2013.09.30. 10Q
Table of Contents


 

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-Q

(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2013.
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________

Commission File Number:  0-21184

 
 
  
MICROCHIP TECHNOLOGY INCORPORATED
(Exact Name of Registrant as Specified in Its Charter)

Delaware
 
86-0629024
(State or Other Jurisdiction of Incorporation or Organization)
 
(IRS Employer Identification No.)

2355 W. Chandler Blvd., Chandler, AZ  85224-6199
(480) 792-7200
(Address, Including Zip Code, and Telephone Number,
Including Area Code, of Registrant's
Principal Executive Offices)

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for the past 90 days. Yes  x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act:
Large accelerated filer
x
 
Accelerated filer
o
Non-accelerated filer
o
 
Smaller reporting company
o
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  (Check One)
Yes    o No   x
Shares Outstanding of Registrant's Common Stock
Class
 
Outstanding at October 31, 2013
Common Stock, $0.001 par value
 
198,368,386 shares
 


MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES

INDEX

 
 
 
Page
 
 
 
PART I.  FINANCIAL INFORMATION
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
PART II.  OTHER INFORMATION
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
CERTIFICATIONS
 
 
 
EXHIBITS
 


Table of Contents


Item1.
Financial Statements

MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
(unaudited)
ASSETS
 
 
 
 
September 30,
2013
 
March 31,
2013
Cash and cash equivalents
$
344,202

 
$
528,334

Short-term investments
807,709

 
1,050,263

Accounts receivable, net
230,493

 
229,955

Inventories
275,124

 
242,334

Prepaid expenses
34,318

 
37,439

Deferred tax assets
70,383

 
80,687

Other current assets
58,677

 
67,358

Total current assets
1,820,906

 
2,236,370

Property, plant and equipment, net
518,191

 
514,544

Long-term investments
829,656

 
257,450

Goodwill
268,570

 
271,348

Intangible assets, net
480,679

 
530,136

Other assets
47,149

 
41,557

Total assets
$
3,965,151

 
$
3,851,405

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
Accounts payable
$
77,768

 
$
75,551

Accrued liabilities
101,701

 
127,108

Short-term borrowings
8,375

 
—

Deferred income on shipments to distributors
151,049

 
138,952

Total current liabilities
338,893

 
341,611

Junior convertible debentures
367,533

 
363,385

Long-term line of credit
290,000

 
620,000

Long-term borrowings, net
340,379

 
—

Long-term income tax payable
192,007

 
182,723

Deferred tax liability
379,761

 
388,250

Other long-term liabilities
38,039

 
21,966

Stockholders' equity:
 
 
 
Preferred stock, $0.001 par value; authorized 5,000,000 shares; no shares issued or outstanding
—

 
—

Common stock, $0.001 par value; authorized 450,000,000 shares; 218,789,994 shares issued and 198,362,359 shares outstanding at September 30, 2013; 218,789,994 shares issued and 196,472,856 shares outstanding at March 31, 2013
198

 
196

Additional paid-in capital
1,255,419

 
1,255,627

Common stock held in treasury: 20,427,635 shares at September 30, 2013; 22,317,138 shares at March 31, 2013
(626,102
)
 
(682,220
)
Accumulated other comprehensive (loss) income
(2,525
)
 
6,935

Retained earnings
1,391,549

 
1,352,932

Total stockholders' equity
2,018,539

 
1,933,470

Total liabilities and stockholders' equity
$
3,965,151

 
$
3,851,405


See accompanying notes to condensed consolidated financial statements

3
Table of Contents


MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
(unaudited)

 
Three Months Ended
 
Six Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Net sales
$
492,669

 
$
383,298

 
$
955,461

 
$
735,432

Cost of sales (1)
203,806

 
189,103

 
400,024

 
336,440

Gross profit
288,863

 
194,195

 
555,437

 
398,992

Operating expenses:
 

 
 

 
 

 
 

Research and development  (1)
78,254

 
64,082

 
151,339

 
112,908

Selling, general and administrative  (1)
69,368

 
71,767

 
135,078

 
127,359

Amortization of acquired intangible assets
23,744

 
27,858

 
51,421

 
31,904

Special (income) charges
(11
)
 
22,394

 
1,690

 
22,394

 
171,355

 
186,101

 
339,528

 
294,565

 
 
 
 
 
 
 
 
Operating income
117,508

 
8,094

 
215,909

 
104,427

Losses on equity method investments
(101
)
 
(32
)
 
(361
)
 
(153
)
Other income (expense):
 
 
 
 
 
 
 

Interest income
4,010

 
3,744

 
7,935

 
8,076

Interest expense
(12,354
)
 
(10,758
)
 
(24,210
)
 
(19,906
)
Other income, net
2,143

 
1,071

 
2,269

 
539

Income before income taxes
111,206

 
2,119

 
201,542

 
92,983

Income tax provision
11,400

 
23,303

 
23,157

 
35,457

Net income (loss)
$
99,806

 
$
(21,184
)
 
$
178,385

 
$
57,526

Basic net income (loss) per common share
$
0.50

 
$
(0.11
)
 
$
0.90

 
$
0.30

Diluted net income (loss) per common share
$
0.46

 
$
(0.11
)
 
$
0.83

 
$
0.28

Dividends declared per common share
$
0.3540

 
$
0.3510

 
$
0.7075

 
$
0.7010

Basic common shares outstanding
197,825

 
194,060

 
197,388

 
193,756

Diluted common shares outstanding
216,475

 
194,060

 
214,371

 
204,627

(1) Includes share-based compensation expense as follows:
 
 
 
 
 
 
 
Cost of sales
$
1,864

 
$
2,614

 
$
3,833

 
$
3,924

Research and development
6,931

 
6,358

 
12,621

 
10,390

Selling, general and administrative
6,205

 
11,581

 
11,202

 
16,225


See accompanying notes to condensed consolidated financial statements

4
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MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
(unaudited)

 
Three Months Ended
 
Six Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Net income (loss)
$
99,806

 
$
(21,184
)
 
$
178,385

 
$
57,526

Components of other comprehensive income (loss):
 
 
 
 
 
 
 
Available-for-sale securities:
 
 
 
 
 
 
 
Unrealized holding gain (losses), net of tax effect of ($11), ($61), $497 and $36, respectively
1,928

 
2,615

 
(8,070
)
 
2,618

Reclassification of realized transactions, net of tax effect of $776, $0, $776 and $51, respectively
(1,340
)
 
(29
)
 
(1,390
)
 
(170
)
Change in net foreign currency translation adjustment
—

 
1,140

 
—

 
1,140

Other comprehensive income (loss), net of taxes
588

 
3,726

 
(9,460
)
 
3,588

Total comprehensive income (loss)
$
100,394

 
$
(17,458
)
 
$
168,925

 
$
61,114


See accompanying notes to condensed consolidated financial statements


5
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MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 
Six Months Ended
 
September 30,
 
2013
 
2012
Cash flows from operating activities:
 
 
 
Net income
$
178,385

 
$
57,526

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
98,462

 
76,456

Deferred income taxes
11,872

 
(9,425
)
Share-based compensation expense related to equity incentive plans
27,656

 
24,593

Excess tax benefit from share-based compensation
—

 
(112
)
Convertible debt derivatives - revaluation and amortization
(248
)
 
589

Amortization of debt discount on convertible debentures
4,396

 
4,017

Amortization of debt issuance costs
872

 
109

Losses on equity method investments
361

 
153

Gain on sale of assets
—

 
(16
)
Impairment of intangible assets
350

 
—

Unrealized impairment loss on available-for-sale investments
—

 
334

Special income, net
(237
)
 
—

Changes in operating assets and liabilities:
 
 
 
Increase in accounts receivable
(693
)
 
(116
)
(Increase) decrease in inventories
(32,103
)
 
22,334

Increase in deferred income on shipments to distributors
12,097

 
3,037

Decrease in accounts payable and accrued liabilities
(2,006
)
 
(27,670
)
Change in other assets and liabilities
20,191

 
40,462

Net cash provided by operating activities
319,355

 
192,271

Cash flows from investing activities:
 

 
 

Purchases of available-for-sale investments
(710,197
)
 
(443,106
)
Sales and maturities of available-for-sale investments
370,806

 
350,593

Acquisition of SMSC, net of cash acquired
—

 
(731,746
)
Other business acquisitions, net of cash acquired
(2,174
)
 
(20,556
)
Investments in other assets
(2,951
)
 
(2,204
)
Proceeds from sale of assets
16,200

 
66

Capital expenditures
(55,206
)
 
(26,212
)
Net cash used in investing activities
(383,522
)
 
(873,165
)
Cash flows from financing activities:
 

 
 

Repayments of revolving loan under previous credit facility
(650,000
)
 
(80,000
)
Repayments of revolving loan under new credit facility
(70,000
)
 
—

Proceeds from borrowings on revolving loan under previous credit facility
30,000

 
680,000

Proceeds from borrowings on revolving loan under new credit facility
360,000

 
—

Proceeds from issuance of long-term borrowings
350,000

 
—

Deferred financing costs
(7,515
)
 
—

Payment of cash dividends
(139,768
)
 
(135,895
)
Proceeds from sale of common stock
22,196

 
16,318

Contingent consideration payment
(14,700
)
 
—

Capital lease payments
(178
)
 
—

Excess tax benefit from share-based compensation
—

 
112

Net cash (used in) provided by financing activities
(119,965
)
 
480,535

Effect of foreign exchange rate changes on cash and cash equivalents
—

 
1,339

Net decrease in cash and cash equivalents
(184,132
)
 
(199,020
)
Cash and cash equivalents at beginning of period
528,334

 
635,755

Cash and cash equivalents at end of period
$
344,202

 
$
436,735

See accompanying notes to condensed consolidated financial statements

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Table of Contents


MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(1)
Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of Microchip Technology Incorporated and its wholly-owned subsidiaries (the Company).  All intercompany balances and transactions have been eliminated in consolidation.  The Company owns 100% of the outstanding stock in all of its subsidiaries.
 
