MICROCHIP TECHNOLOGY, INC. Note Regarding Forward-looking Statements
This report, including "Part I - Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Part II - Item 1A. Risk Factors" contains certain forward-looking statements that involve risks and uncertainties, including statements regarding our strategy, financial performance and revenue sources. We use words such as "anticipate," "believe," "plan," "expect," "future," "continue," "intend" and similar expressions to identify forward-looking statements. Our actual results could differ materially from the results anticipated in these forward-looking statements as a result of certain factors including those set forth under "Risk Factors," beginning at page 38 and elsewhere in this Form 10-Q. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. You should not place undue reliance on these forward-looking statements. We disclaim any obligation to update information contained in any forward-looking statement. These forward-looking statements include, without limitation, statements regarding the following: •Our expectation that certain supply chain constraints will continue through calendar 2022 and possibly beyond; •That if the impact of COVID-19 worsens, the pandemic could adversely impact our business in future periods; •That local governments could require us or our suppliers to temporarily reduce production further, cease operations, or implement mandatory vaccine requirements, and we could experience constraints in fulfilling customer orders; •The impact that local restrictions could have on our manufacturing operations, or the manufacturing operations of our subcontractors, in the future; •That we hope to see more of our team members return to our offices in the coming months, contingent on local conditions; •Our belief that our actions to combat the spread of COVID-19 will help preserve the health of our team members, customers, suppliers, visitors to our facilities, people with whom we conduct business and our communities, and allow us to safely continue operations; •Our inability to predict how the COVID-19 pandemic, and actions taken by others in response to it, will affect our business; •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; •The impact of national security protections, trade restrictions and changes in tariffs, including those impactingChina ; •Our expectation that in the future we will acquire additional businesses that we believe will complement our existing businesses; •Our expectation that in the future we will enter into joint development agreements or other strategic relationships with other companies; •The level of orders that will be received and shipped within a quarter, including the impact of our product lead times; •Our expectation that our days of inventory atDecember 31, 2021 will be 112 to 118 days; •Our belief that customers recognize our products and brand name and use distributors as an effective supply channel; •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 product line and the effect of such an increase; •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 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 expectation that foundry capacity will continue to be tight due to strong demand for wafers across the industry; 24 -------------------------------------------------------------------------------- Table of Contents •Our expectation that we will continue to operate our manufacturing facilities at or above normal capacity if the current supply constraints relative to demand continue; •Our anticipated level of capital expenditures; •Continuation and amount of quarterly cash dividends; •The sufficiency of our existing sources of liquidity to finance anticipated capital expenditures and otherwise meet our anticipated cash requirements, and the effects that our contractual obligations are expected to have on them; •The impact of seasonality on our business; •Our belief that our IT system compromise has not had a material adverse effect on our business or resulted in any material damage to us; •Our expectation that we will continue to be the target of cyber-attacks, computer viruses, unauthorized access and other attempts to breach or otherwise compromise the security of our IT systems and data; •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 accuracy of our estimated tax rate; •Our belief that the expiration of any tax holidays will not have a material impact on our effective tax rate; •The impact of the geographical dispersion of our earnings and losses on our effective tax rate; •Our belief that the estimates used in preparing our condensed 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 we could increase our borrowings or seek additional equity or debt financing to maintain or expand our facilities, or to fund cash dividends, share repurchases, acquisitions or other corporate activities, and that the timing and amount of such financing requirements will depend on a number of factors; •Our intention to satisfy the lesser of the principal amount or the conversion value of our Convertible Debt in cash; •Our intention to invest substantially all of our foreign subsidiary earnings, as well as our capital in our foreign subsidiaries, indefinitely outside of theU.S. in those jurisdictions in which we would incur significant, additional costs upon repatriation of such amounts; •Our expectation that our reliance on third party contractors may increase over time as our business grows; •Our ability to collect accounts receivable; and •The impact of the legislative and policy changes implemented or which may be implemented by the current administration, on our business and the trading price of our stock. 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-Q. 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. 25 -------------------------------------------------------------------------------- Table of Contents Introduction
The following discussion should be read in conjunction with the condensed consolidated financial statements and the related notes that appear elsewhere in this document.
