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EX-32 - EXHIBIT 32 - MICROCHIP TECHNOLOGY INCex325152018.htm
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EX-23.1 - EXHIBIT 23.1 - MICROCHIP TECHNOLOGY INCex2315152018.htm
EX-21.1 - EXHIBIT 21.1 - MICROCHIP TECHNOLOGY INCex2115182018.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-K
(Mark One)
x
Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended March 31, 2018
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
 mchplogohorizontal4ca11.jpg
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
(Address of Principal Executive Offices, Including Zip Code)

(480) 792-7200
(Registrant's Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
 
Name of Each Exchange on Which Registered
Common Stock, $0.001 Par Value Per Share
 
NASDAQ® Global Market

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.     x    Yes    ¨    No

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    o    Yes    x    No

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 such filing requirements for the past 90 days.    x    Yes    o    No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     x    Yes    o    No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§232.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of Form 10-K or any amendment to this Form 10-K.    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 definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act:
Large accelerated filer
x
Accelerated filer
o
Non-accelerated filer
o
(Do not check if a smaller reporting company)
 
 
 
 
 
 
Smaller reporting company
o
 
 
 
 
 
 
Emerging growth company
o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.            o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     o    Yes    x    No

Aggregate market value of the voting and non-voting common equity held by non-affiliates as of September 30, 2017 based upon the closing price of the common stock as reported by the NASDAQ Global Market on such date was approximately $20,543,563,116.

Number of shares of Common Stock, $0.001 par value, outstanding as of May 9, 2018: 235,036,703 shares
 
Documents Incorporated by Reference
Document
 
Part of Form 10-K
Proxy Statement for the 2018 Annual Meeting of Stockholders
 
III




MICROCHIP TECHNOLOGY INCORPORATED AND SUBSIDIARIES

FORM 10-K

TABLE OF CONTENTS

 
 
Page
 
 
 
PART I
 
 
 
 
 
 
PART II
 
 
 
PART III
 
 
 
 
 
 
PART IV
 
 
 
 
 
 
 
 



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PART I

This Form 10-K contains certain forward-looking statements that involve risks and uncertainties, including statements regarding our strategy and future financial performance and those statements identified under "Item 7 – Management's Discussion and Analysis of Financial Condition and Results of Operations – Note Regarding Forward-looking Statements."  Our actual results could differ materially from the results described in these forward-looking statements as a result of certain factors including those set forth under "Item 1A – Risk Factors," beginning below at page 13, and elsewhere in this Form 10-K.  Although we believe that the matters 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. In this Form 10-K, "we," "us," "our," and "Microchip" each refers to Microchip Technology Incorporated and its subsidiaries.  

Item 1.   BUSINESS
 
We develop, manufacture and sell specialized semiconductor products used by our customers for a wide variety of embedded control applications. Our product portfolio comprises general purpose and specialized 8-bit, 16-bit, and 32-bit microcontrollers, 32-bit microprocessors, a broad spectrum of 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 Electrically Erasable Programmable Read Only Memory (EEPROM), Serial Flash memories, Parallel Flash memories and serial Static Random Access Memory (SRAM). We also license Flash-IP solutions that are incorporated in a broad range of products.  Our synergistic product portfolio targets thousands of applications worldwide and a growing demand for high-performance designs in the automotive, communications, computing, consumer and industrial control markets.  Our quality systems are ISO/TS16949 (2009 version) certified.
 
Microchip Technology Incorporated was incorporated in Delaware in 1989.  Our executive offices are located at 2355 West Chandler Boulevard, Chandler, Arizona 85224-6199 and our telephone number is (480) 792-7200.
 
Our Internet address is www.microchip.com.  We post the following filings on our website as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission:
 
our annual report on Form 10-K
our quarterly reports on Form 10-Q
our current reports on Form 8-K
our proxy statement
any amendments to the above-listed reports filed or furnished pursuant to Sections 13(a) or 15(d) of the Securities Exchange Act of 1934

All of our SEC filings on our website are available free of charge.  The information on our website is not incorporated into this Form 10-K.

Recent Developments

On March 1, 2018, we entered into a definitive agreement (the "Merger Agreement") to acquire Microsemi Corporation ("Microsemi") for $68.78 per share in cash. The acquisition price represents a total equity value of approximately $8.35 billion, and a total enterprise value of about $10.15 billion, after accounting for Microsemi’s cash and investments, net of debt, on its balance sheet at December 31, 2017. Microsemi offers a comprehensive portfolio of semiconductor and system solutions for aerospace and defense, communications, data center and industrial markets. Microsemi is headquartered in Aliso Viejo, California, and has approximately 4,800 employees globally. Refer to Note 23 to our consolidated financial statements for additional details.

The Board of Directors of each of Microchip and Microsemi have unanimously approved the Merger and the Merger Agreement. The transaction is subject to customary closing conditions including regulatory approvals and approval by Microsemi stockholders. There is no financing condition to the closing of the Merger. Assuming the timely receipt of the aforementioned regulatory approvals and the satisfaction of the other closing conditions, we anticipate that the merger will be completed in late May/early June 2018.


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We estimate that the total amount of funds necessary to complete the Merger and the other transactions contemplated by the Merger Agreement will be approximately $10.15 billion, which will be funded through a combination of:

the incurrence of loans under a new term loan facility or other debt financing;
revolving loans under Microchip’s amended and restated credit agreement; and
Microchip’s and Microsemi’s cash and cash equivalents on hand at closing.
On March 1, 2018, in connection with our execution of the Merger Agreement, we entered into a Commitment Letter with JPMorgan Chase Bank, N.A. (“JPMorgan”), pursuant to which JPMorgan committed to provide to Microchip, among other things, (1) a senior secured term loan facility in an aggregate principal amount of up to $5.0 billion and (2) a 364-day secured bridge facility in an aggregate principal amount of up to $625.0 million, in each case, subject to the execution of definitive documentation and customary closing conditions. JPMorgan’s commitments in respect of the Term Loan Facility will be reduced in the event Microchip’s raises certain other debt or equity financing.

The Merger Agreement contains customary representations, warranties and covenants of Microchip, Microsemi, and Merger Sub, including among others, (i) covenants by Microsemi concerning the conduct of its business in the ordinary course consistent with past practice during the interim period between the execution of the Merger Agreement and the consummation of the Merger, (ii) a covenant by Microsemi that, subject to certain exceptions, the Board of Directors of Microsemi will recommend to its stockholders adoption of the Merger Agreement, and (iii) a covenant that Microsemi will not solicit, initiate or knowingly encourage, facilitate or induce the making, submission or announcement of an Acquisition Proposal (as defined in the Merger Agreement) or the making of any inquiry, offer or proposal that would reasonably be expected to lead to an Acquisition Proposal. The Merger Agreement contains certain termination rights for both Microchip and Microsemi and further provides that upon termination of the Merger Agreement under specified circumstances (including termination by Microsemi to accept a superior proposal), Microsemi may be required to pay Microchip a termination fee of $290 million. The Merger Agreement also contains a provision requiring Microsemi to reimburse Microchip for up to $35 million of its expenses incurred in connection with the Merger if the approval of the Merger by the holders of a majority of the outstanding shares of Microsemi Common Stock is not obtained at a meeting called for that purpose.

Industry Background
 
Competitive pressures require manufacturers of a wide variety of products to expand product functionality and provide differentiation while maintaining or reducing cost.  To address these requirements, manufacturers often use integrated circuit-based embedded control systems that enable them to:
 
differentiate their products
replace less efficient electromechanical control devices
reduce the number of components in their system
add product functionality
reduce the system level energy consumption
make systems safer to operate
decrease time to market for their products
significantly reduce product cost

Embedded control systems have been incorporated into thousands of products and subassemblies in a wide variety of applications and markets worldwide, including:
 
automotive comfort, safety, information and entertainment applications
remote control devices
handheld tools
large and small home appliances
portable computers and accessories
robotics
energy monitoring
thermostats
motor controls
security systems
smoke and carbon monoxide detectors
consumer electronics
power supplies

4


applications needing touch buttons, touch screens and graphical user interfaces
medical instruments

Embedded control systems typically incorporate a microcontroller as the principal active, and sometimes sole, component.  A microcontroller is a self-contained computer-on-a-chip consisting of a central processing unit, often with on-board non-volatile program memory for program storage, random access memory for data storage and various analog and digital input/output peripheral capabilities.  In addition to the microcontroller, a complete embedded control system incorporates application-specific software, various analog, mixed-signal, timing and connectivity products and non-volatile memory components such as EEPROMs and Flash memory.
 
The increasing demand for embedded control has made the market for microcontrollers a significant segment of the semiconductor market at $18.0 billion in calendar year 2017.  Microcontrollers are primarily available in 8-bit through 32-bit architectures.  8-bit microcontrollers remain very cost-effective for a wide range of high-volume embedded control applications and, as a result, continue to represent a significant portion of the overall microcontroller market.  16-bit and 32-bit microcontrollers provide higher performance and functionality, and are generally found in more complex embedded control applications. The analog and mixed-signal segment of the semiconductor market is very large at over $50 billion in calendar year 2017, and this market is fragmented into a large number of sub segments.
 
Our Products
 
Our strategic focus is on embedded control solutions, including:
 
general purpose and specialized microcontrollers and 32-bit microprocessors
development tools and related software
analog, interface, mixed signal, timing and security products
wired and wireless connectivity products
memory products
technology licensing

We provide highly cost-effective embedded control solutions that also offer the advantages of small size, high performance, extreme low power usage, wide voltage range operation, mixed signal integration, and ease of development, thus enabling timely and cost-effective integration of our solutions by our customers in their end products.

Microcontrollers

We offer a broad family of proprietary general purpose microcontroller products marketed under multiple brand names.  We believe that our microcontroller product families provide leading function and performance characteristics in the worldwide microcontroller market.  We have shipped over 22 billion microcontrollers to customers worldwide since 1990.  We also offer specialized microcontrollers for automotive networking, computing, lighting, power supplies, motor control, human machine interface, security, wired connectivity and wireless connectivity. With almost 3,000 microcontrollers in our product portfolio, we target the 8-bit, 16-bit, and 32-bit microcontroller and 32-bit embedded microprocessor markets.
 
We have used our manufacturing experience and design and process technology to bring additional enhancements and manufacturing efficiencies to the development and production of our microcontroller products.  Our extensive experience base has enabled us to develop microcontrollers with rich analog and digital peripherals, that have a small footprint, extreme low power consumption and are re-programmable, enabling us to be a leader in microcontroller product offerings.
 
Development Tools
 
We offer a comprehensive set of low-cost and easy-to-learn application development tools.  These tools enable system designers to quickly and easily program our microcontroller products for specific applications and, we believe, they are an important factor for facilitating design wins.
 
Our family of development tools for our microcontroller products range from entry-level systems, which include an assembler and programmer or in-circuit debugging hardware, to fully configured systems that provide in-circuit emulation capability.  We also offer a complete suite of compilers, software code configurators and simulators. Customers moving from entry-level designs to those requiring real-time emulation are able to preserve their investment in learning and tools as they migrate to future microcontroller devices in our portfolio.

5


Many independent companies also develop and market application development tools that support our microcontroller product architectures.  Currently, there are more than 250 third-party tool suppliers worldwide whose products support our microcontroller architectures.
 
We believe that familiarity with and adoption of development tools from Microchip as well as third-party development tool partners by an increasing number of product designers will be an important factor in the future selection of our embedded control products.  These development tools allow design engineers to develop thousands of application-specific products from our standard microcontrollers.  To date, we have shipped approximately 2.4 million development tools.
 
Analog, Interface, Mixed Signal and Timing Products
 
Our analog, interface, mixed signal and timing products consist of several families with over 3,800 power management, linear, mixed-signal, high voltage, thermal management, radio frequency (RF), drivers, safety, security, timing, USB, ethernet, wireless and other interface products.  
 
We market and sell our analog, interface, mixed signal and timing products into our microcontroller customer base, to customers who use microcontrollers from other suppliers and to customers who use other products that may not fit our traditional microcontroller and memory products customer base.  

Memory Products

Our memory products consist of EEPROMs, Serial Flash memories, Parallel Flash memories, Serial SRAM memories and EERAM.  Serial EEPROMs, Serial Flash memories, Serial SRAMs and EERAM have a very low I/O pin requirement, permitting production of very small footprint devices.  We sell our memory products primarily into the embedded control market, complementing our microcontroller offerings.
 
Technology Licensing
 
Our technology licensing business includes license fees and royalties associated with technology licenses for the use of our SuperFlash® embedded flash and Smartbits® one time programmable NVM technologies. We also generate fees for engineering services related to these technologies.  We license our NVM technologies to foundries, integrated device manufacturers and design partners throughout the world for use in the manufacture of their advanced microcontroller products, gate array, RF and analog products that require embedded non-volatile memory.

Multi-Market and Other

Our multi-market and other business offers manufacturing services (wafer foundry and assembly and test subcontracting), legacy application specific integrated circuits, complex programmable logic devices, and products for aerospace applications.

Manufacturing
 
Our manufacturing operations include wafer fabrication, wafer probe, 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 techniques (statistical process control, designed experiments and wafer level monitoring), 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 assembly and testing profit margin. We do outsource a significant portion of our manufacturing requirements to third parties and the amount of our outsourced manufacturing has increased in recent years due to our acquisitions of companies that outsource all or substantial portions of their manufacturing.


6


Our manufacturing facilities are located in:
 
Tempe, Arizona (Fab 2)
Gresham, Oregon (Fab 4)
Colorado Springs, Colorado (Fab 5)
Chandler, Arizona (wafer probe)
Bangkok, Thailand (wafer probe, assembly and test)
Calamba, Philippines (wafer probe and test)

Wafer Fabrication
 
Fab 2 currently produces 8-inch wafers and supports various manufacturing process technologies, but predominantly utilizes our 0.5 microns to 1.0 microns processes.  During fiscal 2018, we increased Fab 2's capacity to support more advanced technologies by making process improvements, upgrading existing equipment, and adding equipment.
 
Fab 4 currently produces 8-inch wafers using predominantly 0.13 microns to 0.5 microns manufacturing processes.  During fiscal 2018, we increased Fab 4's capacity to support more advanced technologies by making process improvements, upgrading existing equipment, and adding equipment. A significant amount of additional clean room capacity in Fab 4 can be brought on line in the future to support incremental wafer fabrication capacity needs. 

Fab 5 is a 6-inch wafer fabrication facility that currently utilizes processes from 0.25 microns to 1.0 microns. During fiscal 2018, we made use of the existing capacity of Fab 5 to significantly increase wafer starts to support demand.

We believe the combined capacity of Fab 2, Fab 4, and Fab 5 will provide sufficient capacity to allow us to respond to increases in future demand over the next several years with modest incremental capital expenditures.

We continue to transition products to more advanced process technologies to reduce future manufacturing costs.  We believe that our ability to successfully transition to more advanced process technologies is important for us to remain competitive.
 
We augment our internal manufacturing capabilities by outsourcing a portion of our wafer production requirements to third-party wafer foundries.  As a result of our acquisitions in recent years, we have become more reliant on outside wafer foundries for our wafer fabrication requirements.  In fiscal 2018, approximately 42% of our sales came from products that were produced at outside wafer foundries.

Wafer Probe, Assembly and Test
 
We perform wafer probe, product assembly and testing at our facilities located near Bangkok, Thailand, and we perform wafer probe and testing at our facility in Calamba, Philippines.  We also perform a limited amount of wafer probe and testing at our Chandler, Arizona facility and our Colorado Springs, Colorado facility. During fiscal 2018, we increased our Thailand and Philippines facilities' capacity to support more technologies by making process improvements, upgrading existing equipment, and adding equipment. During fiscal 2018, approximately 42% of our assembly requirements were being performed in our Thailand facilities and approximately 64% of our test requirements were performed in our Thailand and Philippines facilities.  We use third-party assembly and test contractors in several Asian countries for the balance of our assembly and test requirements. Over time, we intend to migrate a portion of the outsourced assembly and test activities to our Thailand and Philippines facilities.
 
General Matters Impacting Our Manufacturing Operations
 
Due to the high fixed costs inherent in semiconductor manufacturing, consistently high manufacturing yields have significant positive effects on our gross profit and overall operating results.  Our continuous focus on manufacturing productivity has allowed us to maintain excellent manufacturing yields at our facilities.  Our manufacturing yields are primarily driven by a comprehensive implementation of statistical process control, extensive employee training and effective use of our manufacturing facilities and equipment.  Maintenance of manufacturing productivity and yields are important factors in the achievement of our operating results.  The manufacture of integrated circuits, particularly non-volatile, erasable complementary metal-oxide semiconductor (CMOS) memory and logic devices, such as those that we produce, are complex processes.  These processes are sensitive to a wide variety of factors, including the level of contaminants in the manufacturing environment, impurities in the materials used and the performance of our manufacturing personnel and equipment.  As is typical in the

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semiconductor industry, we have from time to time experienced lower than anticipated manufacturing yields.  Our operating results will suffer if we are unable to maintain yields at or above approximately the current levels.

Historically, we have relied on our ability to respond quickly to customer orders as part of our competitive strategy, resulting in customers placing orders with relatively short delivery schedules.  In order to respond to such requirements, we have historically maintained a significant work-in-process and finished goods inventory.
 
The following table summarizes our long-lived assets (consisting of property, plant and equipment) by geography at the end of fiscal 2018, fiscal 2017 and fiscal 2016 (in millions).
 
March 31,
 
2018
 
2017
 
2016
United States
$
393.3

 
$
388.5

 
$
373.9

Thailand
215.5

 
178.0

 
182.8

Various other countries
159.1

 
116.8

 
52.7

Total long-lived assets
$
767.9

 
$
683.3

 
$
609.4


We have many suppliers of raw materials and subcontractors which provide our various materials and service needs. We generally seek to have multiple sources of supply for our raw materials and services, but, in some cases, we may rely on a single or limited number of suppliers. In such event, we have plans to reduce the exposure that would result from a disruption in supply.

Research and Development (R&D)
 
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 R&D activities focus on the development of general purpose and specialized microcontrollers, 32-bit microprocessors, wired and wireless connectivity products, analog, interface, mixed signal, timing and security products, human machine interface, security, Serial EEPROM memory, NOR FLASH memory, Embedded FLASH technologies, development systems, software and application-specific software libraries.  We are also developing design, assembly, test and process technologies to enable new products and innovative features as well as to achieve further cost reductions and performance improvements in existing products.
 
In fiscal 2018, our R&D expenses were $529.3 million, compared to $545.3 million in fiscal 2017 and $372.6 million in fiscal 2016.  R&D expenses included share-based compensation expense of $42.5 million in fiscal 2018, $46.8 million in fiscal 2017 and $32.0 million in fiscal 2016.

Sales and Distribution
 
General
 
We market and sell our products worldwide primarily through a network of direct sales personnel and distributors.
 
Our direct sales force focuses on a wide variety of strategic accounts in three geographical markets: the Americas, Europe and Asia.  We currently maintain sales and technical support centers in major metropolitan areas in all three geographic markets.  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 have technical degrees or backgrounds and have been previously employed in high technology environments.  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 customers and to conduct periodic training sessions for the balance of our sales team.  ESEs also frequently conduct technical seminars and workshops in major cities around the world.
 
Our licensing division has dedicated sales, technology, design, product, test and reliability personnel that support the requirements of our licensees.
 
