its Taiwan manufacturing operations over the past several years. The Company is currently benefiting from a tax holiday for its Thailand manufacturing operations. The aggregate dollar benefits derived from this tax holiday status approximated $5,614,000, $5,415,000 and $5,003,000 for the years ended March 31, 1998, 1997 and 1996, respectively. The benefit the tax holiday status had on net income per share approximated $0.10, $0.10 and $0.09 for the years ended March 31, 1998, 1997 and 1996, respectively. The Company's tax holiday status in Taiwan expired in March, 1997, and expires in Thailand in March, 2005.
12. ACCRUED LIABILITIES -------------------
Accrued liabilities consists of the following (amounts in thousands):
March 31, 1998 1997 ----------------- Accrued salaries and wages $ 7,468 $ 6,344 Income taxes 22,396 14,957 Other accrued expenses 23,588 15,091 ------- ------- $53,452 $36,392 ======= =======
13. STOCKHOLDERS' EQUITY --------------------
Stockholder Rights Plan. On February 13, 1995, the Company's Board of Directors adopted a Stockholder Rights Plan (the "Plan"). Under the Plan, each share of the Company's Common Stock has one right which entitles the stockholder to buy 1/100th of a share of the Company's Series A Participating Preferred Stock. The rights have an exercise price of $66.67 and expire in February, 2005. The rights become exercisable and transferable upon the occurrence of certain events.
Stock Repurchase Activity. In connection with a stock repurchase program, during the years ended March 31, 1998 and 1997, the Company purchased a total of 1,277,500 and 1,326,477 shares of the Company's Common Stock in open market activities at a total cost of $31,481,000 and $19,463,000 respectively. Subsequent to March 31, 1998 the Company purchased 222,500 additional shares of Common Stock at a cost of $6,667,000. Also, in connection
with a stock repurchase program, during fiscal 1998 and fiscal 1997 the Company sold put options for 700,000 shares and 500,000 shares of Common Stock, respectively. Pricing per share ranged from $29.50 to $38.81 in fiscal 1998 and from $15.00 to $24.88 in fiscal 1997. Subsequent to March 31, 1998 the Company sold put options for 100,000 shares of Common Stock. Pricing per share was $27.50. During fiscal 1998 and 1997, the Company repurchased put options for 300,000 and 142,500 shares, respectively. As of March 31, 1998, the Company had outstanding put options for 400,000 shares which have expiration dates ranging from June 16, 1998 to March 3, 1999 at prices ranging from $29.63 to $38.81 per share. The net proceeds from the sale and repurchase of these options, in the amount of $2,215,330 and $427,750 for fiscal years 1998 and 1997, respectively, has been credited to additional paid-in capital.
Subsequent to March 31, 1998, the Company completed two transactions in connection with the stock repurchase program. April, 1998 the Company completed a costless collar transaction for 500,000 calls priced at $25.95 and 665,000 puts priced at $25.19. The expiration date of the transaction is April 23, 1999. Also in connection with the stock repurchase program, the Company completed a net share settled forward contract for 2,000,000 shares at an average price of $29.24. The expiration date of this transaction is May, 2000 with quarterly interim settlement dates as determined by the Company.
Also subsequent to March 31, 1998 the Company's Board of Directors authorized an additional share repurchase of Common Stock of 2,000,000 shares and to sell up to 500,000 additional put options. The Company expects from time to time to purchase shares of Common Stock in connection with its authorized Common Stock repurchase plan.
