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UNITED STATES
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 June 30, 2016.
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 July 31, 2016
Common Stock, $0.001 par value
 
215,288,443 shares
 



MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES

INDEX

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




Table of Contents
MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
(unaudited)


Item1.
Financial Statements

ASSETS
June 30,
2016
 
March 31,
2016
Cash and cash equivalents
$
600,526

 
$
2,092,751

Short-term investments
1,266

 
353,284

Accounts receivable, net
435,511

 
290,183

Inventories
518,431

 
306,815

Prepaid expenses
51,769

 
41,992

Assets held for sale
18,398

 

Other current assets
47,087

 
11,688

Total current assets
1,672,988

 
3,096,713

Property, plant and equipment, net
732,816

 
609,396

Long-term investments

 
118,549

Goodwill
2,390,955

 
1,012,652

Intangible assets, net
2,403,357

 
606,349

Long-term deferred tax assets
68,653

 
14,831

Other assets
89,987

 
79,393

Total assets
$
7,358,756

 
$
5,537,883

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
Accounts payable
$
137,614

 
$
79,312

Accrued liabilities
222,500

 
119,265

Deferred income on shipments to distributors
213,171

 
183,432

Total current liabilities
573,285

 
382,009

Long-term line of credit
1,913,745

 
1,043,156

Senior convertible debentures
1,227,444

 
1,216,313

Junior convertible debentures
195,315

 
193,936

Long-term income tax payable
290,742

 
111,061

Long-term deferred tax liability
468,563

 
399,218

Other long-term liabilities
157,113

 
41,271

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; 237,497,913 shares issued and 215,030,824 shares outstanding at June 30, 2016; 227,416,789 shares issued and 204,081,727 shares outstanding at March 31, 2016
215

 
204

Additional paid-in capital
1,901,460

 
1,391,553

Common stock held in treasury: 22,467,089 shares at June 30, 2016; 23,335,062 shares at March 31, 2016
(794,287
)
 
(820,066
)
Accumulated other comprehensive loss
(14,428
)
 
(3,357
)
Retained earnings
1,439,589

 
1,582,585

Total stockholders' equity
2,532,549

 
2,150,919

Total liabilities and stockholders' equity
$
7,358,756

 
$
5,537,883

See accompanying notes to condensed consolidated financial statements

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

 
Three Months Ended
 
June 30,
 
2016
 
2015
Net sales
$
799,411

 
$
533,952

Cost of sales (1)
450,921

 
224,935

Gross profit
348,490

 
309,017

 
 

 
 

Research and development  (1)
147,883

 
84,680

Selling, general and administrative  (1)
157,505

 
66,849

Amortization of acquired intangible assets
80,171

 
34,612

Special charges, net
22,035

 
1,557

 Operating expenses
407,594

 
187,698

 
 
 
 
Operating (loss) income
(59,104
)
 
121,319

Losses on equity method investments
(56
)
 
(177
)
Other income (expense):
 
 
 
Interest income
819

 
5,528

Interest expense
(34,416
)
 
(24,052
)
Other income, net
2,010

 
16,947

(Loss) income before income taxes
(90,747
)
 
119,565

Income tax provision (benefit)
18,478

 
(10,895
)
Net (loss) income from continuing operations
(109,225
)
 
130,460

Discontinued operations:
 
 
 
Loss from discontinued operations
(5,473
)
 

Income tax benefit
(1,335
)
 

Net loss from discontinued operations
(4,138
)
 

 
 
 
 
Net (loss) income
(113,363
)
 
130,460

Less: Net loss attributable to noncontrolling interests

 
207

Net (loss) income attributable to Microchip Technology
$
(113,363
)
 
$
130,667

 
 
 
 
Basic net (loss) income per common share attributable to Microchip Technology stockholders
 
 
 
Net (loss) income from continuing operations
$
(0.51
)
 
$
0.65

Net loss from discontinued operations
(0.02
)
 

Net (loss) income attributable to Microchip Technology
$
(0.53
)
 
$
0.65

Diluted net (loss) income per common share attributable to Microchip Technology stockholders
 
 
 
Net (loss) income from continuing operations
$
(0.51
)
 
$
0.60

Net loss from discontinued operations
(0.02
)
 

Net (loss) income attributable to Microchip Technology
$
(0.53
)
 
$
0.60

Dividends declared per common share
$
0.3595

 
$
0.3575

Basic common shares outstanding
214,345

 
202,232

Diluted common shares outstanding
214,345

 
216,767

(1) Includes share-based compensation expense as follows:
 
 
 
Cost of sales
$
7,897

 
$
1,657

Research and development
17,517

 
7,098

Selling, general and administrative
34,165

 
5,357


See accompanying notes to condensed consolidated financial statements

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

 
Three Months Ended
 
June 30,
 
2016
 
2015
Net (loss) income
$
(113,363
)
 
$
130,460

Less: Net loss attributable to noncontrolling interests

 
207

Net (loss) income attributable to Microchip Technology
(113,363
)
 
130,667

 
 
 
 
Components of other comprehensive loss:
 
 
 
Available-for-sale securities:
 
 
 
Unrealized holding losses, net of tax effect
(1,325
)
 
(2,012
)
Reclassification of realized transactions, net of tax effect
82

 
(13,959
)
Actuarial losses related to defined benefit pension plans, net of tax benefit of $3,003
(6,805
)
 

Change in net foreign currency translation adjustment
(3,023
)
 

Other comprehensive loss, net of taxes attributable to Microchip Technology
(11,071
)
 
(15,971
)
 
 
 
 
Comprehensive (loss) income
(124,434
)
 
114,489

Less: Comprehensive loss attributable to noncontrolling interests

 
207

Comprehensive (loss) income attributable to Microchip Technology
$
(124,434
)
 
$
114,696


See accompanying notes to condensed consolidated financial statements


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MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

 
Three Months Ended
 
June 30,
 
2016
 
2015
Cash flows from operating activities:
 
 
 
Net (loss) income
$
(113,363
)
 
$
130,460

Adjustments to reconcile net (loss) income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
113,141

 
60,375

Deferred income taxes
32,906

 
(17,509
)
Share-based compensation expense related to equity incentive plans
59,579

 
14,112

Excess tax benefit from share-based compensation

 
(263
)
Amortization of debt discount on convertible debentures
12,106

 
11,772

Amortization of debt issuance costs
1,057

 
958

Losses on equity method investments
56

 
177

Gains on sale of assets
(61
)
 
(560
)
Loss on write-down of fixed assets
269

 

Impairment of intangible assets
1,984

 

Realized losses (gains) on available-for-sale investment
82

 
(13,959
)
Realized gains on equity method investment
(468
)
 
(2,225
)
Amortization of premium on available-for-sale investments
13

 
2,396

Changes in operating assets and liabilities, excluding impact of acquisitions:
 
 
 
Increase in accounts receivable
(9,901
)
 
(3,096
)
Decrease (increase) in inventories
121,102

 
(23,893
)
Increase in deferred income on shipments to distributors
29,739

 
1,401

(Decrease) increase in accounts payable and accrued liabilities
(18,000
)
 
16,157

Change in other assets and liabilities
(12,270
)
 
5,225

Operating cash flows related to discontinued operations
5,996

 

Net cash provided by operating activities
223,967

 
181,528

Cash flows from investing activities:
 

 
 

Purchases of available-for-sale investments
(25
)
 
(570,501
)
Sales and maturities of available-for-sale investments
470,551

 
433,446

Sale of equity method investment
468

 
2,667

Acquisition of Atmel, net of cash acquired
(2,747,516
)
 

Purchase of additional controlling interest in ISSC

 
(18,051
)
Investments in other assets
(765
)
 
(1,766
)
Proceeds from sale of assets
52

 
627

Capital expenditures
(18,494
)
 
(33,611
)
Net cash used in investing activities
(2,295,729
)
 
(187,189
)
Cash flows from financing activities:
 

 
 

Repayments of revolving loan under credit facility
(602,000
)
 
(110,000
)
Proceeds from borrowings on revolving loan under credit facility
1,280,000

 
145,000

Deferred financing costs

 
(406
)
Payment of cash dividends
(77,237
)
 
(72,331
)
Proceeds from sale of common stock
4,630

 
3,497

Tax payments related to shares withheld for vested restricted stock units
(25,183
)
 
(4,464
)
Capital lease payments
(195
)
 
(166
)
Excess tax benefit from share-based compensation

 
263

Net cash provided by (used in) financing activities
580,015

 
(38,607
)
Effect of foreign exchange rate changes on cash and cash equivalents
(478
)
 

Net decrease in cash and cash equivalents
(1,492,225
)
 
(44,268
)
Cash and cash equivalents at beginning of period
2,092,751

 
607,815

Cash and cash equivalents at end of period
$
600,526

 
$
563,547

See accompanying notes to condensed consolidated financial statements

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Note 1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of Microchip Technology Incorporated and its majority-owned and controlled subsidiaries (the Company).  All intercompany balances and transactions have been eliminated in consolidation.
 
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (US GAAP), pursuant to the rules and regulations of the Securities and Exchange Commission (the SEC).  The information furnished herein reflects all adjustments which are, in the opinion of management, of a normal recurring nature and necessary for a fair statement of the results for the interim periods reported. Certain information and footnote disclosures normally included in audited consolidated financial statements have been condensed or omitted pursuant to such SEC rules and regulations.  It is suggested that these condensed consolidated financial statements be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 2016.  The results of operations for the three months ended June 30, 2016 are not necessarily indicative of the results that may be expected for the fiscal year ending March 31, 2017 or for any other period.

As further discussed in Note 3, on April 4, 2016, the Company completed its acquisition of Atmel Corporation (Atmel) and the Company's first quarter fiscal 2017 financial results include Atmel's results beginning as of the acquisition date.

Note 2. Recently Issued Accounting Pronouncements

Recently Adopted Accounting Pronouncements

During the three months ended June 30, 2016, the Company adopted Accounting Standards Update (ASU) 2015-03-Simplifying the Presentation of Debt Issuance Costs. The new guidance was adopted on a retrospective basis and as a result, debt issuance costs historically included in other assets have been reclassified as a direct deduction from the carrying amount of the associated debt. Related prior period information included on the Company’s condensed consolidated balance sheets has been retrospectively adjusted as follows (amounts in thousands).

 
As of March 31, 2016
 
As Reported
 
Adjustments
 
As Adjusted
Other assets
$
109,025

 
$
(29,632
)
 
$
79,393

Total assets
$
5,567,515

 
$
(29,632
)
 
$
5,537,883

 
 
 
 
 
 
Senior convertible debentures
$
1,234,733

 
$
(18,420
)
 
$
1,216,313

Junior convertible debentures
$
196,304

 
$
(2,368
)
 
$
193,936

Long-term line of credit
$
1,052,000

 
$
(8,844
)
 
$
1,043,156

Total liabilities and stockholder's equity
$
5,567,515

 
$
(29,632
)
 
$
5,537,883


During the three months ended June 30, 2016, the Company elected to early adopt ASU 2016-09, Compensation - Stock Compensation, Improvements to Employee Share-Based Payment Accounting (Topic 718), which simplifies several aspects of the accounting for share-based payment transactions. Under this standard, entities are permitted to make an accounting policy election to either estimate forfeitures on share-based payment awards, as previously required, or to recognize forfeitures as they occur. The Company has elected to recognize forfeitures as they occur and the impact of that change in accounting policy has been recorded as a $2.0 million cumulative effect adjustment as an increase to the Company's retained earnings and a decrease to additional paid-in capital as of April 1, 2016. The Company also recorded a cumulative-effect adjustment to retained earnings for the increase of $2.3 million in long-term deferred tax assets related to the forfeiture rate reduction on outstanding share-based payment awards. Additionally, ASU 2016-09 eliminates the requirement to report excess tax benefits and certain tax deficiencies related to share-based payment transactions in additional paid-in capital. In accordance with the new standard, the Company will record excess tax benefits and tax deficiencies as income tax benefit or provision on a prospective basis in the condensed consolidated statements of operations. The standard also eliminates the requirement that

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excess tax benefits be realized before companies can recognize them. Accordingly, the Company has recorded a $47.2 million cumulative-effect adjustment to its retained earnings and long-term deferred tax assets as of April 1, 2016 for previously unrecognized excess tax benefits. ASU 2016-09 also requires excess tax benefits to be reported as operating activities in the statement of cash flows rather than as a financing activity. The Company has elected to apply the change in cash flow classification on a prospective basis and prior periods were not retrospectively adjusted.
 