For information regarding our revenue, results of operations, and total assets for each of our last three fiscal years, refer to our financial statements included in this Form 10-K.


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Distribution
 
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 us for our products and brand name and use distributors as an effective supply channel.
 
In fiscal 2018, we derived 54% of our net sales through distributors and 46% of our net sales from customers serviced directly by us. In fiscal 2017, we derived 55% of our net sales through distributors and 45% of our net sales from customers serviced directly by us. In fiscal 2016, we derived 53% of our net sales through distributors and 47% of our net sales from customers serviced directly by us. No distributor or end customer accounted for more than 10% of our net sales in fiscal 2018, fiscal 2017 or fiscal 2016.
 
We do not have long-term agreements with our distributors and we, or our distributors, may each terminate our relationship with little or no advanced 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.

Sales by Geography
 
Sales by geography for fiscal 2018, fiscal 2017 and fiscal 2016 were as follows (dollars in millions):

 
 
Year Ended March 31,
 
 
2018
 
%
 
2017
 
%
 
2016
 
%
Americas
 
$
717.4

 
18.0
 
$
641.8

 
18.8
 
$
417.6

 
19.2
Europe
 
962.1

 
24.2
 
808.6

 
23.7
 
474.6

 
21.8
Asia
 
2,301.3

 
57.8
 
1,957.4

 
57.5
 
1,281.1

 
59.0
Total Sales
 
$
3,980.8

 
100.0
 
$
3,407.8

 
100.0
 
$
2,173.3

 
100.0

Sales to foreign customers accounted for approximately 85% of our net sales in fiscal 2018 and 84% of net sales in each of fiscal 2017 and 2016.  Our sales to foreign customers have been predominately in Asia and Europe, which we attribute to the manufacturing strength in those areas for automotive, communications, computing, consumer and industrial control products.  Americas' sales include sales to customers in the U.S., Canada, Central America and South America.
 
Sales to customers in China, including Hong Kong, accounted for approximately 30%, 32% and 30% of our net sales in fiscal 2018, 2017 and 2016, respectively.  Sales to customers in Taiwan accounted for approximately 11%, 9% and 12% of our net sales in fiscal 2018, 2017 and 2016, respectively. We did not have sales into any other foreign countries that exceeded 10% of our net sales during fiscal 2018, 2017 or 2016.

Our international sales are substantially all U.S. dollar denominated.  Although foreign sales are subject to certain government export restrictions, we have not experienced any material difficulties to date as a result of export restrictions.
 
The semiconductor industry is characterized by seasonality and wide fluctuations of supply and demand.  Our business tends to generate historically stronger revenues in the first and second quarters and comparatively weaker revenues in the third and fourth quarters of our fiscal year. However, broad fluctuations in our overall business, changes in semiconductor industry and global economic conditions, and our acquisition activity (including our acquisition of Atmel and our pending acquisition of Microsemi) can have a more significant impact on our results than seasonality.
 
Backlog
 
As of April 30, 2018, our backlog was approximately $1,833.9 million, compared to $1,624.1 million as of April 30, 2017.  Our backlog includes all purchase orders scheduled for delivery within the subsequent 12 months.

We primarily produce standard products that can be shipped from inventory within a relatively short time after we receive an order.  Our business and, to a large extent, that of the entire semiconductor industry, is characterized by short-term orders and shipment schedules.  Orders constituting our current backlog are subject to changes in delivery schedules, or to cancellation at the customer's option without significant penalty.  Thus, while backlog is useful for scheduling production, backlog as of any particular date may not be a reliable measure of our sales for any future period.
 

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Competition
 
The semiconductor industry is intensely competitive and has been characterized by price erosion and rapid technological change.  We compete with major domestic and international semiconductor companies, many of which have greater market recognition and greater financial, technical, marketing, distribution and other resources than we have with which to pursue engineering, manufacturing, marketing and distribution of their products.  We also compete with a number of companies that we believe have copied, cloned, pirated or reverse engineered our proprietary product lines in such countries as China and Taiwan.  We are continuing to take actions to vigorously and aggressively defend and protect our intellectual property on a worldwide basis.

We currently compete principally on the basis of the technical innovation and performance of our embedded control products, including the following product characteristics:
 
performance
analog, digital and mixed signal functionality and level of functional integration
memory density
low power consumption
extended voltage ranges
reliability
packaging alternatives
complete development tool line

We believe that other important competitive factors in the embedded control market include:
 
ease of use
functionality of application development systems
dependable delivery, quality and availability
technical and innovative service and support
time to market
price

We believe that we compete favorably with other companies on all of these factors, but we may be unable to compete successfully in the future, which could harm our business.

Patents, Licenses and Trademarks
 
We maintain a portfolio of U.S. and foreign patents, expiring on various dates through 2037.  We also have numerous additional U.S. and foreign patent applications pending.  We do not expect that the expiration of any particular patent will have a material impact on our business.  While our intention is to continue to patent our technology and manufacturing processes, we believe that our continued success depends primarily on the technological skills and innovative capabilities of our personnel and our ability to rapidly commercialize new and enhanced products.  As with any operating company, the scope and strength of our intellectual property assets, including our pending and existing patents, trademarks, copyrights, and other intellectual property rights may be insufficient to provide meaningful protection or commercial advantage.  Moreover, pursuing violations of intellectual property rights on a worldwide basis is a complex challenge involving multinational patent, trademark, copyright and trade secret laws. Further, the laws of particular foreign countries often fail to protect our intellectual property rights to the same extent as the laws of the U.S.
 
We have also entered into certain intellectual property licenses and cross-licenses with other companies and those licenses relate to semiconductor products and manufacturing processes.  As is typical in the semiconductor industry, we and our customers from time to time receive, and may continue to receive, demand letters from third parties asserting infringement of patent and other intellectual property rights.  We diligently investigate all such notices and respond as we believe appropriate.  In most cases we believe that we can obtain necessary licenses on commercially reasonable terms, however, we cannot be certain that this would be the case, or that litigation or damages for any past infringement could be avoided. Litigation, which could result in substantial costs and require significant attention from management, may be necessary to enforce our intellectual property rights, or to defend against claimed infringement of the rights of others.  The failure to obtain necessary licenses, or the necessity of engaging in defensive litigation, could harm our business.
 



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Environmental Regulation
 
We must comply with many different federal, state, local and foreign governmental regulations related to the use, storage, discharge and disposal of certain chemicals and gases used in our manufacturing processes.  Our facilities have been designed to comply with these regulations and we believe that our activities are conducted in material compliance with such regulations. Any changes in such regulations or in their enforcement could require us to acquire costly equipment or to incur other significant expenses to comply with environmental regulations.  Any failure by us to adequately control the storage, use, discharge and disposal of regulated substances could result in significant future liabilities.
 
Increasing public attention has been focused on the environmental impact of electronic manufacturing operations.  While we have not experienced any materially adverse effects on our operations from recently adopted environmental regulations, our business and results of operations could suffer if for any reason we fail to control the storage or use of, or to adequately restrict the discharge or disposal of, hazardous substances under present or future environmental regulations.
 
Employees
 
As of March 31, 2018, we had 14,234 employees.  We have never had a work stoppage and believe that our employee relations are good.

Executive Officers of the Registrant
 
The following sets forth certain information regarding our executive officers as of April 30, 2018:

Name
 
Age
 
Position
Steve Sanghi
 
62
 
Chief Executive Officer and Chairman of the Board
Ganesh Moorthy
 
58
 
President and Chief Operating Officer
J. Eric Bjornholt
 
47
 
Vice President, Chief Financial Officer
Stephen V. Drehobl
 
56
 
Vice President, MCU8 and Technology Development Division
Mitchell R. Little
 
66
 
Vice President, Worldwide Sales and Applications
Richard J. Simoncic
 
54
 
Vice President, Analog Power and Interface Division

Mr. Sanghi has served as Chief Executive Officer since October 1991, and as Chairman of the Board since October 1993.  He served as President from August 1990 to February 2016 and has served as a director since August 1990.  Mr. Sanghi holds an M.S. degree in Electrical and Computer Engineering from the University of Massachusetts and a B.S. degree in Electronics and Communication from Punjab University. In November 2016, Mr. Sanghi joined the Board of Directors of Myomo, Inc., a publicly traded commercial stage medical robotics company that offers expanded mobility for those suffering from neurological disorders and upper-limb paralysis.  In February 2018, Mr. Sanghi joined the board of Mellanox Technologies Ltd., a publicly traded supplier of end-to-end Ethernet and InfiniBand intelligent interconnect solutions and services for servers, storage, and hyper-converged infrastructure.

 Mr. Moorthy has served as President since February 2016 and as Chief Operating Officer since June 2009. He also served as Executive Vice President from October 2006 to August 2012 and as a Vice President in various roles since he joined Microchip in 2001.  Prior to this time, he served in various executive capacities with other semiconductor companies.  Mr. Moorthy holds an M.B.A. in Marketing from National University, a B.S. degree in Electrical Engineering from the University of Washington and a B.S. degree in Physics from the University of Mumbai, India. Mr. Moorthy was elected to the Board of Directors of Rogers Corporation in July 2013.
 
Mr. Bjornholt has served as Vice President of Finance since 2008 and as Chief Financial Officer since January 2009.  He has served in various financial management capacities since he joined Microchip in 1995.  Mr. Bjornholt holds a Master's degree in Taxation from Arizona State University and a B.S. degree in Accounting from the University of Arizona.


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Mr. Drehobl has served as Vice President of the MCU8 and Technology Development Division since July 2001. He has been employed by Microchip since August 1989 and has served as a Vice President in various roles since February 1997.  Mr. Drehobl holds a Bachelor of Technology degree from the University of Dayton.

Mr. Little has served as Vice President, Worldwide Sales and Applications since July 2000.  He has been employed by Microchip since 1989 and has served as a Vice President in various roles since September 1993.  Mr. Little holds a B.S. degree in Engineering Technology from United Electronics Institute.

Mr. Simoncic has served as Vice President, Analog Power and Interface Division since September 1999.  From October 1995 to September 1999, he served as Vice President in various roles.  Since joining Microchip in 1990, Mr. Simoncic held various roles in Design, Device/Yield Engineering and Quality Systems.  Mr. Simoncic holds a B.S. degree in Electrical Engineering Technology from DeVry Institute of Technology.


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Item 1A. Risk Factors
 
When evaluating Microchip and its business, you should give careful consideration to the factors listed below, in addition to the information provided elsewhere in this Form 10-K and in other documents that we file with the Securities and Exchange Commission. 

Our operating results are impacted by global economic conditions and may fluctuate in the future due to a number of factors that could reduce our net sales and profitability.

Our operating results are affected by a wide variety of factors that could reduce our net sales and profitability, many of which are beyond our control. Some of the factors that may affect our operating results include:

general economic, industry or political conditions in the U.S. or internationally;
changes in demand or market acceptance of our products and products of our customers, and market fluctuations in the industries into which such products are sold;
changes in tax regulations and policies in the U.S. and other countries in which we do business including the impact of the Tax Cuts and Jobs Act of 2017 (the Act);
new accounting pronouncements or changes in existing accounting standards and practices, including the impact of the new revenue recognition standard (ASC 606) on our financial statements;
our ability to continue to realize the expected benefits of our acquisitions including our pending acquisition of Microsemi;
our ability to ramp our factory capacity to meet customer demand;
our ability to secure sufficient wafer foundry, assembly and testing capacity;
changes or fluctuations in customer order patterns and seasonality;
changes in utilization of our manufacturing capacity and fluctuations in manufacturing yields;
the mix of inventory we hold and our ability to satisfy orders from our inventory;
levels of inventories held by our customers;
risk of excess and obsolete inventories;
competitive developments including pricing pressures;
unauthorized copying of our products resulting in pricing pressure and loss of sales;
availability of raw materials and equipment;
our ability to successfully transition products to more advanced process technologies to reduce manufacturing costs;
the level of orders that are received and can be shipped in a quarter;
the level of sell-through of our products through distribution;
fluctuations in our mix of product sales;
announcements of other significant acquisitions by us or our competitors;
disruptions in our business or our customers' businesses due to terrorist activity, armed conflict, war, worldwide oil prices and supply, public health concerns, natural disasters or disruptions in the transportation system;
constrained availability from other electronic suppliers impacting our customers' ability to ship their products, which in turn may adversely impact our sales to those customers;
costs and outcomes of any current or future tax audits or any litigation or claims involving intellectual property, customers or other issues;
fluctuations in commodity or energy prices; and
property damage or other losses, whether or not covered by insurance.

We believe that period-to-period comparisons of our operating results are not necessarily meaningful and that you should not rely upon any such comparisons as indications of our future performance. In future periods, our operating results may fall below our public guidance or the expectations of public market analysts and investors, which would likely have a negative effect on the price of our common stock. Uncertain global economic conditions, the ongoing economic recovery and uncertainty surrounding the strength and duration of such recovery have caused our operating results to fluctuate significantly and make comparability between periods less meaningful.


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We may not fully realize the anticipated benefits of our completed or future acquisitions or divestitures including our pending acquisition of Microsemi.

We have acquired, and expect in the future to acquire, additional businesses that we believe will complement or augment our existing businesses. On March 1, 2018, we entered into a definitive agreement to acquire Microsemi. We expect the acquisition of Microsemi to close in June 2018. In addition, in April 2016, we completed our acquisition of Atmel; and in August 2015, we completed our acquisition of Micrel. The integration process for our acquisitions is complex and may be costly and time consuming and include unanticipated issues, expenses and liabilities. We may not be able to successfully or profitably integrate, operate, maintain and manage any newly acquired operations or employees. We may not be able to maintain uniform standards, procedures and policies and we may be unable to realize the expected synergies and cost savings from the integration. There may be increased risk due to integrating financial reporting and internal control systems. We may have difficulty in developing, manufacturing and marketing the products of a newly acquired company, or in growing the business at the rate we anticipate. Following an acquisition, we may not achieve the revenue or net income levels that justify the acquisition. We may suffer loss of key employees, customers and strategic partners of acquired companies and it may be difficult to implement our corporate culture at acquired companies. We have been and may in the future be subject to claims from terminated employees, shareholders of acquired companies and other third parties related to the transaction. In particular, as a result of our Atmel acquisition, we became involved with third-party claims, litigation and disputes related to the Atmel business. See Note 12 to our consolidated financial statements for information regarding pending litigation. Acquisitions may also result in charges (such as acquisition-related expenses, write-offs, restructuring charges, or future impairment of goodwill), contingent liabilities, adverse tax consequences, additional share-based compensation expense and other charges that adversely affect our operating results. To fund our pending acquisition of Microsemi, we plan to use a significant portion of our cash balances and incur approximately $8.0 billion of additional debt through borrowings under our credit agreement and issuance of new debt. We may fund future acquisitions of new businesses or strategic alliances by utilizing cash, borrowings under our credit agreement, raising debt, issuing shares of our common stock, or other mechanisms.

Further, if we decide to divest assets or a business, we may encounter difficulty in finding or completing divestiture opportunities or alternative exit strategies on acceptable terms or in a timely manner. These circumstances could delay the achievement of our strategic objectives or cause us to incur additional expenses with respect to assets or a business that we want to dispose of, or we may dispose of assets or a business at a price or on terms that are less favorable than we had anticipated. Even following a divestiture, we may be contractually obligated with respect to certain continuing obligations to customers, vendors, landlords or other third parties. We may also have continuing obligations for pre-existing liabilities related to the assets or businesses. Such obligations may have a material adverse impact on our results of operations and financial condition.

In addition to acquisitions, we have in the past, and expect in the future, to enter into joint development agreements or other business or strategic relationships with other companies. These transactions are subject to a number of risks similar to those we face with our acquisitions including our ability to realize the expected benefits of any such transaction, to successfully market and sell any products resulting from such transactions or to successfully integrate any technology developed through such transactions.

Our financial condition and results of operations could be adversely affected if we do not effectively manage our current or future debt.

As of March 31, 2018, the principal amount of our outstanding indebtedness was $4,481.3 million. In February 2017, we issued $2,645.0 million of aggregate principal value of senior and junior convertible debt and amended our existing credit agreement to, among other things, increase certain covenant compliance ratios. The February 2017 credit agreement amendment included a new collateral agreement that secures our borrowings with all assets of our guarantor subsidiaries with the exception of real property. We used a portion of the proceeds from the issuance of the 2017 senior and junior convertible debt to settle $431.3 million in principal value of our 2007 Junior Debt and $1,682.5 million to pay off the outstanding balance under our credit facility. At March 31, 2018, there were no outstanding borrowings under our credit facility which had a capacity of $3,122.3 million and is comprised of one tranche expiring in February 2020. In connection with the closing of our pending acquisition of Microsemi, we expect to incur approximately $8.0 billion of additional debt through borrowings under our credit agreement and issuance of new debt. As a result of such transactions, we will have a substantially greater amount of debt than we had maintained in the past. Our maintenance of substantial levels of debt could adversely affect our ability to take advantage of corporate opportunities and could adversely affect our financial condition and results of operations. We may need or desire to refinance our convertible debt or any other future indebtedness and there can be no assurance that we will be able to refinance any of our indebtedness on commercially reasonable terms, if at all.



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Servicing our current debt and expected debt to finance the Microsemi acquisition will require a significant amount of cash, and we may not have sufficient cash flow from our business to fund future payments.

Our ability to make scheduled payments of principal, to pay interest on or to refinance our indebtedness, including our outstanding debentures and expected debt to be incurred to finance our acquisition of Microsemi, depends on our future performance, which is subject to economic, financial, competitive and other factors. Our business may not continue to generate cash flow from operations in the future sufficient to service our debt and to fund capital expenditures, dividend payments, share repurchases or acquisitions. If we are unable to generate such cash flow, we may be required to adopt one or more alternatives, such as selling assets, restructuring debt or obtaining additional equity capital on terms that may be onerous or highly dilutive. Our ability to refinance our indebtedness will depend on the capital markets and our financial condition at such time.

We are dependent on orders that are received and shipped in the same quarter and therefore have limited visibility to future product shipments.

Our net sales in any given quarter depend upon a combination of shipments from backlog and customer orders that are both received and shipped in that same quarter, which we refer to as turns orders. We measure turns orders at the beginning of a quarter based on the orders needed to meet the shipment targets that we set entering the quarter. Historically, we have relied on our ability to respond quickly to customer orders as part of our competitive strategy, resulting in customers placing orders with relatively short delivery schedules. Shorter lead times generally mean that turns orders as a percentage of our business are relatively high in any particular quarter and reduce our backlog visibility on future product shipments. Turns orders correlate to overall semiconductor industry conditions and product lead times. Because turns orders are difficult to predict, varying levels of turns orders make it more difficult to forecast net sales. As a significant portion of our products are manufactured at foundries, foundry lead times may affect our ability to satisfy certain turns orders. If we do not achieve a sufficient level of turns orders in a particular quarter relative to our revenue targets, our revenue and operating results will likely suffer.

Intense competition in the markets we serve may lead to pricing pressures, reduced sales of our products or reduced market share.