We begin our Management's Discussion and Analysis of Financial Condition and Results of Operations with a summary of COVID-19 developments followed by a summary of our overall business strategy to give the reader an overview of the goals and overall direction of our business. This is followed by a discussion of the Critical Accounting Policies and Estimates that we believe are important to understanding the assumptions and judgments incorporated in our reported financial results. We then discuss our Results of Operations for the three and six months endedSeptember 30, 2021 compared to the three and six months endedSeptember 30, 2020 , followed by an analysis of changes in our balance sheet and cash flows, and discuss our financial commitments in the section titled "Liquidity and Capital Resources."
COVID-19 Developments
In the first half of fiscal 2021, the COVID-19 pandemic resulted in a global disruption in economic activity by adversely affecting production, creating supply chain and market disruption, and adversely impacting businesses and individuals. In the second half of fiscal 2021, business conditions were unexpectedly strong as businesses and individuals adapted to the effects of the pandemic. Business conditions have continued to be exceptionally strong through the first half of fiscal 2022. At this time, our global manufacturing sites and our logistics channels are fully operational; however, local restrictions have adversely impacted certain subcontractors' manufacturing operations and could adversely impact either our subcontractors or our own manufacturing operations in the future. If the impact of COVID-19 worsens, the pandemic could adversely impact our business in future periods. In response to the early indications of the COVID-19 pandemic, we took proactive measures to safeguard the health of our employees, contractors, customers, suppliers, visitors to our facilities, other business partners, and our communities. We strategically implemented plans intended to ensure business continuity in the event severe outbreaks or government requirements were to impact our operations. We monitor governmental policies and CDC recommendations and take appropriate actions which are designed to prevent and control the spread of COVID-19. We continuously assess our efforts to combat the COVID-19 pandemic which have included the following: •We previously suspended attendance at conferences and other gatherings but recently began to allow limited business travel. While we continue to evolve our work model in response to the ongoing effects of the pandemic, we have some team members that have fully transitioned into working at the office, and we hope to see more of our team members return to our offices in the coming months, contingent on local conditions. All on-site team members are requested to stay home if they do not feel well, stay home if they have been exposed to someone with COVID-19 or its symptoms, maintain a safe distance from others, wash their hands frequently, and wear a mask in common areas at on-site locations. We clean high touch surfaces at least daily. •In partnership with our suppliers, we have evaluated our supply chain to identify gaps or weak points. In order to ensure continuity, in some cases, we have qualified alternative suppliers and increased our inventory of raw materials. •We have added and continue to add assembly and test capacity to increase our manufacturing capability. •We initially implemented measures to help prepare for economic uncertainty, such as employee salary cuts, limiting hiring, reducing business travel costs, reducing discretionary spending, and limiting capital expenditures. However, inDecember 2020 , we restored previous reductions in compensation, resumed hiring, and increased spending for capital expenditures to help meet business demands. •We are working with government authorities in the areas where we have a significant footprint. We continue to update ourselves on government requirements, relevant regulations, industry standards, and best practices to help safeguard our team members across the globe. We believe these actions are important and will help preserve the health of our team members, customers, suppliers, visitors to our facilities, people with whom we conduct business and our communities, and allow us to safely continue operations. However, we cannot predict how these actions, or the actions taken by government entities, suppliers, or customers in response to the COVID-19 pandemic will impact our business, revenues, or results of operations.
Strategy
We develop, manufacture and sell smart, connected and secure embedded control solutions used by our customers for a wide variety of applications. Our strategic focus includes general purpose and specialized 8-bit, 16-bit, and 32-bit
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microcontrollers, microprocessors, analog, FPGA, and memory products. With over
30 years of technology leadership, our broad product portfolio is a Total System
Solution (TSS) for our customers that provides a large portion of the silicon
requirements in their applications. TSS is a combination of hardware, software
and services which help our customers increase their revenue, reduce their costs
and manage their risks compared to other solutions. Our synergistic product
portfolio empowers disruptive growth trends, including 5G, artificial
intelligence and machine learning, Internet of Things (IoT), advanced driver
assist systems (ADAS) and autonomous driving, and electric vehicles, in key end
markets such as automotive, aerospace and defense, communications, consumer,
data centers and computing, and industrial.