Recently Issued Accounting Pronouncements Not Yet Adopted

In May 2014, the FASB issued ASU 2014-09-Revenue from Contracts with Customers (Topic 606), which will supersede nearly all existing revenue recognition guidance under US GAAP.  The standard's core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In July 2015, the FASB delayed the effective date of the new standard by one year to December 15, 2017, for annual and interim reporting periods beginning after that date. In accordance with the delay, the new standard will be effective for the Company beginning no later than April 1, 2018.  Early adoption is permitted, but not before the original effective date of December 15, 2016.  The new standard allows for the amendment to be applied either retrospectively to each prior reporting period presented or retrospectively as a cumulative-effect adjustment as of the date of adoption. In March 2016, the FASB issued ASU 2016-08 - Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net), which clarifies the implementation guidance on principal versus agent considerations. In April 2016, the FASB issued ASU 2016-10 - Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, which clarifies the implementation guidance on identifying performance obligations. In May 2016, the FASB issued ASU 2016-12 - Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients, which addresses implementation issues that were raised by stakeholders and discussed by the Revenue Recognition Transition Resource Group. As described in the Company's significant accounting policies, the Company defers the revenue and cost of sales on shipments to distributors until the distributor sells the product to their end customer. Upon adoption of ASU 2014-09, ASU 2015-14, ASU 2016-08, ASU 2016-10 and ASU 2016-12, the Company will no longer defer revenue until sale by the distributor to the end customer, but rather, will be required to estimate the effects of returns and allowances provided to distributors and record revenue at the time of sale to the distributor. The Company is currently evaluating the impact that the adoption of the standards will have on its condensed consolidated financial statements. The Company has not yet elected a transition method.

In July 2015, the FASB issued ASU 2015-11-Simplifying the Measurement of Inventory. This standard requires that entities measure inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. ASU 2015-11 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2016 and is applied prospectively. Early adoption is permitted. The Company does not expect this standard to have a material impact on its condensed consolidated financial statements.

In January 2016, the FASB issued ASU 2016-01-Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. This standard addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. ASU 2016-01 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is not permitted. The Company is currently evaluating the impact the adoption of this standard will have on its condensed consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, Leases. This standard requires lessees to recognize a lease liability and a right-of-use asset on the balance sheet and aligns many of the underlying principles of the new lessor model with those in Accounting Standards Codification Topic 606, Revenue from Contracts with Customers. ASU 2016-02 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2018. The Company is currently evaluating the impact the adoption of this standard will have on its condensed consolidated financial statements.

Note 3. Business Acquisitions
Acquisition of Atmel
On April 4, 2016, the Company acquired Atmel, a publicly traded company based in San Jose, California. The Company paid an aggregate of approximately $2.98 billion in cash, issued an aggregate of 10.1 million shares of its common stock to Atmel stockholders and incurred transaction and other fees of $14.9 million. The total consideration transferred in the acquisition, including approximately $7.5 million of non-cash consideration for the exchange of certain share-based payment

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awards of Atmel for stock awards of the Company, was approximately $3.47 billion. The Company financed the cash portion of the purchase price using approximately $2.04 billion of cash held by certain of its foreign subsidiaries and approximately $0.94 billion from additional borrowings under its existing credit agreement. As a result of the acquisition, Atmel became a
wholly owned subsidiary of the Company. Atmel is a worldwide leader in the design and manufacture of microcontrollers, capacitive touch solutions, advanced logic, mixed-signal, nonvolatile memory and RF components. The Company's primary reason for this acquisition was to expand the Company's range of solutions, products and capabilities by extending its served available market.
The acquisition was accounted for under the acquisition method of accounting, with the Company identified as the acquirer, and the operating results of Atmel have been included in the Company's consolidated financial statements as of the closing date of the acquisition. Under the acquisition method of accounting, the aggregate amount of consideration paid by the Company was allocated to Atmel's net tangible assets and intangible assets based on their estimated fair values as of April 4, 2016.  The excess of the purchase price over the value of the net tangible assets and intangible assets was recorded to goodwill. The factors contributing to the recognition of goodwill were based upon the Company's conclusion that there are strategic and synergistic benefits that are expected to be realized from the acquisition. The goodwill has been allocated to the Company's semiconductor products reporting segment.  None of the goodwill related to the Atmel acquisition is deductible for tax purposes.  The Company retained independent third-party appraisers to assist management in its valuation. The purchase price allocation has not been finalized, including the valuation of inventory, intangible assets, taxes and other assets and liabilities. This could result in adjustments to the fair values of the assets acquired and liabilities assumed, the useful lives of intangible assets, the residual amount allocated to goodwill and deferred income taxes recognized. The preliminary allocation of the purchase price is based on the best estimates of management and is subject to revision based on the final valuation and estimates of useful lives.

The table below represents the preliminary allocation of the purchase price to the net assets acquired based on their estimated fair values, as well as the associated estimated useful lives of the acquired intangible assets (amounts in thousands).

Assets acquired
April 4, 2016
Cash and cash equivalents
$
230,266

Accounts receivable
135,427

Inventories
333,208

Prepaid expenses and other current assets
28,360

Assets held for sale
24,394

Property, plant and equipment
129,587

Goodwill
1,378,317

Purchased intangible assets
1,880,245

Long-term deferred tax assets
49,466

Other assets
5,948

Total assets acquired
4,195,218

 
 
Liabilities assumed
 
Accounts payable
(55,686
)
Other current liabilities
(119,152
)
Long-term line of credit
(192,000
)
Deferred tax liabilities
(74,334
)
Long-term income tax payable
(174,380
)
Other long-term liabilities
(106,688
)
Total liabilities assumed
(722,240
)
Purchase price allocated
$
3,472,978



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Purchased Intangible Assets
Weighted Average
 
 
 
Useful Life
 
April 4, 2016
 
(in years)
 
(in thousands)
Core/developed technology
11
 
$
1,080,340

In-process technology
 
140,200

Customer-related
6
 
629,200

Backlog
1
 
28,700

Other
5
 
1,805

Total purchased intangible assets
 
 
$
1,880,245

Purchased intangible assets include core and developed technology, in-process research and development, customer-related intangibles, acquisition-date backlog and other intangible assets. The estimated fair values of the core and developed technology and in-process research and development were determined based on the present value of the expected cash flows to be generated by the respective existing technology or future technology. The core and developed technology intangible assets are being amortized in a manner based on the expected cash flows used in the initial determination of fair value. In-process technology is capitalized until such time as the related projects are completed or abandoned at which time the capitalized amounts will begin to be amortized or written off. Customer-related intangible assets consist of Atmel's contractual relationships and customer loyalty related to its distributor and end-customer relationships, and the fair values of the customer-related intangibles were determined based on Atmel's projected revenues. An analysis of expected attrition and revenue growth for existing customers was prepared from Atmel's historical customer information.  Customer relationships are being amortized in a manner based on the estimated cash flows associated with the existing customers and anticipated retention rates. Backlog relates to the value of orders not yet shipped by Atmel at the acquisition date, and the preliminary fair values were based on the estimated profit associated with those orders. Backlog related assets have a one year useful life and are being amortized on a straight-line basis over that year. Amortization expense associated with acquired intangible assets is not deductible for tax purposes.  Thus, approximately $163.5 million was established as a net deferred tax liability for the future amortization of the intangible assets.
The amount of continuing Atmel net sales and net loss included in the Company's condensed consolidated statements of operations for the three months ended June 30, 2016 was approximately $219.0 million and $163.6 million, respectively.
The following unaudited pro-forma consolidated results of operations for the three months ended June 30, 2016 and 2015 assume the closing of the Atmel acquisition occurred as of April 1, 2015. The pro-forma adjustments are mainly comprised of acquired inventory fair value costs and amortization of purchased intangible assets. The pro-forma results of operations are presented for informational purposes only and are not indicative of the results of operations that would have been achieved if the acquisition had taken place on April 1, 2015 or of results that may occur in the future (amounts in thousands except per share data):

 
Three Months Ended
 
June 30, 2016
 
June 30, 2015
Net sales
$
837,118

 
$
796,122

Net income (loss) from continuing operations
$
8,401

 
$
(68,623
)
Basic net income (loss) per common share
$
0.04

 
$
(0.32
)
Diluted net income (loss) per common share
$
0.04

 
$
(0.32
)
Acquisition of Micrel
On August 3, 2015, the Company acquired Micrel, Incorporated (Micrel), a publicly traded company based in San Jose, California. The Company paid an aggregate of approximately $430.0 million in cash and issued an aggregate of 8.6 million shares of its common stock to Micrel shareholders. The number of shares issued in the transaction was subsequently repurchased in the open market during the year ended March 31, 2016. The total consideration transferred in the acquisition, including approximately $4.1 million of non cash consideration for the exchange of certain share-based payment awards of Micrel for stock awards of the Company, and approximately $13.1 million of cash consideration for the payout of vested employee stock awards, was approximately $816.2 million. The Company financed the cash portion of the purchase price using borrowings under its existing credit agreement. As a result of the acquisition, Micrel became a wholly owned subsidiary of the Company. Micrel's business is to design, develop, manufacture and market a range of high-performance analog, power

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and mixed-signal integrated circuits. Micrel's products address a wide range of end markets including industrial, automotive and communications. Micrel also manufactures custom analog and mixed-signal circuits and provides wafer foundry services for customers which produce electronic systems utilizing semiconductor manufacturing processes as well as micro-electrical mechanical system technologies. The Company's primary reason for this acquisition was to expand the Company's range of solutions, products and capabilities by extending its served available market.
The acquisition was accounted for under the acquisition method of accounting, with the Company identified as the acquirer, and the operating results of Micrel have been included in the Company's condensed consolidated financial statements as of the closing date of the acquisition. Under the acquisition method of accounting, the aggregate amount of consideration paid by the Company was allocated to Micrel's net tangible assets and intangible assets based on their estimated fair values as of August 3, 2015.  The excess of the purchase price over the value of the net tangible assets and intangible assets was recorded to goodwill. The factors contributing to the recognition of goodwill were based upon the Company's conclusion that there are strategic and synergistic benefits that are expected to be realized from the acquisition. The goodwill has been allocated to the Company's semiconductor products reporting segment.  None of the goodwill related to the Micrel acquisition is deductible for tax purposes.  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, 2016, to the net assets acquired based on their estimated fair values as of August 3, 2015, as well as the associated estimated useful lives of the acquired intangible assets at that date (amounts in thousands):
Assets acquired
Previously Reported March 31, 2016
 
Adjustments
 
June 30, 2016
Cash and cash equivalents
$
99,196

 
$

 
$
99,196

Accounts receivable, net
14,096

 

 
14,096

Inventories
73,468

 

 
73,468

Prepaid expenses and other current assets
10,652

 

 
10,652

Property, plant and equipment, net
38,566

 
(75
)
 
38,491

Goodwill
440,992

 
(14
)
 
440,978

Purchased intangible assets
273,500

 

 
273,500

Other assets
4,268

 

 
4,268

Total assets acquired
954,738

 
(89
)
 
954,649

 
 
 
 
 
 
Liabilities assumed
 
 
 
 
 
Accounts payable
(11,068
)
 

 
(11,068
)
Other current liabilities
(31,641
)
 
89

 
(31,552
)
Deferred tax liabilities
(88,035
)
 

 
(88,035
)
Long-term income tax payable
(7,637
)
 

 
(7,637
)
Other long-term liabilities
(127
)
 

 
(127
)
Total liabilities assumed
(138,508
)
 
89

 
(138,419
)
Purchase price allocated
$
816,230

 
$

 
$
816,230


Purchased Intangible Assets
Weighted Average
 
 
 
Useful Life
 
August 3, 2015
 
(in years)
 
(in thousands)
Core/developed technology
10
 
$
175,800

In-process technology
 
21,000

Customer-related
5
 
71,100

Backlog
1
 
5,600

Total purchased intangible assets
 
 
$
273,500



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Purchased intangible assets include core and developed technology, in-process research and development, customer-related intangibles and acquisition-date backlog. The estimated fair values of the core and developed technology and in-process research and development were determined based on the present value of the expected cash flows to be generated by the respective existing technology or future technology. The core and developed technology intangible assets are being amortized commensurate with the expected cash flows used in the initial determination of fair value. In-process technology is capitalized until such time as the related projects are completed or abandoned at which time the capitalized amounts will begin to be amortized or written off.
Customer-related intangible assets consist of Micrel's contractual relationships and customer loyalty related to its distributor and end-customer relationships, and the fair values of the customer-related intangibles were determined based on Micrel's projected revenues. An analysis of expected attrition and revenue growth for existing customers was prepared from Micrel's historical customer information.  Customer relationships are being amortized in a manner consistent with the estimated cash flows associated with the existing customers and anticipated retention rates. Backlog relates to the value of orders not yet shipped by Micrel at the acquisition date, and the preliminary fair values were based on the estimated profit associated with those orders. Backlog related assets are being recognized commensurate with recognition of the revenue for the orders on which the backlog intangible assets were determined.  Amortization expense associated with acquired intangible assets is not deductible for tax purposes.  Thus, approximately $99.7 million was established as a net deferred tax liability for the future amortization of the intangible assets offset by $11.4 million of net deferred tax assets.