The semiconductor industry is intensely competitive and has been characterized by price erosion and rapid technological change. We compete with major domestic and international semiconductor companies, many of which have greater market recognition and substantially greater financial, technical, marketing, distribution and other resources than we do. The semiconductor industry has experienced significant merger and acquisition activity and consolidation in recent years which has resulted in several of our competitors becoming much larger in terms of revenue, product offerings and scale. We may be unable to compete successfully in the future, which could harm our business. Our ability to compete successfully depends on a number of factors both within and outside our control, including, but not limited to:

the quality, performance, reliability, features, ease of use, pricing and diversity of our products;
our success in designing and manufacturing new products including those implementing new technologies;
our ability to ramp production and increase capacity, as needed, at our wafer fabrication and assembly and test facilities;
the rate at which customers incorporate our products into their own applications and the success of such applications;
the rate at which the markets that we serve redesign and change their own products;
our ability to obtain adequate foundry and assembly and test capacity and supplies of raw materials and other supplies at acceptable prices;
changes in demand in the markets that we serve and the overall rate of growth or contraction of such markets, including but not limited to the automotive, personal computing and consumer electronics markets;
product introductions by our competitors;
the number, nature and success of our competitors in a given market;
our ability to protect our products and processes by effective utilization of intellectual property rights;
our ability to remain price competitive against companies that have copied our proprietary product lines, especially in countries where intellectual property rights protection is difficult to achieve and maintain;
our ability to address the needs of our customers; and
general market and economic conditions.


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Historically, average selling prices in the semiconductor industry decrease over the life of any particular product. The average selling prices of our microcontroller and proprietary analog, interface, mixed signal and timing products have remained relatively constant, while average selling prices of our memory and non-proprietary analog, interface, mixed signal and timing products have declined over time. The overall average selling price of our products is affected by these trends; however, variations in our product and geographic mix of sales can cause wider fluctuations in our overall average selling price in any given period.

We have experienced, and expect to continue to experience, modest pricing declines in certain of our more mature proprietary product lines, primarily due to competitive conditions. We have been able to moderate average selling price declines in many of our proprietary product lines by continuing to introduce new products with more features and higher prices. However, there can be no assurance that we will be able to do so in the future. We have experienced in the past, and expect to continue to experience in the future, varying degrees of competitive pricing pressures in our memory and non-proprietary analog, interface, mixed signal and timing products. We may be unable to maintain average selling prices for our products as a result of increased pricing pressure in the future, which could adversely impact our operating results.

We are dependent on wafer foundries and other contractors to perform key manufacturing functions for us, and our licensees of our SuperFlash and other technologies also rely on foundries and other contractors.

We rely on outside wafer foundries for a significant portion of our wafer fabrication needs. Specifically, during fiscal 2018 and fiscal 2017, approximately 42% and 41%, respectively, of our net sales came from products that were produced at outside wafer foundries. We also use several contractors located primarily in Asia for a portion of the assembly and testing of our products. Specifically, during fiscal 2018, approximately 58% of our assembly requirements and 36% of our test requirements were performed by third party contractors compared to approximately 64% of our assembly requirements and 40% of our test requirements during fiscal 2017. Our reliance on third party contractors and foundries increased as a result of our acquisitions of Atmel, Micrel, SMSC, Supertex and ISSC. Microsemi relies on wafer foundries for a significant portion of its wafer fabrication needs. Accordingly, upon completion of our acquisition of Microsemi, our reliance on third party contractors and foundries will increase significantly. The disruption or termination of any of our contractors could harm our business and operating results.

Our use of third parties somewhat reduces our control over the subcontracted portions of our business. Our future operating results could suffer if any contractor were to experience financial, operational or production difficulties or situations when demand exceeds capacity, or if they were unable to maintain manufacturing yields, assembly and test yields and costs at approximately their current levels, or if the countries in which such contractors are located were to experience political upheaval or infrastructure disruption. If these third parties are unable or unwilling to timely deliver products or services conforming to our quality standards, we may not be able to qualify additional manufacturing sources for our products in a timely manner on terms favorable to us, or at all. Additionally, these subcontractors could abandon fabrication processes that are important to us, or fail to adopt advanced manufacturing technologies that we desire to control costs. In any such event, we could experience an interruption in production, an increase in manufacturing and production costs or a decline in product reliability, and our business and operating results could be adversely affected. Further, our use of subcontractors increases the risks of potential misappropriation of our intellectual property.

Certain of our SuperFlash and other technology licensees also rely on outside wafer foundries for wafer fabrication services. If our licensees were to experience any disruption in supply from outside wafer foundries, this would reduce the revenue we receive in our technology licensing business and would harm our operating results.

Our operating results will suffer if we ineffectively utilize our manufacturing capacity or fail to maintain manufacturing yields.

The manufacture and assembly of integrated circuits, particularly non-volatile, erasable CMOS memory and logic devices such as those that we produce, are complex processes. These processes are sensitive to a wide variety of factors, including the level of contaminants in the manufacturing environment, impurities in the materials used, the performance of our wafer fabrication and assembly and test personnel and equipment, and other quality issues. As is typical in the semiconductor industry, we have from time to time experienced lower than anticipated manufacturing yields. Our operating results will suffer if we are unable to maintain yields at or above approximately the current levels. This could include delays in the recognition of revenue, loss of revenue or future orders, and customer-imposed penalties for our failure to meet contractual shipment deadlines. Our operating results are also adversely affected when we operate at less than optimal capacity. Although we operated at normal capacity levels during fiscal 2018 and fiscal 2017, there can be no assurance that such production levels will be maintained in future periods.


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Our operating results are impacted by both seasonality and the wide fluctuations of supply and demand in the semiconductor industry.

The semiconductor industry is characterized by seasonality and wide fluctuations of supply and demand.  Since a significant portion of our revenue is from consumer markets and international sales, our business tends to generate historically stronger revenues in the first and second quarters and comparatively weaker revenues in the third and fourth quarters of our fiscal year. However, broad fluctuations in our overall business, changes in semiconductor industry and global economic conditions, and our acquisition activity (including our acquisition of Atmel and our pending acquisition of Microsemi) can have a more significant impact on our results than seasonality. As a result, in periods when these broad fluctuations, changes in business conditions or acquisitions occur, it is difficult to assess the impact of seasonal factors on our business. The semiconductor industry has also experienced significant economic downturns, characterized by diminished product demand and production over-capacity. We have sought to reduce our exposure to this industry cyclically by selling proprietary products, that cannot be easily or quickly replaced, to a geographically diverse customer base across a broad range of market segments. However, we have experienced substantial period-to-period fluctuations in operating results and expect, in the future, to experience period-to-period fluctuations in operating results due to general industry or economic conditions.

Our business is dependent on selling through distributors.

Sales through distributors accounted for approximately 54% of our net sales in fiscal 2018 and approximately 55% of our net sales in fiscal 2017. We do not have long-term agreements with our distributors, and we and our distributors may each terminate our relationship with little or no advance notice.

Any future adverse conditions in the U.S. or global economies or in the U.S. or global credit markets could materially impact the operations of our distributors. Any deterioration in the financial condition of our distributors or any disruption in the operations of our distributors could adversely impact the flow of our products to our end customers and adversely impact our results of operation. In addition, during an industry or economic downturn, it is possible there will be an oversupply of products and a decrease in demand for our products from our distributors, which could reduce our net sales in a given period and result in an increase in inventory returns. Violations of the Foreign Corrupt Practices Act, or similar laws, by our distributors or other channel partners could have a material adverse impact on our business.

Our success depends on our ability to introduce new products on a timely basis.

Our future operating results depend on our ability to develop and timely introduce new products that compete effectively on the basis of price and performance and which address customer requirements. The success of our new product introductions depends on various factors, including, but not limited to:

effective new product selection;
timely completion and introduction of new product designs;
procurement of licenses for intellectual property rights from third parties under commercially reasonable terms;
timely filing and protection of intellectual property rights for new product designs;
availability of development and support tools and collateral literature that make complex new products easy for engineers to understand and use; and
market acceptance of our customers' end products.

Because our products are complex, we have experienced delays from time to time in completing new product development. In addition, our new products may not receive or maintain substantial market acceptance.  We may be unable to timely design, develop and introduce competitive products, which could adversely impact our future operating results.

Our success also depends upon our ability to develop and implement new design and process technologies. Semiconductor design and process technologies are subject to rapid technological change and require significant R&D expenditures. We and other companies in the industry have, from time to time, experienced difficulties in effecting transitions to advanced process technologies and, consequently, have suffered reduced manufacturing yields or delays in product deliveries. Our future operating results could be adversely affected if any transition to future process technologies is substantially delayed or inefficiently implemented.


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We may lose sales if our suppliers of raw materials and equipment fail to meet our needs.

Our semiconductor manufacturing operations require raw and processed materials and equipment that must meet exacting standards.  We generally have more than one source for these supplies, but there are only a limited number of suppliers capable of delivering various materials and equipment that meet our standards.  The materials and equipment necessary for our business could become more difficult to obtain as worldwide use of semiconductors in product applications increases. Additionally, consolidation in our supply chain due to mergers and acquisitions may reduce the number of suppliers or change the relationships that we have with our suppliers. This could impair sourcing flexibility or increase costs. We have experienced supply shortages from time to time in the past, and on occasion our suppliers have told us they need more time than expected to fill our orders or that they will no longer support certain equipment with updates or spare and replacement parts. In particular, we have recently experienced longer lead times for equipment which we need for capacity expansion at certain of our manufacturing facilities. An interruption of any materials or equipment sources, or the lack of supplier support for a particular piece of equipment, could harm our business.

Our reported financial results may be adversely affected by new accounting pronouncements or changes in existing accounting standards and practices, including ASC 606 which will impact our revenue recognition.

We prepare our financial statements in conformity with accounting principles generally accepted in the U.S. These accounting principles are subject to interpretation or changes by the FASB and the SEC. New accounting pronouncements and varying interpretations of accounting standards and practices have occurred in the past and are expected to occur in the future. New accounting pronouncements or a change in the interpretation of existing accounting standards or practices may have a significant effect on our reported financial results and may even affect our reporting of transactions completed before the change is announced or effective. In May 2014, the FASB issued Accounting Standards Update (ASU) 2014-09 - Revenue from Contracts with Customers (Topic 606), which supersedes nearly all existing revenue recognition guidance under generally accepted accounting principles in the Unites States of America (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. Upon our adoption of ASU 2014-09 beginning with our fiscal year commencing on April 1, 2018, we 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. Refer to Note 1 to our consolidated financial statements for additional information on the new guidance and its expected impact on us.

Business interruptions to our operations or the operations of our key vendors, subcontractors, licensees or customers, whether due to natural disasters or other events, could harm our business.

Operations at any of our facilities, at the facilities of any of our wafer fabrication or assembly and test subcontractors, or at any of our significant vendors or customers may be disrupted for reasons beyond our control. These reasons may include work stoppages, power loss, cyber attacks, incidents of terrorism or security risk, political instability, public health issues, telecommunications, transportation or other infrastructure failure, radioactive contamination, fire, earthquake, floods, volcanic eruptions or other natural disasters. We have taken steps to mitigate the impact of some of these events should they occur; however, we cannot be certain that our actions will be effective to avoid a significant impact on our business in the event of a disaster or other business interruption.

In particular, Thailand has experienced periods of severe flooding in recent years. While our facilities in Thailand have continued to operate normally, there can be no assurance that any future flooding in Thailand would not have a material adverse impact on our operations. If operations at any of our facilities, or our subcontractors' facilities are interrupted, we may not be able to shift production to other facilities on a timely basis, and we may need to spend significant amounts to repair or replace our facilities and equipment.  If we experienced business interruptions, we would likely experience delays in shipments of products to our customers and alternate sources for production may be unavailable on acceptable terms. This could result in reduced revenues and profits and the cancellation of orders or loss of customers. Although we maintain business interruption insurance, such insurance will likely not be enough to compensate us for any losses that may occur and any losses or damages incurred by us as a result of business interruptions could significantly harm our business.

Additionally, operations at our customers and licensees may be disrupted for a number of reasons. In the event of customer disruptions, sales of our products may decline and our revenue, profitability and financial condition could suffer. Likewise, if our licensees are unable to manufacture and ship products incorporating our technology, or if there is a decrease in product demand due to a business disruption, our royalty revenue may decline.



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Our technology licensing business exposes us to various risks.

Our technology licensing business is based on our SuperFlash and other technologies. The success of our licensing business depends on the continued market acceptance of these technologies and on our ability to further develop and enhance such technologies and to introduce new technologies in the future. To be successful, any such technology must be able to be repeatably implemented by licensees, provide satisfactory yield rates, address licensee and customer requirements, and perform competitively. The success of our technology licensing business depends on various other factors, including, but not limited to:

proper identification of licensee requirements;
timely development and introduction of new or enhanced technology;
our ability to protect and enforce our intellectual property rights for our licensed technology;
our ability to limit our liability and indemnification obligations to licensees;
availability of sufficient development and support services to assist licensees in their design and manufacture of products integrating our technology;
availability of foundry licensees with sufficient capacity to support original equipment manufacturers (OEM) production; and
market acceptance of our customers' end products.

Because our licensed technologies are complex, there may be delays from time to time in developing and enhancing such technologies. There can be no assurance that our existing or any enhanced or new technology will achieve or maintain substantial market acceptance. Our licensees may experience disruptions in production or lower than expected production levels which would adversely affect the revenue that we receive from them. Our technology license agreements generally include an indemnification clause that indemnifies the licensee against liability and damages (including legal defense costs) arising from intellectual property matters. We could be exposed to substantial liability for claims or damages related to intellectual property matters or indemnification claims. Any claim, with or without merit, could result in significant legal fees and require significant attention from our management. Any of the foregoing issues may adversely impact the success of our licensing business and adversely affect our future operating results.

We are exposed to various risks related to legal proceedings or claims.

We are currently, and in the future may be, involved in legal proceedings or claims regarding patent infringement, other intellectual property rights, product failures, contracts and other matters. As is typical in the semiconductor industry, we receive notifications from third parties from time to time who believe that we owe them indemnification or other obligations related to claims made against us, our direct or indirect customers or our licensees. These legal proceedings and claims, even if meritless, could result in substantial costs to us and divert our resources. If we are not able to resolve a claim, settle a matter, obtain necessary licenses on commercially reasonable terms, reengineer our products or processes to avoid infringement, provide a cost-effective remedy, or successfully prosecute or defend our position, we could incur uninsured liability in any of them, be required to take an appropriate charge to operations, be enjoined from selling a material portion of our products or using certain processes, suffer a reduction or elimination in the value of our inventories, and our business, financial condition or results of operations could be harmed.

It is also possible that from time to time we may be subject to claims related to the manufacture, performance or use of our products. These claims may be due to injuries, economic damage or environmental exposures related to manufacturing, a product's nonconformance to our specifications or specifications agreed upon with the customer, changes in our manufacturing processes, or unexpected customer system issues due to the integration of our products or insufficient design or testing by our customers. We could incur significant expenses related to such matters, including, but not limited to:

costs related to writing off the value of our inventory of nonconforming products;
recalling nonconforming products;
providing support services, product replacements, or modifications to products and the defense of such claims;
diversion of resources from other projects;
lost revenue or a delay in the recognition of revenue due to cancellation of orders or unpaid receivables;
customer imposed fines or penalties for failure to meet contractual requirements; and
a requirement to pay damages or penalties.


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Because the systems into which our products are integrated have a higher cost of goods than the products we sell, the expenses and damages we are asked to pay may be significantly higher than the sales and profits we received from the products involved. While we specifically exclude consequential damages in our standard terms and conditions, certain of our contracts may not exclude such liabilities. Further, our ability to avoid such liabilities may be limited by applicable law. We do have liability insurance which covers certain damages arising out of product defects, but we do not expect that insurance will cover all claims or be of a sufficient amount to fully protect against such claims. Costs or payments we may make in connection with these customer claims may adversely affect the results of our operations.

Further, we sell to customers in industries such as automotive, aerospace, defense, safety, security, and medical, where failure of the systems in which our products are integrated could cause damage to property or persons. We may be subject to claims if our products, or the integration of our products, cause system failures. We will face increased exposure to claims if there are substantial increases in either the volume of our sales into these applications or the frequency of system failures integrating our products.

Failure to adequately protect our intellectual property could result in lost revenue or market opportunities.

Our ability to obtain patents, licenses and other intellectual property rights covering our products and manufacturing processes is important for our success. To that end, we have acquired certain patents and patent licenses and intend to continue to seek patents on our technology and manufacturing processes. The process of seeking patent protection can be long and expensive, and patents may not be issued from currently pending or future applications. In addition, our existing and new patents, trademarks and copyrights that issue may not have sufficient scope or strength to provide meaningful protection or commercial advantage to us. We may be subject to, or may ourselves initiate, interference proceedings in the U.S. Patent and Trademark Office, patent offices of a foreign country or U.S. or foreign courts, which can require significant financial and management resources. In addition, the laws of certain foreign countries do not protect our intellectual property rights to the same extent as the laws of the U.S. Infringement of our intellectual property rights by a third party could result in uncompensated lost market and revenue opportunities for us. Although we continue to vigorously and aggressively defend and protect our intellectual property on a worldwide basis, there can be no assurance that we will be successful in our endeavors.

Our operating results may be adversely impacted if economic conditions impact the financial viability of our licensees, customers, distributors, or suppliers.

We regularly review the financial performance of our licensees, customers, distributors and suppliers. However, any downturn in global economic conditions may adversely impact the financial viability of our licensees, customers, distributors or suppliers. The financial failure of a large licensee, customer or distributor, an important supplier, or a group thereof, could have an adverse impact on our operating results and could result in our not being able to collect our accounts receivable balances, higher reserves for doubtful accounts, write-offs for accounts receivable, and higher operating costs as a percentage of net sales.

We are highly dependent on foreign sales and operations, which exposes us to foreign political and economic risks.

Sales to foreign customers account for a substantial portion of our net sales. During fiscal 2018, approximately 85% of our net sales were made to foreign customers, including 30% in China. During fiscal 2017, approximately 84% of our net sales were made to foreign customers, including 32% in China.

A strong position in the Chinese market is a key component of our global growth strategy. The market for integrated circuit products in China is highly competitive, and both international and domestic competitors are aggressively seeking to increase their market share. Increased competition or economic weakness in the China market may make it difficult for us to achieve our desired sales volumes in China. In particular, economic conditions in China remain uncertain and we are unable to predict whether such uncertainty will continue or worsen in future periods.

We purchase a substantial portion of our raw materials and equipment from foreign suppliers. In addition, we own product assembly and testing facilities near Bangkok, Thailand, which has experienced periods of political instability in the past. A large portion of our finished goods inventory is maintained in Thailand. From time to time, Thailand has also experienced periods of severe flooding. There can be no assurance that any future flooding or political instability in Thailand would not have a material adverse impact on our operations. As part of our Atmel acquisition, we acquired a test facility in Calamba, Philippines. We use various foundries and other foreign contractors for a significant portion of our assembly and testing and wafer fabrication requirements.



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Our reliance on foreign operations, foreign suppliers, maintenance of substantially all of our finished goods inventory at foreign locations and significant foreign sales exposes us to foreign political and economic risks, including, but not limited to:

political, social and economic instability;
potentially adverse tax consequences;
economic uncertainty in the worldwide markets served by us;
trade restrictions and changes in tariffs;
import and export license requirements and restrictions;
changes in rules and laws related to taxes, environmental, health and safety, technical standards and consumer protection in various jurisdictions;
currency fluctuations and foreign exchange regulations;
difficulties in staffing and managing international operations;
employment regulations;
disruptions in international transport or delivery;
public health conditions; and
difficulties in collecting receivables and longer payment cycles.