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 Microsemi and other companies that outsourced
all or substantial portions of their manufacturing.
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 tools and software to perform
circuit design, simulation and layout, and our in-house photomask and wafer
fabrication facilities enable us to rapidly verify design techniques by
processing test wafers quickly and efficiently.
We are committed to continuing our investment in new and enhanced products,
including development systems, and in our design and manufacturing process
technologies. We believe these investments are significant factors in
maintaining our competitive position. Our current research and development
activities focus on the design of new microcontrollers, digital signal
controllers, memory, analog and mixed-signal products, FPGAs, timing systems,
Flash-IP, 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 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 CEMs, ESEs, and sales management have
technical degrees or backgrounds and have been previously employed in high
technology environments. We believe that the technical and business 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 or through online webcasts. Our licensing division has
dedicated sales, technology, design, product, test and reliability personnel
that support the requirements of our licensees.
In the fourth quarter of fiscal 2021, we launched our Preferred Supply Program,
which provides our customers with prioritized capacity beginning 6 months after
their order of 12 months of continuous, non-cancellable and non-reschedulable
backlog. Demand outpaced capacity improvements that we implemented in the first
half of fiscal 2022 resulting in lead times continuing to extend out. We
experienced constraints in our internal and external factories and their related
manufacturing supply chains. We worked closely with our wafer fabrication,
assembly and test subcontractors to secure additional capacity wherever
possible. We expect that certain wafer fabrication, assembly and test
constraints will persist through calendar 2022 and possibly beyond.
See "Our operating results are impacted by seasonality and wide fluctuations of
supply and demand in the industry," on page 44 for discussion of the impact of
seasonality on our business.
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Critical Accounting Policies and Estimates
Except for the changes discussed in "Recently Adopted Accounting Pronouncements"
in Note 2 to our condensed consolidated financial statements in this Form 10-Q,
there were no changes to our critical accounting policies and estimates during
the first six months of the fiscal year ending March 31, 2022 compared to our
"Critical Accounting Policies and Estimates" as previously described in Part II,
Item 7 of our Annual Report on Form 10-K for the fiscal year ended March 31,
2021 .
Results of Operations
The following table sets forth certain operational data as a percentage of net sales for the periods covered by this report:
Three Months Ended September 30, Six Months Ended September 30,
2021 2020 2021 2020
Net sales 100.0 % 100.0 % 100.0 % 100.0 %
Cost of sales 35.2 38.3 35.5 38.7
Gross profit 64.8 61.7 64.5 61.3
Research and development 14.9 15.3 15.1 15.2
Selling, general and
administrative 10.9 11.1 11.0 11.1
Amortization of acquired
intangible assets 13.2 17.7 13.4 17.8
Special charges and other, net 0.6 0.3 0.6 0.2
Operating income 25.2 % 17.3 % 24.4 % 17.0 %
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 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 in the form of letters of
credit.
The following table summarizes our net sales for the periods covered by this report (dollars in millions):
Three Months Ended September 30, Six Months Ended September 30,
2021 2020 Change 2021 2020 Change
Net sales $ 1,649.8 $1,309.5 26.0 %$ 3,219.2 $ 2,619.2 22.9 % The increases in net sales in the three and six months endedSeptember 30, 2021 compared to the three and six months endedSeptember 30, 2020 were primarily due to strong business conditions that began in the second half of fiscal 2021 as businesses and individuals adapted to the effects of the COIVD-19 pandemic. Business conditions have continued to be exceptionally strong in the three and six months endedSeptember 30, 2021 . Additionally, semiconductor industry conditions have resulted in increased costs throughout our supply chain, which we have been passing on to our customers in the form of price increases. These price increases also contributed to the increases in net sales during the three and six months endedSeptember 30, 2021 compared to the three and six months endedSeptember 30, 2020 . The net sales value of inventory at our distributor customers increased$13.5 million during the three months endedSeptember 30, 2021 compared to an increase of$22.0 million during the three months endedSeptember 30, 2020 . Excluding the impact of changes in distributor inventory levels on net sales, net sales increased by 27.1% in the three months endedSeptember 30, 2021 compared to the three months endedSeptember 30, 2020 . Demand for our products was positively impacted by strength in our microcontroller and analog product lines. Due to the size, complexity and diversity of our customer base, we are not able to quantify any material factor contributing to the change other than net demand fluctuations in the end markets that we serve. The net sales value of inventory at