Note 4. Discontinued Operations and Assets Held for Sale

Discontinued operations include the mobile touch business that the Company acquired as part of its acquisition of Atmel. The mobile touch business has been marketed for sale since the acquisition of Atmel on April 4, 2016 based on management's decision that it was not a strategic fit for the Company's product portfolio.

For financial statement purposes, the results of operations for this discontinued business has been segregated from those of the continuing operations and are presented in the Company's condensed consolidated financial statements as discontinued operations and the net assets of the remaining discontinued business has been presented as assets held for sale.

The results of discontinued operations for the three months ended June 30, 2016 are as follows (amounts in thousands):

Net sales
$
9,376

Cost of sales
8,424

Operating expenses
6,425

Income tax benefit
(1,335
)
Net loss from discontinued operations
$
(4,138
)

As of June 30, 2016, assets held for sale are comprised of the following (amounts in thousands):

Accounts receivable, net
$
5,932

Inventories
4,966

Intangible assets
7,500

Total assets held for sale
$
18,398


Note 5. Special Charges

The Company incurred special charges related to severance, office closing and other costs associated with its acquisition activity of $22.0 million for the three months ended June 30, 2016 (of which $17.0 million was paid during the quarter) and $1.6 million for the three months ended June 30, 2015.



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Note 6. Segment Information
 
The Company's reportable segments are semiconductor products and technology licensing.  The Company does not allocate operating expenses, interest income, interest expense, other income or expense, or provision for or benefit from income taxes to these segments for internal reporting purposes, as the Company does not believe that allocating these expenses is beneficial in evaluating segment performance.  Additionally, the Company does not allocate assets to segments for internal reporting purposes as it does not manage its segments by such metrics.

The following table represents net sales and gross profit for each segment for the three months ended June 30, 2016 (amounts in thousands):
 
Three Months Ended
 
June 30, 2016
 
Net Sales
 
Gross Profit
Semiconductor products
$
778,823

 
$
327,902

Technology licensing
20,588

 
20,588

 
$
799,411

 
$
348,490


The following table represents net sales and gross profit for each segment for the three months ended June 30, 2015 (amounts in thousands):
 
Three Months Ended
 
June 30, 2015
 
Net Sales
 
Gross Profit
Semiconductor products
$
510,689

 
$
285,754

Technology licensing
23,263

 
23,263

 
$
533,952

 
$
309,017


Note 7. Investments
 
The Company's investments are intended to establish a high-quality portfolio that preserves principal, meets liquidity needs, avoids inappropriate concentrations, and delivers an appropriate yield in relationship to the Company's investment guidelines and market conditions.  The following is a summary of available-for-sale securities at June 30, 2016 (amounts in thousands):
 
Available-for-sale Securities
 
Adjusted
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
Marketable equity securities
$
2,161

 
$

 
$
(895
)
 
$
1,266


The following is a summary of available-for-sale securities at March 31, 2016 (amounts in thousands):
 
Available-for-sale Securities
 
Adjusted
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
Government agency bonds
$
468,290

 
$
439

 
$
(99
)
 
$
468,630

Corporate bonds and debt
1,000

 

 

 
1,000

Marketable equity securities
2,195

 
8

 

 
2,203

 
$
471,485

 
$
447

 
$
(99
)
 
$
471,833




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At June 30, 2016, the Company's available-for-sale securities are presented on the condensed consolidated balance sheets as short-term investments of $1.3 million.  At March 31, 2016, the Company's available-for-sale securities are presented on the condensed consolidated balance sheets as short-term investments of $353.3 million and long-term investments of $118.5 million.

The Company sold available-for-sale investments for proceeds of $470.6 million during the three months ended June 30, 2016. The Company sold available-for-sale investments during the first quarter of fiscal 2017 and the fourth quarter of fiscal 2016 to finance a portion of the purchase price of its Atmel acquisition which closed on April 4, 2016. The Company sold available-for-sale investments for proceeds of $89.2 million during the three months ended June 30, 2015. The Company had no material realized gains from the sale of available-for-sale securities during the three months ended June 30, 2016. During the three months ended June 30, 2015, the Company had net realized gains of $14.0 million, from sales of available-for-sale marketable equity and debt securities. The Company determines the cost of available-for-sale debt securities sold on a FIFO basis at the individual security level for sales from multiple lots. For sales of marketable equity securities, the Company uses an average cost basis at the individual security level. Gains and losses recognized in earnings are credited or charged to other income (expense) on the consolidated statements of operations.

The following tables show all investments in an unrealized loss position for which an other-than-temporary impairment has not been recognized and the related gross unrealized losses and fair value, aggregated by investment category and the length of time that the individual securities have been in a continuous unrealized loss position (amounts in thousands):
 
June 30, 2016
 
Less than 12 Months
 
12 Months or Greater
 
Total
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
Marketable equity securities
$
1,266

 
$
(895
)
 
$

 
$

 
$
1,266

 
$
(895
)

 
March 31, 2016
 
Less than 12 Months
 
12 Months or Greater
 
Total
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
Government agency bonds
$
148,562

 
$
(99
)
 
$

 
$

 
$
148,562

 
$
(99
)
Corporate bonds and debt

 

 
1,000

 

 
1,000

 

 
$
148,562

 
$
(99
)
 
$
1,000

 
$

 
$
149,562

 
$
(99
)

Management does not believe any of the unrealized losses represent an other-than-temporary impairment based on its evaluation of available evidence as of June 30, 2016 and the Company's intent is to hold these investments until these assets are no longer impaired. 

Note 8. Fair Value Measurements

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

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


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Table of Contents


Marketable Debt Instruments

Marketable debt instruments include instruments such as corporate bonds and debt, government agency bonds, bank deposits, municipal bonds, and money market mutual funds. When the Company uses observable market prices for identical securities that are traded in less active markets, the Company classifies its marketable debt instruments as Level 2. When observable market prices for identical securities are not available, the Company prices its marketable debt instruments using non-binding market consensus prices that are corroborated with observable market data; quoted market prices for similar instruments; or pricing models, such as a discounted cash flow model, with all significant inputs derived from or corroborated with observable market data. Non-binding market consensus prices are based on the proprietary valuation models of pricing providers or brokers. These valuation models incorporate a number of inputs, including non-binding and binding broker quotes; observable market prices for identical or similar securities; and the internal assumptions of pricing providers or brokers that use observable market inputs and, to a lesser degree, unobservable market inputs. The Company corroborates non-binding market consensus prices with observable market data using statistical models when observable market data exists. The discounted cash flow model uses observable market inputs, such as LIBOR-based yield curves, currency spot and forward rates, and credit ratings.
 
Assets Measured at Fair Value on a Recurring Basis
 
Assets measured at fair value on a recurring basis at June 30, 2016 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
 
 
 
 
 
 
 
Cash and cash equivalents:
 
 
 
 
 
 
 
Money market mutual funds
$
147,618

 
$

 
$

 
$
147,618

Deposit accounts

 
452,908

 

 
452,908

Short-term investments:
 
 
 
 
 
 
 
Marketable equity securities

1,266

 

 

 
1,266

Total assets measured at fair value
$
148,884

 
$
452,908

 
$

 
$
601,792


Assets measured at fair value on a recurring basis at March 31, 2016 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
 
 
 
 
 
 
 
Cash and cash equivalents:
 
 
 
 
 
 
 
Money market mutual funds
$
1,787,446

 
$

 
$

 
$
1,787,446

Deposit accounts

 
305,305

 

 
305,305

Short-term investments:
 
 
 
 
 
 
 
Marketable equity securities
2,203

 

 

 
2,203

Corporate bonds and debt

 
1,000

 

 
1,000

Government agency bonds

 
350,081

 

 
350,081

Long-term investments:
 
 
 
 
 
 
 
Government agency bonds

 
118,549

 

 
118,549

Total assets measured at fair value
$
1,789,649

 
$
774,935

 
$

 
$
2,564,584


There were no transfers between Level 1 and Level 2 during the three-months ended June 30, 2016 or the year ended March 31, 2016.


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Assets and Liabilities Measured and Recorded at Fair Value on a Non-Recurring Basis
 
The Company's non-marketable equity, cost method investments, certain acquired liabilities and non-financial assets, such as intangible assets, assets held for sale and property, plant and equipment, are recorded at fair value on a non-recurring basis. These assets are subject to fair value adjustments in certain circumstances, for example, when there is evidence of impairment.  

The Company's non-marketable and cost method investments are monitored on a quarterly basis for impairment charges.  The fair values of these investments have been determined as Level 3 fair value measurements because the valuations use unobservable inputs that require management's judgment due to the absence of quoted market prices. There were no impairment charges recognized on these investments during each of the three-month periods ended June 30, 2016 and June 30, 2015. These investments are included in other assets on the condensed consolidated balance sheet.

The fair value measurements related to the Company's non-financial assets, such as intangible assets, assets held for sale and property, plant and equipment are based on available market prices at the measurement date based on transactions of similar assets and third-party independent appraisals, less costs to sell where appropriate. The Company classifies these measurements as Level 2.
  
Note 9. Fair Value of Financial Instruments
 
The carrying amount of cash equivalents approximates fair value because their maturity is less than three months.  Management believes the carrying amount of the equity and cost-method investments materially approximated fair value at June 30, 2016 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 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 excluding debt issuance costs. 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 borrowings at June 30, 2016 approximated the carrying value and are considered Level 2 in the fair value hierarchy described in Note 8. The carrying amount of accounts receivable, accounts payable and accrued liabilities approximates fair value due to the short-term maturity of the amounts and are considered Level 2 in the fair value hierarchy. 

Fair Value of Subordinated Convertible Debentures

The Company measures the fair value of its senior and junior subordinated convertible debentures for disclosure purposes. These fair values are 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.

The following table shows the carrying amounts and fair values of the Company’s senior and junior subordinated convertible debentures as of June 30, 2016 and March 31, 2016 (amounts in thousands). As of June 30, 2016, the carrying amounts of the Company's senior and junior subordinated convertible debentures have been reduced by debt issuance costs of of $18.0 million and $2.3 million, respectively. As of March 31, 2016, the carrying amounts of the Company's senior and junior subordinated convertible debentures have been reduced by debt issuance costs of $18.4 million and $2.4 million, respectively.