If any of these risks materialize, or are worse than we anticipate, our sales could decrease and our operating results could suffer.

Our contractual relationships with our customers expose us to risks and liabilities.

We do not typically enter into long-term contracts with our customers, and therefore we cannot be certain about future order levels from our customers. When we do enter into customer contracts, the contract is generally cancelable at the convenience of the customer. Even though we had over 119,000 customers and our ten largest direct customers made up approximately 11% of our total revenue for fiscal 2018 and five of our top ten direct customers are contract manufacturers that perform manufacturing services for many customers, cancellation of customer contracts could have an adverse impact on our revenue and profits.

We have contracts with certain customers that differ from our standard terms of sale. For several of the significant markets that we sell into, such as the automotive and personal computer markets, our current or potential customers may possess significant leverage over us in negotiating the terms and conditions of supply as a result of their market size and position. For example, under certain contracts we may commit to supply specific quantities of products on scheduled delivery dates, or agree to extend our obligations for certain liabilities such as warranties or indemnification for quality issues or claims of intellectual property infringement. If we are unable to supply the customer as required under the contract, the customer may incur additional production costs, lost revenues due to subsequent delays in their own manufacturing schedule, or quality-related issues. We may be liable for the customer's costs, expenses and damages associated with their claims and we may be obligated to defend the customer against claims of intellectual property infringement and pay the associated legal fees. While we try to minimize the number of contracts which contain such provisions, manage the risks underlying such liabilities, and set caps on our liability exposure, sometimes we are not able to do so. In order to win important designs, avoid losing business to competitors, maintain existing business, or be permitted to bid on new business, we have been, and may in the future be, forced to agree to uncapped liability for such items as intellectual property infringement, product failure, or confidentiality. Such provisions expose us to risk of liability far exceeding the purchase price of the products we sell under such contracts, the lifetime revenues we receive from such products, or various forms of potential consequential damages. Further, where we do not have negotiated contracts with our customers, the terms of our customer's orders may govern the transaction and contain terms that are not favorable to us. These significant additional risks could result in a material adverse impact on our results of operations and financial condition.

With respect to our pending acquisition of Microsemi, a significant portion of their sales are, or may be derived from U.S. government agencies or customers whose principal sales are to U.S. government agencies. Such sales are subject to significant uncertainties regarding government spending and policy changes. Also, the U.S. government and its contractors may terminate their contracts with Microsemi at any time. Uncertainty with respect to governmental spending and policies, or termination of contracts associated with governmental projects could have a material adverse impact on the revenues and other benefits that we achieve from the Microsemi acquisition. Prior to the Microsemi transaction, Microchip has not derived significant sales from government related customers.





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We must attract and retain qualified personnel to be successful, and competition for qualified personnel can be intense.

Our success depends upon the efforts and abilities of our senior management, engineering, manufacturing and other personnel. The competition for qualified engineering and management personnel can be intense. We may be unsuccessful in retaining our existing key personnel or in attracting and retaining additional key personnel that we require. The loss of the services of one or more of our key personnel or the inability to add key personnel could harm our business. The loss of, or any inability to attract personnel, even if not key personnel, if experienced in sufficient numbers could harm our business. We have no employment agreements with any member of our senior management team. 

Fluctuations in foreign currency exchange rates could adversely impact our operating results.

We use forward currency exchange contracts in an attempt to reduce the adverse earnings impact from the effect of exchange rate fluctuations on our non-U.S. dollar net balance sheet exposures. Nevertheless, in periods when the U.S. dollar significantly fluctuates in relation to the non-U.S. currencies in which we transact business, the value of our non-U.S. dollar transactions can have an adverse effect on our results of operations and financial condition. In particular, in periods when a foreign currency significantly declines in value in relation to the U.S. dollar, customers transacting in that foreign currency may find it more difficult to fulfill their previously committed contractual obligations or to undertake new obligations to make payments or purchase products. In periods when the U.S. dollar is significantly declining in relation to the British pound, Euro and Thai baht, the operational costs in our European and Thailand subsidiaries are adversely affected. Although our business has not been materially adversely impacted by recent changes in the value of the U.S. dollar, there can be no assurance as to the future impact that any weakness or strength in the U.S. dollar will have on our business or results of operations.

Interruptions in our information technology systems, or improper handling of data, could adversely affect our business.

We rely on the efficient and uninterrupted operation of complex information technology systems and networks to operate our business.  Any significant disruption to our systems or networks, including, but not limited to, new system implementations, computer viruses, security breaches, facility issues, natural disasters, terrorism, war, telecommunication failures or energy blackouts could have a material adverse impact on our operations, sales and operating results.  Such disruption could result in a loss of our intellectual property or the release of sensitive competitive information or supplier, customer or employee personal data. Any loss of such information could harm our competitive position, result in a loss of customer confidence, and cause us to incur significant costs to remedy the damages caused by any such disruptions or security breaches. Additionally, any failure to properly manage the collection, handling, transfer or disposal of personal data of employees and customers may result in regulatory penalties, enforcement actions, remediation obligations, litigation, fines and other sanctions.

From time to time, we have experienced verifiable attacks on our data, attempts to breach our security and attempts to introduce malicious software into our IT systems; however, such attacks have not previously resulted in any material damage to us. Were future attacks successful, we may be unaware of the incident, its magnitude, or its effects until significant harm is done. In recent years, we have implemented improvements to our protective measures which are not limited to the following: firewalls, antivirus measures, patches, log monitors, event correlation tools, routine backups with offsite retention of storage media, system audits, data partitioning and routine password modifications. There can be no assurance that such system improvements will be sufficient to prevent or limit the damage from any future cyber attacks or disruptions. Any such attack or disruption could result in additional costs related to rebuilding of our internal systems, defending litigation, responding to regulatory actions, or paying damages. Such attacks or disruptions could have a material adverse impact on our business, operations and financial results.

Third-party service providers, such as wafer foundries, assembly and test contractors, distributors, credit card processors and other vendors have access to certain portions of our and our customers' sensitive data. In the event that these service providers do not properly safeguard the data that they hold, security breaches and loss of data could result. Any such loss of data by our third-party service providers could negatively impact our business, operations and financial results, as well as our relationship with our customers.


22


The occurrence of events for which we are self-insured, or which exceed our insurance limits, may adversely affect our profitability and liquidity.

We have insurance contracts with independent insurance companies related to many different types of risk; however, we self-insure for some potentially significant risks and obligations. In these circumstances, we believe that it is more cost effective for us to self-insure certain risks than to pay the high premium costs. The risks and exposures that we self-insure include, but are not limited to certain property, product defects, employment risks, environmental matters, political risks, and intellectual property matters. Should there be a loss or adverse judgment or other decision in an area for which we are self-insured, then our financial condition, results of operations and liquidity may be adversely affected.

If we fail to maintain proper and effective internal control or remediate current or future deficiencies, our ability to produce accurate and timely financial statements could be impaired, which could harm our operating results, our ability to operate our business and investors’ views of us.

Ensuring that we have adequate internal financial and accounting controls and procedures so that we can produce accurate financial statements on a timely basis is a costly and time-consuming effort that needs to be re-evaluated frequently. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with United States generally accepted accounting principles. We are required to comply with Section 404 of the Sarbanes-Oxley Act of 2002 which requires annual management assessment of the effectiveness of our internal control over financial reporting and a report by our independent auditors. Although we have never identified a material weakness in our internal control over financial reporting, we have from time to time identified significant deficiencies. If we fail to remediate these significant deficiencies or to maintain proper and effective internal control over financial reporting in the future, our ability to produce accurate and timely financial statements could be impaired, which could harm our operating results, harm our ability to operate our business and reduce the trading price of our stock.

We are subject to stringent environmental and other regulations, which may force us to incur significant expenses.

We must comply with all applicable federal, state, local and foreign governmental regulations related to the use, storage, discharge and disposal of toxic, volatile or otherwise hazardous substances used in our products and manufacturing processes. Our failure to comply with applicable regulations could result in fines, suspension of production, cessation of operations or future liabilities. Such environmental regulations have required us in the past, and could require us in the future, to buy costly equipment or to incur significant expenses to comply with such regulations. Our failure to control the use of, or adequately restrict the discharge of, hazardous substances could impact the health of our employees and others and could impact our ability to operate. Such failure could also restrict our ability to ship certain products to certain countries, require us to modify our operations' logistics, or require us to incur other significant costs and expenses. There is a continuing expansion in environmental laws with a focus on reducing or eliminating hazardous substances and substances of high concern in electronic products and shipping materials. These and other future environmental regulations could require us to reengineer certain of our existing products and may make it more expensive for us to manufacture, sell and ship our products. In addition, the number and complexity of laws focused on the energy efficiency of electronic products and accessories, the recycling of electronic products, and the reduction in the quantity and the recycling of packing materials have expanded significantly. It may be difficult for us to timely comply with these laws and we may not have sufficient quantities of compliant products to meet customers' needs, thereby adversely impacting our sales and profitability. We may also have to write off inventory in the event that we hold unsaleable inventory as a result of changes to regulations or customer requirements. We expect these risks and trends to continue. In addition, we anticipate increased customer requirements to meet voluntary criteria related to the reduction or elimination of substances of high concern in our products, energy efficiency measures, and supplier practices associated with sourcing and manufacturing. These requirements may increase our own costs, as well as those passed on to us by our supply chain.

Customer demands for us to implement business practices that are more stringent than existing legal requirements may reduce our revenue opportunities or cause us to incur higher costs.

Some of our customers and potential customers are requiring that we implement operating practices that are more stringent than what is required by applicable laws with respect to workplace and labor requirements, the type of materials we use in our products, environmental matters or other items. To comply with such requirements, we may have to pass these same operating practices on to our suppliers. Our suppliers may refuse to implement these operating practices, or may charge us more for complying with them. The cost to implement such practices may cause us to incur higher costs and reduce our profitability, and if we choose not to implement such practices, such customers may disqualify us as a supplier, resulting in decreased revenue

23


opportunities. Developing, administering, monitoring and auditing these customer-requested practices at our own sites and those in our supply chain will increase our costs and may require that we hire more personnel.

Customer demands and regulations related to conflict-free minerals may force us to incur additional expenses.

As required by the Dodd-Frank Wall Street Reform and Consumer Protection Act, in August 2012, the SEC released investigation, disclosure and reporting requirements regarding the use of "conflict" minerals mined from the Democratic Republic of Congo and adjoining countries and which are necessary to the functionality or production of products.  We filed a report on Form SD with the SEC regarding such matters on May 31, 2017. Other countries are considering similar regulations.  If we cannot certify that we are using conflict-free minerals, customers may demand that we change the sourcing of minerals and other materials used in the manufacture of our products, even if the costs for compliant minerals and materials significantly increases and availability is limited.  If we make changes to materials or suppliers, there will likely be costs associated with qualifying new suppliers and production capacity and quality could be negatively impacted.  Our relationships with customers and suppliers may be adversely affected if we are unable to certify that our products are "conflict-free." We have incurred, and expect in the future to incur, additional costs associated with complying with these new disclosure requirements, such as costs related to determining the source of any conflict minerals used in our products.  We may also encounter challenges to satisfy those customers who require that all of the components of our products be certified as conflict free in a materially different manner than advocated by the Responsible Minerals Initiative or the Dodd-Frank Wall Street Reform and Consumer Protection Act.  If we are not able to meet customer requirements, customers may choose to disqualify us as a supplier and we may have to write off inventory in the event that it cannot be sold.

Regulatory authorities in jurisdictions into which we ship our products could levy fines or restrict our ability to export or transfer products.

A significant portion of our sales are made through the exporting and importing of products. In addition to local jurisdictions' trade regulations, our U.S.-manufactured products or products based on U.S. technology are subject to U.S. laws and regulations governing international trade, including, but not limited to the Foreign Corrupt Practices Act, Export Administration Regulations (EAR), International Traffic in Arms Regulations (ITAR) and trade sanctions against embargoed countries and denied entities administered by the U.S. Department of the Treasury, Office of Foreign Assets Control (OFAC). Licenses or proper license exceptions are required for the shipment of our products to certain countries. A determination by the U.S. or foreign government that we have failed to comply with trade or export regulations or anti-bribery regulations can result in penalties which may include denial of export privileges, fines, civil or criminal penalties, and seizure of products. Such penalties could have a material adverse effect on our business, sales and earnings. Further, a change in these laws and regulations could restrict our ability to transfer product to previously permitted countries, customers, distributors or other third parties. Any one or more of these sanctions or a change in laws or regulations could have a material adverse effect on our business, financial condition and results of operations.

The outcome of future examinations of our income tax returns could have an adverse effect on our results of operations.

We are subject to examination of our income tax returns by the IRS and other tax authorities for fiscal 2005 and later.  We are subject to certain income tax examinations in foreign jurisdictions for fiscal 2007 and later.

We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes and have reserved for potential adjustments that may result from the current examinations. There can be no assurance that the final determination of any of these or any future examinations will not have an adverse effect on our effective tax rates, financial position and results of operations.

Exposure to greater than anticipated income tax liabilities, changes in tax rules and regulations (including the Act), changes in the interpretation of tax rules and regulations, or unfavorable assessments from tax audits could affect our effective tax rates, financial condition and results of operations

We are a U.S.-based multinational company subject to tax in multiple U.S. and foreign tax jurisdictions. Our income tax obligations could be affected by many factors, including but not limited to changes to our corporate operating structure, intercompany arrangements and tax planning strategies.

Our income tax expense is computed based on tax rates at the time of the respective financial period. Our future effective tax rates, financial condition and results from operations could be unfavorably affected by changes in the tax rates in jurisdictions where our income is earned, by changes in the tax rules and regulations or the interpretation of tax rules and regulations in the jurisdictions in which we do business or by changes in the valuation of our deferred tax assets.

24


Currently, a majority of our revenue is generated from customers located outside the U.S., and a substantial portion of our assets, including employees, are located outside of the U.S. Recently enacted U.S. tax legislation will significantly change the taxation of U.S.-based multinational corporations, by, among other things, reducing the U.S. corporate income tax rate, adopting elements of a territorial tax system, assessing a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred, and creating new taxes on certain foreign-sourced earnings. The new legislation is unclear in some respects and will require interpretations and implementing regulations by the Internal Revenue Service, as well as state tax authorities, and the legislation could be subject to potential amendments and technical corrections, any of which could lessen or increase certain adverse impacts of the legislation. A significant portion of our earnings are earned by our subsidiaries outside the U.S. Changes to the taxation of certain foreign earnings resulting from the newly enacted U.S. tax legislation, along with the state tax impact of these changes and potential future cash distributions, will likely have an adverse effect on our effective tax rate. Furthermore, changes to the taxation of undistributed foreign earnings could change our future intentions regarding reinvestment of such earnings. The foregoing items could have a material adverse effect on our business, cash flow, results of operations or financial conditions.

The future trading price of our common stock could be subject to wide fluctuations in response to a variety of factors.

The market price of our common stock has fluctuated significantly in the past and is likely to fluctuate in the future. The future trading price of our common stock could be subject to wide fluctuations in response to a variety of factors, many of which are beyond our control, including, but not limited to:

quarterly variations in our operating results or the operating results of other technology companies;
developments with respect to timely completion or financing of our pending acquisition of Microsemi;
general conditions in the semiconductor industry;
global economic and financial conditions;
changes in our financial guidance or our failure to meet such guidance;
changes in analysts' estimates of our financial performance or buy/sell recommendations;
any other acquisitions we pursue or complete; and
actual or anticipated announcements of technical innovations or new products by us or our competitors.

In addition, the stock market has from time to time experienced significant price and volume fluctuations that have affected the market prices for many companies and that often have been unrelated to the operating performance of such companies. These broad market fluctuations and other factors have harmed and may harm the market price of our common stock. Some or all of the foregoing factors could also cause the market price of our convertible debentures to decline or fluctuate substantially.

Anti-takeover defenses in our charter documents and under Delaware law could discourage takeover attempts, which could also reduce the market price of our common stock.

Our certificate of incorporation and bylaws contain provisions that could delay or prevent a change in control of Microchip. These provisions could also make it difficult for stockholders to elect directors that are not nominated by the current members of our board of directors or take other corporate actions, including effecting changes in our management. These provisions include:

the ability of our board of directors to issue shares of preferred stock and to determine the price and other terms of those shares, including preferences and voting rights, without stockholder approval, which could be used to significantly dilute the ownership of a hostile acquiror;
the right of our board of directors to elect a director to fill a vacancy created by the expansion of our board of directors or the resignation, death or removal of a director, which prevents stockholders from being able to fill vacancies on our board of directors;
the requirement that a special meeting of stockholders may be called only by the holders of 50% or more of the combined voting power of all classes of our capital stock, which could delay the ability of our stockholders to force consideration of a proposal or to take action, including the removal of directors;
the ability of our board of directors, by majority vote, to amend the bylaws, which may allow our board of directors to take additional actions to prevent an unsolicited takeover and inhibit the ability of an acquiror to amend the bylaws to facilitate an unsolicited takeover attempt; and
advance notice procedures with which stockholders must comply to nominate candidates to our board of directors or to propose matters to be acted upon at a stockholders' meeting, which may discourage or deter a potential acquiror from conducting a solicitation of proxies to elect the acquiror's own slate of directors or otherwise attempting to obtain control of us.


25


In addition, as a Delaware corporation, we are subject to Section 203 of the Delaware General Corporation Law. These provisions may prohibit large stockholders, in particular those owning 15% or more of our outstanding voting stock, from merging or combining with us for a certain period of time. The application of Section 203 also could have the effect of delaying or preventing a change in control of us.

Any of these provisions could, under certain circumstances, depress the market price of our common stock.

As a result of our acquisition activity, our goodwill and intangible assets have increased significantly in recent years and we may in the future incur impairments to goodwill or intangible assets including impairments related to Microsemi following our completion of our acquisition of such company.

When we acquire a business, a substantial portion of the purchase price of the acquisition is allocated to goodwill and other identifiable intangible assets. The amount of the purchase price which is allocated to goodwill is determined by the excess of the purchase price over the net identifiable assets acquired. As of March 31, 2018, we had goodwill of $2,299.0 million and net intangible assets of $1,662.0 million. In connection with the completion of our pending acquisition of Microsemi, our balance of goodwill and intangible assets will increase significantly. We review our indefinite-lived intangible assets, including goodwill, for impairment annually in the fourth fiscal quarter or whenever events or changes in circumstances indicate that the carrying amount of those assets is more likely than not impaired.  Factors that may be considered in assessing whether goodwill or intangible assets may be impaired include a decline in our stock price or market capitalization, reduced estimates of future cash flows and slower growth rates in our industry.  Our valuation methodology for assessing impairment requires management to make judgments and assumptions based on historical experience and to rely heavily on projections of future operating performance.  Because we operate in highly competitive environments, projections of our future operating results and cash flows may vary significantly from our actual results.  No goodwill impairment charges were recorded in fiscal 2018 or in fiscal 2017.  No material intangible asset impairment charges were recorded in fiscal 2018. In fiscal 2017, we recognized $11.9 million of intangible asset impairment charges. If in future periods, we determine that our goodwill or intangible assets are impaired, we will be required to write down these assets which would have a negative effect on our consolidated financial statements.

Our foreign pension plans are unfunded, and any requirement to fund these plans in the future could negatively affect our cash position and operating capital.