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America, pursuant to the rules and regulations of the Securities and Exchange Commission (the SEC).  The information furnished herein reflects all adjustments which are, in the opinion of management, of a normal recurring nature and necessary for a fair statement of the results for the interim periods reported. Certain information and footnote disclosures normally included in audited consolidated financial statements have been condensed or omitted pursuant to such SEC rules and regulations.  It is suggested that these condensed consolidated financial statements be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 2013.  The results of operations for the six months ended September 30, 2013 are not necessarily indicative of the results that may be expected for the fiscal year ending March 31, 2014 or for any other period.

(2)
Business Acquisitions
Acquisition of SMSC
On August 2, 2012, the Company acquired SMSC, a publicly traded company based in Hauppauge, New York. The acquisition was accounted for under the acquisition method of accounting. The Company retained an independent third-party appraiser to assist management in its valuation. The table below represents the allocation of the purchase price, including adjustments to the purchase price allocation from the previously reported figures at March 31, 2013, to the net assets acquired based on their estimated fair values as of August 2, 2012. The purchase price was finalized as of August 2, 2013. All adjustments shown in the table below were recorded during the three months ended June 30, 2013 (amounts in thousands):

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Assets acquired

Previously Reported
March 31, 2013
 
Adjustments
 
September 30, 2013
Cash and cash equivalents
$
180,925

 
$
—

 
$
180,925

Accounts receivable, net
58,441

 
—

 
58,441

Inventories
86,244

 
—

 
86,244

Prepaid expenses
5,617

 
—

 
5,617

Deferred tax assets
15,843

 
—

 
15,843

Other current assets
17,578

 
—

 
17,578

Property, plant and equipment, net
35,608

 
—

 
35,608

Long-term investments
24,275

 
—

 
24,275

Goodwill
169,065

 
(3,473
)
 
165,592

Intangible assets, net
10,214

 
—

 
10,214

Purchased intangible assets
517,800

 
—

 
517,800

Other assets
3,835

 
—

 
3,835

Total assets acquired
1,125,445

 
(3,473
)
 
1,121,972

 
 
 
 
 
 
Liabilities assumed
 
 
 
 
 
Accounts payable
(28,035
)
 
—

 
(28,035
)
Accrued liabilities
(62,038
)
 
(209
)
 
(62,247
)
Deferred income on shipments to distributors
(11,376
)
 
—

 
(11,376
)
Long-term income tax payable
(72,781
)
 
—

 
(72,781
)
Deferred tax liability
(21,079
)
 
4,397

 
(16,682
)
Other liabilities
(10,535
)
 
(715
)
 
(11,250
)
Total liabilities assumed
(205,844
)
 
3,473

 
(202,371
)
Purchase price allocated
$
919,601

 
$
—

 
$
919,601


(3)
Recently Issued Accounting Pronouncements

In the first quarter of fiscal 2014, the Company adopted the provisions of Accounting Standard Update 2013-02 Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, which required the disclosure of amounts reclassified out of accumulated other comprehensive income (AOCI) to net income. The adoption of this amendment did not have a material impact on the Company's consolidated financial statements and related disclosures (See Note 18).

(4)
Special (Income) Charges

During the three months ended September 30, 2013, the Company incurred special charges of $0.8 million for an additional liability related to the acquisition of Roving Networks and $0.4 million of severance-related, office closing, and other costs associated with the acquisition of SMSC which were offset by $1.1 million of special income related to the release of an accrued bonus for a milestone that was not met for a business that SMSC had acquired prior to the Company's acquisition of SMSC. During the six months ended September 30, 2013, the Company incurred special charges of $1.4 million due to the increase in the fair value of contingent consideration related to one of its acquisitions, $0.8 million for an additional liability related to the acquisition of Roving Networks and $0.7 million of severance-related, office closing, and other costs associated with the acquisition of SMSC which were offset by $1.1 million of special income related to the release of an accrued bonus for a milestone that was not met for a business that SMSC had acquired prior to the Company's acquisition of SMSC.

During the three and six months ended September 30, 2012, the Company incurred approximately $10.9 million of severance related, office closing, and other costs associated with the acquisition of SMSC. Also, during the three and six months ended September 30, 2012, the Company incurred legal settlement costs of approximately $11.5 million for certain legal matters related to Silicon Storage Technology, Inc. (which the Company acquired in April 2010) in excess of previously accrued amounts.



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(5)
Segment Information
 
The Company's reportable segments are semiconductor products and technology licensing.  The Company does not allocate operating expenses, interest income, interest expense, other income or expense, or provision for or benefit from income taxes to these segments for internal reporting purposes, as the Company does not believe that allocating these expenses is beneficial in evaluating segment performance.  Additionally, the Company does not allocate assets to segments for internal reporting purposes as it does not manage its segments by such metrics.

The following table represents net sales and gross profit for each segment for the three and six months ended September 30, 2013 (amounts in thousands):
 
Three Months Ended
 
Six Months Ended
 
September 30, 2013
 
September 30, 2013
 
Net Sales
 
Gross Profit
 
Net Sales
 
Gross Profit
Semiconductor products
$
467,843

 
$
264,037

 
$
908,117

 
$
508,093

Technology licensing
24,826

 
24,826

 
47,344

 
47,344

 
$
492,669

 
$
288,863

 
$
955,461

 
$
555,437


The following table represents net sales and gross profit for each segment for the three and six months ended September 30, 2012 (amounts in thousands):
 
Three Months Ended
 
Six Months Ended
 
September 30, 2012
 
September 30, 2012
 
Net Sales
 
Gross Profit
 
Net Sales
 
Gross Profit
Semiconductor products
$
363,177

 
$
174,074

 
$
695,029

 
$
358,589

Technology licensing
20,121

 
20,121

 
40,403

 
40,403

 
$
383,298

 
$
194,195

 
$
735,432

 
$
398,992


(6)
Investments
 
The Company's investments are intended to establish a high-quality portfolio that preserves principal, meets liquidity needs, avoids inappropriate concentrations, and delivers an appropriate yield in relationship to the Company's investment guidelines and market conditions.  The following is a summary of available-for-sale securities at September 30, 2013 (amounts in thousands):
 
Available-for-sale Securities
 
Adjusted
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
Government agency bonds
$
781,230

 
$
269

 
$
(5,467
)
 
$
776,032

Municipal bonds
54,286

 
60

 
(575
)
 
53,771

Auction rate securities
9,829

 
—

 
—

 
9,829

Corporate bonds and debt
796,035

 
2,902

 
(1,204
)
 
797,733

 
$
1,641,380

 
$
3,231

 
$
(7,246
)
 
$
1,637,365

 

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The following is a summary of available-for-sale and marketable equity securities at March 31, 2013 (amounts in thousands):
 
Available-for-sale Securities
 
Adjusted
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
Government agency bonds
$
558,116

 
$
335

 
$
(298
)
 
$
558,153

Municipal bonds
25,000

 
146

 
(8
)
 
25,138

Auction rate securities
33,459

 
332

 
—

 
33,791

Corporate bonds and debt
680,144

 
5,137

 
(159
)
 
685,122

Marketable equity securities
5,270

 
239

 
—

 
5,509

 
$
1,301,989

 
$
6,189

 
$
(465
)
 
$
1,307,713

   
At September 30, 2013, the Company's available-for-sale debt securities are presented on the condensed consolidated balance sheets as short-term investments of $807.7 million and long-term investments of $829.7 million.  At March 31, 2013, the Company’s available-for-sale debt securities and marketable equity securities are presented on the condensed consolidated balance sheets as short-term investments of $1,050.3 million and long-term investments of $257.5 million.

At September 30, 2013, the Company evaluated its investment portfolio and noted unrealized losses of $7.2 million on its debt securities which were due primarily to higher interest rates and resulting declines in market prices.  Management does not believe any of the unrealized losses represent an other-than-temporary impairment based on its evaluation of available evidence as of September 30, 2013 and the Company's intent is to hold these investments until these assets are no longer impaired, except for certain auction rate securities (ARS).  For those debt securities not scheduled to mature until after September 30, 2014, such recovery is not anticipated to occur in the next year and these investments have been classified as long-term investments.
 
The amortized cost and estimated fair value of the available-for-sale securities at September 30, 2013, by contractual maturity, excluding corporate debt of $6.2 million, which have no contractual maturity, are shown below (amounts in thousands).  Expected maturities can differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties, and the Company views its available-for-sale securities as available for current operations.
 
Adjusted
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
Available-for-sale
 
 
 
 
 
 
 
Due in one year or less
$
234,539

 
$
1,133

 
$
(7
)
 
$
235,665

Due after one year and through five years
1,280,074

 
2,098

 
(2,973
)
 
1,279,199

Due after five years and through ten years
110,748

 
—

 
(4,266
)
 
106,482

Due after ten years
9,829

 
—

 
—

 
9,829

 
$
1,635,190

 
$
3,231

 
$
(7,246
)
 
$
1,631,175

 
The Company had a realized gain of $1.0 million from the sale of available-for-sale marketable equity securities during the three and six-month periods ended September 30, 2013. The Company had net realized gains of $1.1 million and $1.2 million from the sale of available-for-sale debt securities during the three and six-month periods ended September 30, 2013, respectively. The Company had no material realized gains or losses from the sale of available-for-sale marketable equity securities or debt securities during the three or six-month periods ended September 30, 2012.

(7)
Fair Value Measurements

Accounting rules for fair value clarify that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.  As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability.  As a basis for considering such assumptions, the Company utilizes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:

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Level 1-
Observable inputs such as quoted prices in active markets;
Level 2-
Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and
Level 3-
Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

Marketable Debt Instruments

Marketable debt instruments include instruments such as corporate bonds and debt, government agency bonds, bank deposits, municipal bonds, and money market fund deposits. When the Company uses observable market prices for identical securities that are traded in less active markets, the Company classifies its marketable debt instruments as Level 2. When observable market prices for identical securities are not available, the Company prices its marketable debt instruments using non-binding market consensus prices that are corroborated with observable market data; quoted market prices for similar instruments; or pricing models, such as a discounted cash flow model, with all significant inputs derived from or corroborated with observable market data. Non-binding market consensus prices are based on the proprietary valuation models of pricing providers or brokers. These valuation models incorporate a number of inputs, including non-binding and binding broker quotes; observable market prices for identical or similar securities; and the internal assumptions of pricing providers or brokers that use observable market inputs and, to a lesser degree, unobservable market inputs. The Company corroborates non-binding market consensus prices with observable market data using statistical models when observable market data exists. The discounted cash flow model uses observable market inputs, such as LIBOR-based yield curves, currency spot and forward rates, and credit ratings.
 