 
June 30, 2016
 
March 31, 2016
 
Carrying Amount
 
Fair Value
 
Carrying Amount
 
Fair Value
1.625% Senior Subordinated Convertible Debentures
$
1,227,444

 
$
1,919,356

 
$
1,216,313

 
$
1,762,088

2.125% Junior Subordinated Convertible Debentures
$
195,315

 
$
1,187,375

 
$
193,936

 
$
1,143,117




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Note 10.
Accounts Receivable
 
Accounts receivable consists of the following (amounts in thousands):
 
June 30, 2016
 
March 31, 2016
Trade accounts receivable
$
433,766

 
$
289,013

Other
4,135

 
3,710

Total accounts receivable, gross
437,901

 
292,723

Less allowance for doubtful accounts
2,390

 
2,540

Total accounts receivable, net
$
435,511

 
$
290,183


Note 11.
Inventories

The components of inventories consist of the following (amounts in thousands):
 
June 30, 2016
 
March 31, 2016
Raw materials
$
14,971

 
$
12,179

Work in process
346,506

 
208,283

Finished goods
156,954

 
86,353

Total inventories
$
518,431

 
$
306,815


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. The inventory balance at June 30, 2016 includes a $80.9 million acquired inventory fair value adjustment resulting from the acquisition of Atmel.

Note 12.
Property, Plant and Equipment

Property, plant and equipment consists of the following (amounts in thousands):
 
June 30, 2016
 
March 31, 2016
Land
$
73,692

 
$
63,907

Building and building improvements
498,860

 
458,379

Machinery and equipment
1,739,188

 
1,645,617

Projects in process
109,168

 
99,370

Total property, plant and equipment, gross
2,420,908

 
2,267,273

Less accumulated depreciation and amortization
1,688,092

 
1,657,877

Total property, plant and equipment, net
$
732,816

 
$
609,396

 
Depreciation expense attributed to property, plant and equipment was $30.6 million and $24.7 million for the three months ended June 30, 2016 and June 30, 2015, respectively.




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Table of Contents


Note 13.     Intangible Assets and Goodwill
 
Intangible assets consist of the following (amounts in thousands):
 
 
June 30, 2016
 
 
Gross Amount
 
Accumulated Amortization
 
Net Amount
Core and developed technology
 
$
1,813,105

 
$
(301,019
)
 
$
1,512,086

Customer-related
 
907,742

 
(229,241
)
 
678,501

Trademarks and trade names
 
11,700

 
(8,088
)
 
3,612

Backlog
 
28,700

 
(7,075
)
 
21,625

In-process technology
 
185,566

 

 
185,566

Distribution rights
 
5,580

 
(5,313
)
 
267

Other
 
1,805

 
(105
)
 
1,700

Total
 
$
2,954,198

 
$
(550,841
)
 
$
2,403,357


 
 
March 31, 2016
 
 
Gross Amount
 
Accumulated Amortization
 
Net Amount
Core and developed technology
 
$
724,883

 
$
(255,460
)
 
$
469,423

Customer-related
 
278,542

 
(200,331
)
 
78,211

Trademarks and trade names
 
11,700

 
(7,571
)
 
4,129

In-process technology
 
54,308

 

 
54,308

Distribution rights
 
5,580

 
(5,302
)
 
278

Total
 
$
1,075,013

 
$
(468,664
)
 
$
606,349


The Company amortizes intangible assets over their expected useful lives, which range between 1 and 15 years.  During the three months ended June 30, 2016, as a result of the Atmel transaction, the Company acquired $1,080.3 million of core and developed technology which has a weighted average amortization period of 11 years, $629.2 million of customer-related intangible assets which have a weighted average amortization period of 6 years, $28.7 million of intangible assets related to backlog with an amortization period of 1 year, $1.8 million of other intangible assets which have a weighted average amortization period of 5 years and $140.2 million of in-process technology which will begin amortization once the technology reaches technological feasibility. During the three months ended June 30, 2016, $8.9 million of in-process technology reached technological feasibility and was reclassified as core and developed technology and began being amortized over its estimated useful life. The following is an expected amortization schedule for the intangible assets for the remainder of fiscal 2017 through fiscal 2021, absent any future acquisitions or impairment charges (amounts in thousands):

Year ending
March 31,
Projected Amortization
Expense
2017
$253,615
2018
445,471
2019
363,978
2020
314,257
2021
288,469
 
Amortization expense attributed to intangible assets was $82.5 million and $35.7 million for the three months ended June 30, 2016 and June 30, 2015, respectively. In the three months ended June 30, 2016, approximately $0.9 million was charged to cost of sales, and approximately $81.6 million was charged to operating expenses.  In the three months ended June 30, 2015, approximately $0.9 million was charged to cost of sales, and approximately $34.8 million was charged to operating expenses.  The Company recognized impairment charges of $2.0 million in three months ended June 30, 2016. The Company recognized no impairment charges in the three months ended June 30, 2015.
 


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Goodwill activity for the three months ended June 30, 2016 was as follows (amounts in thousands):
 
Semiconductor Products
Reporting Unit
 
Technology
Licensing
Reporting Unit
Balance at March 31, 2016
$
993,452

 
$
19,200

Additions due to the acquisition of Atmel
1,378,317

 

Adjustments due to the acquisition of Micrel
(14
)
 

Balance at June 30, 2016
$
2,371,755

 
$
19,200

 
At March 31, 2016, the Company applied a qualitative goodwill impairment test to its two reporting units, concluding it was not more likely than not that goodwill was impaired. Through June 30, 2016, the Company has never recorded an impairment charge against its goodwill balance.

Note 14.
Income Taxes

The provision for income taxes reflects tax on foreign earnings and federal and state tax on U.S. earnings.  The Company had a negative effective tax rate of 20.4% for the three months ended June 30, 2016 and a negative effective tax rate of 9.1% for the three months ended June 30, 2015.  The Company's effective tax rate for the three months ended June 30, 2016 is lower compared to the prior year primarily due to acquisition related expenses. The Company's effective tax rate is lower than statutory rates in the U.S. due primarily to its mix of earnings in foreign jurisdictions with lower tax rates as well as numerous tax holidays it receives related to its Thailand manufacturing operations based on its investment in property, plant and equipment in Thailand. The Company’s tax holiday periods in Thailand expire at various times in the future, however, the Company actively seeks to obtain new tax holidays. The Company does not expect the future expiration of any of its tax holiday periods in Thailand to have a material impact on its effected tax rate. The remaining material components of foreign income taxed at a rate lower than the U.S. are earnings accrued in Ireland and earnings accrued by the Company's offshore technology company which is resident in the Cayman Islands.

The following tables summarize the activity related to the Company's gross unrecognized tax benefits for the three months ended June 30, 2016 and the year ended March 31, 2016 (amounts in thousands):
 
 
Three Months Ended
 
June 30, 2016
Beginning balance
$
220,669

Increases related to acquisitions
193,889

Decreases related to statute of limitation expirations
(249
)
Increases related to current year tax positions
6,773

Decreases related to prior year tax positions
(134
)
Ending Balance
$
420,948


 
Year Ended
 
March 31, 2016
Beginning balance
$
170,654

Increases related to acquisitions
46,245

Decreases related to settlements with tax authorities
(7,954
)
Decreases related to statute of limitation expirations
(4,591
)
Increases related to current year tax positions
16,315

Ending Balance
$
220,669


    


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Table of Contents


As of June 30, 2016, the Company had accrued approximately $12.2 million related to the potential payment of interest on the Company's uncertain tax positions. The current year increase to the potential payment of interest is primarily composed of a $9.3 million increase related to acquisitions. As of March 31, 2016, the Company had accrued approximately $2.4 million related to the potential payment of interest on the Company's uncertain tax positions. As of June 30, 2016, the Company had accrued for approximately $53.2 million in penalties related to its uncertain tax positions. The current year increase to the potential payment of penalties is primarily composed of a $25.6 million increase related to acquisitions. As of March 31, 2016, the Company had accrued for approximately $27.6 million in penalties related to its uncertain tax 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 2005 and later tax years remain effectively open for examination by tax authorities.  The U.S. Internal Revenue Service (IRS) is currently auditing the Company'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 2007.
 
The Company recognizes liabilities for anticipated tax audit issues in the U.S. and other domestic and international tax jurisdictions based on its estimate of whether, and the extent to which, additional tax payments are more likely than not.  The Company believes that it has appropriate support for the income tax positions taken and to be taken on its tax returns and that its accruals for tax liabilities are adequate for all open years based on an assessment of many factors including past experience and interpretations of tax laws applied to the facts of each matter.
 
The Company believes it maintains appropriate reserves to offset any potential income tax liabilities that may arise upon final resolution of matters for open tax years.  If such reserve amounts ultimately prove to be unnecessary, the resulting reversal of such reserves would result in tax benefits being recorded in the period the reserves are no longer deemed necessary.  If such amounts prove to be less than an ultimate assessment, a future charge to expense would be recorded in the period in which the assessment is determined.  Although the timing of the resolution or closure of audits is highly uncertain, the Company does not believe it is reasonably possible that the unrecognized tax benefits would materially change in the next 12 months.

Note 15.
1.625% Senior Subordinated Convertible Debentures

In February 2015, the Company issued $1,725.0 million principal amount of 1.625% senior subordinated convertible debentures due February 15, 2025. The debentures are subordinated to the Company's senior debt, including amounts borrowed under its amended credit facility, but are senior to the Company's outstanding 2.125% junior subordinated convertible debentures. The debentures are convertible, subject to certain conditions, into cash, shares of the Company's common stock or a combination thereof, at the Company's election, at an initial base conversion rate of 14.5654 shares of common stock per $1,000 principal amount of debentures, representing an initial base conversion price of approximately $68.66 per share of common stock.  As a result of cash dividends paid since the issuance of the debentures, the conversion rate has been adjusted to 15.2530 shares of common stock per $1,000 of principal amount of debentures, representing a base conversion price of approximately $65.56 per share of common stock. In addition, if at the time of conversion the applicable price of the Company's common stock exceeds the base conversion price, the conversion rate will be increased by up to an additional initial base conversion rate of 7.2827 shares of common stock per $1,000 principal amount of debentures, as determined pursuant to a specified formula. As a result of cash dividends paid since the issuance of the debentures, the maximum number of additional shares that may be issued if the stock price of the Company's common stock exceeds the base conversion price has been adjusted to 7.6265 shares of common stock per $1,000 principal amount of debentures. However, in no event will the conversion rate exceed 20.3915 (adjusted to 21.3542 as a result of cash dividends paid since the issuance of the debentures) shares of common stock per $1,000 principal amount of debentures. The Company received net proceeds of approximately $1,694.7 million from the issuance of its senior subordinated convertible debentures after deduction of issuance costs of approximately $30.3 million. The $30.3 million in issuance costs was split between a debt component of $20.4 million and an equity component of $9.9 million.  The debt component of the debt issuance costs is recorded as a direct deduction from the carrying value of the debentures and is being amortized using the effective interest method over the term of the debentures.

Prior to the close of business on the business day immediately preceding November 15, 2024, the debentures will be convertible at the option of the debenture holders only upon the satisfaction of specified conditions and during certain periods. Thereafter until close of business on the second scheduled trading day immediately preceding February 15, 2025, the debentures will be convertible at the option of the debenture holders at any time regardless of these conditions. Accrued and unpaid interest will be considered fully paid upon settlement of shares.
 



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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 June 30, 2016 and March 31, 2016 was $564.9 million.  The estimated fair value of the liability component of the debentures at the issuance date was $1,160.1 million resulting in a debt discount of $564.9 million.  The unamortized debt discount was $479.6 million at June 30, 2016 and $490.3 million at March 31, 2016.  The remaining period over which the unamortized debt discount will be recognized as non-cash interest expense is 8.62 years.  In the three months ended June 30, 2016, the Company recognized $10.7 million in non-cash interest expense related to the amortization of the debt discount compared to $10.5 million in the three months ended June 30, 2015.  The Company recognized $7.0 million of interest expense related to the 1.625% coupon on the debentures in each of the three month periods ended June 30, 2016 and June 30, 2015. The effective interest rate of the debentures is 5.9%.