In connection with our acquisition of Atmel, we assumed unfunded defined benefit pension plans that cover certain of our French and German employees. Plan benefits are managed in accordance with local statutory requirements. Benefits are based on years of service and employee compensation levels. The projected benefit obligation totaled $61.0 million at March 31, 2018. The plans are unfunded in compliance with local statutory regulations, and we have no immediate intention of funding these plans. Benefits are paid when amounts become due, commencing when participants retire. We expect to pay approximately $0.9 million in fiscal 2019 for benefits earned. Should legislative regulations require complete or partial funding of these plans in the future, it could negatively affect our cash position and operating capital.

From time to time we receive grants from governments, agencies and research organizations. If we are unable to comply with the terms of those grants, we may not be able to receive or recognize grant benefits or we may be required to repay grant benefits previously paid to us and recognize related charges, which would adversely affect our operating results and financial position.

From time to time, we receive economic incentive grants and allowances from European governments, agencies and research organizations targeted at increasing employment at specific locations. The subsidy grant agreements typically contain economic incentive, headcount, capital and research and development expenditure and other covenants that must be met to receive and retain grant benefits, and these programs can be subjected to periodic review by the relevant governments. Noncompliance by us with the conditions of the grants could result in our forfeiture of all or a portion of any future amounts to be received, as well as the repayment of all or a portion of amounts received to date.

Conversion of our debentures will dilute the ownership interest of our existing stockholders.

The conversion of some or all of our outstanding debentures will dilute the ownership interest of existing stockholders to the extent we deliver common stock upon conversion of the debentures. Upon conversion, we may satisfy our conversion obligation by delivering cash, shares of common stock or any combination, at our option. If upon conversion we elect to deliver cash for the lesser of the conversion value and principal amount of the debentures, we would pay the holder the cash value of the applicable number of shares of our common stock. Upon conversion, we intend to satisfy the lesser of the principal amount or the conversion value of the debentures in cash. If the conversion value of a debenture exceeds the principal amount

26


of the debenture, we may also elect to deliver cash in lieu of common stock for the conversion value in excess of the one thousand dollars principal amount (i.e., the conversion spread). There would be no adjustment to the numerator in the net income per common share computation for the cash settled portion of the debentures as that portion of the debt instrument will always be settled in cash. The conversion spread will be included in the denominator for the computation of diluted net income per common share. Any sales in the public market of any common stock issuable upon conversion of our debentures could adversely affect prevailing market prices of our common stock. In addition, the existence of the debentures may encourage short selling by market participants because the conversion of the debentures could be used to satisfy short positions, or anticipated conversion of the debentures into shares of our common stock could depress the price of our common stock.

Climate change regulations and sustained adverse climate change pose regulatory and physical risks that could harm our results of operations or affect the way we conduct business.

Climate change regulations at the federal, state or local level or in international jurisdictions could require us to limit emissions, change our manufacturing processes, obtain substitute materials which may cost more or be less available, increase our investment in control technology for greenhouse gas emissions, fund offset projects or undertake other costly activities. These regulations could significantly increase our costs and restrict our manufacturing operations by virtue of requirements for new equipment. New permits may be required for our current operations, or expansions thereof. Failure to timely receive permits could result in fines, suspension of production, or cessation of operations at one or more facilities. In addition, restrictions on carbon dioxide or other greenhouse gas emissions could result in significant costs such as higher energy costs, and utility companies passing down carbon taxes, emission cap and trade programs and renewable portfolio standards. The cost of complying, or of failing to comply, with these and other climate change and emissions regulations could have an adverse effect on our operating results.

Further, any sustained adverse change in climate could have a direct adverse economic impact on us, such as water and power shortages, and higher costs of water or energy to control the temperature of our facilities. Certain of our operations are located in arid or tropical regions, such as Arizona, Thailand, and the Philippines. Some environmental experts predict that these regions may become vulnerable to storms, severe floods and droughts due to climate change. While we maintain business recovery plans that are intended to allow us to recover from natural disasters or other events that can interrupt our business, we cannot be certain that our plans will protect us from all such disasters or events. 

Item 1B.    UNRESOLVED STAFF COMMENTS
 
None.


27


Item 2.    PROPERTIES
 
At March 31, 2018, we owned and used the facilities described below:

Location
 
Approximate
Total Sq. Ft.
 
Uses
Gresham, Oregon
 
826,500
 
Wafer Fabrication (Fab 4); R&D Center; Administrative Offices; and Warehousing
Chacherngsao, Thailand
 
489,000
 
Assembly and Test; Wafer Probe; Sample Center; Warehousing; and Administrative Offices
Colorado Springs, Colorado
 
480,000
 
Manufacturing, Test, Research and Development, Computer and Service Functions, Design and Engineering
Calamba, Philippines
 
460,000
 
Wafer Probe, Test, Warehousing and Administrative Offices
Tempe, Arizona
 
457,000
 
Wafer Fabrication (Fab 2); R&D Center; Administrative Offices; and Warehousing
Chandler, Arizona
 
415,000
 
Executive and Administrative Offices; Wafer Probe; R&D Center; Sales and Marketing; and Computer and Service Functions
Bangalore, India
 
281,000
 
Research and Development; Sales and Marketing Support, and Administrative Offices
Chacherngsao, Thailand
 
215,000
 
Assembly and Test
Rousset, France
 
170,000
 
Design, Engineering, Test and Administrative
Nantes, France
 
77,000
 
Design, Engineering, Test and Probe, Administrative and Warehousing
Shanghai, China
 
21,000
 
Research and Development; Marketing Support, and Administrative Offices
Hsinchu, Taiwan
 
15,000
 
Design, Engineering and Administrative

The following additional facilities are under construction for additional office space: In Chandler, Arizona an additional 260,000 sq. ft, in Chennai, India an additional 96,000 sq. ft., and in Heilbronn, Germany an additional 46,000 sq. ft.

In addition to the facilities we own, we lease several research and development facilities and sales offices in North America, Europe and Asia.  Our aggregate monthly rental payment for our leased facilities is approximately $2.2 million.
 
We currently believe that our existing facilities are suitable and will be adequate to meet our requirements for at least the next 12 months.
 
See page 45 for a discussion of the capacity utilization of our manufacturing facilities.

Item 3.    LEGAL PROCEEDINGS

Refer to Note 12 to our consolidated financial statements for information regarding legal proceedings.

Item 4.    MINE SAFETY DISCLOSURES

Not applicable.

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PART II

Item 5.    MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Our common stock is traded on the NASDAQ Global Market under the symbol "MCHP." The following table sets forth the quarterly high and low closing prices of our common stock as reported by NASDAQ for our last two fiscal years.

Fiscal 2018
 
High
 
Low
 
Fiscal 2017
 
High
 
Low
First Quarter
 
$
86.86

 
$
72.15

 
First Quarter
 
$
52.99

 
$
47.16

Second Quarter
 
$
91.01

 
$
75.81

 
Second Quarter
 
$
62.80

 
$
49.49

Third Quarter
 
$
95.36

 
$
85.47

 
Third Quarter
 
$
66.18

 
$
58.41

Fourth Quarter
 
$
100.24

 
$
79.90

 
Fourth Quarter
 
$
74.52

 
$
62.59


Stock Price Performance Graph
 
The following graph and table show a comparison of the five-year cumulative total stockholder return, calculated on a dividend reinvestment basis, for Microchip Technology Incorporated, the Standard & Poor's (S&P) 500 Stock Index, and the Philadelphia Semiconductor Index.

Comparison of 5 year Cumulative Total Return*
chart-3dbfdd914f6154bbbd8.jpg
*$100 invested on March 31, 2013 in stock or index, including reinvestment of dividends
Fiscal year ending March 31.

Copyright © 2017 S&P, a division of McGraw Hill Financial. All rights reserved.


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Cumulative Total Return
 
 
March 2013
 
March 2014
 
March 2015
 
March 2016
 
March 2017
 
March 2018
Microchip Technology Incorporated
 
100.00
 
134.48
 
141.94
 
144.39
 
226.37
 
285.15
S&P 500 Stock Index
 
100.00
 
121.86
 
137.37
 
139.82
 
163.83
 
186.75
Philadelphia Semiconductor Index
 
100.00
 
129.22
 
150.41
 
150.14
 
210.77
 
290.57

Data acquired by Research Data Group, Inc. (www.researchdatagroup.com)

On May 9, 2018, there were approximately 566 holders of record of our common stock.  This figure does not reflect beneficial ownership of shares held in nominee names.

We have been declaring and paying quarterly cash dividends on our common stock since the third quarter of fiscal 2003.  Our total cash dividends paid were $337.5 million, $315.4 million and $291.1 million in fiscal 2018, fiscal 2017 and fiscal 2016, respectively.  The following table sets forth our quarterly cash dividends per common share and the total amount of the dividend payment for each quarter in fiscal 2018 and fiscal 2017 (amounts in millions, except per share amounts):
 
Fiscal 2018
 
Dividends per Common Share
 
Aggregate
Amount of Dividend
Payment
 
Fiscal 2017
 
Dividends per Common Share
 
Aggregate
Amount of Dividend
Payment
First Quarter
 
$
0.3615

 
$
82.9

 
First Quarter
 
$
0.3595

 
$
77.2

Second Quarter
 
$
0.3620

 
$
84.5

 
Second Quarter
 
$
0.3600

 
$
77.6

Third Quarter
 
$
0.3625

 
$
84.9

 
Third Quarter
 
$
0.3605

 
$
78.0

Fourth Quarter
 
$
0.3630

 
$
85.2

 
Fourth Quarter
 
$
0.3610

 
$
82.6

 
On May 8, 2018, we declared a quarterly cash dividend of $0.3635 per share, which will be paid on June 4, 2018 to stockholders of record on May 21, 2018 and the total amount of such dividend is expected to be approximately $85.6 million. Our Board of Directors is free to change our dividend practices at any time and to increase or decrease the dividend paid, or not to pay a dividend, on our common stock on the basis of our results of operations, financial condition, cash requirements and future prospects, and other factors deemed relevant by our Board of Directors.  Our current intent is to provide for ongoing quarterly cash dividends depending upon market conditions and our results of operations.
 
Refer to "Item 12 - Security Ownership Of Certain Beneficial Owners And Management And Related Stockholder Matters," at page 53 below, for the information required by Item 201(d) of Regulation S-K with respect to securities authorized for issuance under our equity compensation plans at March 31, 2018.

Issuer Purchases of Equity Securities

In May 2015, our Board of Directors authorized the repurchase of up to 20.0 million shares of our common stock in the open market or in privately negotiated transactions.  As of March 31, 2016, we had repurchased 8.6 million shares under this authorization for approximately $363.8 million.  In January 2016, our Board of Directors authorized an increase in 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 fiscal 2018.  There is no expiration date associated with this repurchase program.



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Item 6.    SELECTED FINANCIAL DATA 

You should read the following selected consolidated financial data for the five-year period ended March 31, 2018 in conjunction with our consolidated financial statements and notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in Items 7 and 8 of this Form 10-K.  Our consolidated statements of income data for each of the years in the three-year period ended March 31, 2018, and the balance sheet data as of March 31, 2018 and 2017, are derived from our audited consolidated financial statements, included in Item 8 of this Form 10-K.  The statement of income data for the years ended March 31, 2015 and 2014 and balance sheet data as of March 31, 2016, 2015 and 2014 have been derived from our audited consolidated financial statements not included herein (in the tables below all amounts are in millions, except per share data).

Statement of Income Data:

 
 
Year ended March 31,
 
 
2018
 
2017 (1)
 
2016 (1)
 
2015
 
2014
Net sales
 
$
3,980.8

 
$
3,407.8

 
$
2,173.3

 
$
2,147.0

 
$
1,931.2

Cost of sales
 
1,560.1

 
1,650.6

 
967.8

 
917.5

 
802.5

Research and development
 
529.3

 
545.3

 
372.6

 
349.5

 
305.0

Selling, general and administrative
 
452.1

 
499.8

 
301.7

 
274.8

 
267.3

Amortization of acquired intangible assets
 
485.5

 
337.7

 
174.9

 
176.8

 
94.5

Special charges and other, net (2)
 
17.5

 
98.6

 
4.0

 
2.8

 
3.0

Operating income
 
936.3

 
275.8

 
352.3

 
425.6

 
458.9

Losses on equity method investments
 
(0.2
)
 
(0.2
)
 
(0.3
)
 
(0.3
)
 
(0.2
)
Interest income
 
22.0

 
3.1

 
24.4

 
19.5

 
16.5

Interest expense
 
(199.0
)
 
(146.3
)
 
(104.0
)
 
(62.0
)
 
(48.7
)
Loss on settlement of convertible debt (3)
 
(16.0
)
 
(43.9
)
 

 
(50.6
)
 

Other income (loss), net
 
(5.8
)
 
1.3

 
8.9

 
13.7

 
5.9

Income from continuing operations before income taxes
 
737.3

 
89.8

 
281.3

 
345.9

 
432.4

Income tax (benefit) provision
 
481.9

 
(80.8
)
 
(42.6
)
 
(19.4
)
 
37.1

Net income from continuing operations
 
255.4

 
170.6

 
323.9

 
365.3

 
395.3

Less: Net loss attributable to noncontrolling interests
 

 

 
0.2

 
3.7

 

Net income from continuing operations attributable to Microchip Technology
 
$
255.4

 
$
170.6

 
$
324.1

 
$
369.0

 
$
395.3

Basic net income per common share from continuing operations attributable to Microchip Technology stockholders
 
$
1.10

 
$
0.79

 
$
1.59

 
$
1.84

 
$
1.99

Diluted net income per common share from continuing operations attributable to Microchip Technology stockholders
 
$
1.03

 
$
0.73

 
$
1.49

 
$
1.65

 
$
1.82

Dividends declared per common share
 
$
1.449

 
$
1.441

 
1.433

 
1.425

 
1.417

Basic common shares outstanding
 
232.9

 
217.2

 
203.4

 
200.9

 
198.3

Diluted common shares outstanding
 
248.9

 
234.8

 
217.4

 
223.6

 
217.6

 
(1) 
Refer to Note 2 to our consolidated financial statements for an explanation of our material business combinations during fiscal 2017 and fiscal 2016.

(2) The following table presents a summary of special charges and other, net for the five-year period ended March 31, 2018:


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March 31,
 
 
2018
 
2017
 
2016
 
2015
 
2014
Acquisition related expenses
 
$
(2.5
)
 
$
98.6

 
$
11.2

 
$
2.8

 
$
1.6

Legal settlement
 

 

 
(7.2
)
 

 

Adjustment to contingent consideration
 

 

 

 

 
1.4

Non-acquisition related contract exit costs and other
 
$
20.0

 
$

 
$

 
$

 
$

Totals
 
$
17.5

 
$
98.6

 
$
4.0

 
$
2.8

 
$
3.0


Discussions of the special charges and other, net for fiscal 2018, fiscal 2017 and fiscal 2016 are contained in Note 3 to our consolidated financial statements.

During fiscal 2015 and fiscal 2014, we incurred special charges of $2.8 million and $3.0 million, respectively, related to severance, office closing and other costs associated with our acquisition activity.

(3) Refer to Note 11 to our consolidated financial statements for an explanation of the loss on settlement of debt of approximately $16.0 million in fiscal 2018 and $43.9 million in fiscal 2017.

Balance Sheet Data:

 
 
March 31,
 
 
2018
 
2017
 
2016
 
2015
 
2014
Working capital (1)
 
$
1,338.9

 
$
1,600.5

 
$
2,714.7

 
$
2,310.6

 
$
1,633.3

Total assets
 
8,257.2

 
7,686.9

 
5,537.9

 
4,780.7

 
4,067.6

Long-term obligations, less current portion (1)
 
1,758.4

 
2,900.5

 
2,453.4

 
1,826.9

 
1,003.3

Microchip Technology Stockholders' equity
 
3,279.8

 
3,270.7

 
2,150.9

 
2,044.7

 
2,135.5


(1) $1,309.9 million of the 2015 senior convertible debt is classified as short-term as of March 31, 2018 as it is currently convertible.

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Item 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Note Regarding Forward-looking Statements
 
This report, including "Item 1 – Business," "Item 1A – Risk Factors," and "Item 7 – Management's Discussion and Analysis of Financial Condition and Results of Operations," 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 13 and elsewhere in this Form 10-K.  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 uncertain 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 and modest pricing declines in certain of our more mature proprietary 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;
The Microsemi acquisition is expected to close in the June 2018 quarter;
That we currently expect to finance the purchase price of our pending Microsemi acquisition using a combination of cash, our existing line of credit and new debt;
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 June 2018 days of inventory levels will be down six days to up four days compared to the March 2018 levels. Our belief that our existing level of inventory 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;
The accuracy of our estimates of the useful life and values of our property, assets and other liabilities;
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;

33


Continuation and amount of quarterly cash dividends;
That the Atmel 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;
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 we intend to pay the one-time transition tax over a period of eight years;
Our belief that our determinations with respect to the tax consequences of the Atmel acquisition are reasonable;
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 a portion of our offshore earnings is considered to be permanently reinvested offshore and the remaining portion is earmarked for repatriation;
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 satisfy the lesser of the principal amount or the conversion value of our debentures in cash;
Changes to the taxation of undistributed foreign earnings could change our future intentions regarding reinvestment of such earnings;
Our belief that the effect the new tax laws will have on low-taxed income of foreign subsidiaries will have the most significant, adverse impact;
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.

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 in "Item 1A – Risk Factors," and elsewhere in this Form 10-K.  Although we believe that the expectations reflected in our 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 the information contained in any forward-looking statement.

Introduction
 
The following discussion should be read in conjunction with the consolidated financial statements and the related notes that appear elsewhere in this document, as well as with other sections of this Annual Report on Form 10-K, including "Item 1 Business;" "Item 6 Selected Financial Data;" and "Item 8 Financial Statements and Supplementary Data."
 
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 fiscal 2018 compared to fiscal 2017, and for fiscal 2017 compared to fiscal 2016.  We then

34


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."

Recent Developments

On March 1, 2018, we entered into the Merger Agreement to acquire Microsemi for $68.78 per share in cash. The acquisition price represents a total equity value of approximately $8.35 billion, and a total enterprise value of about $10.15 billion, after accounting for Microsemi’s cash and investments, net of debt, on its balance sheet at December 31, 2017. Microsemi offers a comprehensive portfolio of semiconductor and system solutions for aerospace and defense, communications, data center and industrial markets. Microsemi recorded net sales of $492.2 million for its second fiscal quarter ended April 1, 2018 compared to $442.9 million for its second fiscal quarter ended April 2, 2017 and net sales of $960.9 million for the six months ended April 1, 2018 compared to $878.4 million for the six months ended April 2, 2017.  Microsemi is headquartered in Aliso Viejo, California, and has approximately 4,800 employees globally.

The Board of Directors of each of Microchip and Microsemi have unanimously approved the Merger and the Merger Agreement. The transaction is subject to customary closing conditions including regulatory approvals and approval by Microsemi stockholders. There is no financing condition to the closing of the Merger. Assuming the timely receipt of the aforementioned regulatory approvals and the satisfaction of the other closing conditions, we anticipate that the merger will be completed in late May/early June 2018.

We plan to finance the acquisition of Microsemi with a combination of cash and cash equivalents, new borrowings on our line of credit, and the issuance of new debt. For further details, see the discussion in Liquidity and Capital Resources.