Assets and Liabilities Measured at Fair Value on a Recurring Basis
 
Assets and liabilities measured at fair value on a recurring basis at September 30, 2013 are as follows (amounts in thousands):
 
Quoted Prices
in Active
Markets for
Identical
Instruments
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total
Balance
Assets
 
 
 
 
 
 
 
Money market mutual funds
$
49,949

 
$
—

 
$
—

 
$
49,949

Corporate bonds and debt
—

 
791,543

 
6,190

 
797,733

Government agency bonds
—

 
776,032

 
—

 
776,032

Deposit accounts
—

 
294,253

 
—

 
294,253

Municipal bonds
—

 
53,771

 
—

 
53,771

Auction rate securities
—

 
—

 
9,829

 
9,829

Total assets measured at fair value
$
49,949

 
$
1,915,599

 
$
16,019

 
$
1,981,567

 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
Contingent consideration
$
—

 
$
—

 
$
1,022

 
$
1,022

Total liabilities measured at fair value
$
—

 
$
—

 
$
1,022

 
$
1,022



11
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Assets measured at fair value on a recurring basis at March 31, 2013 are as follows (amounts in thousands):
 
Quoted Prices
in Active
Markets for Identical Instruments
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total
Balance
Assets
 
 
 
 
 
 
 
Money market fund deposits
$
100,878

 
$
—

 
$
—

 
$
100,878

Marketable equity securities
5,509

 
—

 
—

 
5,509

Corporate bonds and debt
—

 
678,932

 
6,190

 
685,122

Government agency bonds
—

 
558,153

 
—

 
558,153

Deposit accounts
—

 
427,456

 
—

 
427,456

Municipal bonds
—

 
25,138

 
—

 
25,138

Auction rate securities
—

 
—

 
33,791

 
33,791

Total assets measured at fair value
$
106,387

 
$
1,689,679

 
$
39,981

 
$
1,836,047

 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
Contingent consideration
$
—

 
$
—

 
$
19,100

 
$
19,100

Total liabilities measured at fair value
$
—

 
$
—

 
$
19,100

 
$
19,100


There were no transfers between Level 1 and Level 2 during the three and six-month periods ended September 30, 2013 or the year ended March 31, 2013.

At September 30, 2013, the Company's ARS for which recent auctions were unsuccessful are made up of securities related to the insurance industry valued at $9.8 million. At March 31, 2013, the Company's ARS for which recent auctions were unsuccessful were made up of bonds related to the insurance sector valued at $9.8 million, securities related to the energy and telecommunications sectors valued at $5.3 million, and student loan securities valued at $18.7 million.
The Company estimated the fair value of its ARS, which are classified as Level 3 securities, based on the following: (i) the underlying structure of each security; (ii) the present value of future principal and interest payments discounted at rates considered to reflect current market conditions; (iii) consideration of the probabilities of default, auction failure, or repurchase at par for each period; and (iv) estimates of the recovery rates in the event of default for each security. The significant unobservable inputs used in the fair value measurement of the insurance sector ARS were estimated risk free discount rates, liquidity risk premium, and the liquidity horizon. The risk free discount rate applied to these securities was 2% to 2.5% adjusted for the liquidity risk premium which ranged from 9.1% to 29.5%. The anticipated liquidity horizon ranged from 7 to 10 years. A significant increase in the liquidity premium or discount rate, in isolation, would lead to a significantly lower fair value measurement. A significant increase in the liquidity horizon, in isolation, would lead to a significantly lower fair value measurement. Each quarter the Company investigates material changes in the fair value measurements of its ARS.
Level 3 liabilities include contingent consideration from the Company's Roving Networks acquisition, of which the majority was paid in the three months ended September 30, 2013. The Company evaluates the estimated fair value of its contingent consideration on a quarterly basis based on certain revenue and gross margin performance criteria and records fair value adjustments as necessary. The final measurement date for the contingent consideration was June 30, 2013 and there will be no further adjustments to such liability.


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The following tables present a reconciliation for all assets and liabilities measured at fair value on a recurring basis, excluding accrued interest components, using significant unobservable inputs (Level 3) for the six months ended September 30, 2013, and the year ended March 31, 2013 (amounts in thousands):
Six months ended September 30, 2013
 
Auction Rate
Securities
 
Corporate
Debt
 
Contingent
Consideration
 
Total Gains
(Losses)
Balance at March 31, 2013
 
$
33,791

 
$
6,190

 
$
(19,100
)
 
$
—

Total gains or losses (realized and unrealized):
 
 
 
 
 
 
 
 
Included in earnings
 
1,105

 
—

 
(1,392
)
 
(287
)
  Included in other comprehensive income
 
(332
)
 
—

 
—

 
(332
)
Purchases, sales, issuances, and settlements, net
 
(24,735
)
 
—

 
19,470

 
—

Balance at September 30, 2013
 
$
9,829

 
$
6,190

 
$
(1,022
)
 
$
(619
)

Year ended March 31, 2013
 
Auction Rate
Securities
 
Corporate
Debt
 
Contingent
Consideration
 
Total Gains (Losses)
Balance at March 31, 2012
 
$
10,246

 
$
4,625

 
$
—

 
$
—

Total gains or losses (realized and unrealized):
 
 
 
 
 
 
 
 
Included in earnings
 
(412
)
 
—

 
(4,400
)
 
$
(4,813
)
  Included in other comprehensive income
 
332

 
—

 
—

 
332

Purchases, sales, issuances, and settlements, net
 
(650
)
 
1,565

 
—

 
—

Acquisition-related
 
24,275

 
—

 
(14,700
)
 
—

Balance at March 31, 2013
 
$
33,791

 
$
6,190

 
$
(19,100
)
 
$
(4,481
)

Assets measured at fair value on a recurring basis are presented/classified on the condensed consolidated balance sheets at September 30, 2013 as follows (amounts in thousands):
 
Quoted Prices
 in Active
Markets for
Identical
Instruments
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total
Balance
Assets
 
 
 
 
 
 
 
Cash and cash equivalents
$
49,949

 
$
294,253

 
$
—

 
$
344,202

Short-term investments
—

 
807,709

 
—

 
807,709

Long-term investments
—

 
813,637

 
16,019

 
829,656

Total assets measured at fair value
$
49,949

 
$
1,915,599

 
$
16,019

 
$
1,981,567


Assets measured at fair value on a recurring basis are presented/classified in the consolidated balance sheets at March 31, 2013 as follows (amounts in thousands):
 
Quoted Prices
in Active
Markets for
Identical
Instruments
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
 (Level 3)
 
Total
Balance
Assets
 
 
 
 
 
 
 
Cash and cash equivalents
$
100,878

 
$
427,456

 
$
—

 
$
528,334

Short-term investments
—

 
1,050,263

 
—

 
1,050,263

Long-term investments
5,509

 
211,960

 
39,981

 
257,450

Total assets measured at fair value
$
106,387

 
$
1,689,679

 
$
39,981

 
$
1,836,047



13
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Financial Assets Not Recorded at Fair Value on a Recurring Basis
 
The Company's non-marketable equity and cost method investments are not recorded at fair value on a recurring basis.  These investments are monitored on a quarterly basis for impairment charges.  The investments will only be recorded at fair value when an impairment charge is recognized.  There were no impairment charges recognized on these investments in the three and six months ended September 30, 2013 and September 30, 2012. These investments are included in other assets on the condensed consolidated balance sheet.

(8)
Fair Value of Financial Instruments
 
The carrying amount of cash equivalents approximates fair value because their maturity is less than three months.  Management believes the carrying amount of the equity and cost-method investments materially approximated fair value at September 30, 2013 based upon unobservable inputs. The fair values of these investments have been determined as Level 3 fair value measurements. The fair values of the Company's line of credit, short-term and long-term borrowings are estimated using discounted cash flow analyses, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements and approximate carrying value. Based on the borrowing rates currently available to the Company for bank loans with similar terms and average maturities, the fair value of the Company's line of credit and long-term borrowings at September 30, 2013 approximated book value and are considered Level 2 in the fair value hierarchy described in Note 7. The carrying amount of accounts receivable, accounts payable and accrued liabilities approximates fair value due to the short-term maturity of the amounts.  The fair value of the Company's junior subordinated convertible debentures was $1.804 billion at September 30, 2013 and $1.639 billion at March 31, 2013 based on observable market prices for these debentures, which are traded in less active markets and are therefore classified as a Level 2 fair value measurement.

(9)
Accounts Receivable
 
Accounts receivable consists of the following (amounts in thousands):
 
September 30, 2013
 
March 31, 2013
Trade accounts receivable
$
231,208

 
$
230,469

Other
1,994

 
2,250

 
233,202

 
232,719

Less allowance for doubtful accounts
2,709

 
2,764

 
$
230,493

 
$
229,955


(10)
Inventories

The components of inventories consist of the following (amounts in thousands):
 
September 30, 2013
 
March 31, 2013
Raw materials
$
8,690

 
$
9,020

Work in process
211,917

 
181,750

Finished goods
54,517

 
51,564

 
$
275,124

 
$
242,334


Inventories are valued at the lower of cost or market using the first-in, first-out method. Inventory impairment charges establish a new cost basis for inventory and charges are not subsequently reversed to income even if circumstances later suggest that increased carrying amounts are recoverable.

(11)
Property, Plant and Equipment

Property, plant and equipment consists of the following (amounts in thousands):

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September 30, 2013
 
March 31, 2013
Land
$
55,464

 
$
47,102

Building and building improvements
395,971

 
396,611

Machinery and equipment
1,421,806

 
1,377,814

Projects in process
69,753

 
76,158

 
1,942,994

 
1,897,685

Less accumulated depreciation and amortization
1,424,803

 
1,383,141

 
$
518,191

 
$
514,544

 
Depreciation expense attributed to property, plant and equipment was $23.0 million and $44.4 million for the three and six months ended September 30, 2013, respectively, and $22.4 million and $43.1 million for the three and six months ended September 30, 2012, respectively.