Note 16.
2.125% Junior Subordinated Convertible Debentures
 
The Company's remaining $575.0 million 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 (including the Company's senior subordinated convertible debentures) 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 cash, shares of the Company's common stock or a combination thereof, at the Company's election, 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 June 30, 2016, the holders of the debentures had the right to convert their debentures between July 1, 2016 and September 30, 2016 because for at least 20 trading days during the 30 consecutive trading day period ending on June 30, 2016, the Company's common stock had a last reported sale price greater than 130% of the conversion price. As of June 30, 2016, the Company has classified the junior subordinated convertible debentures as long-term on the consolidated balance sheets as the Company has the intent and ability to refinance the obligation on a long-term basis. As of June 30, 2016, 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 41.4433 shares of common stock per $1,000 of principal amount of debentures, representing a conversion price of approximately $24.13 per share of common stock. The if-converted value of the debentures exceeded the principal amount by $634.6 million at June 30, 2016. The debentures include a contingent interest mechanism that begins in December 2017. The terms of the contingent interest include a 0.25% additional interest rate if the debentures are trading at less than $400 and a 0.5% additional interest rate if the debentures are trading at greater than $1,500. Based on the current trading price of the debentures, the contingent interest rate beginning in December 2017 would be 0.5% of the average trading price.
 
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 were both initially recorded at fair value.  The carrying value of the equity component at June 30, 2016 and at March 31, 2016 was $411.2 million.  The estimated fair value of the liability component of the debentures at the issuance date was $163.8 million, resulting in a debt discount of $411.2 million.  The unamortized debt discount was $376.9 million at June 30, 2016 and $378.3 million at March 31, 2016.  The remaining period over which the unamortized debt discount will be recognized as non-cash interest expense is 21.46 years.  In the three months ended June 30, 2016, the Company recognized $1.4 million in non-cash interest expense related to the amortization of the debt discount compared to $1.3 million in the three months ended June 30, 2015.  The Company recognized $3.1 million of interest expense related to the 2.125% coupon on the debentures in each of the three month periods ended June 30, 2016 and June 30, 2015. The effective interest rate of the debentures is 9.1%.

Note 17.
Credit Facility

In February 2015, the Company amended its existing $2.0 billion credit agreement by increasing the revolving credit facility to $2.555 billion and removing the term loan portion of the agreement. The new credit agreement includes two tranches. One tranche consists of bank commitments through February 2020 and another tranche consists of bank commitments through June 2018, the maturity date of the original credit agreement. The increase option permitting the Company, subject to certain requirements, to arrange with existing lenders or new lenders to provide up to an aggregate of $300 million in additional commitments, was also adjusted to $249.4 million. The credit agreement provides for a $125 million foreign currency sublimit, a $25 million letter of credit sublimit and a $25 million swingline loan sublimit. The amended credit agreement was accounted for as a modification and as such any remaining unamortized deferred costs associated with the prior credit agreement was associated with the new agreement since the borrowing capacity was increased. At June 30, 2016, $1,922.0 million of revolving credit facility borrowings were outstanding under the credit agreement compared to $1,052.0 million at March 31, 2016. The carrying values reflected in the Company's condensed consolidated balance sheets as of June 30, 2016 and March 31, 2016 have been reduced by debt issuance costs of $8.3 million and $8.8 million, respectively.


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In December 2015, the Company secured additional revolving credit commitments of $219 million from various banks in the February 2020 tranche under the increase option of the credit agreement, bringing its revolving credit facility to $2.774 billion. The remaining increase option was $30.4 million as of June 30, 2016.

In December 2015, the Company amended the maximum total leverage ratio in Section 6.11 of its existing credit agreement to allow the Total Leverage Ratio (as defined in that agreement) to be temporarily increased to 5.00 to 1.00 for a period of four consecutive quarters in conjunction with a permitted acquisition occurring during the first of the four quarters.
The Total Leverage Ratio then decreases to 4.75 to 1.00 for three consecutive quarters, finally returning to the stated 4.50 to 1.00 Total Leverage Ratio of the credit agreement after a period of seven consecutive fiscal periods. The Company can elect to use this special feature, also referred to as an Adjusted Covenant Period, no more than two times during the term of the credit agreement and also can terminate an Adjusted Covenant Period earlier than the seven consecutive quarters allowed. The Company elected to use this feature in conjunction with its acquisition of Atmel during the quarter ended June 30, 2016.

The loans under the credit agreement bear interest, at the Company's option, at the base rate plus a spread of 0.25% to 1.25% or an adjusted LIBOR rate (based on one, two, three, or six-month interest periods) plus a spread of 1.25% to 2.25%, in each case with such spread being determined based on the consolidated leverage ratio for the preceding four fiscal quarters (in the case of the 2018 tranche revolving loans) or the consolidated senior leverage ratio (in the case of the 2020 tranche revolving loans). The base rate means the highest of JPMorgan Chase Bank, N.A.'s prime rate, the federal funds rate plus a margin equal to 0.50% and the adjusted LIBOR rate for a 1-month interest period plus a margin equal to 1.00%. Swingline loans accrue interest at a per annum rate based on the base rate plus the applicable margin for base rate loans. Base rate loans may only be made in U.S. Dollars. The Company is also obligated to pay other customary administration fees and letter of credit fees for a credit facility of this size and type.

Interest is due and payable in arrears quarterly for loans bearing interest at the base rate and at the end of an interest period (or at each three-month interval in the case of loans with interest periods greater than three months) in the case of loans bearing interest at the adjusted LIBOR rate. Interest expense related to the credit agreement was approximately $11.6 million and $3.6 million in the three months ended June 30, 2016 and June 30, 2015, respectively. Principal, together with all accrued and unpaid interest, is due and payable on the respective tranche maturity date, which is June 27, 2018 and February 4, 2020. The weighted average interest rate on borrowings outstanding at June 30, 2016 related to the credit agreement was 1.95%. The Company also pays a quarterly commitment fee on the available but unused portion of its line of credit which is calculated on the average daily available balance during the period. The Company may prepay the loans and terminate the commitments, in whole or in part, at any time without premium or penalty, subject to certain conditions including minimum amounts in the case of commitment reductions and reimbursement of certain costs in the case of prepayments of LIBOR loans.

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

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 consolidated senior and total leverage ratios and a consolidated interest coverage ratio. At June 30, 2016, 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.



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Note 18.     Pension Plans

In connection with the acquisition of Atmel, the Company assumed unfunded defined benefit pension plans that cover certain French and German employees. Plan benefits are provided in accordance with local statutory requirements. Benefits are based on years of service and employee compensation levels. Pension liabilities and charges are based upon various assumptions, updated annually, including discount rates, future salary increases, employee turnover, and mortality rates. The Company’s French pension plan provides for termination benefits paid to covered French employees only at retirement, and consists of approximately one to five months of salary. The Company’s German pension plan provides for defined benefit payouts for covered German employees following retirement.

The aggregate net pension expense relating to these two plans are as follows (amounts in thousands):

 
Three Months Ended
 
June 30, 2016
Service costs
$
364

Interest costs
243

Amortization of actuarial loss
65

Settlements
231

Net pension period cost
$
903


The change in projected benefit obligation and the accumulated benefit obligation, were as follows (amounts in thousands):

 
June 30, 2016
Projected benefit obligation April 4, 2016
$
40,313

Service cost
364

Interest cost
243

Settlements
231

Actuarial losses
9,808

Benefits paid
(107
)
Foreign currency exchange rate changes
(115
)
Projected benefit obligation at June 30, 2016
$
50,737

Accumulated benefit obligation at June 30, 2016
44,552


As the defined benefit plans are unfunded, the liability recognized on the condensed consolidated balance sheets as of June 30, 2016 was $50.7 million, of which $0.7 million is included in accrued and other liabilities and $50.0 million is included in other long-term liabilities on the condensed consolidated balance sheets.

Actuarial assumptions used to determine benefit obligations for the plans were as follows:

Assumed discount rate
1.05% - 1.31%
Assumed compensation rate of increase
2.90% - 3.00%

The discount rate is based on the quarterly average yield for Euros treasuries with a duration of 30 years, plus a supplement for corporate bonds (Euros, AA rating).


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Future estimated expected benefit payments for the remainder of fiscal 2017 through 2026 are as follows (amounts in thousands):

Fiscal Year Ending
March 31,
Expected Benefit Payments
2017
$
352

2018
848

2019
885

2020
1,139

2021
1,685

2022 through 2026
8,465

 
$
13,374


The Company’s pension liability represents the present value of estimated future benefits to be paid.

Actuarial losses (gains) for the three months ended June 30, 2016 is comprised of a $10.5 million loss recognized due to declines in the discount rates used to calculate the present value of pension obligation and a $0.7 million settlement gain. Net actuarial losses (gains) will be recognized as a component of net periodic pension cost during fiscal 2018, which is included in accumulated other comprehensive loss in the condensed consolidated balance sheets as of June 30, 2016.
The Company’s net periodic pension cost for fiscal 2017 is expected to be approximately $2.9 million. Cash funding for benefits paid was $0.1 million for the three months ended June 30, 2016. The Company expects total contributions to these plans to be approximately $0.5 million in fiscal 2017.

Note 19.
Contingencies

In the ordinary course of the Company's business, it is exposed to various liabilities as a result of contracts, product liability, customer claims and other matters.  Additionally, the Company is involved in a limited number of legal actions, both as plaintiff and defendant.  Consequently, the Company could incur uninsured liability in any of those actions.  The Company also periodically receives notifications from various third parties alleging infringement of patents or other intellectual property rights, or from customers requesting reimbursement for various costs.  With respect to pending legal actions to which the Company is a party and other claims, although the outcomes are generally not determinable, the Company believes that the ultimate resolution of these matters will not have a material adverse effect on its financial position, cash flows or results of operations.  Litigation and disputes relating to the semiconductor industry are not uncommon, and the Company is, from time to time, subject to such litigation and disputes.  As a result, no assurances can be given with respect to the extent or outcome of any such litigation or disputes in the future.

The Company accrues for claims and contingencies when losses become probable and reasonably estimable. As of the end of each applicable reporting period, the Company reviews each of its matters and, where it is probable that a liability has been or will be incurred, the Company accrues for all probable and reasonably estimable losses. Where the Company can reasonably estimate a range of losses it may incur regarding such a matter, the Company records an accrual for the amount within the range that constitutes its best estimate. If the Company can reasonably estimate a range but no amount within the range appears to be a better estimate than any other, the Company uses the amount that is the low end of such range. As of June 30, 2016, the Company's estimate of the aggregate potential liability that is possible but not probable is approximately $100 million in excess of amounts accrued.

The Company's technology license agreements generally include an indemnification clause that indemnifies the licensee against liability and damages (including legal defense costs) arising from any claims of patent, copyright, trademark or trade secret infringement by the Company's proprietary technology.  The terms of these indemnification provisions approximate the terms of the outgoing technology license agreements, which are typically perpetual unless terminated by either party for breach. The possible amount of future payments the Company could be required to make based on agreements that specify indemnification limits, if such indemnifications were required on all of these agreements, is approximately $147 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 June 30, 2016.



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Note 20.
Derivative Instruments
 
Foreign Currency Exchange Rate Risk

The Company has international operations and is thus subject to foreign currency rate fluctuations.  To help manage the risk of changes in foreign currency rates, the Company periodically enters into derivative contracts comprised of foreign currency forward contracts to hedge its asset and liability foreign currency exposure and a portion of its foreign currency operating expenses.  Approximately 96% 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 June 30, 2016 and March 31, 2016, the Company had no foreign currency forward contracts outstanding. The Company recognized an immaterial amount of net realized gains and losses on foreign currency forward contracts in each of the three months ended June 30, 2016 and 2015. Gains and losses from changes in the fair value of these foreign currency forward contracts and foreign currency exchange rate fluctuations are credited or charged to other income (expense) on the condensed consolidated statements of operations. The Company does not apply hedge accounting to its foreign currency derivative instruments.