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, analog, interface, mixed signal and timing products, wired and wireless connectivity products, memory products and technology licensing.  We provide highly cost-effective embedded control solutions that also offer the advantages of small size, high performance, extreme low power usage, wide voltage range operation, mixed signal integration and ease of development, thus enabling timely and cost-effective integration of our solutions by our customers in their end products.  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, radio frequency (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 communication, computing and aerospace.  Our business is subject to fluctuations based on economic conditions within these markets. 

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


35


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 17 for discussion of the impact of seasonality on our business.

Critical Accounting Policies and Estimates
 
General
 
Our discussion and analysis of our financial condition and results of operations is based upon our 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 debt 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 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 which prevent the sales pricing from being fixed or determinable at the time of shipment to our distributors. Therefore, revenue recognition is deferred until the pricing uncertainty is resolved, which generally occurs when the distributor sells the product to their customer. 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 consolidated balance sheets. 

In connection with our acquisitions of Atmel and Micrel, we acquired certain distributor relationships where revenue was recognized upon shipment to the distributors based on certain contractual terms or prevailing business practices that resulted in the price being fixed and determinable at such time. Following an acquisition, we undertake efforts to align the contract terms and business practices of the acquired entity with our own. Once these efforts are complete, revenue recognition is changed. With respect to such distributor relationships acquired in the Atmel acquisition, as of October 1, 2016, these business practices were conformed to those of our other distributors resulting in the deferral of revenue recognition until the distributor sells the product to their customers. With respect to such distributor relationships acquired in the Micrel acquisition, in the December 2015 quarter,

36


these distributor contracts were changed 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.

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 broad range of individually negotiated price points.  The majority of our distributors' resales require a reduction from the original list price paid.  Often, under these circumstances, we remit back to the distributor a portion of their original purchase price after the resale transaction is completed in the form of a credit against the distributors' outstanding accounts receivable balance.  The credits are on a per unit basis and are not given to the distributor until they provide information to us regarding the sale to their end customer.  The price reductions vary significantly based on the customer, product, quantity ordered, geographic location and other factors. 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.  We do not reduce deferred income on shipments to distributors or accounts receivable by anticipated future concessions; rather, price concessions are typically recorded against deferred income on shipments to distributors and accounts receivable when incurred, which is generally at the time the distributor sells the product.  At March 31, 2018, we had approximately $479.6 million of deferred revenue and $145.8 million in deferred cost of sales recognized as $333.8 million of deferred income on shipments to distributors.  At March 31, 2017, we had approximately $418.0 million of deferred revenue and $125.2 million in deferred cost of sales recognized as $292.8 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 consolidated balance sheets, totaled $203.9 million at March 31, 2018 and March 31, 2017. 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 distributors' 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 consolidated statements of income.  We process discounts taken by distributors against our deferred income on shipments to distributors' balance and true-up the advanced amounts generally after the end of each completed fiscal quarter.  The terms of these advances are set forth in binding legal agreements and are unsecured, bear no interest on unsettled balances and are due upon demand.  The agreements governing these advances can be canceled by us at any time.

We reduce product pricing through price protection based on market conditions, competitive considerations and other factors.  Price protection is granted to distributors on the inventory they have on hand at the date the price protection is offered.  When we reduce the price of our products, it allows the distributor to claim a credit against its outstanding accounts receivable balances based on the new price of the inventory it has on hand as of the date of the price reduction.  There is no immediate revenue impact from the price protection, as it is reflected as a reduction of the deferred income on shipments to distributors' balance.

Products returned by distributors and subsequently scrapped have historically been immaterial to our consolidated results of operations.  We routinely evaluate the risk of impairment of the deferred cost of sales component of the deferred income on shipments to 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.

37


Recent Updates to Revenue Recognition

In May 2014, the Financial Accounting Standards Board (FASB) issued ASU 2014-09-Revenue from Contracts with Customers (Topic 606), which superseded nearly all existing revenue recognition guidance under generally accepted accounting principles in the United States of America (US GAAP).  In August 2015, the FASB issued ASU 2015-14-Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which 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 was effective for the Company beginning April 1, 2018.  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. 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. For a discussion of the financial statement impact related to the adoption of these standards, see “Recently Issued Accounting Pronouncements Not Yet Adopted” in Note 1 to our consolidated financial statements.

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, 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.  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 March 31, 2018, 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.  For the past several years, we have utilized RSUs as our primary equity incentive compensation instrument for employees.  Share-based compensation cost is measured on the grant date based on the fair market value of our common stock discounted for expected future dividends and is recognized as expense on a straight-line basis over the requisite service periods. Total share-based compensation expense recognized in fiscal 2018 was $93.2 million, of which $79.4 million was reflected in operating expenses and $13.8 million was reflected in cost of sales. Total share-based compensation included in our inventory balance was $8.1 million at March 31, 2018

During the year ended March 31, 2017, 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. Prior to the adoption of ASU 2016-09, we estimated the number of share-based awards to be forfeited due to employee turnover.


38


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 net realizable value 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 net realizable 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. As a result of production being below normal operating levels in our wafer fabrication facilities, approximately $1.9 million was charged to cost of sales in fiscal 2016. We operated at slightly below normal capacity levels in our Thailand assembly and test facilities during the third quarter of fiscal 2016, resulting in approximately $1.0 million in charges to cost of sales. There was no charge to cost of sales for reduced production levels in each of fiscal 2018 and fiscal 2017.
 
Income Taxes
 
As part of the process of preparing our 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 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 provided valuation allowances for certain of our deferred tax assets, including state net operating loss carryforwards and state tax credits, where it is more likely than not that some portion, or all of such assets, will not be realized. Due to the Tax Cuts and Jobs Act (the "Act"), we released our valuation allowance on foreign tax credits during the period ending March 31, 2018, which was provisional. We are still evaluating how the Act impacts our valuation allowance on state net operating loss carryforwards and state tax credits, and we may report an adjustment to the valuation allowances under Staff Accounting Bulletin ("SAB") 118 in subsequent quarters. 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.   

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.  During the year ended March 31, 2018, various foreign jurisdictions finalized their audits. The close of these audits did not have an adverse impact on our financial statements. We are currently being audited by the tax authorities in the United States and in various foreign jurisdictions. At this time, we do not know what the outcome of these audits will be. We record benefits for uncertain tax positions based on an assessment of whether it is more likely than not that the tax positions will be sustained based on their technical merits under currently enacted law. If this threshold is not met, no tax benefit of the uncertain tax position is recognized. If the threshold is met, we recognize the largest amount of the tax benefit that is more than 50% likely to be realized upon ultimate settlement.  

The accounting model as defined in Accounting Standards Codification ("ASC") 740 related to the valuation of uncertain tax positions requires us to presume that the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information and that each tax position will be evaluated without consideration of the possibility of offset or aggregation with other positions.  The recognition requirement for the liability exists even if we believe the possibility of examination by a taxing authority or discovery of the related risk matters is remote or where we have a long history of the

39


taxing authority not performing an exam or overlooking an issue.  We will record an adjustment to a previously recorded position if new information or facts related to the position are identified in a subsequent period.  All adjustments to the positions are recorded through the income statement.  Generally, adjustments will be recorded in periods subsequent to the initial recognition if the taxing authority has completed an audit of the period or if the statute of limitation expires.  Due to the inherent uncertainty in the estimation process and in consideration of the criteria of the accounting model, amounts recognized in the financial statements in periods subsequent to the initial recognition may significantly differ from the estimated exposure of the position under the accounting model.

On December 22, 2017, the Act was enacted into law. The Act provides for numerous significant tax law changes and modifications including the reduction of the U.S. federal corporate income tax rate from 35.0% to 21.0%, the requirement for companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred and the creation of new taxes on certain foreign-sourced earnings. As a fiscal year-end taxpayer, certain provisions of the Act began to impact us in our third quarter of fiscal 2018, while other provisions will impact us beginning in fiscal 2019.

The corporate tax rate reduction is effective as of January 1, 2018. Since we have a fiscal year rather than a calendar year, we are subject to rules relating to transitional tax rates. As a result, our fiscal 2018 federal statutory rate will be a blended rate of 31.5%.

In addition to the impacts of tax reform on fiscal 2018, the Act also establishes new tax laws that will be effective for our fiscal 2019, including, but not limited to, (1) a new provision designed to tax low-taxed income of foreign subsidiaries, which allows for the possibility of using foreign tax credits ("FTCs") and a deduction of up to 50% to offset the income tax liability (subject to some limitations); (2) limitations on the deductibility of certain executive compensation; (3) limitations on the deductibility of interest expense; and (4) limitations on the use of FTCs to reduce the U.S. income tax liability. While each of these provisions is expected to have an impact on our tax expense for fiscal 2019 and future periods, we expect the tax on low-taxed income of foreign subsidiaries to have the most significant, adverse impact.

Due to the complexity of the new tax on low-taxed income of foreign subsidiaries, we are continuing to evaluate this provision of the Act and the application of ASC 740. Based on recent FASB deliberations, it appears we will be allowed to make an accounting policy choice of either (1) treating taxes due on future U.S. inclusions in taxable income as a current-period expense when incurred or (2) factoring such amounts into our measurement of our deferred taxes. Our selection of an accounting policy will depend, in part, on analyzing our facts to determine what the impact is expected to be under each method.
 
Senior and Junior Subordinated Convertible Debt
 
We separately account for the liability and equity components of our senior and junior subordinated convertible debt 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 consolidated statements of income.  Lastly, we include the dilutive effect of the shares of our common stock issuable upon conversion of the outstanding senior and junior subordinated convertible debt 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 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.


40


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. Contingencies of an acquired company that exist as of the date of the acquisition are measured at fair value if determinable, which generally is based on a probability weighted model. If fair value is not determinable, contingencies of an acquired company are recognized when they become probable and reasonably estimable.

Results of Continuing Operations
 
The following table sets forth certain operational data as a percentage of net sales for the fiscal years indicated:
 
 
Year Ended March 31,
 
 
2018
 
2017
 
2016
Net sales
 
100.0
%
 
100.0
%
 
100.0
%
Cost of sales
 
39.2

 
48.4

 
44.5

Gross profit
 
60.8

 
51.6

 
55.5

 
 
 
 
 
 
 
Research and development
 
13.3

 
16.0

 
17.1

Selling, general and administrative
 
11.4

 
14.7

 
13.9

Amortization of acquired intangible assets
 
12.2

 
9.9

 
8.1

Special charges and other, net
 
0.4

 
2.9

 
0.2

Operating income
 
23.5
%
 
8.1
%
 
16.2
%

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.

The following table summarizes our net sales for the periods covered by this report (dollars in millions):

 
Year Ended March 31,
 
2018
 
% Change
 
2017
 
% Change
 
2016
Net Sales
$
3,980.8

 
16.8
%
 
$
3,407.8

 
56.8
%
 
$
2,173.3


The increases in net sales in fiscal 2018 compared to fiscal 2017 and in fiscal 2017 compared to fiscal 2016 were impacted by the following two accounting factors, which occurred in fiscal 2017:

an amount of revenue that could not be recognized under generally accepted accounting principles in the United States of America relating to Atmel's inventory in the distribution channel on the acquisition date; and
the impact of the change in timing of revenue recognition for some of Atmel's distributors from shipment to the distributor to upon sale by the distributor to their customers.

Excluding the impact of the two accounting factors described above, net sales for fiscal 2018 compared to fiscal 2017 increased 14.0%. This increase was primarily due to growth in our business driven by favorable economic and semiconductor industry conditions. Approximately 6% of the increase in net sales during this period was due to increases in the overall average selling price of products sold as a result of favorable market conditions and product and geographic mix.  The remaining sales growth was primarily due to a net increase in the volume of products sold.  We sell a large number of products to a large and diverse customer base and there was not any product, customer or market that accounted for a material portion of the increase. The overall average selling price of our products is affected by pricing declines over the life of individual

41


products; however, variations in our product and geographic mix of sales can cause wider fluctuations in our overall average selling price in any given period.

Excluding the impact of the two accounting factors described above, net sales for fiscal 2017 compared to fiscal 2016 increased 60.7%. This increase was primarily due to our acquisition of Atmel and also due to growth in our historical business driven by general economic and semiconductor industry conditions. Average selling prices were not a material factor in the sales growth as they were flat in fiscal 2017 compared to fiscal 2016. Sales growth was primarily driven by the increase in the number of units of our semiconductor products sold in fiscal 2017 compared to fiscal 2016 as a result of our acquisition of Atmel and growth in our historical business.

As discussed in the following paragraphs, there were revenue gains across our product lines with the largest dollar value increase in microcontrollers, which is our largest product line.  This growth was due to favorable economic and semiconductor conditions and market share gains.  Key factors impacting the amount of net sales during the last three fiscal years 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.

Net sales by product line for fiscal 2018, 2017 and 2016 were as follows (dollars in millions):
 
Year Ended March 31,
 
2018
 
%
 
2017
 
%
 
2016
 
%
Microcontrollers
$
2,619.1

 
65.9
 
$
2,147.3

 
63.0
 
$
1,345.5

 
61.9
Analog, interface, mixed signal and timing products
952.0

 
23.9
 
888.9

 
26.1
 
595.5

 
27.4
Memory products
199.7

 
5.0
 
184.1

 
5.4
 
116.9

 
5.4
Technology licensing
104.8

 
2.6
 
91.2

 
2.7
 
89.1

 
4.1
Multi-market and other
105.2

 
2.6
 
96.3

 
2.8
 
26.3

 
1.2
Total net sales
$
3,980.8

 
100.0
 
$
3,407.8

 
100.0
 
$
2,173.3

 
100.0

Microcontrollers
 
Our microcontroller product line represents the largest component of our total net sales.  Microcontrollers and associated application development systems accounted for approximately 65.9%, 63.0% and 61.9% of our net sales in fiscal 2018, 2017 and 2016, respectively.
 
Net sales of our microcontroller products increased approximately 22.0% in fiscal 2018 compared to fiscal 2017, and increased approximately 59.6% in fiscal 2017 compared to fiscal 2016.  The increase in net sales in fiscal 2018 compared to fiscal 2017 resulted primarily from growth in our business driven by general economic and semiconductor industry conditions and market share gains. The increase in net sales in fiscal 2017 compared to fiscal 2016 resulted primarily from our acquisition of Atmel and also by growth in our historical business driven by general economic and semiconductor industry conditions.

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. The average selling price of our microcontroller products is affected by these trends; however, variations in our product and geographic mix of sales can cause wider fluctuations in the average selling price of our microcontroller products in any given period.

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Analog, Interface, Mixed Signal and Timing Products
 
Sales of our analog, interface, mixed signal and timing products accounted for approximately 23.9%, 26.1% and 27.4% of our net sales in fiscal 2018, 2017 and 2016, respectively.
 
Net sales of our analog, interface, mixed signal and timing products increased approximately 7.1% in fiscal 2018 compared to fiscal 2017 and increased approximately 49.3% in fiscal 2017 compared to fiscal 2016.  The increase in net sales in fiscal 2018 compared to fiscal 2017 resulted primarily from growth in our business driven by general economic and semiconductor industry conditions and market share gains. The increase in net sales in fiscal 2017 compared to fiscal 2016 was driven primarily by our acquisition of Atmel and also by growth in our historical business driven by general economic and semiconductor industry conditions. Additionally, some new analog products, which are integrated with a microcontroller core, are classified as microcontrollers, rather than analog. This classification adversely impacted some of the increases in net sales of analog products during fiscal 2018 compared to fiscal 2017 and fiscal 2017 compared to fiscal 2016.
 
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. 

Memory Products
 
Sales of our memory products accounted for approximately 5.0% of our net sales in fiscal 2018 and approximately 5.4% of our net sales in each of fiscal 2017 and fiscal 2016.
 
Net sales of our memory products increased approximately 8.5% in fiscal 2018 compared to fiscal 2017, and increased approximately 57.5% in fiscal 2017 compared to fiscal 2016.  The increase in memory product net sales in fiscal 2018 compared to fiscal 2017 resulted primarily from growth in our business driven by general economic and semiconductor industry conditions. The increase in memory product net sales in fiscal 2017 compared to fiscal 2016 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%, 2.7% and 4.1% of our net sales in fiscal 2018, 2017 and 2016, respectively.
 
Net sales related to our technology licensing increased approximately 14.9% in fiscal 2018 compared to fiscal 2017 and increased approximately 2.4% in fiscal 2017 compared to fiscal 2016. 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
 
 Multi-market and Other (MMO) consists of manufacturing services (wafer foundry and assembly and test subcontracting), legacy application specific integrated circuits, complex programmable logic devices, and products for aerospace applications. Revenue from these services and products accounted for approximately 2.6%, 2.8% and 1.2% of our net sales in fiscal 2018, 2017 and 2016, respectively.

Net sales related to these services and products increased approximately $8.9 million in fiscal 2018 compared to fiscal 2017 and increased approximately $70.0 million in fiscal 2017 compared to fiscal 2016. The increase in MMO net sales in fiscal 2018 compared to fiscal 2017 resulted primarily from growth in our business driven by general economic and

43


semiconductor industry conditions. The increase in MMO net sales in fiscal 2017 compared to fiscal 2016 was driven primarily by our acquisition of Atmel. MMO net sales can fluctuate over time based on general economic and semiconductor industry conditions as well as changes in demand for our manufacturing services (wafer foundry and assembly and test subcontracting).
 
Distribution
 
Distributors accounted for approximately 54% of our net sales in fiscal 2018, approximately 55% of our net sales in fiscal 2017 and approximately 53% of our net sales in fiscal 2016. No single distributor accounted for more than 10% of our net sales in each of fiscal 2018, 2017 or 2016. 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 March 31, 2018, our distributors maintained 36 days of inventory of our products compared to 33 days at March 31, 2017 and 32 days at March 31, 2016.  Over the past ten fiscal years, the days of inventory maintained by our distributors have fluctuated between approximately 27 days and 47 days.  Prior to our adoption of ASU 2014-09-Revenue from Contracts with Customers (Topic 606) on April 1, 2018, we did not believe that inventory holding patterns at our distributors materially impacted our net sales due to the fact that we recognized revenue based on when the distributor sells the product to their customer. Upon our adoption of Topic 606 commencing on April 1, 2018, we will be required to recognize revenue from distributors at the time our products are sold to the distributor.  As a result, beginning April 1, 2018, inventory holding patterns at our distributors may have a material impact on our net sales.
 
Sales by Geography
 
Sales by geography for fiscal 2018, 2017 and 2016 were as follows (dollars in millions):
 
Year Ended March 31,
 
2018
 
%
 
2017
 
%
 
2016
 
%
Americas
$
717.4

 
18.0
 
$
641.8

 
18.8
 
$
417.6

 
19.2
Europe
962.1

 
24.2
 
808.6

 
23.7
 
474.6

 
21.8
Asia
2,301.3

 
57.8
 
1,957.4

 
57.5
 
1,281.1

 
59.0
Total net sales
$
3,980.8

 
100.0
 
$
3,407.8

 
100.0
 
$
2,173.3

 
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 fiscal 2018 and 84% of our total net sales in each of fiscal 2017 and 2016. 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.

Sales to customers in China, including Hong Kong, accounted for approximately 30%, 32% and 30% of our net sales in fiscal 2018, 2017 and 2016, respectively.  Sales to customers in Taiwan accounted for approximately 11%, 9% and 12% of our net sales in fiscal 2018, 2017 and 2016, respectively. We did not have sales into any other foreign countries that exceeded 10% of our net sales during fiscal 2018, 2017 or 2016.
 