(12)
Accrued Liabilities

Accrued liabilities consist of the following (amounts in thousands):
 
September 30, 2013
 
March 31, 2013
Acquisition related contingent consideration
$
1,022

 
$
19,100

Other accrued expenses
100,679

 
108,008

 
$
101,701

 
$
127,108


(13)
Income Taxes
 
The provision for income taxes reflects tax on foreign earnings and federal and state tax on U.S. earnings.  The Company had an effective tax rate of 11.5% for the six-month period ended September 30, 2013 and 38.1% for the six-month period ended September 30, 2012.  The Company's effective tax rate is lower than statutory rates in the U.S. due primarily to its mix of earnings in foreign jurisdictions with lower tax rates. The Company's effective tax rate was higher in the September 30, 2012 period due to certain tax expenses associated with the acquisition of SMSC.

At September 30, 2013, the Company had $192.0 million of unrecognized tax benefits.  Unrecognized tax benefits increased by $9.3 million compared to March 31, 2013 primarily as a result of the ongoing accrual for uncertain tax positions and the accrual of deficiency interest on these positions.
 
The Company files U.S. federal, U.S. state, and foreign income tax returns.  For U.S. federal, and in general for U.S. state tax returns, the fiscal 2009 and later tax years remain open for examination by tax authorities.  The Internal Revenue Service (IRS) is currently auditing the Company's fiscal years ended March 31, 2009 and 2010 tax years as well as SMSC's 2011 and 2012 tax years.  For foreign tax returns, the Company is generally no longer subject to income tax examinations for years prior to fiscal 2005.
 
The Company recognizes liabilities for anticipated tax audit issues in the U.S. and other tax jurisdictions based on its estimate of whether, and the extent to which, additional tax payments are more likely than not.  The Company believes that it has appropriate support for the income tax positions taken on its tax returns and that its accruals for tax liabilities are adequate for all open years based on an assessment of many factors including past experience and interpretations of tax laws applied to the facts of each matter.
 
The Company believes that it maintains appropriate reserves to offset any potential income tax liabilities that may arise upon final resolution of matters for open tax years.  If such reserve amounts ultimately prove to be unnecessary, the resulting reversal of such reserves would result in tax benefits being recorded in the period the reserves are no longer deemed necessary.  If such amounts prove to be less than an ultimate assessment, a future charge to expense would be recorded in the period in which the assessment is determined.  Although the timing of the resolution and/or closure of audits is highly uncertain, the Company does not believe it is reasonably possible that its unrecognized tax benefits would materially change in the next 12 months.



15
Table of Contents


(14)
2.125% Junior Subordinated Convertible Debentures
 
The Company's $1.15 billion principal amount of 2.125% junior subordinated convertible debentures due December 15, 2037, are subordinated in right of payment to any future senior debt of the Company and are effectively subordinated in right of payment to the liabilities of the Company's subsidiaries.  The debentures are convertible, subject to certain conditions, into shares of the Company's common stock at an initial conversion rate of 29.2783 shares of common stock per $1,000 principal amount of debentures, representing an initial conversion price of approximately $34.16 per share of common stock.  As of September 30, 2013, the holders of the debentures had the right to convert their debentures between July 1, 2013 and September 30, 2013 because for at least 20 trading days during the 30 consecutive trading day period ending on September 30, 2013, the Company's common stock had a last reported sale price greater than 130% of the conversion price. As of September 30, 2013, a holder could realize more economic value by selling its debentures in the over the counter market than from converting its debentures. As a result of cash dividends paid since the issuance of the debentures, the conversion rate has been adjusted to 38.0436 shares of common stock per $1,000 of principal amount of debentures, representing a conversion price of approximately $26.29 per share of common stock.
 
As the debentures can be settled in cash upon conversion, for accounting purposes, the debentures were bifurcated into a liability component and an equity component, which are both initially recorded at fair value.  The carrying value of the equity component at September 30, 2013 and at March 31, 2013 was $822.4 million.  The estimated fair value of the liability component of the debentures at the issuance date was $327.6 million, resulting in a debt discount of $822.4 million.  The unamortized debt discount was $781.8 million at September 30, 2013 and $786.2 million at March 31, 2013.  The carrying value of the debentures was $367.5 million at September 30, 2013 and $363.4 million at March 31, 2013.  The remaining period over which the unamortized debt discount will be recognized as non-cash interest expense is 24.25 years.  In the three and six months ended September 30, 2013, the Company recognized $2.2 million and $4.4 million, respectively, in non-cash interest expense related to the amortization of the debt discount.  In the three and six months ended September 30, 2012, the Company recognized $2.0 million and $4.0 million, respectively, in non-cash interest expense related to the amortization of the debt discount.  The Company recognized $6.1 million and $12.2 million of interest expense related to the 2.125% coupon on the debentures in each of the three and six-month periods ended September 30, 2013 and September 30, 2012, respectively.

(15)
Credit Facility

On June 27, 2013, the Company entered into a $2.0 billion credit agreement among the Company, the lenders from time to time that are parties thereto and JPMorgan Chase Bank, N.A., as administrative agent (the "Credit Agreement"). The Credit Agreement provides for a $350 million term loan and a $1.65 billion revolving credit facility, with a $125 million foreign currency sublimit, a $35 million letter of credit sublimit and a $25 million swingline loan sublimit, terminating on June 27, 2018 (the "Maturity Date"). The Credit Agreement also contains an increase option permitting the Company, subject to certain requirements, to arrange with existing lenders and/or new lenders for them to provide up to an aggregate of $300 million in additional commitments, which may be for revolving loans or term loans. Proceeds of loans made under the Credit Agreement may be used for working capital and general corporate purposes. The Credit Agreement replaced another credit agreement the Company had in place since August 2011. At September 30, 2013, $640.0 million of borrowings were outstanding under the Credit Agreement consisting of $290.0 million of a revolving line of credit and $350.0 million of a term loan, net of $1.2 million of debt discount resulting from amounts paid to the lenders.

The loans under the Credit Agreement bear interest, at the Company's option, at the base rate plus a spread of 0.25% to 1.25% or an adjusted LIBOR rate (based on one, two, three, or six-month interest periods) plus a spread of 1.25% to 2.25%, in each case with such spread being determined based on the consolidated leverage ratio for the preceding four fiscal quarter period. The base rate means the highest of JPMorgan Chase Bank, N.A.'s prime rate, the federal funds rate plus a margin equal to 0.50% and the adjusted LIBOR rate for a 1-month interest period plus a margin equal to 1.00%. Swingline loans accrue interest at a per annum rate based on the base rate plus the applicable margin for base rate loans. Base rate loans may only be made in U.S. dollars. The Company is also obligated to pay other customary administration fees and letter of credit fees for a credit facility of this size and type.

Interest is due and payable in arrears quarterly for loans bearing interest at the base rate and at the end of an interest period (or at each three-month interval in the case of loans with interest periods greater than three months) in the case of loans bearing interest at the adjusted LIBOR rate. Interest expense related to the Credit Agreement was approximately $4.0 million in the three months ended September 30, 2013 and $7.5 million in the six months ended September 30, 2013. Interest expense related to the Company's prior credit agreement was approximately $2.3 million and $3.0 million in the three and six months ended September 30, 2012, respectively. Principal, together with all accrued and unpaid interest, is due and payable on the maturity date. The Company may prepay the loans and terminate the commitments, in whole or in part, at any time without

16
Table of Contents


premium or penalty, subject to certain conditions including minimum amounts in the case of commitment reductions and reimbursement of certain costs in the case of prepayments of LIBOR loans.

The Company's obligations under the Credit Agreement are guaranteed by certain of its subsidiaries meeting materiality thresholds set forth in the Credit Agreement. To secure the Company's obligations under the Credit Agreement, the Company and its domestic subsidiaries will be required to pledge the equity securities of certain of their respective material subsidiaries, subject to certain exceptions and limitations.

The Credit Agreement contains customary affirmative and negative covenants, including covenants that limit or restrict the Company and its subsidiaries' ability to, among other things, incur subsidiary indebtedness, grant liens, merge or consolidate, dispose of assets, make investments, make acquisitions, enter into certain transactions with affiliates, pay dividends or make distributions, repurchase stock, enter into restrictive agreements and enter into sale and leaseback transactions, in each case subject to customary exceptions for a credit facility of this size and type. The Company is also required to maintain compliance with a consolidated leverage ratio and a consolidated interest coverage ratio. At September 30, 2013, the Company was in compliance with these covenants.

The Credit Agreement includes customary events of default that, include among other things, non-payment defaults, inaccuracy of representations and warranties, covenant defaults, cross default to material indebtedness, bankruptcy and insolvency defaults, material judgment defaults, ERISA defaults and a change of control default. The occurrence of an event of default could result in the acceleration of the obligations under the Credit Agreement. Under certain circumstances, a default interest rate will apply on all obligations during the existence of an event of default under the Credit Agreement at a per annum rate equal to 2.00% above the applicable interest rate for any overdue principal and 2.00% above the rate applicable for base rate loans for any other overdue amounts.

(16)
Contingencies

In the ordinary course of the Company's business, it is involved in a limited number of legal actions, both as plaintiff and defendant, and could incur uninsured liability in any one or more of them.  The Company also periodically receives notifications from various third parties alleging infringement of patents, intellectual property rights or other matters.  With respect to pending legal actions to which the Company is a party, although the outcomes of these actions are not generally determinable, the Company believes that the ultimate resolution of these matters will not have a material adverse effect on its financial position, cash flows or results of operations.  Litigation relating to the semiconductor industry is not uncommon, and the Company is, and from time to time has been, subject to such litigation.  No assurances can be given with respect to the extent or outcome of any such litigation in the future.
 
The Company's technology license agreements generally include an indemnification clause that indemnifies the licensee against liability and damages (including legal defense costs) arising from any claims of patent, copyright, trademark or trade secret infringement by the Company's proprietary technology.  The terms of these indemnification provisions approximate the terms of the outgoing technology license agreements, which are typically perpetual unless terminated by either party for breach.  The possible amount of future payments the Company could be required to make based on agreements that specify indemnification limits, if such indemnifications were required on all of these agreements, is approximately $119 million. There are some licensing agreements in place that do not specify indemnification limits.  The Company had not recorded any liabilities related to these indemnification obligations as of September 30, 2013.