our distributor customers decreased$23.8 million during the six months endedSeptember 30, 2021 compared to an increase of$38.5 million during the six months endedSeptember 30, 2020 . Excluding the impact of changes in distributor inventory levels on net sales, net sales increased by 25.7% in the six months endedSeptember 30, 2021 compared to the six months endedSeptember 30, 2020 . Demand for our products was positively impacted by strength 28 -------------------------------------------------------------------------------- Table of Contents in our microcontroller and analog product lines. Due to the size, complexity and diversity of our customer base, we are not able to quantify any material factor contributing to the change other than net demand fluctuations in the end markets that we serve. Other factors that we believe contributed to changes in our reported net sales for the three and six months endedSeptember 30, 2021 compared to the three and six months endedSeptember 30, 2020 and which are drivers of long-term trends in our net sales but which factors we are not able to quantify include: •semiconductor industry conditions; •our various new product offerings that have increased our served available market; •customers' increasing needs for the flexibility offered by our programmable solutions; and •increasing semiconductor content in our customers' products through our Total Systems Solutions. We sell a large number of products to a large and diverse customer base and there was not any single product or customer that accounted for a material portion of the change in our net sales in the three and six months endedSeptember 30, 2021 orSeptember 30, 2020 . The overall average selling price of our products is affected by pricing declines over the life of individual 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.
Net sales by product line for the periods covered by this report were as follows (dollars in millions):
Three Months Ended September 30, Six Months Ended September 30,
2021 % 2020 % 2021 % 2020 %
Microcontrollers $ 894.0 54.1 $ 703.1 53.7 $ 1,796.5 55.8 $ 1,419.5 54.2
Analog 490.9 29.8 361.7 27.6 923.0 28.7 731.9 27.9
Other 264.9 16.1 244.7 18.7 499.7 15.5 467.8 17.9
Total net sales $ 1,649.8 100.0 $ 1,309.5 100.0 $ 3,219.2 100.0 $ 2,619.2 100.0
Microcontrollers
Our microcontroller product line represents the largest component of our total
net sales. Microcontrollers and associated application development systems
accounted for approximately 54.1% and 55.8% of our net sales for the three and
six months ended September 30, 2021 , respectively, compared to approximately
53.7% and 54.2% of our net sales for the three and six months ended September
30, 2020 , respectively.
Net sales of our microcontroller products increased 27.2% and 26.6% in the three
and six months ended September 30, 2021 , respectively, compared to the three and
six months ended September 30, 2020 . These sales increases were due primarily to
strength in demand for our microcontroller products in end markets that we
serve.
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 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.
Analog
Our analog product line includes analog, interface, mixed signal and timing
products. Our analog product line accounted for approximately 29.8% and 28.7% of
our net sales for the three and six months ended September 30, 2021 ,
respectively, compared to approximately 27.6% and 27.9% of our net sales for the
three and six months ended September 30, 2020 , respectively.
Net sales from our analog product line increased 35.7% and 26.1% in the three
and six months ended September 30, 2021 , respectively, compared to the three and
six months ended September 30, 2020 , primarily due to strength in demand for our
analog products in end markets that we serve.
We consider a majority of the products in our analog product line 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
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product line 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 product line as a result of increased pricing
pressure in the future, which would adversely affect our operating results.
Other
Our other product line includes FPGA products, royalties associated with licenses for the use of our SuperFlash and other technologies, sales of our intellectual property, fees for engineering services, memory products, timing systems, manufacturing services (wafer foundry and assembly and test subcontracting), legacy application specific integrated circuits, and certain products for aerospace applications. Revenue from these services and products accounted for approximately 16.1% and 15.5% of our net sales for the three and six months endedSeptember 30, 2021 , respectively, compared to approximately 18.7% and 17.9% of our net sales for the three and six months endedSeptember 30, 2020 , respectively. Net sales related to these services and products increased 8.3% and 6.8% in the three and six months endedSeptember 30, 2021 , respectively, compared to the three and six months endedSeptember 30, 2020 . These sales increases were primarily due to strength in demand for our products in end markets that we serve. Net sales of our other product line can fluctuate over time based on general economic and semiconductor industry conditions as well as changes in demand for our FPGA products, licenses, engineering services, memory products, and manufacturing services (wafer foundry and assembly and test subcontracting).