Gross Profit
 
Our gross profit was $2,420.7 million in fiscal 2018, $1,757.2 million in fiscal 2017 and $1,205.5 million in fiscal 2016.  Gross profit as a percentage of sales was 60.8% in fiscal 2018, 51.6% in fiscal 2017 and 55.5% in fiscal 2016.
 


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The most significant factors affecting our gross profit percentage in the periods covered by this Form 10-K were:
 
charges of approximately $186.7 million in fiscal 2017 and approximately $44.9 million in fiscal 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 fiscal 2017 and fiscal 2016, inventory write-downs being higher than the gross margin impact of sales of inventory that was previously written down; and
for fiscal 2018, inventory write-downs being lower 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-K include:
 
continual cost reductions in wafer fabrication and assembly and test manufacturing, such as new manufacturing technologies and more efficient manufacturing techniques;
lower depreciation as a percentage of cost of sales;
increases in the level of assembly and test operations performed at our internal facilities compared to assembly and test operations performed by our third-party contractors, which lower our manufacturing costs as these functions are performed internally; and
favorable market conditions and product mix.

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. In fiscal 2018 and fiscal 2017, 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. During the third quarter of fiscal 2016, our wafer fabrication facilities operated below normal capacity levels in response to uncertain global economic conditions and our inventory position at the time. As a result of production being below normal operating levels in our wafer fabrication facilities, approximately $1.9 million was charged to cost of sales in fiscal 2016. We operated at slightly below normal capacity levels in our Thailand assembly and test facilities during the third quarter of fiscal 2016, resulting in approximately $1.0 million in charges to cost of sales.

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 0.13 micron to 0.5 micron processes.  We continue to transition products to more advanced process technologies to reduce future manufacturing costs.  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%. Our wafer fabrication facility in Colorado Springs, Colorado (Fab 5) currently utilizes processes between 0.25 micron and 1.0 micron that run on 6-inch wafers. We consider normal capacity at Fab 5 to be 70% to 75%. As a result of our acquisition of Micrel in August 2015, we acquired a 6-inch wafer fabrication facility in San Jose, California and have since transitioned products previously manufactured at this facility to our Fab 2, Fab 4 and Fab 5 facilities. During the quarter ended December 31, 2016, we decommissioned this San Jose facility and, in June 2017, we completed the sale of these assets for proceeds of $10.0 million.

Our overall inventory levels were $476.2 million at March 31, 2018, compared to $417.2 million at March 31, 2017 and $306.8 million at March 31, 2016.  We maintained 112 days of inventory on our balance sheet at March 31, 2018 compared to 103 days of inventory at March 31, 2017 and 110 days at March 31, 2016.  We expect our days of inventory levels in the June 2018 quarter to be down six days to up four days compared to the March 2018 levels. 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.
 
We operate assembly and test facilities in Thailand and Philippines and, as a result of our acquisition of Atmel, we acquired a test facility in Calamba, Philippines. During fiscal 2018, approximately 42% of our assembly requirements were performed in our Thailand facilities, compared to approximately 36% during fiscal 2017 and approximately 53% during fiscal 2016.  The

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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 fiscal 2018 and fiscal 2017, approximately 64% and 60%, respectively, of our test requirements were performed in our Thailand and Philippines facilities compared to approximately 81% of our test requirements performed in our Thailand facilities during fiscal 2016. The increase in the percentage of assembly and test work that was performed internally in fiscal 2018 compared to fiscal 2017 is primarily due to our recent investments in assembly and test equipment, which have increased our internal capacity capabilities. The primary reason for the percentage reduction in the assembly and test operations performed internally in fiscal 2017 compared to fiscal 2016 is our acquisition of Atmel, which outsourced most of these activities. 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. During fiscal 2018, approximately 42% of our total net sales came from products that were produced at outside wafer foundries compared to approximately 41% during fiscal 2017 and approximately 39% during fiscal 2016.

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 fiscal 2018 were $529.3 million, or 13.3% of sales, compared to $545.3 million, or 16.0% of sales, for fiscal 2017 and $372.6 million, or 17.1% of sales, for fiscal 2016. 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.
 
R&D expenses decreased $16.0 million, or 2.9%, for fiscal 2018 compared to fiscal 2017 primarily due to reductions in personnel and associated costs in connection with synergies realized from our Atmel acquisition and lower share-based compensation expense due to accelerated vesting of equity awards held by terminated Atmel employees during fiscal 2017. Our goal is to continue to be more efficient with our operating expenses as our revenue increases. R&D expenses increased $172.7 million, or 46.3%, for fiscal 2017 compared to fiscal 2016 primarily due to additional compensation and other costs from our acquisition of Atmel. R&D as a percentage of revenue decreased in fiscal 2018 compared to fiscal 2017 and in fiscal 2017 compared to fiscal 2016 due to our restructuring activities and synergies realized following the 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 fiscal 2018 were $452.1 million, or 11.4% of sales, compared to $499.8 million, or 14.7% of sales, for fiscal 2017, and $301.7 million, or 13.9% of sales, for fiscal 2016.  Selling, general and administrative expenses include salary expenses related to field sales, marketing and administrative personnel, advertising and promotional expenditures and legal expenses.  Selling, general and administrative expenses also include costs related to our direct sales force, CEMs and ESEs who work in sales offices worldwide to stimulate demand by assisting customers in the selection and use of our products.

Selling, general and administrative expenses decreased $47.7 million, or 9.5%, for fiscal 2018 compared to fiscal 2017 due primarily to reductions in personnel and associated costs in connection with synergies realized from our Atmel acquisition and lower share-based compensation expense due to accelerated vesting of equity awards held by terminated Atmel employees during fiscal 2017. Our goal is to continue to be more efficient with our operating expenses as our revenue increases. Selling, general and administrative expenses increased $198.1 million, or 65.7%, for fiscal 2017 compared to fiscal 2016 due primarily to additional costs from our acquisition of Atmel.


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Selling, general and administrative expenses fluctuate over time, primarily due to revenue and operating expense investment levels.
 
Amortization of Acquired Intangible Assets

Amortization of acquired intangible assets in fiscal 2018 was $485.5 million compared to $337.7 million in fiscal 2017 and $174.9 million in fiscal 2016. The primary reason for the increase in acquired intangible asset amortization for fiscal 2018 compared to fiscal 2017 was amortization of in-process R&D assets from our acquisition of Atmel, which assets started to amortize during the third quarter of fiscal 2017. The primary reasons for the increase in acquired intangible asset amortization for fiscal 2017 compared to fiscal 2016 were increased amortization from our acquisitions of Atmel and Micrel partially offset by decreased amortization from our customer-related intangible assets from our acquisitions of Standard Microsystems Corporation (SMSC) and ISSC Technologies Corporation (ISSC).

Special Charges and Other, Net
 
During fiscal 2018, we incurred special charges and other, net of $17.5 million comprised primarily of a $19.5 million charge for fees associated with transitioning from a public utility provider in Oregon to a lower cost direct access provider. During fiscal 2017, we incurred special charges and other, net of $98.6 million comprised primarily of restructuring charges. Our restructuring activities include workforce, property and other operating expense rationalizations as well as combining product roadmaps and manufacturing operations. In connection with these activities we incurred employee separation costs, contract exit costs, other operating expenses and intangible asset impairment losses. The impairment losses were recognized as a result of changes in the combined product roadmaps after the acquisition of Atmel that affected the use and life of these assets. During fiscal 2016, we incurred special charges and other, net of $4.0 million comprised of $11.2 million of restructuring charges associated with our acquisition activity and legal settlement costs of approximately $4.3 million partially offset by special income and other, net of $11.5 million related to an insurance settlement for reimbursement of funds we previously paid to settle a lawsuit in the second quarter of fiscal 2013.
 
Other Income (Expense)
 
Interest income in fiscal 2018 was $22.0 million compared to $3.1 million in fiscal 2017 and $24.4 million in fiscal 2016.  The primary reason for the increase in interest income in fiscal 2018 compared to fiscal 2017 relates to higher cash and investment balances. The primary reason for the decrease in interest income in fiscal 2017 compared to fiscal 2016 relates to lower invested cash balances as we used cash to finance a significant portion of the purchase price of our acquisition of Atmel.

Interest expense in fiscal 2018 was $199.0 million compared to $146.3 million in fiscal 2017 and $104.0 million in fiscal 2016. The primary reasons for the increase in interest expense in fiscal 2018 compared to fiscal 2017 relates to our issuance of $2,645.0 million of convertible notes in February 2017 partially offset by lower interest expense on amounts borrowed under our credit facility. In February 2017, we paid off the remaining balance on our credit facility. The primary reasons for the increase in interest expense in fiscal 2017 compared to fiscal 2016 relates to higher interest expense on amounts borrowed under our credit facility to partially finance our acquisition of Atmel, as well as the aforementioned issuance of convertible notes in February 2017.

Loss on settlement of convertible debt in fiscal 2018 and fiscal 2017 was $16.0 million and $43.9 million, respectively. In fiscal 2018 and fiscal 2017, we settled $143.8 million and $431.3 million, respectively, in principal of our 2007 Junior Subordinated Convertible Debt (2007 Junior Debt). Total conversions for fiscal 2018 were for a principal amount of $32.5 million for which we settled the principal amount in cash and issued 0.5 million shares of our common stock in respect of the conversion value in excess of the principal amount for the conversions occurring prior to the call notice and $41.0 million in cash for the conversion value in excess of the principal amount for the conversion requests received after the call notice. In June 2017, we exchanged in privately negotiated transactions $111.3 million aggregate principal amount of our 2007 Junior Debt for (i) $111.3 million principal amount of our 2017 Junior Subordinated Convertible Debt (2017 Junior Debt) with a market value of $119.3 million plus (ii) the issuance of 3.2 million shares of our common stock with a value of $254.6 million. In the case of the fiscal 2017 settlement, the principal value of $431.3 million was settled in cash and we issued shares of our common stock in respect of the conversion value in excess of the principal amount plus a cash inducement fee of $5.0 million.

Other loss, net in fiscal 2018 was $5.8 million compared to other income, net of $1.3 million in fiscal 2017 and other income, net of $8.9 million in fiscal 2016. The primary reasons for the change in other income (loss) during fiscal 2018 compared to fiscal 2017 relates to impairments on available for sale investments partially offset by gains on foreign currency exchange rate fluctuations. The impairments on the available for sale investments are due to the anticipated liquidation of these investments in the first quarter of fiscal 2019 to fund our pending acquisition of Microsemi. The primary reason for the change

47


in other income (loss) during fiscal 2017 compared to fiscal 2016 relate to the lower realized gains on the sale of marketable equity and debt securities.

Provision for Income Taxes
 
The provision for income taxes reflects tax on foreign earnings and federal and state tax on U.S. earnings. We had an effective tax rate of 65.4% in fiscal 2018, a 90.0% benefit in fiscal 2017, and a 15.2% benefit in fiscal 2016.  Excluding certain tax events described below, our effective tax rates were lower than statutory rates in the U.S. primarily due to our mix of earnings in foreign jurisdictions with lower tax rates.  

Our effective tax rate in fiscal 2018 includes $644.7 million of tax expense estimated on a provisional basis, calculated under SAB 118, related to the one-time transition tax on certain foreign earnings, $136.7 million of tax benefit estimated on a provisional basis related to the revaluation of our deferred tax assets and liabilities to the newly enacted U.S. statutory tax rate of 21.0%, and $20.5 million of tax benefit estimated on a provisional basis related to the release of valuation allowances against our foreign tax credit carryforwards. These three adjustments increased (reduced) our effective tax rate by 87.4%, (18.5%), and (2.8%), respectively. Our effective tax rate in fiscal 2018 also includes a $17.0 million tax benefit received from current year generated R&D credits, which reduced our effective tax rate by 2.3%. Our effective tax rate in 2018 also includes a $27.2 million tax benefit for share-based compensation deductions, which reduced our effective tax rate by 3.7%. Our effective tax rate in 2018 also includes a $11.3 million benefit related to audit closures and expirations of the statute of limitations on various tax reserves, which reduced our effective tax rate by 1.5%.

Our effective tax rate in fiscal 2017 included $36.3 million of benefits related to audit closures and expirations of the statute of limitations on various tax reserves and $7.9 million of expense related to intercompany prepaid tax amortization, which reduced our effective tax rate by 40.4% and increased our effective tax rate by 8.8%, respectively. Our effective tax rate in fiscal 2017 included a $12.8 million benefit received from current year generated R&D credits, which reduced our effective tax rate by 14.3%. Our effective tax rate in fiscal 2017 also included a $25.0 million benefit for share-based compensation deductions, which reduced our effective tax rate by 27.8%.

Our effective tax rate in fiscal 2016 included $12.1 million of benefits related to audit closures and expirations of the statute of limitations on various tax reserves and $15.5 million of benefits related to intercompany prepaid tax amortization, which reduced our effective rate by 4.3% and 5.5%, respectively. Our effective tax rate in fiscal 2016 also included a $2.5 million benefit received from the reinstatement of the R&D credit and a $13.5 million benefit received from current year generated R&D credits, which reduced our effective tax rate by 0.9% and 4.8%, respectively.

We are also subject to taxation in many other jurisdictions where we have operations. The effective tax rates that we pay in these jurisdictions vary widely, but they are generally lower than our combined U.S. federal and state effective tax rate. Our domestic statutory tax rate for the fiscal year ended March 31, 2018 was approximately 33% and our domestic statutory tax rate for fiscal 2017 was approximately 37%. Our non-U.S. blended statutory tax rates for fiscal 2018 and fiscal 2017 were much lower than this amount. The difference in rates applicable in foreign jurisdictions results from a number of factors, including lower statutory rates, historical loss carry-forwards, financing arrangements and other factors. Our effective tax rate has been, and will continue to be impacted by the geographical dispersion of our earnings and losses.

Our foreign tax rate differential benefit primarily relates to our operations in Thailand, Cayman and Ireland. Our Thailand manufacturing operations are currently subject to numerous tax holidays granted to us based on our investment in property, plant and equipment in Thailand. Our tax holiday periods in Thailand expire at various times in the future, however, we actively seek to obtain new tax holidays or we will be subject to tax at the statutory tax rate of 20%. We do not expect the future expiration of any of our tax holiday periods in Thailand to have a material impact on our effective tax rate. The remaining material components of foreign income taxed at a rate lower than the U.S. are earnings accrued in Ireland at a 12.5% statutory tax rate and earnings accrued by Microchip’s offshore technology company which was resident in the Cayman Islands at a 0% statutory tax rate. The tax rate differential in Ireland, Thailand, and Cayman plus the tax holiday in Thailand make up approximately 100% of the $208.8 million benefit of foreign income taxed at a lower rate than the federal rate for fiscal 2018.
 
Various taxing authorities in the U.S. and other countries in which we do business are increasing their scrutiny of 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.  For U.S. federal, and in general for U.S. state tax returns, our fiscal 2005 and later tax returns remain effectively open for examination by the taxing authorities. We are currently being audited by the tax authorities in the United States and in various foreign jurisdictions. At this time, we do not know what the outcome of these audits will be. We record benefits for uncertain tax positions based on an assessment of whether it is more likely than not that the tax positions will be sustained based on their technical merits under currently enacted law. If this threshold is not met,

48


no tax benefit of the uncertain tax position is recognized. If the threshold is met, we recognize the largest amount of the tax benefit that is more than 50% likely to be realized upon ultimate settlement.

Results of Discontinued Operations

Discontinued operations represent the mobile touch operations that we acquired as part of our acquisition of Atmel. On November 10, 2016, we completed the sale of the mobile touch assets to Solomon Systech (Limited) International, a Hong Kong based semiconductor company. The transaction included the sale of certain semiconductor products, equipment, customer list, backlog, patents, and a license to certain other intellectual property and patents related to Atmel's mobile touch product line. We also agreed to provide certain transition services to Solomon Systech. For financial statement purposes, the results of operations for this discontinued business have been segregated from those of the continuing operations and are presented in our consolidated financial statements as discontinued operations. Net loss from discontinued operations for the year ended March 31, 2017 was $6.0 million, consisting of a pre-tax loss from operations of $8.2 million and a pre-tax gain on sale of $0.6 million.

Liquidity and Capital Resources
 
We had $2,196.6 million in cash, cash equivalents and short-term investments at March 31, 2018, an increase of $786.3 million from the March 31, 2017 balance of cash, cash equivalents, short-term investments, and long term investments.  The increase in cash, cash equivalents and short-term investments over this time period is primarily attributable to cash generated from operations of $1,419.6 million, offset by dividend payments of $337.5 million, $206.8 million in capital payments and $73.4 million on the settlement of a portion of our convertible debt.
 
Net cash provided from operating activities was $1,419.6 million for fiscal 2018, $1,059.5 million for fiscal 2017 and $744.4 million for fiscal 2016.  The increase in net cash provided from operating activities in fiscal 2018 compared to fiscal 2017 was primarily due to higher net sales as well as operating cash flows resulting from synergies realized from our process efficiencies and restructuring efforts related to our acquisition of Atmel. The increase in net cash provided by operating activities in fiscal 2017 compared to fiscal 2016 was primarily due to operating cash flows resulting from our acquisitions of Atmel and Micrel and operating synergies from our process efficiency and restructuring efforts.

Net cash used in investing activities was $1,011.7 million for fiscal 2018 compared to $2,838.0 million for fiscal 2017 and net cash provided by investing activities of $800.4 million in fiscal 2016.   Fiscal 2018 net investing cash flows primarily result from the net increase in investments of $808.1 million due to cash from operations as well as capital purchases. Fiscal 2017 and fiscal 2016 investing cash flows include net cash and cash equivalents used to finance acquisitions of $2,747.5 million and $361.9 million, respectively. Excluding cash flows used in acquisitions, net investing activities resulted in a use of $90.5 million in fiscal 2017 and net cash provided of $1,162.3 million in fiscal 2016, and represented primarily the net change in our investments, capital purchases and sale of assets.
 
Our level of capital expenditures varies from time to time as a result of actual and anticipated business conditions.  Capital expenditures were $206.8 million in fiscal 2018, $75.3 million in fiscal 2017 and $97.9 million in fiscal 2016.  Capital expenditures are primarily for the expansion of production capacity, the addition of research and development equipment and new office buildings. Capital expenditures in fiscal 2017 were relatively less than we have experienced in recent years as we delayed certain purchases until we had finalized and developed plans following our acquisition of Atmel regarding technology platforms and other manufacturing activities. We currently intend to spend approximately $225.0 million during the next twelve months to invest in equipment and facilities. We believe that the capital expenditures anticipated to be incurred over the next twelve months will provide sufficient manufacturing capacity to support the growth of our production capabilities for our new products and technologies and to bring in-house more of the assembly and test operations that are currently outsourced. We expect to finance our capital expenditures through our existing cash balances and cash flows from operations. 
 
Net cash used in financing activities was $415.3 million for fiscal 2018 compared to net cash provided from financing activities of $595.5 million for fiscal 2017 and net cash used in financing activities of $59.9 million for fiscal 2016. Fiscal 2018 financing cash outflows were primarily the result of dividend payments and payments on the settlement of our convertible debt. Fiscal 2017 cash flows were favorably impacted by the net proceeds of debt issued that year. Significant transactions affecting our net financing cash flows include:

In fiscal 2017, we issued $2,645.0 million of debt, of which $2,118.7 million was used to settle debt and reduce borrowings on our credit facility.
In fiscal 2016, we repurchased shares of our common stock for $363.8 million, which was primarily funded with borrowings under our credit facility.