Contingent liabilities in the amount of $13.0 million were recorded in connection with the Company's April 10, 2010 acquisition of Silicon Storage Technology Inc. (SST) as an adverse outcome was determined to be probable and estimable.  One of the contingent liabilities associated with the SST acquisition was resolved in the second quarter of fiscal 2013 with legal settlement costs of approximately $11.5 million for certain legal matters related to SST in excess of previously accrued amounts, for which were expensed as special charges in the statement of income. At September 30, 2013, $5.7 million of the original contingent liabilities recorded were still outstanding.

(17)
Derivative Instruments
 
The Company has international operations and is thus subject to foreign currency rate fluctuations.  To manage the risk of changes in foreign currency rates, the Company periodically enters into derivative contracts comprised of foreign currency forward contracts to hedge its asset and liability foreign currency exposure and a portion of its foreign currency operating expenses.  Approximately 99% of the Company's sales are U.S. dollar denominated.  To date, the exposure related to foreign exchange rate volatility has not been material to the Company's operating results.  As of September 30, 2013, the Company had no foreign currency forward contracts outstanding. As of March 31, 2013, the Company had foreign currency forward

17
Table of Contents


contracts with notional amounts of $6.0 million to economically hedge certain balance sheet exposures related to the Japanese yen. As these contracts were executed at or near the end of the respective periods, there were no unrecognized gains or losses on these contracts at March 31, 2013. The Company recognized an immaterial amount of net realized gains and losses on foreign currency forward contracts in each of the three and six months ended September 30, 2013 and 2012. Gains and losses from changes in the fair value of these foreign currency forward contracts are credited or charged to Other Income (Expense). The Company does not apply hedge accounting to its foreign currency derivative instruments.
 
(18)
Comprehensive Income

The following table presents the changes in the components of accumulated other comprehensive income (AOCI) for the six months ended September 30, 2013 (amounts in thousands):
 
Unrealized
holding gains (losses)
available-for-sale securities
 
Minimum
pension
liability
 
Foreign
Currency
 
Total
Balance at March 31, 2013
$
5,444

 
$
52

 
$
1,439

 
$
6,935

Other comprehensive loss before reclassifications
(8,070
)
 
—

 
—

 
(8,070
)
Amounts reclassified from accumulated other comprehensive income (loss)
(1,390
)
 
—

 
—

 
(1,390
)
Net other comprehensive loss
(9,460
)
 
—

 
—

 
(9,460
)
Balance at September 30, 2013
$
(4,016
)
 
$
52

 
$
1,439

 
$
(2,525
)

The table below details where reclassifications of realized transactions out of AOCI are recorded on the Consolidated Statements of Income.
 
 
Three Months Ended
 
Six Months Ended
 
 
 
 
September 30,
 
September 30,
 
 
Description of AOCI Component
 
2013
 
2012
 
2013
 
2012
 
Related Statement of Income Line
Unrealized gains (losses) on available-for-sale securities
 
$
2,116

 
$
29

 
$
2,166

 
$
221

 
Other income
Taxes
 
(776
)
 
—

 
(776
)
 
(51
)
 
Provision for income taxes
Reclassification of realized transactions, net of taxes
 
$
1,340

 
$
29

 
$
1,390

 
$
170

 
Net Income

(19)
Share-Based Compensation
 
The following table presents the details of the Company's share-based compensation expense (amounts in thousands):
 
Three Months Ended
 
Six Months Ended
 
 
September 30,
 
September 30,
 
 
2013
 
2012
 
2013
 
2012
 
Cost of sales
$
1,864

(1) 
$
2,614

(1) 
$
3,833

(1) 
$
3,924

(1) 
Research and development
6,931

 
6,358

 
12,621

 
10,390

 
Selling, general and administrative
6,205

 
11,581

 
11,202

 
16,225

 
Pre-tax effect of share-based compensation
15,000

 
20,553

 
27,656

 
30,539

 
Income tax benefit
1,589

 
3,419

 
2,991

 
4,741

 
Net income effect of share-based compensation
$
13,411

 
$
17,134

 
$
24,665

 
$
25,798

 
 
(1) During the three and six months ended September 30, 2013, $2.4 million and $3.8 million, respectively, of share-based compensation expense was capitalized to inventory and $1.9 million and $3.8 million, respectively, of previously capitalized share-based compensation expenses in inventory was sold.  During the three and six months ended September 30, 2012, $1.8 million and $3.5 million of share-based compensation expense was capitalized to inventory and

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$2.6 million and $3.9 million, respectively, of previously capitalized share-based compensation expense in inventory was sold.

(20)
Net Income (Loss) Per Common Share
 
The following table sets forth the computation of basic and diluted net income (loss) per common share (in thousands, except per share amounts):
 
Three Months Ended
 
Six Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Net income (loss)
$
99,806

 
$
(21,184
)
 
$
178,385

 
$
57,526

Weighted average common shares outstanding
197,825

 
194,060

 
197,388

 
193,756

Dilutive effect of stock options and RSUs
4,144

 
—

 
3,908

 
3,701

Dilutive effect of convertible debt
14,506

 
—

 
13,075

 
7,170

Weighted average common and potential common shares outstanding
216,475

 
194,060

 
214,371

 
204,627

Basic net income (loss) per common share
$
0.50

 
$
(0.11
)
 
$
0.90

 
$
0.30

Diluted net income (loss) per common share
$
0.46

 
$
(0.11
)
 
$
0.83

 
$
0.28


Diluted net income per common share for the three and six months ended September 30, 2013 includes 14,506,100 shares and 13,075,168 shares, respectively, issuable upon the exchange of debentures (see Note 14).  Diluted net income per common share for the six months ended September 30, 2012 includes 7,169,730 shares issuable upon the exchange of debentures.  The debentures have no impact on diluted net income per common share unless the average price of the Company's common stock exceeds the conversion price because the principal amount of the debentures will be settled in cash upon conversion.  Prior to conversion, the Company will include, in the diluted net income per common share calculation, the effect of the additional shares that may be issued when the Company's common stock price exceeds the conversion price using the treasury stock method.  The weighted average conversion price per share used in calculating the dilutive effect of the convertible debt for the three and six-month periods ended September 30, 2013 was $26.42 and $26.54, respectively. The weighted average conversion price per share used in calculating the dilutive effect of the convertible debt for the six-month period ended September 30, 2012 was $27.65.

Weighted average common shares exclude the effect of option shares which are not dilutive.  There were no antidilutive option shares for the three and six months ended September 30, 2013. For the three and six months ended September 30, 2012, the number of option shares that were antidilutive was 3,367,634 and 110,021, respectively.

(21)
Dividends

A quarterly cash dividend of $0.3540 per share was paid on September 4, 2013 in the aggregate amount of $70.1 million.  Through the first six months of fiscal 2014, cash dividends of $0.7075 per share have been paid in the aggregate of $139.8 million. A quarterly cash dividend of $0.3545 per share was declared on October 30, 2013 and will be paid on December 5, 2013 to stockholders of record as of November 21, 2013. The Company expects the December 2013 payment of its quarterly cash dividend to be approximately $70.4 million.


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Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations
 
This report, including "Part I – Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Part II - Item 1A Risk Factors" contains certain forward-looking statements that involve risks and uncertainties, including statements regarding our strategy, financial performance and revenue sources.  We use words such as "anticipate," "believe," "plan," "expect," "future," "intend" and similar expressions to identify forward-looking statements.  Our actual results could differ materially from the results anticipated in these forward-looking statements as a result of certain factors including those set forth under "Risk Factors," beginning at page 36 and elsewhere in this Form 10-Q.  Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.  You should not place undue reliance on these forward-looking statements.  We disclaim any obligation to update information contained in any forward-looking statement.  These forward-looking statements include, without limitation, statements regarding the following:
 
•
The effects that adverse global economic conditions and fluctuations in the global credit and equity markets may have on our financial condition and results of operations;
•
The effects and amount of competitive pricing pressure on our product lines;
•
Our ability to moderate future average selling price declines;
•
The effect of product mix, capacity utilization, yields, fixed cost absorption, competition and economic conditions on gross margin;
•
The amount of, and changes in, demand for our products and those of our customers;
•
The level of orders that will be received and shipped within a quarter;
•
Our expectation that our inventory levels will be relatively flat to up modestly in the December 2013 quarter compared to the September 2013 quarter and that it will allow us to maintain competitive lead times;
•
The effect that distributor and customer inventory holding patterns will have on us;
•
Our belief that customers recognize our products and brand name and use distributors as an effective supply channel;
•
Our belief that deferred cost of sales are recorded at their approximate carrying value and will have low risk of material impairment;
•
Our belief that our direct sales personnel combined with our distributors provide an effective means of reaching our customer base;
•
Our ability to increase the proprietary portion of our analog and interface product lines and the effect of such an increase;
•
Our belief that our processes afford us both cost-effective designs in existing and derivative products and greater functionality in new product designs;
•
The impact of any supply disruption we may experience;
•
Our ability to effectively utilize our facilities at appropriate capacity levels and anticipated costs;
•
That we adjust capacity utilization to respond to actual and anticipated business and industry-related conditions;
•
That our existing facilities will provide sufficient capacity to respond to increases in demand with modest incremental capital expenditures;
•
That manufacturing costs will be reduced by transition to advanced process technologies;
•
Our ability to maintain manufacturing yields;
•
Continuing our investments in new and enhanced products;
•
The cost effectiveness of using our own assembly and test operations;
•
Our anticipated level of capital expenditures;
•
Continuation and amount of quarterly cash dividends;
•
The sufficiency of our existing sources of liquidity to finance anticipated capital expenditures and otherwise meet our anticipated cash requirements, and the effects that our contractual obligations are expected to have on them;
•
The impact of seasonality on our business;
•
The accuracy of our estimates used in valuing employee equity awards;
•
That the resolution of legal actions will not have a material effect on our business, and the accuracy of our assessment of the probability of loss and range of potential loss;
•
The recoverability of our deferred tax assets;
•
The adequacy of our tax reserves to offset any potential tax liabilities, having the appropriate support for our income tax positions and the accuracy of our estimated tax rate;
•
Our belief that the expiration of any tax holidays will not have a material impact on our overall tax expense or effective tax rate;
•
Our belief that the estimates used in preparing our consolidated financial statements are reasonable;

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•
Our belief that recently issued accounting pronouncements listed in this document will not have a significant impact on our consolidated financial statements;
•
Our actions to vigorously and aggressively defend and protect our intellectual property on a worldwide basis;
•
Our ability to obtain patents and intellectual property licenses and minimize the effects of litigation;
•
The level of risk we are exposed to for product liability claims or indemnification claims;
•
The effect of fluctuations in market interest rates on our income and/or cash flows;
•
The effect of fluctuations in currency rates;
•
The accuracy of our estimates of market information that determines the value of our Auction Rate Securities (ARS), and that the lack of markets for the ARS will not have a material impact on our liquidity, cash flow, or ability to fund operations;
•
That our offshore earnings are considered to be permanently reinvested offshore and that we could determine to repatriate some of our offshore earnings in future periods to fund stockholder dividends, share repurchases, acquisitions or other corporate activities;
•
That a significant portion of our future cash generation will be in our foreign subsidiaries;
•
Our intention to indefinitely reinvest undistributed earnings of certain non-US subsidiaries in those subsidiaries;
•
Our intent to maintain a high-quality investment portfolio that preserves principal, meets liquidity needs, avoids inappropriate concentrations and delivers an appropriate yield; and
•
Our ability to collect accounts receivable.