Distribution
Distributors accounted for approximately 50% of our net sales in each of the three and six months endedSeptember 30, 2021 , compared to approximately 51% of our net sales in each of the three and six months endedSeptember 30, 2020 . No distributor or end customer accounted for more than 10% of our net sales in the three and six months endedSeptember 30, 2021 orSeptember 30, 2020 . 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, with the exception of orders placed under our Preferred Supply Program. 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. AtSeptember 30, 2021 , our distributors maintained 19 days of inventory of our products compared to 22 days atMarch 31, 2021 . Over the past ten fiscal years, the days of inventory maintained by our distributors have fluctuated between approximately 19 days and 47 days. Inventory holding patterns at our distributors may have a material impact on our net sales. Our distributor inventory days are at historic lows due to the imbalance between the supply of and the demand for our products in the current supply-constrained environment.
Sales by Geography
Sales by geography for the periods covered by this report were as follows (dollars in millions):
Three Months Ended September 30, Six Months Ended September 30,
2021 % 2020 % 2021 % 2020 %
Americas $ 419.8 25.4 $ 345.4 26.4 $ 792.9 24.6 $ 688.4 26.3
Europe 324.6 19.7 237.6 18.1 634.3 19.7 482.9 18.4
Asia 905.4 54.9 726.5 55.5 1,792.0 55.7 1,447.9 55.3
Total net sales $ 1,649.8 100.0 $ 1,309.5 100.0 $ 3,219.2 100.0 $ 2,619.2 100.0
Americas sales include sales to customers in the U.S. , Canada , Central America
and South America . Sales to foreign customers accounted for approximately 77%
and 78% of our total net sales in the three and six months ended September 30,
2021 , respectively, compared to approximately 76% of our total net sales in each
of the three and six months ended September 30, 2020 . Substantially all of our
foreign sales are U.S. dollar denominated. Sales to customers in Europe as a
percentage of total net sales increased in the three and six months ended
September 30, 2021 compared to the three and six months ended September 30, 2020
primarily due to strength in demand in our microcontroller and analog product
lines. Sales to customers in the Americas increased in the three and six months
ended September 30, 2021 compared to the three and six months ended
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September 30, 2020 , however, they decreased as a percentage of total net sales
due to strength in demand for our products in the Europe and Asia markets. Our
sales force in the Americas and Europe supports a significant portion of the
design activity for products which are ultimately shipped to Asia .
Gross Profit
Our gross profit in the three months endedSeptember 30, 2021 was$1.07 billion , or 64.8% of net sales, compared to$807.9 million , or 61.7% of net sales, in the three months endedSeptember 30, 2020 . Our gross profit in the six months endedSeptember 30, 2021 was$2.08 billion , or 64.5% of net sales, compared to$1.61 billion , or 61.3% of net sales, in the six months endedSeptember 30, 2020 . The following table summarizes the material and primary drivers of our change in gross profit as a percentage of net sales, with the material factors discussed in more detail below the table (dollars in millions): % % Gross Profit of Net Sales Gross Profit of Net Sales Three and six months ended September 30,$ 807.9 61.7$ 1,606.2 61.3 2020 Increase in semiconductor net sales at prior year gross margins and excluding the impact of other factors quantified in 204.7 - 361.7 - this table 12.2 0.7 26.1 0.8 Impact of unabsorbed capacity charges Net impact of product mix and average 29.8 1.5 44.6 1.2 gross profit per unit Increase in net sales to licensing customers, which has no associated cost 9.5 0.6 15.0 0.5 of sales Net impact of excess and obsolete 4.2 0.3 22.3 0.7 inventories Three and six months ended September 30,$ 1,068.3 64.8$ 2,075.9 64.5 2021 Unabsorbed capacity charges - When production levels are below normal capacity, which we measure as a percentage of the capacity of the installed equipment, we charge cost of sales for the unabsorbed capacity. We consider normal capacity at Fab 2 and Fab 4 to be 90% to 95%. We consider normal capacity at Fab 5 to be 70% to 75%. During the three and six months endedSeptember 30, 2021 , we operated at above normal capacity levels and we expect this to continue if the current supply constraints relative to demand