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In fiscal 2018, fiscal 2017 and fiscal 2016, we paid cash dividends to our stockholders of $337.5 million, $315.4 million, and $291.1 million, respectively. The amount of dividends paid has increased due to an increase in the amount of dividends declared per share and in the number of shares outstanding.

On May 18, 2018, we entered into an amended and restated credit agreement which provides for a revolving loan facility in an aggregate principal amount of approximately $3.8 billion, with a $250.0 million foreign currency sublimit, a $50.0 million letter of credit sublimit and a $25.0 million swingline loan sublimit.  The revolving loan facility consists of approximately $244.3 million of revolving loan commitments (the “2020 Revolving Loans”) that terminate on February 4, 2020 (the “2020 Maturity Date”) and approximately $3.6 billion of revolving loan commitments (the “2023 Revolving Loans” and, together with the 2020 Revolving Loans, the “Revolving Loans”) that terminate on May 18, 2023 (the “2023 Maturity Date”).  The Revolving Loans bear interest, at our option, at (a) in the case of 2020 Revolving Loans, the base rate plus a spread of 0.25% to 1.25% or an adjusted LIBOR rate plus a spread of 1.25% to 2.25%, and (b) in the case of 2023 Revolving Loans, the base rate plus a spread of 0.00% to 1.00% or an adjusted LIBOR rate plus a spread of 1.00% to 2.00%, in each case, with such spread being determined based on the consolidated senior leverage ratio for the preceding four fiscal quarter period. 

In June 2017, in connection with the settlement of $111.3 million of our convertible debt, we amended our credit agreement to (i) extend the time period during which we are permitted to repurchase, redeem or exchange our 2007 junior debt and (ii) amend the maximum total leverage ratio covenant to extend the time period for permitted refinancings or exchanges of the 2007 junior debt that may be excluded from the calculation of the ratio, subject to certain conditions.

In February 2017, we amended our credit agreement to, among other things, increase certain covenant compliance ratios. The February 2017 amendment included a new collateral agreement that secures our borrowings with all assets of our guarantor subsidiaries with the exception of real property. Proceeds of loans made under our credit agreement may be used for working capital and general corporate purposes. At March 31, 2018 and 2017, we had no borrowings outstanding under the credit facility. See Note 11 of the notes to consolidated financial statements for more information regarding our credit agreement.
The enactment of the recent U.S tax reform Act in December 2017 imposes a tax on all previously untaxed earnings of non-U.S. subsidiaries of U.S. corporations. Due to this change, the jurisdiction in which our cash is at any given point in time, no longer has a significant impact on our liquidity.  Future distributions of non-U.S. assets to the U.S. will no longer be subject to U.S. federal taxation.  As a result of the Act, we recognized a one-time transition tax expense of $644.7 million on accumulated unrepatriated foreign earnings.  This value is identified as provisional in our consolidated financial statements for the period ended March 31, 2018, and is subject to future measurement period adjustments in accordance with SEC staff issued Staff Accounting Bulletin ("SAB") 118.  We intend to elect to pay this tax over a period of eight years, with 8% of the transition tax paid each year for fiscal 2019 through fiscal 2023, and 15%, 20%, and 25%, respectively, to be paid during fiscal 2024, fiscal 2025, and fiscal 2026.

In February 2016, we terminated our ten-year fixed-to-floating interest rate swap agreements which were related to a portion of our fixed-rate 1.625% 2015 senior subordinated convertible debt. The interest rate swap agreements were designated as fair value hedges. We paid variable interest equal to the three-month LIBOR minus 53.6 basis points and we received a fixed interest rate of 1.625%. Upon termination, the contracts were in an asset position, resulting in cash receipts of approximately $25.7 million, which included $3.7 million of accrued interest. The cash flows from the termination of these interest rate swap agreements have been reported as operating activities in the consolidated statement of cash flows.

We enter into derivative transactions from time to time in an attempt to reduce our exposure to currency rate fluctuations.  Although none of the countries in which we conduct significant foreign operations has had a highly inflationary economy in the last five years, there is no assurance that inflation rates or fluctuations in foreign currency rates in countries where we conduct operations will not adversely affect our operating results in the future.  At March 31, 2018, we had no foreign currency forward contracts outstanding.

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 credit agreement and approximately $486.1 million through the issuance of an aggregate of 10.1 million shares of our common stock. The acquisition price represented a total equity value of approximately $3.47 billion, and a total enterprise value of approximately $3.44 billion, after excluding Atmel's cash and investments net of debt on its balance sheet of approximately $39.3 million. 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. Although we

50


believe our determinations with respect to the tax consequences of the acquisition are reasonable, we are regularly audited by the IRS and may be audited by other taxing authorities, and there can be no assurance as to the outcome of any such audit.

On August 3, 2015, we acquired Micrel for $14.00 per share and paid an aggregate of approximately $430.0 million in cash and issued an aggregate of 8.6 million shares of our common stock to Micrel shareholders. We financed the cash portion of the purchase price with amounts borrowed under our credit agreement.
On March 1, 2018, in connection with our execution of the Merger Agreement, we entered into a Commitment Letter with JPMorgan, pursuant to which JPMorgan committed to provide to us, among other things, (1) a senior secured term loan facility in an aggregate principal amount of up to $5.0 billion and (2) a 364-day secured bridge facility in an aggregate principal amount of up to $625.0 million, in each case, subject to the execution of definitive documentation and customary closing conditions. JPMorgan’s commitments in respect of the Term Loan Facility will be reduced in the event we raise certain other debt or equity financing.
We estimate that the total amount of funds necessary to complete the acquisition of Microsemi and the other transactions contemplated by the Merger Agreement will be approximately $10.15 billion to:

make payments to Microsemi’s stockholders of the amounts due to them under the Merger Agreement;
make payments in respect of Microsemi’s outstanding equity-based awards pursuant to the Merger Agreement;
refinance or otherwise discharge outstanding indebtedness of Microsemi that is required to be refinanced or discharged pursuant to the Merger Agreement, including, without limitation, the termination of commitments and the refinancing of indebtedness under Microsemi’s existing credit agreement, and the optional redemption of Microsemi’s 9.125% Senior Notes due 2023; and
pay related fees, expenses and taxes in connection with the foregoing and consummation of the Merger.
We expect to finance the foregoing through a combination of:

the incurrence of loans under our new term loan facility or other debt financing;
revolving loans under our amended and restated credit agreement; and
Microchip’s and Microsemi’s cash and cash equivalents on hand at closing.
As of March 31 2018, Microchip and Microsemi had combined cash, cash equivalents and short-term investments of approximately $2,419.8 million.

In May 2015, our Board of Directors authorized the repurchase of up to 20.0 million shares of our common stock in the open market or in privately negotiated transactions.  In January 2016, our Board of Directors authorized an increase in the existing share repurchase program to 15.0 million shares of common stock from the approximately 11.4 million shares remaining under the current authorization. As of March 31, 2016, we had repurchased 8.6 million shares under this authorization for approximately $363.8 million.  There were no repurchases of common stock during fiscal 2018 and fiscal 2017. There is no expiration date associated with this repurchase program. 

As of March 31, 2018, we held approximately 18.2 million shares as treasury shares.

On October 28, 2002, we announced that our Board of Directors had approved and instituted a quarterly cash dividend on our common stock.  The initial quarterly dividend of $0.02 per share was paid on December 6, 2003 in the amount of $4.1 million.  To date, our cumulative dividend payments have totaled approximately $3.5 billion.  Cash dividends paid per share were $1.449, $1.441 and $1.433 during fiscal 2018, fiscal 2017 and fiscal 2016, respectively. Total dividend payments amounted to $337.5 million, $315.4 million, $291.1 million during fiscal 2018, fiscal 2017 and fiscal 2016, respectively. On May 8, 2018, we declared a quarterly cash dividend of $0.3635 per share, which will be paid on June 4, 2018, to stockholders of record on May 21, 2018 and the total amount of such dividend is expected to be approximately $85.6 million.  Our Board is free to change our dividend practices at any time and to increase or decrease the dividend paid, or not to pay a dividend, on our common stock on the basis of our results of operations, financial condition, cash requirements and future prospects, and other factors deemed relevant by our Board.  Our current intent is to provide for ongoing quarterly cash dividends depending upon market conditions, our results of operations and potential changes in tax laws.


As discussed above, we plan to finance our pending acquisition of Microsemi through a combination of incurrence of loans under a new term loan facility, revolving loans under Microchip's amended and restated credit agreement, the issuance of the

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senior secured debt; and Microchip's and Microsemi's cash and cash equivalents on hand at closing. Other than such financing required to fund our Microsemi acquisition, we believe that our existing sources of liquidity combined with cash generated from operations and borrowings under our credit agreement will be sufficient to meet our currently anticipated cash requirements for at least the next 12 months. However, the semiconductor industry is capital intensive.  In order to remain competitive, we must constantly evaluate the need to make significant investments in capital equipment for both production and research and development.  We may increase our borrowings under our credit agreement or seek additional equity or debt financing from time to time to maintain or expand our wafer fabrication and product assembly and test facilities, for cash dividends, for share repurchases or for acquisitions or other purposes.  The timing and amount of any such financing requirements will depend on a number of factors, including our level of dividend payments, changes in tax laws and regulations regarding the repatriation of offshore cash, (including the impact of the Act), demand for our products, changes in industry conditions, product mix, competitive factors and our ability to identify suitable acquisition candidates.  There can be no assurance that such financing will be available on acceptable terms, and any additional equity financing would result in incremental ownership dilution to our existing stockholders.

Contractual Obligations
 
The following table summarizes our significant contractual obligations at March 31, 2018, and the effect such obligations are expected to have on our liquidity and cash flows in future periods.  This table excludes amounts already recorded on our balance sheet as current liabilities at March 31, 2018 (dollars in millions):
 
Payments Due by Period
 
Total
 
Less than
1 year
 
1 – 3 years
 
3 – 5 years
 
More than
5 years
Operating lease obligations (1)
$
69.9

 
$
26.0

 
$
32.0

 
$
11.9

 
$

Capital purchase obligations (2)
144.4

 
144.4

 

 

 

Other purchase obligations and commitments (3)
101.6

 
101.0

 
0.6

 

 

2017 senior debt (4)
2,372.8

 
33.6

 
67.3

 
67.3

 
2,204.6

2015 senior debt (5)
1,921.3

 
28.0

 
56.1

 
56.1

 
1,781.1

2017 junior debt (6)
979.7

 
15.4

 
30.9

 
30.9

 
902.5

Pension obligations (7)
16.8

 
0.9

 
2.1

 
3.2

 
10.6

Transition tax obligation (8)
336.1

 
26.9

 
53.8

 
53.8

 
201.6

Total contractual obligations (9)
$
5,942.6


$
376.2

 
$
242.8

 
$
223.2

 
$
5,100.4

(1) Operating lease obligations include $23.3 million of future lease payments which is recorded as a liability on the balance sheet as of March 31, 2018. This obligation is due under an operating lease from the acquisition of Atmel for a building in San Jose, California.
(2) 
Capital purchase obligations represent commitments for construction or purchases of property, plant and equipment.  These obligations were not recorded as liabilities on our balance sheet as of March 31, 2018, as we have not yet received the related goods or taken title to the property.
(3) 
Other purchase obligations and commitments include payments due under various types of licenses and outstanding purchase commitments with our wafer foundries of approximately $101.6 million for delivery of wafers in fiscal 2019.
(4) 
For purposes of this table we have assumed that the principal of our 2017 senior convertible debt will be paid on February 15, 2027, which is the maturity date of such debt.
(5) 
For purposes of this table we have assumed that the principal of our 2015 senior convertible debt will be paid on February 15, 2025, which is the maturity date of such debt.
(6) 
For purposes of this table we have assumed that the principal of our 2017 junior convertible debt will be paid on February 15, 2037, which is the maturity date of such debt.
(7) 
For purposes of this table pension obligations due in more than 5 years represent the expected pension payments from 2023 through 2027. It excludes pension obligations subsequent to 2027.
(8) 
During fiscal 2018, we recognized a provisionary one-time transition tax on accumulated unrepatriated foreign earnings, estimated at $644.7 million, as a result of the recent U.S. tax reform of which we expect to result in future cash payments of approximately $336.1 million. This one-time transition tax is identified as provisional in our consolidated financial statements for the period ended March 31, 2018, and is subject to future measurement period adjustments in accordance with SAB 118. We intend to elect to pay this tax over a period of eight years, with 8% of the transition tax paid each

52


year for fiscal 2019 through fiscal 2023, and 15%, 20%, and 25%, respectively, to be paid during fiscal 2024, 2025, and 2026.
(9) 
Total contractual obligations do not include contractual obligations recorded on our balance sheet as current liabilities, or certain purchase obligations as discussed below.  The contractual obligations also do not include amounts related to uncertain tax positions because reasonable estimates cannot be made.

Purchase orders or contracts for the purchase of raw materials and other goods and services, with the exception of commitments to our wafer foundries, are not included in the table above.  We are not able to determine the aggregate amount of such purchase orders that represent contractual obligations, as purchase orders may represent authorizations to purchase rather than binding agreements.  For the purpose of this table, contractual obligations for the purchase of goods or services are defined as agreements that are enforceable and legally binding on us and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction.  Our purchase orders are based on our current manufacturing needs and are fulfilled by our vendors with short time horizons.  We do not have significant agreements for the purchase of raw materials or other goods specifying minimum quantities or set prices that exceed our expected requirements for three months.  We also enter into contracts for outsourced services; however, the obligations under these contracts were not significant and the contracts generally contain clauses allowing for cancellation without significant penalty.
 
The expected timing of payment of the obligations discussed above is estimated based on current information.  Timing of payments and actual amounts paid may be different depending on the time of receipt of goods or services or changes to agreed-upon amounts for some obligations.

Off-Balance Sheet Arrangements (Including Guarantees)
 
As of March 31, 2018, we are not involved in any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K. In the ordinary course of business, we may provide standby letters of credit or other guarantee instruments to certain parties as required for certain transactions initiated by us or our subsidiaries. We have not recorded any liability in connection with these guarantee arrangements. Based on historical experience and information currently available, we believe we will not be required to make any payments under these guarantee arrangements.
 
Recently Issued Accounting Pronouncements
 
Refer to Note 1 to our consolidated financial statements regarding recently issued accounting pronouncements.

Item 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Our 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 our investment guidelines and market conditions.  Our investment portfolio, consisting of fixed income securities, money market funds, cash deposits, and marketable securities that we hold on an available-for-sale basis, was $2,196.6 million as of March 31, 2018 compared to $1,410.3 million as of March 31, 2017. In fiscal 2018, an other-than-temporary-impairment was recognized as we intend to sell our investments in the first quarter of fiscal 2019 to fund our pending acquisition of Microsemi. Our available-for-sale debt securities, like all fixed income instruments, are subject to interest rate risk and will decline in value if market interest rates increase.  The following table provides information about our available-for-sale securities that are sensitive to changes in interest rates as of March 31, 2018.  We have aggregated our available-for-sale securities by contractual maturity date for presentation purposes since they are all very similar in nature (dollars in millions):

 
Financial instruments maturing during the fiscal year ended March 31,
 
2019
 
2020
 
2021
 
2022
 
2023
 
Thereafter
Available-for-sale securities
$
246.5

 
$
243.3

 
$
802.7

 
$

 
$

 
$

Weighted-average yield rate
1.70
%
 
1.93
%
 
1.91
%
 
%
 
%
 
%

See Note 1 to our Consolidated Financial Statements for additional information on our investments.
 

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Item 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The consolidated financial statements listed in the index appearing under Item 15(a)(1) hereof are filed as part of this Form 10-K.  See also Index to Financial Statements below.

Item 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 

None.

Item 9A.    CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures
 
As of the end of the period covered by this Annual Report on Form 10-K, as required by paragraph (b) of Rule 13a-15 or Rule 15d-15 under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), we evaluated under the supervision of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) of the Exchange Act.  Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Exchange Act (i) is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.  Our disclosure controls and procedures are designed to provide reasonable assurance that such information is accumulated and communicated to our management.  Our disclosure controls and procedures include components of our internal control over financial reporting.  Management's assessment of the effectiveness of our internal control over financial reporting is expressed at the level of reasonable assurance because a control system, no matter how well designed and operated, can provide only reasonable, but not absolute, assurance that the control system's objectives will be met.

Management Report on Internal Control Over Financial Reporting
 
Our management is responsible for establishing and maintaining adequate internal control over financial reporting to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.  Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements.
 
Management assessed our internal control over financial reporting as of March 31, 2018, the end of our fiscal year.  Management based its assessment on criteria established in Internal Control Integrated Framework (2013 framework) issued by the Committee of Sponsoring Organizations of the Treadway Commission.  Management's assessment included an evaluation of such elements as the design and operating effectiveness of key financial reporting controls, process documentation, accounting policies, and our overall control environment.  This assessment is supported by testing and monitoring performed by our finance organization.
 
Based on our assessment, management has concluded that our internal control over financial reporting was effective as of the end of the fiscal year to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with generally accepted accounting principles.  We reviewed the results of management's assessment with the Audit Committee of our Board of Directors.
 
Ernst & Young LLP, an independent registered public accounting firm, who audited our consolidated financial statements included in this Form 10-K has issued an attestation report on our internal control over financial reporting as of March 31, 2018, which is included on page F-2.
 



54


Changes in Internal Control over Financial Reporting
 
During the three months ended March 31, 2018, there was no change in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Item 9B.    OTHER INFORMATION

J. Eric Bjornholt, our Chief Financial Officer, Mitch Little, our Vice President, Worldwide Sales and Applications, Steve Drehobl, our Vice President, MCU8 and Technology Development Division, and Rich Simoncic, our Vice President, Analog Power and Interface Division, have entered into trading plans as contemplated by Rule 10b-5-1 under the Exchange Act and periodic sales of our common stock have occurred and are expected to occur under such plans.
 
The foregoing disclosure is being made on a voluntary basis and not pursuant to any specific requirement under Form 10‑K, Form 8‑K or otherwise.



55


PART III

Item 10.    DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

Information on the members of our Board of Directors is incorporated herein by reference to our proxy statement for our 2018 annual meeting of stockholders under the captions "The Board of Directors," and "Proposal One – Election of Directors."
 
Information on the composition of our audit committee and the members of our audit committee, including information on our audit committee financial experts, is incorporated by reference to our proxy statement for our 2018 annual meeting of stockholders under the caption "The Board of Directors – Committees of the Board of Directors – Audit Committee."
 
Information on our executive officers is provided in Item 1, Part I of this Form 10-K under the caption "Executive Officers of the Registrant" at page 11, above.
 
Information with respect to compliance with Section 16(a) of the Exchange Act, is incorporated herein by reference to our proxy statement for our 2018 annual meeting of stockholders under the caption "Section 16(a) Beneficial Ownership Reporting Compliance."
 
Information with respect to our code of ethics that applies to our directors, executive officers (including our principal executive officer and our principal financial and accounting officer) and employees is incorporated by reference to our proxy statement for our 2018 annual meeting of stockholders under the caption "Code of Business Conduct and Ethics."  A copy of our Code of Business Conduct and Ethics is available on our website at the Investor Relations section under Mission S