We begin our Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) with a summary of Microchip's overall business strategy to give the reader an overview of the goals of our business and the overall direction of our business and products.  This is followed by a discussion of the Critical Accounting Policies and Estimates that we believe are important to understanding the assumptions and judgments incorporated in our reported financial results.  We then discuss our Results of Operations for the three and six months ended September 30, 2013 compared to the three and six months ended September 30, 2012.  We then provide an analysis of changes in our balance sheet and cash flows, and discuss our financial commitments in sections titled "Liquidity and Capital Resources," "Contractual Obligations" and "Off-Balance Sheet Arrangements." 

Strategy
 
Our goal is to be a worldwide leader in providing specialized semiconductor products for a wide variety of embedded control applications. Our strategic focus is on the embedded control market, which includes microcontrollers, high-performance linear and mixed signal devices, power management and thermal management devices, connectivity devices, interface devices, Serial EEPROMs, SuperFlash memory products, our patented KeeLoq® security devices and Flash IP solutions.  We provide highly cost-effective embedded control products that also offer the advantages of small size, high performance, low voltage/power operation and ease of development, enabling timely and cost-effective embedded control product integration by our customers.  We license SuperFlash technology to foundries, integrated device manufacturers and design partners throughout the world for use in the manufacture of advanced microcontroller products.
 
We sell our products to a broad base of domestic and international customers across a variety of industries.  The principal markets that we serve include consumer, automotive, industrial, office automation and telecommunications.  Our business is subject to fluctuations based on economic conditions within these markets. 
 
Our manufacturing operations include wafer fabrication, wafer probe and assembly and test.  The ownership of a substantial portion of our manufacturing resources is an important component of our business strategy, enabling us to maintain a high level of manufacturing control resulting in us being one of the lowest cost producers in the embedded control industry.  By owning our wafer fabrication facilities and our assembly and test operations, and by employing statistical process control techniques, we have been able to achieve and maintain high production yields.  Direct control over manufacturing resources allows us to shorten our design and production cycles.  This control also allows us to capture a portion of the wafer manufacturing and the assembly and test profit margin. We do outsource a significant portion of our wafer fabrication and assembly and test requirements to third parties.
 
We employ proprietary design and manufacturing processes in developing our embedded control products.  We believe our processes afford us both cost-effective designs in existing and derivative products and greater functionality in new product designs.  While many of our competitors develop and optimize separate processes for their logic and memory product lines, we use a common process technology for both microcontroller and non-volatile memory products.  This allows us to more fully leverage our process research and development costs and to deliver new products to market more rapidly.  Our engineers utilize advanced computer-aided design (CAD) tools and software to perform circuit design, simulation and layout, and our in-house

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photomask and wafer fabrication facilities enable us to rapidly verify design techniques by processing test wafers quickly and efficiently.

We are committed to continuing our investment in new and enhanced products, including development systems, and in our design and manufacturing process technologies.  We believe these investments are significant factors in maintaining our competitive position.  Our current research and development activities focus on the design of new microcontrollers, digital signal controllers, memory, analog and mixed-signal products, Flash-IP systems, new development systems, software and application-specific software libraries.  We are also developing new design and process technologies to achieve further cost reductions and performance improvements in our products.
 
We market our products worldwide primarily through a network of direct sales personnel and distributors.  Our distributors focus primarily on servicing the product and technical support requirements of a broad base of diverse customers.  We believe that our direct sales personnel combined with our distributors provide an effective means of reaching this broad and diverse customer base.  Our direct sales force focuses primarily on major strategic accounts in three geographical markets: the Americas, Europe and Asia.  We currently maintain sales and support centers in major metropolitan areas in North America, Europe and Asia.  We believe that a strong technical service presence is essential to the continued development of the embedded control market.  Many of our field sales engineers (FSEs), field application engineers (FAEs), and sales management have technical degrees and have been previously employed in an engineering environment.  We believe that the technical knowledge of our sales force is a key competitive advantage in the sale of our products.  The primary mission of our FAE team is to provide technical assistance to strategic accounts and to conduct periodic training sessions for FSEs and distributor sales teams.  FAEs also frequently conduct technical seminars for our customers in major cities around the world, and work closely with our distributors to provide technical assistance and end-user support.
 
Critical Accounting Policies and Estimates
 
General
 
Our discussion and analysis of Microchip's financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S.  We review the accounting policies we use in reporting our financial results on a regular basis.  The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent liabilities.  On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, business combinations, share-based compensation, inventories, income taxes, junior subordinated convertible debentures and contingencies.  We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources.  Our results may differ from these estimates due to actual outcomes being different from those on which we based our assumptions.  We review these estimates and judgments on an ongoing basis.  We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements.  We also have other policies that we consider key accounting policies, such as our policy regarding revenue recognition to OEMs; however, we do not believe these policies require us to make estimates or judgments that are as difficult or subjective as our policies described below.
 
Revenue Recognition - Distributors
 
Our distributors worldwide generally have broad price protection and product return rights, so we defer revenue recognition until the distributor sells the product to their customer.  Revenue is recognized when the distributor sells the product to an end-customer, at which time the sales price becomes fixed or determinable.  Revenue is not recognized upon shipment to our distributors since, due to discounts from list price as well as price protection rights, the sales price is not substantially fixed or determinable at that time.  At the time of shipment to these distributors, we record a trade receivable for the selling price as there is a legally enforceable right to payment, relieve inventory for the carrying value of goods shipped since legal title has passed to the distributor, and record the gross margin in deferred income on shipments to distributors on our condensed consolidated balance sheets.
 
Deferred income on shipments to distributors effectively represents the gross margin on the sale to the distributor; however, the amount of gross margin that we recognize in future periods could be less than the deferred margin as a result of credits granted to distributors on specifically identified products and customers to allow the distributors to earn a competitive gross margin on the sale of our products to their end customers and price protection concessions related to market pricing conditions.

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We sell the majority of the items in our product catalog to our distributors worldwide at a uniform list price.  However, distributors resell our products to end customers at a very broad range of individually negotiated price points.  The majority of our distributors' resales require a reduction from the original list price paid.  Often, under these circumstances, we remit back to the distributor a portion of their original purchase price after the resale transaction is completed in the form of a credit against the distributors' outstanding accounts receivable balance.  The credits are on a per unit basis and are not given to the distributor until they provide information to us regarding the sale to their end customer.  The price reductions vary significantly based on the customer, product, quantity ordered, geographic location and other factors, and discounts to a price less than our cost have historically been rare.  The effect of granting these credits establishes the net selling price to our distributors for the product and results in the net revenue recognized by us when the product is sold by the distributors to their end customers.  Thus, a portion of the "deferred income on shipments to distributors" balance represents the amount of distributors' original purchase price that will be credited back to the distributor in the future.  The wide range and variability of negotiated price concessions granted to distributors does not allow us to accurately estimate the portion of the balance in the deferred income on shipments to distributor's account that will be credited back to the distributors.  Therefore, we do not reduce deferred income on shipments to distributors or accounts receivable by anticipated future concessions; rather, price concessions are typically recorded against deferred income on shipments to distributors and accounts receivable when incurred, which is generally at the time the distributor sells the product.  At September 30, 2013, we had approximately $225.5 million of deferred revenue and $74.5 million in deferred cost of sales recognized as $151.0 million of deferred income on shipments to distributors.  At March 31, 2013, we had approximately $201.8 million of deferred revenue and $62.8 million in deferred cost of sales recognized as $139.0 million of deferred income on shipments to distributors.  The deferred income on shipments to distributors that will ultimately be recognized in our income statement will be lower than the amount reflected on the balance sheet due to additional price credits to be granted to the distributors when the product is sold to their customers.  These additional price credits historically have resulted in the deferred income approximating the overall gross margins that we recognize in the distribution channel of our business.
 
Distributor advances, reflected as a reduction of deferred income on shipments to distributors on our condensed consolidated balance sheets, totaled $97.9 million at September 30, 2013 and $70.1 million at March 31, 2013.  On sales to distributors, our payment terms generally require the distributor to settle amounts owed to us for an amount in excess of their ultimate cost.  The sales price to our distributors may be higher than the amount that the distributors will ultimately owe us because distributors often negotiate price reductions after purchasing the product from us and such reductions are often significant.  It is our practice to apply these negotiated price discounts to future purchases, requiring the distributor to settle receivable balances, on a current basis, generally within 30 days, for amounts originally invoiced.  This practice has an adverse impact on the working capital of our distributors.  As such, we have entered into agreements with certain distributors whereby we advance cash to the distributors to reduce the distributor's working capital requirements.  These advances are reconciled at least on a quarterly basis and are estimated based on the amount of ending inventory as reported by the distributor multiplied by a negotiated percentage.  Such advances have no impact on our revenue recognition or our condensed consolidated statements of income.  We process discounts taken by distributors against our deferred income on shipments to distributors' balance and true-up the advanced amounts generally after the end of each completed fiscal quarter.  The terms of these advances are set forth in binding legal agreements and are unsecured, bear no interest on unsettled balances and are due upon demand.  The agreements governing these advances can be canceled by us at any time.
 