continue. During the three and six months endedSeptember 30, 2020 , we operated at below normal capacity levels primarily due to general economic conditions and uncertainty from the COVID-19 pandemic resulting in unabsorbed capacity charges of$12.2 million and$26.1 million , respectively. We adjust our wafer fabrication and assembly and test capacity utilization as required to respond to actual and anticipated business and industry-related conditions. Net impact of product mix and average gross profit per unit - The net impact of product mix and average gross profit per unit may fluctuate over time due to sales volumes of lower or higher margin products, changes in selling prices, and fluctuations in product costs. During the three and six months endedSeptember 30, 2021 , product mix resulted in a decrease of$29.8 million and$44.6 million , respectively, in cost of goods sold and an increase in gross profit compared to the three and six months endedSeptember 30, 2020 . Our overall inventory levels were$713.6 million atSeptember 30, 2021 , compared to$665.0 million atMarch 31, 2021 . We maintained 112 days of inventory on our balance sheet atSeptember 30, 2021 andMarch 31, 2021 . We expect our days of inventory levels atDecember 31, 2021 to be 112 to 118 days. We anticipate that our gross margins will fluctuate over time, driven primarily by capacity utilization levels, the overall product mix of microcontroller, analog, FPGA 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 continue to transition products to more advanced process technologies to reduce future manufacturing costs. We operate assembly and test facilities inThailand ,the Philippines , and other locations throughout the world. During the three and six months endedSeptember 30, 2021 , approximately 59% of our assembly requirements were performed in our internal assembly facilities, compared to approximately 47% during the three and six months endedSeptember 30, 2020 . During the three and six months endedSeptember 30, 2021 , approximately 64% of our test requirements were performed in our internal test facilities, compared to approximately 55% during the three and six months endedSeptember 30, 2020 . The increases in the percentage of assembly and test operations that were performed internally in the three and six months endedSeptember 30, 2021 compared to the three and six months endedSeptember 30, 2020 are primarily due to our investments in assembly and test equipment, which increased our internal capacity capabilities. Third-party contractors located primarily in 31 -------------------------------------------------------------------------------- Table of ContentsAsia perform the balance of our assembly and test operations. The percentage of our assembly and test operations that are performed internally fluctuates over time based on supply and demand conditions in the semiconductor industry, our internal capacity capabilities and our acquisition 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 plan to continue to transition certain outsourced assembly and test capacity to our internal facilities. We rely on outside wafer foundries for a significant portion of our wafer fabrication requirements. Approximately 60% and 59% of our net sales came from products that were produced at outside wafer foundries in the three and six months endedSeptember 30, 2021 , respectively, compared to 61% in each of the three and six months endedSeptember 30, 2020 . 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 expenses for the three months endedSeptember 30, 2021 were$246.2 million , or 14.9% of net sales, compared to$199.8 million , or 15.3% of net sales, for the three months endedSeptember 30, 2020 . R&D expenses for the six months endedSeptember 30, 2021 were$484.6 million , or 15.1% of net sales, compared to$397.8 million , or 15.2% of net sales, for the six months endedSeptember 30, 2020 . 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 increased$46.4 million , or 23.2%, for the three months endedSeptember 30, 2021 over the same period last year. R&D expenses increased$86.8 million , or 21.8%, for the six months endedSeptember 30, 2021 over the same period last year. The primary reason for the increases in R&D costs was higher compensation costs related to restoring previous reductions in compensation programs implemented in the six months endedSeptember 30, 2020 due to uncertainty surrounding the COVID-19 pandemic.
R&D expenses fluctuate over time, primarily due to revenue and operating expense investment levels.