Note 21.
Comprehensive (Loss) Income

The following table presents the changes in the components of accumulated other comprehensive (loss) income (AOCI) for the three months ended June 30, 2016 (amounts in thousands):
 
Unrealized
holding gains (losses)
available-for-sale securities
 
Defined benefit pension plans
 
Foreign
Currency
 
Total
Accumulated other comprehensive (loss) income at March 31, 2016
$
348

 
$
44

 
$
(3,749
)
 
$
(3,357
)
Other comprehensive loss before reclassifications
(1,325
)
 
(6,805
)
 
(3,023
)
 
(11,153
)
Amounts reclassified from accumulated other comprehensive loss
82

 

 

 
82

Net other comprehensive loss
(1,243
)
 
(6,805
)
 
(3,023
)
 
(11,071
)
Accumulated other comprehensive loss at June 30, 2016
$
(895
)
 
$
(6,761
)
 
$
(6,772
)
 
$
(14,428
)

The table below details where reclassifications of realized transactions out of AOCI are recorded on the condensed consolidated statements of operations (amounts in thousands):
 
 
Three Months Ended
 
 
 
June 30,
 
Description of AOCI Component
 
2016
 
2015
Related Statement
 of Income Line
Unrealized (losses) gains on available-for-sale securities
 
$
(82
)
 
$
13,959

Other income



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Note 22.
Share-Based Compensation
 
The following table presents the details of the Company's share-based compensation expense (amounts in thousands):
 
Three Months Ended
 
 
June 30,
 
 
2016
 
2015
 
Cost of sales
$
7,897

(1) 
$
1,657

(1) 
Research and development
17,517

 
7,098

 
Selling, general and administrative
34,165

 
5,357

 
Pre-tax effect of share-based compensation
59,579

 
14,112

 
Income tax benefit
20,888

 
3,532

 
Net income effect of share-based compensation
$
38,691

 
$
10,580

 

(1) During the three months ended June 30, 2016, $2.8 million of share-based compensation expense was capitalized to inventory. The amount of share-based compensation included in cost of sales during the three months ended June 30, 2016, included $3.7 million of previously capitalized share-based compensation expense in inventory that was sold and $4.2 million of share-based compensation expense related to the Company's acquisition of Atmel that was not previously capitalized to inventory.  During the three months ended June 30, 2015, $1.8 million of share-based compensation expense was capitalized to inventory and $1.7 million of previously capitalized share-based compensation expense in inventory was sold.

Atmel Acquisition-related Equity Awards

    In connection with the acquisition of Atmel, the Company assumed certain restricted stock units (RSUs) granted by Atmel. The assumed awards were measured at the acquisition date based on the estimated fair value, which was a total of $95.9 million. A portion of that fair value, $7.5 million, which represented the pre-acquisition vested service provided by employees to Atmel, was included in the total consideration transferred as part of the acquisition. As of the acquisition date, the remaining portion of the fair value of those awards was $88.4 million, representing post-acquisition share-based compensation expense that will be recognized as these employees provide service over the remaining vesting periods. During the three months ended June 30, 2016, the Company recognized $43.2 million of share-based compensation expense in connection with the acquisition of Atmel, of which $37.1 million was due to the accelerated vesting of outstanding equity awards upon termination of certain Atmel employees.

Note 23.
Net (Loss) Income Per Common Share Attributable to Microchip Technology Stockholders
 
The following table sets forth the computation of basic and diluted net (loss) income per common share from continuing operations attributable to Microchip Technology stockholders (in thousands, except per share amounts):
 
Three Months Ended
 
June 30,
 
2016
 
2015
Net (loss) income from continuing operations attributable to Microchip Technology
$
(109,225
)
 
$
130,667

Weighted average common shares outstanding
214,345

 
202,232

Dilutive effect of stock options and RSUs

 
3,392

Dilutive effect of 2037 junior subordinated convertible debentures

 
11,143

Weighted average common and potential common shares outstanding
214,345

 
216,767

Basic net (loss) income per common share from continuing operations attributable to Microchip Technology stockholders
$
(0.51
)
 
$
0.65

Diluted net (loss) income per common share from continuing operations attributable to Microchip Technology stockholders
$
(0.51
)
 
$
0.60





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The Company computed basic net (loss) income per common share from continuing operations attributable to its stockholders using net (loss) income from continuing operations available to common stockholders and the weighted average number of common shares outstanding during the period. The Company computed diluted net (loss) income per common share from continuing operations attributable to its stockholders using net (loss) income from continuing operations available to common stockholders and the weighted average number of common shares outstanding plus potentially dilutive common shares outstanding during the period.

Potentially dilutive common shares from employee equity incentive plans are determined by applying the treasury stock method to the assumed exercise of outstanding stock options and the assumed vesting of outstanding RSUs. For the three months ended June 30, 2016, the calculation of diluted net loss per common share excluded 4,159,273 common shares from employee equity incentive plans as the related impact would have been anti-dilutive as the Company generated a net loss.

For the three months ended June 30, 2016, the calculation of diluted net loss per common share excluded 12,165,812 shares issuable upon the exchange of the Company's 2.125% junior subordinated convertible debentures as the related impact would have been anti-dilutive as the Company generated a net loss. Diluted net income per common share from continuing operations attributable to stockholders for the three months ended June 30, 2015 includes 11,142,772 shares issuable upon the exchange of the Company's 2.125% junior subordinated convertible 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-month periods ended June 30, 2016 and 2015 was $24.23 and $25.01, respectively.

There were no shares issuable upon the exchange of the Company's 1.625% senior subordinated convertible debentures due February 15, 2025 (see Note 15). 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-month periods ended June 30, 2016 and 2015 was $65.82 and $67.95, respectively.

Note 24. Stock Repurchase

In December 2007, the Company announced that its Board of Directors had authorized the repurchase of up to 10.0 million shares of its common stock in the open market or in privately negotiated transactions.  As of March 31, 2015, the Company had repurchased 7.5 million shares under this authorization for $234.7 million.  In May 2015, the Company's Board of Directors authorized an increase to the existing share repurchase program to 20 million shares of common stock from the approximately 2.5 million shares remaining under the prior authorization. During fiscal 2016, the Company purchased 8.6 million shares of its common stock for a total of $363.8 million. In January 2016, the Company's Board of Directors authorized an increase to the existing share repurchase program to 15.0 million shares of common stock from the approximately 11.4 million shares remaining under the prior authorization. There were no repurchases of common stock during the three months ended June 30, 2016. There is no expiration date associated with this repurchase program. As of June 30, 2016, approximately 22.5 million shares remained as treasury shares with the balance of the shares being used to fund share issuance requirements under the Company's equity incentive plans.

Note 25.
Dividends

A quarterly cash dividend of $0.3595 per share was paid on June 6, 2016 in the aggregate amount of $77.2 million.  A quarterly cash dividend of $0.3600 per share was declared on August 8, 2016 and will be paid on September 6, 2016 to stockholders of record as of August 22, 2016. The Company expects the September payment of its quarterly cash dividend to be approximately $77.6 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," "continue," "intend" and similar expressions to identify forward-looking statements.  Our actual results could differ materially from the results anticipated in these forward-looking statements as a result of certain factors including those set forth under "Risk Factors," beginning at page 45 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;
Our expectation that in the future we will acquire additional businesses that we believe will complement our existing businesses;
Our expectation that in the future we will enter into joint development agreements or other business or strategic relationships with other companies;
The level of orders that will be received and shipped within a quarter;
Our expectation that our inventory levels will be flat to down 4 days, excluding impacts from the sell through of acquired inventory fair value mark-up, in the September 2016 quarter compared to the June 2016 quarter and that it will allow us to maintain competitive lead times and provide strong delivery performance to our customers;
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;
Anticipating increased customer requirements to meet voluntary criteria related to the reduction or elimination of substances in our products;
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;
That the acquisition was structured in a manner that enabled us to utilize a substantial portion of the cash, cash equivalents, short-term investments and long-term investments held by certain of our foreign subsidiaries in a tax efficient manner and that our determinations with respect to the tax consequences of the acquisition are reasonable;

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The sufficiency of our existing sources of liquidity to finance anticipated capital expenditures and otherwise meet our anticipated cash requirements, and the effects that our contractual obligations are expected to have on them;
That our U.S. operations and capital requirements are funded primarily by cash generated from U.S. operating activities, which has been and is expected to be sufficient to meet our business needs in the U.S. for the foreseeable future;
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;
That when the UK leaves the EU, we may lose our ability to import and export products tax-free throughout Europe which may increase the costs to us for the import and sale of our products to our customers, result in a decrease in sales to certain of our customers or disrupt our operations and product shipments;
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;
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;
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 our overall business strategy to give the reader an overview of the goals of our business and the overall direction of our business and products.  This is followed by a discussion of the Critical Accounting Policies and Estimates that we believe are important to understanding the assumptions and judgments incorporated in our reported financial results.  We then discuss our Results of Operations for the three months ended June 30, 2016 compared to the three months ended June 30, 2015.  We then provide an analysis of changes in our balance sheet and cash flows, and discuss our financial commitments in sections titled "Liquidity and Capital Resources," "Contractual Obligations" and "Off-Balance Sheet Arrangements." 

Strategy
 
Our goal is to be a worldwide leader in providing specialized semiconductor products for a wide variety of embedded control applications. Our strategic focus is on embedded control solutions, including general purpose and specialized microcontrollers, development tools and related software, high-performance linear, mixed-signal, power management, thermal management, radio frequency (RF), timing, safety, security, wired connectivity and wireless connectivity devices, as well as serial EEPROMs, SuperFlash memories, Parallel Flash memories and serial SRAM memories. 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 our SuperFlash technology and other technologies to wafer foundries, integrated device manufacturers and design partners throughout the world for use in the manufacture of advanced microcontroller products, gate array, RF and analog products that require embedded non-volatile memory.
 
We sell our products to a broad base of domestic and international customers across a variety of industries.  The principal markets that we serve include consumer, automotive, industrial, office automation and telecommunications.  Our business is subject to fluctuations based on economic conditions within these markets. 


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Our manufacturing operations include wafer fabrication, wafer probe and assembly and test.  The ownership of a substantial portion of our manufacturing resources is an important component of our business strategy, enabling us to maintain a high level of manufacturing control resulting in us being one of the lowest cost producers in the embedded control industry.  By owning wafer fabrication facilities and 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 manufacturing requirements to third parties.

We employ proprietary design and manufacturing processes in developing our embedded control products.  We believe our processes afford us both cost-effective designs in existing and derivative products and greater functionality in new product designs.  While many of our competitors develop and optimize separate processes for their logic and memory product lines, we use a common process technology for both microcontroller and non-volatile memory products.  This allows us to more fully leverage our process research and development costs and to deliver new products to market more rapidly.  Our engineers utilize advanced computer-aided design (CAD) tools and software to perform circuit design, simulation and layout, and our in-house photomask and wafer fabrication facilities enable us to rapidly verify design techniques by processing test wafers quickly and efficiently.

We are committed to continuing our investment in new and enhanced products, including development systems, and in our design and manufacturing process technologies.  We believe these investments are significant factors in maintaining our competitive position.  Our current research and development activities focus on the design of new microcontrollers, digital signal controllers, memory, analog and mixed-signal products, Flash-IP systems, development systems, software and application-specific software libraries.  We are also developing new design and process technologies to achieve further cost reductions and performance improvements in our products.
 
We market and sell our products worldwide primarily through a network of direct sales personnel and distributors.  Our distributors focus primarily on servicing the product and technical support requirements of a broad base of diverse customers.  We believe that our direct sales personnel combined with our distributors provide an effective means of reaching this broad and diverse customer base.  Our direct sales force focuses primarily on major strategic accounts in three geographical markets: the Americas, Europe and Asia.  We currently maintain sales and support centers in major metropolitan areas in North America, Europe and Asia.  We believe that a strong technical service presence is essential to the continued development of the embedded control market.  Many of our client engagement managers (CEMs), embedded system engineers (ESEs), and sales management personnel have technical degrees and have been previously employed in an engineering environment.  We believe that the technical knowledge of our sales force is a key competitive advantage in the sale of our products.  The primary mission of our ESE team is to provide technical assistance to strategic accounts and to conduct periodic training sessions for CEMs and distributor sales teams.  ESEs also frequently conduct technical seminars for our customers in major cities around the world, and work closely with our distributors to provide technical assistance and end-user support.

See "Our operating results are impacted by both seasonality and the wide fluctuation of supply and demand in the semiconductor industry," on page 49 for discussion of the impact of seasonality on our business.
 