We reduce product pricing through price protection based on market conditions, competitive considerations and other factors.  Price protection is granted to distributors on the inventory they have on hand at the date the price protection is offered.  When we reduce the price of our products, it allows the distributor to claim a credit against its outstanding accounts receivable balances based on the new price of the inventory it has on hand as of the date of the price reduction.  There is no immediate revenue impact from the price protection, as it is reflected as a reduction of the deferred income on shipments to distributors' balance.
 
Products returned by distributors and subsequently scrapped have historically been immaterial to our consolidated results of operations.  We routinely evaluate the risk of impairment of the deferred cost of sales component of the deferred income on shipments to distributor's account.  Because of the historically immaterial amounts of inventory that have been scrapped, and historically rare instances where discounts given to a distributor result in a price less than our cost, we believe the deferred costs are recorded at their approximate carrying value.


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Business Combinations 

All of our business combinations are accounted for at fair value under the acquisition method of accounting.  Under the acquisition method of accounting, (i) acquisition-related costs, except for those costs incurred to issue debt or equity securities, will be expensed in the period incurred; (ii) non-controlling interests will be valued at fair value at the acquisition date; (iii) in-process research and development will be recorded at fair value as an intangible asset at the acquisition date and amortized once the technology reaches technological feasibility; (iv) restructuring costs associated with a business combination will be expensed subsequent to the acquisition date; and (v) changes in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date will be recognized through income tax expense or directly in contributed capital.  The measurement of fair value of assets accrued and liabilities assumed requires significant judgment.  The valuation of intangible assets and acquired investments in privately held companies, in particular, requires that we use valuation techniques such as the income approach.  The income approach includes the use of a discounted cash flow model, which includes discounted cash flow scenarios and requires the following significant estimates:  revenue, expenses, capital spending and other costs, and
discount rates based on the respective risks of the cash flows.  The valuation of non-marketable equity investments acquired also takes into account variables such as conditions reflected in the capital markets, recent financing activity by the investees, the investees' capital structure and the terms of the investees' issued interests.
 
Share-Based Compensation
 
We measure fair value and recognize compensation expense for all share-based payment awards, including grants of employee stock options, RSUs, stock appreciation rights, and employee stock purchase rights, to be recognized in our financial statements based on their respective grant date fair values.  Total share-based compensation during the six months ended September 30, 2013 was $27.7 million, of which $23.8 million was reflected in operating expenses.  Total share-based compensation reflected in cost of sales during the six months ended September 30, 2013 was $3.8 million.  Total share-based compensation included in our inventory balance was $5.3 million at September 30, 2013.
 
Determining the appropriate fair-value model and calculating the fair value of share-based awards at the date of grant requires judgment.  The fair value of our RSUs is based on the fair market value of our common stock on the date of grant discounted for expected future dividends.  We use the Black-Scholes option pricing model to estimate the fair value of employee stock options and rights to purchase shares under our employee stock purchase plans.  Option pricing models, including the Black-Scholes model, also require the use of input assumptions, including expected volatility, expected life, expected dividend rate, and expected risk-free rate of return.  We use a blend of historical and implied volatility based on options freely traded in the open market as we believe this is more reflective of market conditions and a better indicator of expected volatility than using purely historical volatility.  The expected life of the awards is based on historical and other economic data trended into the future.  The risk-free interest rate assumption is based on observed interest rates appropriate for the terms of our awards.  The dividend yield assumption is based on our history and expectation of future dividend payouts.  We estimate the number of share-based awards which will be forfeited due to employee turnover.  Quarterly changes in the estimated forfeiture rate can have a significant effect on reported share-based compensation, as the effect of adjusting the rate for all expense amortization after April 1, 2006 is recognized in the period the forfeiture estimate is changed.  If the actual forfeiture rate is higher or lower than the estimated forfeiture rate, then an adjustment is made to increase or decrease the estimated forfeiture rate, which will result in a decrease or increase to the expense recognized in our financial statements.  If forfeiture adjustments are made, they would affect our gross margin, research and development expenses, and selling, general and administrative expenses.  The effect of forfeiture adjustments in the second quarter of fiscal 2014 was immaterial.
 
We evaluate the assumptions used to value our awards on a quarterly basis.  If factors change and we employ different assumptions, share-based compensation expense may differ significantly from what we have recorded in the past.  If there are any modifications or cancellations of the underlying unvested securities, we may be required to accelerate, increase or cancel any remaining unearned share-based compensation expense.  Future share-based compensation expense and unearned share-based compensation will increase to the extent that we grant additional equity awards to employees.
 
Inventories
 
Inventories are valued at the lower of cost or market using the first-in, first-out method.  We write down our inventory for estimated obsolescence or unmarketable inventory in an amount equal to the difference between the cost of inventory and the estimated market value based on assumptions about future demand and market conditions.  If actual market conditions are less favorable than those we projected, additional inventory write-downs may be required.  Inventory impairment charges establish a new cost basis for inventory and charges are not subsequently reversed to income even if circumstances later suggest that increased carrying amounts are recoverable.  In estimating our inventory obsolescence, we primarily evaluate estimates of demand over a 12-month period and record impairment charges for inventory on hand in excess of the estimated

24
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12-month demand. Estimates for projected 12-month demand are based on the average shipments of the prior three-month period, which are then annualized to adjust for any potential seasonality in our business. The estimated 12-month demand is compared to our most recently developed sales forecast to further reconcile the 12-month demand estimate. Management reviews and adjusts the estimates as appropriate based on specific situations. For example, demand can be adjusted up for new products for which historic sales are not representative of future demand. Alternatively, demand can be adjusted down to the extent any existing products are being replaced or discontinued.

In periods where our production levels are substantially below our normal operating capacity, the reduced production levels of our manufacturing facilities are charged directly to cost of sales.  Approximately $5.0 million and $15.4 million was charged to cost of sales in the three and six months ended September 30, 2013, respectively, as a result of decreased production in our wafer fabs compared to approximately $4.5 million and $8.3 million in the three and six months ended September 30, 2012, respectively.

Income Taxes
 
As part of the process of preparing our condensed consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate.  This process involves estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes.  These differences result in deferred tax assets and liabilities, which are included within our condensed consolidated balance sheets.  We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income within the relevant jurisdiction and to the extent we believe that recovery is not likely, we must establish a valuation allowance.  We have provided valuation allowances for certain of our deferred tax assets, including state net operating loss carryforwards, foreign tax credits and state tax credits, where it is more likely than not that some portion, or all of such assets, will not be realized. At September 30, 2013, the valuation allowances totaled $93.1 million. Should we determine that we would not be able to realize all or part of our net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made.  At September 30, 2013, our deferred tax asset, net of valuation allowances, was $70.4 million.
 
Various taxing authorities in the U.S. and other countries in which we do business scrutinize the tax structures employed by businesses.  Companies of our size and complexity are regularly audited by the taxing authorities in the jurisdictions in which they conduct significant operations.  We are currently under audit by the U.S. Internal Revenue Service (IRS) for our fiscal years 2009 and 2010 and SMSC is currently under IRS audit for fiscal years 2011 and 2012. We recognize liabilities for anticipated tax audit issues in the U.S. and other tax jurisdictions based on our estimate of whether, and the extent to which, additional tax payments are probable.  We believe that we maintain adequate tax reserves to offset any potential tax liabilities that may arise upon these and other pending audits in the U.S. and other countries in which we do business.  If such amounts ultimately prove to be unnecessary, the resulting reversal of such reserves would result in tax benefits being recorded in the period the reserves are no longer deemed necessary.  If such amounts ultimately prove to be less than an ultimate assessment, a future charge to expense would be recorded in the period in which the assessment is determined. 
 
Junior Subordinated Convertible Debentures

We separately account for the liability and equity components of our junior subordinated convertible debentures in a manner that reflects our nonconvertible debt (unsecured debt) borrowing rate when interest cost is recognized.  This results in a bifurcation of a component of the debt, classification of that component in equity and the accretion of the resulting discount on the debt to be recognized as part of interest expense in our condensed consolidated statements of income.  Additionally, certain embedded features of the debentures qualify as derivatives and are bundled as a compound embedded derivative that is measured at fair value.  Lastly, we include the dilutive effect of the shares of our common stock issuable upon conversion of the outstanding junior subordinated convertible debentures in our diluted income per share calculation regardless of whether the market price trigger or other contingent conversion feature has been met.  We apply the treasury stock method as we have adopted an accounting policy to settle the principal amount of the junior subordinated convertible debentures in cash.  This method results in incremental dilutive shares when the average fair value of our common stock for a reporting period exceeds the conversion price per share which was $26.29 at September 30, 2013 and adjusts as dividends are recorded in the future.
 
Contingencies
 
In the ordinary course of our business, we are 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.  We also periodically receive notifications from various third parties alleging infringement of patents, intellectual property rights or other matters.  With respect to pending legal actions to which we are a party, although the outcomes of these actions are not generally determinable, we believe that the

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ultimate resolution of these matters will not have a material adverse effect on our financial position, cash flows or results of operations.  Litigation relating to the semiconductor industry is not uncommon, and we are, and from time to time have been, subject to such litigation.  No assurances can be given with respect to the extent or outcome of any such litigation in the future.

Results of Operations
 
The following table sets forth certain operational data as a percentage of net sales for the periods indicated:
 
 
Three Months Ended
 
Six Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Net sales
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%
Cost of sales
41.4

 
49.3

 
41.9

 
45.7

Gross profit
58.6

 
50.7

 
58.1

 
54.3

Research and development
15.9

 
16.7

 
15.8

 
15.4

Selling, general and administrative
14.0

 
18.7

 
14.1

 
17.3

Amortization of acquired intangible assets
4.8

 
7.3

 
5.4

 
4.3

Special charges
—

 
5.9

 
0.2

 
3.1

Operating income
23.9
%
 
2.1
%
 
22.6
%
 
14.2
%

Net Sales
 
We operate in two industry segments and engage primarily in the design, development, manufacture and marketing of semiconductor products as well as the licensing of SuperFlash intellectual property.  We sell our products to distributors and original equipment manufacturers, referred to as OEMs, in a broad range of markets, perform ongoing credit evaluations of our customers and generally require no collateral.  In certain circumstances, a customer's financial condition may require collateral, and, in such cases, the collateral would be provided primarily by letters of credit.
 