14. GEOGRAPHIC INFORMATION ----------------------
The Company operates in one industry segment and engages primarily in the design, development, manufacture and marketing of semiconductor products. The Company sells its products to system manufacturers and distributors in a broad range of industries, performs on-going credit evaluations of its customers and generally requires no collateral. The Company's operations outside the United States consist of comprehensive product final test facilities in Taiwan and Thailand and sales offices in certain foreign countries. Domestic operations are responsible for the design, development and wafer fabrication of all products, as well as the coordination of production planning and shipping to meet worldwide customer commitments. The Taiwan and Thailand test facilities are reimbursed in relation to value added with respect to test operations and other functions performed, and certain foreign sales offices receive a commission on export sales within their territory. Accordingly, for financial statement purposes, it is not meaningful to segregate sales or operating profits for the test and foreign sales office operations. Identifiable assets by geographic area are as follows (amounts in thousands):
March 31, 1998 1997 -------------------
United States $306,142 $254,477 Taiwan 136,128 101,036 Thailand 57,374 44,126 Other 25,099 28,453 -------- --------
Total Assets $524,743 $428,092 ======== ========
Sales to unaffiliated customers located outside the United States, primarily in Asia and Europe, aggregated approximately 68%, 66% and 65% of consolidated net sales for the years ended March 31, 1998, 1997 and 1996, respectively.
15. FAIR VALUE OF FINANCIAL INSTRUMENTS -----------------------------------
The carrying amount of cash equivalents approximates fair value because their maturity is less than three months. The carrying amount of accounts receivable, accounts payable and accrued liabilities approximates fair value due to the short term maturity of the amounts. The fair value of capital lease obligations, long-term debt and lines of credit approximate their carrying value as they are estimated by discounting the future cash flows at rates currently offered to the Company for similar debt instruments.
The Company is party to financial instruments with off-balance-sheet risk in the normal course of business to reduce its exposure to fluctuations in foreign exchange rates. These financial instruments include standby letters of credit and foreign currency forward contracts. When engaging in forward contracts, risks arise from the possible inability of counterparties to meet the terms of their contracts and from movements in securities values, interest rates and foreign exchange rates. At March 31, 1998 and 1997, the Company held contracts totaling $9,158,000 and $5,421,000, respectively, which were entered into and hedged the Company's foreign currency risk. The contracts matured in April and May of 1998 and 1997, respectively. Unrealized gains and losses as of the balance sheet dates and realized gains and losses for the years ending March 31, 1998, 1997 and 1996 were not material.
16. 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):
Years Ended March 31, 1998 1997 1996 --------------------------- Net income $64,368 $51,132 $43,752 ======= ======= =======
Weighted average common shares outstanding 53,376 51,569 50,750
Dilutive effect of stock options 2,937 3,114 3,783 ------- ------- -------
Weighted average common and common 56,313 54,683 54,533 equivalent shares outstanding ======= ======= =======
Basic net income per share $ 1.21 $ 0.99 $ 0.86 ======= ======= ======= Diluted net income per share $ 1.14 $ 0.94 $ 0.80 ======= ======= =======
17. QUARTERLY RESULTS (UNAUDITED) -----------------------------
The following table presents the Company's selected unaudited quarterly operating results for eight quarters ended March 31, 1998. The Company believes that all necessary adjustments have been made to present fairly the related quarterly results (in thousands except per share amounts).
18. SUPPLEMENTAL FINANCIAL INFORMATION ----------------------------------
Cash paid for income taxes amounted to $19,857,000, $8,108,000 and $17,557,000 during the years ended March 31, 1998, 1997 and 1996, respectively. Cash paid for interest amounted to $796,000, $3,183,000 and $2,643,000 during the years ended March 31, 1998, 1997 and 1996, respectively.
A summary of additions and deductions related to the allowances for accounts receivable and inventories for the years ended March 31, 1998, 1997 and 1996 follows:
Balance at Charged to beginning costs and Balance at of year expenses Deductions end of year ------------------------------------------------------
Allowance for doubtful accounts:
1998 $ 2,094 $ 638 $ (340) $ 2,392 1997 1,834 452 (192) 2,094 1996 1,394 634 (194) 1,834
Allowance for inventory valuation:
1998 $ 8,331 $ 2,126 $ (934) $ 9,523 1997 10,372 1,886 (3,927) 8,331 1996 4,373 7,639 (1,640) 10,372
EXHIBIT INDEX -------------
E-1
EXHIBIT INDEX -------------
E-2
EXHIBIT INDEX -------------
E-3