Selling, General and Administrative
Selling, general and administrative expenses for the three months endedSeptember 30, 2021 were$179.9 million , or 10.9% of net sales, compared to$144.7 million , or 11.1% of net sales, for the three months endedSeptember 30, 2020 . Selling, general and administrative expenses for the six months endedSeptember 30, 2021 were$354.2 million , or 11.0% of net sales, compared to$291.0 million , or 11.1% of net sales, for the six months endedSeptember 30, 2020 . Our goal is to continue to be more efficient with our selling, general and administrative expenses. Selling, general and administrative expenses include salary expenses related to field sales, marketing and administrative personnel, advertising and promotional expenditures and legal expenses as well as costs related to our direct sales force, CEMs and ESEs who work remotely from sales offices worldwide to stimulate demand by assisting customers in the selection and use of our products. Selling, general and administrative expenses increased$35.2 million , or 24.3%, for the three months endedSeptember 30, 2021 over the same period last year. Selling, general and administrative expenses increased$63.2 million , or 21.7%, for the six months endedSeptember 30, 2021 over the same period last year.
The
primary reason for the increases in selling, general and administrative expenses was higher compensation costs related to restoring previous reductions in compensation programs implemented in the six months endedSeptember 30, 2020 due to uncertainty surrounding the COVID-19 pandemic.
Selling, general and administrative expenses fluctuate over time, primarily due to revenue and operating expense investment levels.
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Amortization of Acquired Intangible Assets
Amortization of acquired intangible assets for the three and six months ended
September 30, 2021 was $215.7 million and $431.3 million , respectively, compared
to $232.9 million and $468.3 million for the three and six months ended
September 30, 2020 , respectively. The primary reason for the decreases in
acquired intangible asset amortization was lower amortization from our
acquisition of Microsemi and from our prior acquisitions.
Special Charges and Other, Net
During the three and six months endedSeptember 30, 2021 , we incurred special charges and other, net of$10.2 million and$20.7 million , respectively. During the three and six months endedSeptember 30, 2020 , we incurred special charges and other, net of$4.3 million and$4.6 million , respectively. The costs incurred during these periods were primarily related to restructuring of acquired and existing wafer fabrication operations to increase operational efficiency, and individually insignificant one-time costs associated with litigation matters and exiting non-manufacturing facilities including contract termination costs, employee severance, and the disposal of assets.
Other Income (Expense)
Interest income in the three and six months ended
Interest expense in the three and six months endedSeptember 30, 2021 was$64.8 million and$137.1 million , respectively, compared to$93.3 million and$192.4 million , respectively, for the three and six months endedSeptember 30, 2020 . The primary reason for the decreases in interest expense relates to the cumulative pay down of our debt and lower interest rates on our outstanding variable rate debt. During the three and six months endedSeptember 30, 2021 , we recognized losses of$85.2 million and$85.5 million , respectively, related to the settlement of a portion of our outstanding 2015 Senior Convertible Debt, our 2017 Senior Convertible Debt, and our 2017 Junior Convertible Debt as well as the repayment of$1.00 billion aggregate principal amount outstanding of our 3.922% 2021 Notes. The net losses recognized on the settlement of our Convertible Debt are comprised of two components (i) the inducement loss, which is the excess of the fair value of the consideration provided to the holder over the fair value of the debt and (ii) the extinguishment loss or gain, which is the difference between the fair value of the debt component and the carrying value on the settlement date. During the three and six months endedSeptember 30, 2020 , we recognized losses of$45.1 million and$71.9 million , respectively, related to the settlement of a portion of our outstanding 2015 Senior Convertible Debt, our 2017 Senior Convertible Debt, and our 2017 Junior Convertible Debt as well as the payment of all amounts outstanding under our Bridge Loan Facility. Other loss, net in the three months endedSeptember 30, 2021 was$1.6 million compared to other income, net of$0.7 million for the three months endedSeptember 30, 2020 . Other loss, net in the six months endedSeptember 30, 2021 was$1.1 million compared to other loss, net of$2.5 million for the six months endedSeptember 30, 2020 . The primary reason for these changes relates to foreign currency exchange rate fluctuations.