Acquisition of Atmel

On April 4, 2016, we completed our acquisition of Atmel. Under the terms of the merger agreement executed on January 19, 2016, Atmel stockholders received $8.15 per share consisting of $7.00 per share in cash and $1.15 per share in shares of Microchip common stock. We financed the purchase price of our Atmel acquisition using approximately $2.04 billion of cash held by certain of our foreign subsidiaries, approximately $0.94 billion from additional borrowings under our existing line of credit agreement and approximately $487.7 million by issuing an aggregate of 10.1 million shares of our common stock. The acquisition price represents a total equity value of approximately $3.47 billion, and a total enterprise value of approximately $3.43 billion, after excluding Atmel's cash and investments net of debt of approximately $39.3 million. Atmel is a worldwide leader in the design and manufacture of microcontrollers, capacitive touch solutions, advanced logic, mixed-signal, nonvolatile memory and RF components. Atmel is headquartered in San Jose, California and has offices, manufacturing and research facilities in North America, Europe and Asia.



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Critical Accounting Policies and Estimates
 
General
 
Our discussion and analysis of our financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S.  We review the accounting policies we use in reporting our financial results on a regular basis.  The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent liabilities.  On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, business combinations, share-based compensation, inventories, income taxes, senior and junior subordinated convertible 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 original equipment manufacturers (OEMs); however, we do not believe these policies require us to make estimates or judgments that are as difficult or subjective as our policies described below.

Revenue Recognition - Distributors
 
Our distributors worldwide generally have broad price protection and product return rights, 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-user, 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.

As a result of our acquisitions of Atmel and Micrel, we acquired certain distributor relationships where revenue is recognized upon shipment to the distributors. With respect to the distributor relationships acquired in the Micrel acquisition, in the December 2015 quarter, we changed substantially all of these distributor contracts to be consistent with those of our other distributors which resulted in the deferral of revenue recognition under such contracts until the distributor sells the product to their customers. With respect to the distributor relationships acquired in the Atmel acquisition, we currently expect to change substantially all of these distributor contracts to be consistent with those of our other distributors during the quarter ending December 31, 2016 which will result in the deferral of revenue recognition at that time under such contracts until the distributor sells the product to their customers.
 
Deferred income on shipments to distributors effectively represents the gross margin on the sale to the distributor; however, the amount of gross margin that we recognize in future periods could be less than the deferred margin as a result of credits granted to distributors on specifically identified products and customers to allow the distributors to earn a competitive gross margin on the sale of our products to their end customers and price protection concessions related to market pricing conditions.

We sell the majority of the items in our product catalog to our distributors worldwide at a uniform list price.  However, distributors resell our products to end customers at a very broad range of individually negotiated price points.  The majority of our distributors' resales require a reduction from the original list price paid.  Often, under these circumstances, we remit back to the distributor a portion of their original purchase price after the resale transaction is completed in the form of a credit against the distributor's 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 distributors in the future.  The wide range and variability of negotiated price concessions granted to distributors does not allow us to accurately estimate the portion of the balance in the deferred income on shipments to distributors account that will be credited back to the distributors.  Therefore, we do not reduce deferred income on shipments to

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distributors or accounts receivable by anticipated future concessions; rather, price concessions are typically recorded against deferred income on shipments to distributors and accounts receivable when incurred, which is generally at the time the distributor sells the product.  At June 30, 2016, we had approximately $338.0 million of deferred revenue and $124.8 million in deferred cost of sales recognized as $213.2 million of deferred income on shipments to distributors.  At March 31, 2016, we had approximately $267.2 million of deferred revenue and $83.8 million in deferred cost of sales recognized as $183.4 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 $138.7 million at June 30, 2016 and $102.9 million at March 31, 2016.  On sales to distributors, our payment terms generally require the distributor to settle amounts owed to us for an amount in excess of their ultimate cost.  The sales price to our distributors may be higher than the amount that the distributors will ultimately owe us because distributors often negotiate price reductions after purchasing products from us and such reductions are often significant.  It is our practice to apply these negotiated price discounts to future purchases, requiring the distributor to settle receivable balances, on a current basis, generally within 30 days, for amounts originally invoiced.  This practice has an adverse impact on the working capital of our distributors.  As such, we have entered into agreements with certain distributors whereby we advance cash to the distributors to reduce the 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 operations.  We process discounts taken by distributors against our deferred income on shipments to distributors' balance and true-up the advanced amounts generally after the end of each completed fiscal quarter.  The terms of these advances are set forth in binding legal agreements and are unsecured, bear no interest on unsettled balances and are due upon demand.  The agreements governing these advances can be canceled by us at any time.
 
We reduce product pricing through price protection based on market conditions, competitive considerations and other factors.  Price protection is granted to distributors on the inventory they have on hand at the date the price protection is offered.  When we reduce the price of our products, it allows the distributor to claim a credit against its outstanding accounts receivable balances based on the new price of the inventory it has on hand as of the date of the price reduction.  There is no immediate revenue impact from the price protection, as it is reflected as a reduction of the deferred income on shipments to distributors' balance.
 
Products returned by distributors and subsequently scrapped have historically been immaterial to our consolidated results of operations.  We routinely evaluate the risk of impairment of the deferred cost of sales component of the deferred income on shipments to distributors account.  Because of the historically immaterial amounts of inventory that have been scrapped, and historically rare instances where discounts given to a distributor result in a price less than our cost, we believe the deferred costs are recorded at their approximate carrying value.

Business Combinations

All of our business combinations are accounted for at fair value under the acquisition method of accounting.  Under the acquisition method of accounting, (i) acquisition-related costs, except for those costs incurred to issue debt or equity securities, will be expensed in the period incurred; (ii) non-controlling interests will be valued at fair value at the acquisition date; (iii) in-process research and development will be recorded at fair value as an intangible asset at the acquisition date and amortized once the technology reaches technological feasibility; (iv) restructuring costs associated with a business combination will be expensed subsequent to the acquisition date; and (v) changes in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date will be recognized through income tax expense or directly in contributed capital.  The measurement of the fair value of assets acquired and liabilities assumed requires significant judgment.  The valuation of intangible assets and acquired investments, 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

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investees' capital structure and the terms of the investees' issued interests. Under the acquisition method of accounting, the aggregate amount of consideration we pay for a company is allocated to net tangible assets and intangible assets based on their estimated fair values as of the acquisition date.  The excess of the purchase price over the value of the net tangible assets and intangible assets is recorded to goodwill. On an annual basis, we test goodwill for impairment and, through June 30, 2016, we have never recorded an impairment charge against our goodwill balance.
 
Share-based Compensation
 
We measure at fair value and recognize compensation expense for all share-based payment awards, including grants of employee stock options, restricted stock units (RSUs) and employee stock purchase rights, to be recognized in our financial statements based on their respective grant date fair values.  Total share-based compensation during the three months ended June 30, 2016 was $59.6 million, of which $51.7 million was reflected in operating expenses.  Total share-based compensation included in cost of sales during the three months ended June 30, 2016 was $7.9 million.  Total share-based compensation included in our inventory balance was $7.4 million at June 30, 2016.
 
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, 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 most 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.  During the three months ended June 30, 2016, we elected to early adopt ASU 2016-09, Compensation - Stock Compensation, Improvements to Employee Share-Based Payment Accounting (Topic 718). Under this standard, entities are permitted to make an accounting policy election to either estimate forfeitures on share-based payment awards, as previously required, or to recognize forfeitures as they occur. We have elected to recognize forfeitures as they occur.
 
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 or we assume unvested equity awards in connection with acquisitions.
 
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 upon assumptions about future demand and market conditions.  If actual market conditions are less favorable than those we projected, additional inventory write-downs may be required.  Inventory impairment charges establish a new cost basis for inventory and charges are not subsequently reversed to income even if circumstances later suggest that increased carrying amounts are recoverable.  In estimating our inventory obsolescence, we primarily evaluate estimates of demand over a 12-month period and record impairment charges for inventory on hand in excess of the estimated 12-month demand. Estimates for projected 12-month demand are generally based on the average shipments of the prior three-month period, which are then annualized to adjust for any potential seasonality in our business. The estimated 12-month demand is compared to our most recently developed sales forecast to further reconcile the 12-month demand estimate. Management reviews and adjusts the estimates as appropriate based on specific situations. For example, demand can be adjusted up for new products for which historic sales are not representative of future demand. Alternatively, demand can be adjusted down to the extent any existing products are being replaced or discontinued.

In periods where our production levels are substantially below our normal operating capacity, the reduced production levels of our manufacturing facilities are charged directly to cost of sales.  There was no charge to cost of sales for reduced production levels in the three-month periods ended June 30, 2016 and 2015.




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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 June 30, 2016, the valuation allowances totaled $199.9 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 June 30, 2016, our deferred tax asset, net of valuation allowances, was $68.7 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 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. 

Senior and Junior Subordinated Convertible Debentures

We separately account for the liability and equity components of our senior and 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 operations.  Lastly, we include the dilutive effect of the shares of our common stock issuable upon conversion of the outstanding senior and junior subordinated convertible debentures in our diluted income per share calculation regardless of whether the market price triggers or other contingent conversion features have been met.  We apply the treasury stock method as we have the intent and have adopted an accounting policy to settle the principal amount of the senior and junior subordinated convertible debentures in cash.  This method results in incremental dilutive shares when the average fair value of our common stock for a reporting period exceeds the conversion prices per share which were $65.56 and $24.13 for our senior and junior subordinated convertible debentures, respectively, at June 30, 2016 and adjusts as dividends are recorded in the future.
 
Contingencies
 
In the ordinary course of our business, we are exposed to various liabilities as a result of contracts, product liability, customer claims and other matters.  Additionally, we are involved in a limited number of legal actions, both as plaintiff and defendant.  Consequently, we could incur uninsured liability in any of those actions.  We also periodically receive notifications from various third parties alleging infringement of patents or other intellectual property rights, or from customers requesting reimbursement for various costs.  With respect to pending legal actions to which we are a party and other claims, although the outcomes are generally not determinable, we believe that the ultimate resolution of these matters will not have a material adverse effect on our financial position, cash flows or results of operations.  Litigation and disputes relating to the semiconductor industry are not uncommon, and we are, from time to time, subject to such litigation and disputes.  As a result, no assurances can be given with respect to the extent or outcome of any such litigation or disputes in the future.

We accrue for claims and contingencies when losses become probable and reasonably estimable. As of the end of each applicable reporting period, we review each of our matters and, where it is probable that a liability has been or will be incurred, we accrue for all probable and reasonably estimable losses. Where we can reasonably estimate a range of losses we may incur regarding such a matter, we record an accrual for the amount within the range that constitutes our best estimate. If we can reasonably estimate a range but no amount within the range appears to be a better estimate than any other, we use the amount that is the low end of such range.



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Results of Continuing Operations
 
The following table sets forth certain operational data as a percentage of net sales for the periods indicated:
 
Three Months Ended
 
June 30,
 
2016
 
2015
Net sales
100.0
 %
 
100.0
%
Cost of sales
56.4

 
42.1

Gross profit
43.6

 
57.9

Research and development
18.5

 
15.9

Selling, general and administrative
19.7

 
12.5

Amortization of acquired intangible assets
10.0

 
6.5

Special charges, net
2.8

 
0.3

Operating (loss) income
(7.4
)%
 
22.7
%

Net Sales
 
We operate in two industry segments and engage primarily in the design, development, manufacture and sale of semiconductor products as well as the licensing of our SuperFlash and other technologies.  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 typically provided by letters of credit.
 