Our net sales for the quarter ended September 30, 2013 were $492.7 million, an increase of 6.5% from the previous quarter's sales of $462.8 million, and an increase of 28.5% from net sales of $383.3 million in the quarter ended September 30, 2012. Our net sales for the six months ended September 30, 2013 were $955.5 million, an increase of 29.9% from net sales of $735.4 million in the six months ended September 30, 2012. The increase in net sales in the quarter ended September 30, 2013 over the previous quarter was due primarily to general economic and semiconductor industry conditions and market share gains. The increases in net sales in the three and six months ended September 30, 2013 compared to the three and six months ended September 30, 2012 were due primarily to our acquisition of SMSC on August 2, 2012, general economic and semiconductor industry conditions and market share gains. Average selling prices for our semiconductor products were up approximately 6% and 9% for the three and six-month periods ended September 30, 2013, over the corresponding periods of the previous fiscal year. The number of units of our semiconductor products sold was up approximately 21% and 20% for the three and six-month periods ended September 30, 2013 over the corresponding periods of the previous fiscal year. The increases in the number of units of our semiconductor products sold and our average selling prices in the three and six-month periods ended September 30, 2013 compared to the corresponding periods of the previous fiscal year were mainly due to our acquisition of SMSC during the second quarter of fiscal 2013. The average selling prices and the unit volumes of our sales are impacted by the mix of our products sold and overall semiconductor market conditions.  Key factors related to the amount of net sales during the three and six-month periods ended September 30, 2013 compared to the three and six-month periods ended September 30, 2012 include:

•
our acquisition of SMSC during the second quarter of fiscal 2013;
•
global economic conditions in the markets we serve;
•
semiconductor industry conditions;
•
inventory holding patterns of our customers;
•
increasing semiconductor content in our customers' products;
•
customers' increasing needs for the flexibility offered by our programmable solutions;
•
our new product offerings that have increased our served available market; and
•
continued market share gains in the segments of the markets we address.


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Sales by product line for the three and six months ended September 30, 2013 and 2012 were as follows (dollars in thousands):
 
Three Months Ended
 
Six Months Ended
 
September 30,
 
September 30,
 
(unaudited)
 
(unaudited)
 
2013
 
%
 
2012
 
%
 
2013
 
%
 
2012
 
%
Microcontrollers
$
321,004

 
65.2

 
$
253,315

 
66.1

 
$
621,309

 
65.0

 
$
493,657

 
67.1

Analog, interface and mixed signal products
108,460

 
22.0

 
70,069

 
18.3

 
211,675

 
22.2

 
117,253

 
15.9

Memory products
34,987

 
7.1

 
36,570

 
9.5

 
68,979

 
7.2

 
77,288

 
10.5

Technology licensing
24,826

 
5.0

 
20,121

 
5.3

 
47,344

 
5.0

 
40,403

 
5.5

Other
3,392

 
0.7

 
3,223

 
0.8

 
6,154

 
0.6

 
6,831

 
1.0

Total sales
$
492,669

 
100.0
%
 
$
383,298

 
100.0
%
 
$
955,461

 
100.0
%
 
$
735,432

 
100.0
%

Microcontrollers
 
Our microcontroller product line represents the largest component of our total net sales.  Microcontrollers and associated application development systems accounted for approximately 65.2% of our total net sales for the three-month period ended September 30, 2013 and approximately 65.0% of our total net sales for the six-month period ended September 30, 2013 compared to approximately 66.1% of our total net sales for the three-month period ended September 30, 2012 and approximately 67.1% of our total net sales for the six-month period ended September 30, 2012.

Net sales of our microcontroller products increased approximately 26.7% in the three-month period ended September 30, 2013 and approximately 25.9% in the six-month period ended September 30, 2013 compared to the three and six-month periods ended September 30, 2012. These sales increases were driven primarily by our acquisition of SMSC, market share gains and general economic and semiconductor industry conditions in the end markets that we serve including the consumer, automotive, industrial control, communications and computing markets.
 
Historically, average selling prices in the semiconductor industry decrease over the life of any particular product.  The overall average selling prices of our microcontroller products have remained relatively constant over time due to the proprietary nature of these products.  We have experienced, and expect to continue to experience, moderate pricing pressure in certain microcontroller product lines, primarily due to competitive conditions. We have in the past been able to, and expect in the future to be able to, moderate average selling price declines in our microcontroller product lines by introducing new products with more features and higher prices.  We may be unable to maintain average selling prices for our microcontroller products as a result of increased pricing pressure in the future, which would adversely affect our operating results.

Analog, Interface and Mixed Signal Products
 
Sales of our analog, interface and mixed signal products accounted for approximately 22.0% of our total net sales for the three-month period ended September 30, 2013 and approximately 22.2% of our total net sales for the six-month period ended September 30, 2013 compared to approximately 18.3% of our total net sales for the three-month period ended September 30, 2012 and approximately 15.9% of our total net sales for the six-month period ended September 30, 2012.
 
Net sales of our analog, interface and mixed signal products increased approximately 54.8% in the three-month period ended September 30, 2013 and approximately 80.5% in the six-month period ended September 30, 2013 compared to the three and six-month periods ended September 30, 2012. These sales increases were driven primarily by our acquisition of SMSC, general economic and semiconductor industry conditions and market share gains achieved within the analog, interface and mixed signal market.
 
Analog, interface and mixed signal products can be proprietary or non-proprietary in nature.  Currently, we consider more than 80% of our analog, interface and mixed signal product mix to be proprietary in nature, where prices are relatively stable, similar to the pricing stability experienced in our microcontroller products.  The non-proprietary portion of our analog, interface and mixed signal business will experience price fluctuations driven primarily by the current supply and demand for those products.  We may be unable to maintain the average selling prices of our analog, interface and mixed signal products as

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a result of increased pricing pressure in the future, which would adversely affect our operating results.  We anticipate the proprietary portion of our analog, interface and mixed signal products will increase over time.
 
Memory Products
 
Sales of our memory products accounted for approximately 7.1% of our total net sales for the three-month period ended September 30, 2013 and approximately 7.2% of our total net sales for the six-month period ended September 30, 2013 compared to approximately 9.5% of our total net sales for the three-month period ended September 30, 2012 and approximately 10.5% of our total net sales for the six-month period ended September 30, 2012 .

Net sales of our memory products decreased approximately 4.3% in the three-month period ended September 30, 2013 and approximately 10.8% in the six-month period ended September 30, 2013 compared to the three and six-month periods ended September 30, 2012. These sales decreases were driven primarily by adverse customer demand conditions within the Serial EEPROM and Flash memory markets.
 
Memory product pricing has historically been cyclical in nature, with steep price declines followed by periods of relative price stability, driven by changes in industry capacity at different stages of the business cycle.  We have experienced, and expect to continue to experience, varying degrees of competitive pricing pressures in our memory products.  We may be unable to maintain the average selling prices of our memory products as a result of increased pricing pressure in the future, which could adversely affect our operating results.
 
Technology Licensing
 
Technology licensing revenue includes a combination of royalties associated with technology licensed for the use of our SuperFlash technology and fees for engineering services.  Technology licensing accounted for approximately 5.0% of our total net sales for each of the three and six-month periods ended September 30, 2013 compared to approximately 5.3% of our total net sales for the three-month period ended September 30, 2012 and approximately 5.5% of our total net sales for the six-month period ended September 30, 2012 .
 
Net sales related to our technology licensing increased approximately 23.4% in the three-month period ended September 30, 2013 and approximately 17.2% in the six-month period ended September 30, 2013 compared to the three and six-month periods ended September 30, 2012. These sales increases were driven primarily by the adoption of our technology by more manufacturers of semiconductors as well as semiconductor industry and global economic conditions.

Other

Revenue from assembly and test subcontracting services performed during the three-month period ended September 30, 2013 accounted for approximately 0.7% of our total net sales compared to approximately 0.8% of our total net sales for the three-month period ended September 30, 2012. During the six-month period ended September 30, 2013, revenue from assembly and test subcontracting services accounted for approximately 0.6% of our total net sales compared to approximately 1.0% of our total net sales for the six-month period ended September 30, 2012.
 
Distribution
 
Distributors accounted for approximately 53.1% of our net sales in the three-month period ended September 30, 2013 and approximately 50.5% of our net sales in the three-month period ended September 30, 2012.  Distributors accounted for approximately 53.7% of our net sales in the six-month period ended September 30, 2013 and approximately 54.4% of our net sales in the six-month period ended September 30, 2012. Our distributors focus primarily on servicing the product requirements of a broad base of diverse customers.  We believe that distributors provide an effective means of reaching this broad and diverse customer base.  We believe that customers recognize Microchip for its products and brand name and use distributors as an effective supply channel.
 
Generally, we do not have long-term agreements with our distributors and we, or our distributors, may terminate our relationships with each other with little or no advance notice.  The loss of, or the disruption in the operations of, one or more of our distributors could reduce our future net sales in a given quarter and could result in an increase in inventory returns.


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Table of Contents


At September 30, 2013, our distributors maintained 33 days of inventory of our products compared to 30 days at March 31, 2013.  Over the past three fiscal years, the days of inventory maintained by our distributors have fluctuated between 27 days and 47 days.  We do not believe that inventory holding patterns at our distributors will materially impact our net sales, due to the fact that we recognize revenue based on sell-through for all our distributors.
 
Sales by Geography
 
Sales by geography for the three and six months ended September 30, 2013 and 2012 were as follows (dollars in thousands):
 
Three Months Ended
 
Six Months Ended
 
September 30,
 
September 30,
 
(unaudited)
 
(unaudited)
 
2013
 
%
 
2012
 
%
 
2013
 
%
 
2012
 
%
Americas
$
95,185

 
19.3

 
$
79,533

 
20.8

 
$
182,113

 
19.1

 
$
151,536

 
20.6

Europe
98,913

 
20.1

 
83,679

 
21.8

 
200,161

 
20.9

 
160,985

 
21.9

Asia
298,571

 
60.6

 
220,086

 
57.4

 
573,187

 
60.0

 
422,911

 
57.5

Total sales
$
492,669

 
100.0
%
 
$
383,298

 
100.0
%
 
$
955,461

 
100.0
%
 
$
735,432

 
100.0
%