Our net sales for the three months ended June 30, 2016 were $799.4 million, an increase of 43.4% from the previous quarter's net sales of $557.6 million, and an increase of 49.7% from net sales of $534.0 million in the three months ended June 30, 2015. The increase in net sales in the quarter ended June 30, 2016 over the previous quarter was due primarily to our acquisition of Atmel and also by growth in our historical business driven by general economic and semiconductor industry conditions. The increase in net sales in the three months ended June 30, 2016 compared to the three months ended June 30, 2015 was due primarily to our acquisitions of Atmel and Micrel, and also by growth in our historical business driven by general economic and semiconductor industry conditions. Average selling prices for our semiconductor products were down approximately 1% for the three-month period ended June 30, 2016 over the corresponding period of the previous fiscal year. The average selling price per unit was primarily impacted by the mix of our products sold and overall semiconductor market conditions.  The number of units of our semiconductor products sold was up approximately 53% for the three-month period ended June 30, 2016 over the corresponding period of the previous fiscal year. The unit volumes were primarily impacted by our acquisitions of Atmel and Micrel and overall semiconductor market conditions.  Key factors related to the amount of net sales during the three-month period ended June 30, 2016 compared to the three-month period ended June 30, 2015 include:

our acquisition of Atmel which closed on April 4, 2016;
our acquisition of Micrel which closed on August 3, 2015;
global economic conditions in the markets we serve;
semiconductor industry conditions;
our new product offerings that have increased our served available market;
customers' increasing needs for the flexibility offered by our programmable solutions;
inventory holding patterns of our customers;
increasing semiconductor content in our customers' products; and
continued market share gains in the segments of the markets we address.


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Net sales by product line for the three months ended June 30, 2016 and 2015 were as follows (dollars in thousands):
 
Three Months Ended
 
June 30,
 
(unaudited)
 
2016
 
%
 
2015
 
%
Microcontrollers
$
498,310

 
62.3

 
$
348,170

 
65.2

Analog, interface, mixed signal and timing products
212,335

 
26.6

 
127,055

 
23.8

Memory products
45,914

 
5.7

 
31,773

 
5.9

Technology licensing
20,588

 
2.6

 
23,263

 
4.4

Multi-market and other
22,264

 
2.8

 
3,691

 
0.7

Total sales
$
799,411

 
100.0
%
 
$
533,952

 
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 62.3% of our net sales for the three-month period ended June 30, 2016 compared to approximately 65.2% of our net sales for the three-month period ended June 30, 2015.

Net sales of our microcontroller products increased approximately 43.1% in the three-month period ended June 30, 2016 compared to the three-month period ended June 30, 2015. This sales increase was driven primarily by our acquisition of Atmel, market-share gains and general economic and semiconductor industry conditions in the end markets 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, Mixed Signal and Timing Products
 
Sales of our analog, interface, mixed signal and timing products accounted for approximately 26.6% of our net sales for the three-month period ended June 30, 2016 compared to approximately 23.8% of our net sales for the three-month period ended June 30, 2015.
 
Net sales of our analog, interface, mixed signal and timing products increased approximately 67.1% in the three-month period ended June 30, 2016 compared to the three-month period ended June 30, 2015. This sales increase was driven primarily by our acquisitions of Micrel and Atmel and market share gains achieved within the analog, interface, mixed signal and timing market.
 
Analog, interface, mixed signal and timing products can be proprietary or non-proprietary in nature.  Currently, we consider a majority of our analog, interface, mixed signal and timing products 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, mixed signal and timing 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, mixed signal and timing products as 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, mixed signal and timing products will increase over time.
 

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Memory Products
 
Sales of our memory products accounted for approximately 5.7% of our net sales for the three-month period ended June 30, 2016 compared to approximately 5.9% of our net sales for the three-month period ended June 30, 2015.

Net sales of our memory products increased approximately 44.5% in the three-month period ended June 30, 2016 compared to the three-month period ended June 30, 2015. The increase in net sales of our memory products over these periods was driven primarily by our acquisition of Atmel.
 
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 licenses for the use of our SuperFlash and other technologies and fees for engineering services.  Technology licensing accounted for approximately 2.6% of our net sales for the three-month period ended June 30, 2016 compared to approximately 4.4% of our net sales for the three-month period ended June 30, 2015.

Net sales related to our technology licensing decreased approximately 11.5% in the three-month period ended June 30, 2016 compared to the three-month period ended June 30, 2015. Revenue from technology licensing can fluctuate over time based on the production activities of our licensees as well as general economic and semiconductor industry conditions.

Multi-Market and Other

Our Multi-Market and Other (MMO) product line consists of manufacturing services (wafer foundry and assembly and test subcontracting), legacy application specific IC's (ASIC's), complex programmable logic devices (CPLD's), and aerospace products. Revenue from this product line accounted for approximately 2.8% of our net sales for the three-month period ended June 30, 2016 compared to approximately 0.7% of our net sales for the three-month period ended June 30, 2015. The increase in net sales in our MMO product line over these periods was primarily driven by our acquisition of Atmel.
 
Distribution
 
Distributors accounted for approximately 56.0% of our net sales in the three-month period ended June 30, 2016 and approximately 52.2% of our net sales in the three-month period ended June 30, 2015. 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.

At June 30, 2016, our distributors maintained 32 days of inventory of our products which was flat compared to the days of inventory at our distributors at March 31, 2016.  Over the past five 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 the vast majority of our distributors.
 

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Sales by Geography
 
Sales by geography for the three months ended June 30, 2016 and 2015 were as follows (dollars in thousands):
 
Three Months Ended
 
June 30,
 
(unaudited)
 
2016
 
%
 
2015
 
%
Americas
$
142,675

 
17.9

 
$
104,544

 
19.6

Europe
182,465

 
22.8

 
114,678

 
21.5

Asia
474,271

 
59.3

 
314,730

 
58.9

Total sales
$
799,411

 
100.0
%
 
$
533,952

 
100.0
%

Americas sales include sales to customers in the U.S., Canada, Central America and South America. Sales to foreign customers accounted for approximately 85% of our total net sales in the three-month period ended June 30, 2016 compared to 84% in the three month period ended June 30, 2015. Substantially all of our foreign sales are U.S. dollar denominated.  Sales to customers in Asia have generally increased over time due to many of our customers transitioning their manufacturing operations to Asia and growth in demand from the emerging Asian market.  Our sales force in the Americas and Europe supports a significant portion of the design activity for products which are ultimately shipped to Asia.
 
Gross Profit
 
Our gross profit was $348.5 million in the three-month period ended June 30, 2016 and $309.0 million in the three-month period ended June 30, 2015. Gross profit as a percentage of sales was 43.6% in the three-month period ended June 30, 2016 and 57.9% in the three-month period ended June 30, 2015.

The most significant factors affecting our gross profit percentage in the periods covered by this Form 10-Q were:
 
charges of approximately $91.5 million in the three-month period ended June 30, 2016 related to the recognition of acquired inventory at fair value as a result of our acquisitions which increased the value of our acquired inventory and subsequently increased our cost of sales and reduced our gross margins when the related revenue was recognized;
for each of the three-month periods ended June 30, 2016 and June 30, 2015, inventory write-downs being higher than the gross margin impact of sales of inventory that was previously written down; and
fluctuations in the product mix of microcontrollers, analog, interface, mixed signal and timing products, memory products and technology licensing.

Other factors that impacted our gross profit percentage in the periods covered by this Form 10-Q include:

continual cost reductions in wafer fabrication and assembly and test manufacturing, such as new manufacturing technologies and more efficient manufacturing techniques; and
lower depreciation as a percentage of cost of sales. 

We adjust our wafer fabrication and assembly and test capacity utilization as required to respond to actual and anticipated business and industry-related conditions. When production levels are below normal capacity, we charge cost of sales for the unabsorbed capacity. During each of the three-month periods ended June 30, 2016 and 2015, our wafer fabrication facilities and assembly and test facilities operated at normal capacity levels, which we measure as a percentage of the capacity of the installed equipment. We operate an assembly and test facility in Thailand and, as a result of our acquisition of Atmel, we acquired a test facility in Calamba, Philippines.


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The process technologies utilized in our wafer fabrication facilities impact our gross margins.  Our wafer fabrication facility located in Tempe, Arizona (Fab 2) currently utilizes various manufacturing process technologies, but predominantly utilizes our 0.5 micron to 1.0 micron processes.  Our wafer fabrication facility located in Gresham, Oregon (Fab 4) predominantly utilizes our 0.22 micron to 0.5 micron processes.  We continue to transition products to more advanced process technologies to reduce future manufacturing costs.  Substantially all of our production in Fab 2 and Fab 4 has been on 8-inch wafers during the periods covered by this report. We consider normal capacity at Fab 2 and Fab 4 to be 90% to 95%. As a result of our acquisition of Atmel, we acquired a 6-inch wafer fabrication facility in Colorado Springs, Colorado (Fab 5) that currently utilizes processes between 0.25 micron and 1.0 micron. We consider normal capacity at Fab 5 to be 70% to 75%.
 
Our overall inventory levels were $518.4 million at June 30, 2016, compared to $306.8 million at March 31, 2016.  We maintained 105 days of inventory on our balance sheet at June 30, 2016 compared to 110 days of inventory at March 31, 2016.  The primary reason for the increase in our inventory levels at June 30, 2016 compared to March 31, 2016 is an additional $209.7 million of inventory from our acquisition of Atmel, including approximately $80.9 million of remaining acquired inventory fair value mark-up. We expect our days of inventory levels in the September 2016 quarter to be flat to down 4 days from the June 2016 levels, excluding the impact from the sell through of acquired inventory fair value mark-up. We believe our existing level of inventory will allow us to maintain competitive lead times and provide strong delivery performance to our customers.
 
We anticipate that our gross margins will fluctuate over time, driven primarily by capacity utilization levels, the overall product mix of microcontroller, analog, interface, mixed signal and timing products, memory products and technology licensing revenue and the percentage of net sales of each of these products in a particular quarter, as well as manufacturing yields, fixed cost absorption, and competitive and economic conditions in the markets we serve.

During the three months ended June 30, 2016, approximately 43% of our assembly requirements were performed in our Thailand facilities compared to approximately 56% during the three months ended June 30, 2015.  The percentage of our assembly work that is performed internally fluctuates over time based on supply and demand conditions in the semiconductor industry, our internal capacity capabilities and our acquisition activities.  Third-party contractors located primarily in Asia perform the balance of our assembly operations.  During the three months ended June 30, 2016, approximately 63% of our test requirements were performed in our Thailand and Philippines facilities compared to approximately 89% during the three months ended June 30, 2015. The primary reasons for the percentage reduction in the assembly and test operations performed internally in the three months ended June 30, 2016 compared to the same period last year are our acquisitions of Atmel and Micrel, which companies outsourced most of these activities. Over time, we intend to migrate a portion of the outsourced assembly and test activities from our Atmel and Micrel acquisitions to our Thailand and Philippines facilities. We believe that the assembly and test operations performed at our internal facilities provide us with significant cost savings compared to contractor assembly and test costs, as well as increased control over these portions of the manufacturing process.
 
We rely on outside wafer foundries for a significant portion of our wafer fabrication requirements. Approximately 40% of our net sales came from products that were produced at outside wafer foundries in each of the three months ended June 30, 2016 and 2015.
 
Our use of third parties involves some reduction in our level of control over the portions of our business that we subcontract.  While we review the quality, delivery and cost performance of our third-party contractors, our future operating results could suffer if any third-party contractor is unable to maintain manufacturing yields, assembly and test yields and costs at approximately their current levels.
 
Research and Development (R&D)
 
R&D expenses for the three months ended June 30, 2016 were $147.9 million, or 18.5% of net sales, compared to $84.7 million, or 15.9% of net sales, for the three months ended June 30, 2015.  We are committed to investing in new and enhanced products, including development systems software, and in our design and manufacturing process technologies.  We believe these investments are significant factors in maintaining our competitive position.  R&D costs are expensed as incurred.  Assets purchased to support our ongoing research and development activities are capitalized when related to products which have achieved technological feasibility or that have alternative future uses and are amortized over their expected useful lives.  R&D expenses include labor, depreciation, masks, prototype wafers, and expenses for the development of process technologies, new packages, and software to support new products and design environments.


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R&D expenses increased $63.2 million, or 74.6%, for the three months ended June 30, 2016 over the same period last year.  The primary reasons for the increase in R&D costs were additional costs from our acquisitions of Atmel and Micrel.

R&D expenses fluctuate over time, primarily due to revenue and operating expense investment levels.

Selling, General and Administrative
 
Selling, general and administrative expenses for the three months ended June 30, 2016 were $157.5 million, or 19.7% of net sales, compared to $66.8 million, or 12.5% of net sales, for the three months ended June 30, 2015.  Selling, general and ad