Provision for Income Taxes
Our provision or benefit for income taxes is attributable toU.S. federal, state, and foreign income taxes. A comparison of our effective tax rates in the six months endedSeptember 30, 2021 andSeptember 30, 2020 is not meaningful due to the amount of pre-tax income, and income tax benefits recorded during the prior period. We are subject to taxation in many jurisdictions in which we have operations. The effective tax rates that we pay in these jurisdictions vary widely, but they are generally lower than our combinedU.S. federal and state effective tax rate. Our domestic blended statutory tax rate in each of the six months endedSeptember 30, 2021 andSeptember 30, 2020 was approximately 22%. Our non-U.S. blended statutory tax rates in the six months endedSeptember 30, 2021 andSeptember 30, 2020 were much lower than this amount. The difference in rates applicable in foreign jurisdictions results from a number of factors, including lower statutory rates, tax holidays, 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 and assets inThailand ,Malta andIreland . OurThailand manufacturing operations are currently subject to numerous tax holidays granted to us based on our investment in property, plant and equipment inThailand . Our tax holiday periods inThailand expire at various times in the future; however, 33 -------------------------------------------------------------------------------- Table of Contents we actively seek to obtain new tax holidays, otherwise 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 inThailand to have a material impact on our effective tax rate. The remaining material components of foreign income taxed at a rate lower than theU.S. are earnings accrued inIreland at a 12.5% statutory tax rate and earnings accrued inMalta at a 0% to 5% tax rate. InSeptember 2021 , we received a Statutory Notice of Deficiency (Notice) from the Internal Revenue Service (IRS) for fiscal 2007 through fiscal 2012. The disputed amounts largely relate to transfer pricing matters. We firmly believe that the assessments are without merit and plan to pursue all available administrative and judicial remedies necessary to resolve this matter. Initially, we expect to file a petition inthe United States Tax Court challenging the Notice. We intend to vigorously defend our position and we are confident in our ability to prevail on the merits. We regularly assess the likelihood of adverse outcomes resulting from examinations such as this to determine the adequacy of our tax reserves. We believe that the final adjudication of this matter will not have a material impact on our consolidated financial position, results of operations or cash flows and that we have adequate tax reserves for all tax matters. However, the ultimate outcome of disputes of this nature is uncertain, and if theIRS were to prevail on all of its assertions, the assessed tax, penalties, and deficiency interest could have a material adverse impact on our financial position, results of operations or cash flows. Various taxing authorities in theU.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. ForU.S. federal, and in general forU.S. state tax returns, our fiscal 2007 and later tax returns remain effectively open for examination by the taxing authorities. We are currently being audited by the tax authorities in theU.S. 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. 34
-------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources
We had
Net cash provided by operating activities was$1.24 billion in the six months endedSeptember 30, 2021 compared to$957.6 million in the six months endedSeptember 30, 2020 . The increase in net cash provided by operating activities was primarily due to higher net sales compared to the prior year period, which was unfavorably impacted by uncertainty surrounding the COVID-19 pandemic, offset by efforts focused on working capital and discretionary spending management. Net cash used in investing activities was$208.7 million in the six months endedSeptember 30, 2021 compared to$58.6 million in the six months endedSeptember 30, 2020 . During the six months endedSeptember 30, 2021 andSeptember 30, 2020 , net investing activities primarily related to capital purchases and investments in other assets. Our level of capital expenditures varies from time to time as a result of actual and anticipated business conditions. Capital expenditures in the six months endedSeptember 30, 2021 were$164.8 million compared to$15.8 million in the six months endedSeptember 30, 2020 . Capital expenditures were primarily for the expansion of production capacity and the addition of research and development equipment. Towards the second half of fiscal 2021 we started to invest more significantly to expand manufacturing capacity in response to supply constraints relative to current demand levels and we expect this to continue through calendar 2022. We currently expect to invest between$350.0 million and$450.0 million in equipment and facilities during the next twelve months. 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$1.06 billion in the six months endedSeptember 30, 2021 compared to$931.7 million in the six months endedSeptember 30, 2020 . Significant transactions affecting our net financing cash flows include: •in the first six months of fiscal 2022,$806.6 million of cash used to pay down certain principal of our debt, including the cash portion of the settlement of our 2015 Senior Convertible Debt, our 2017 Senior Convertible Debt and our 2017 Junior Convertible Debt, our Revolving Credit Facility and our 3.922% 2021 Notes, partially funded by the issuance of our senior notes, and •in the first six months of fiscal 2021,$743.0 million of cash used to pay down certain principal of our debt, including the cash portion of the settlement of our 2015 Senior Convertible Debt and our 2017 Senior Convertible Debt, partially funded by the issuance of our senior notes, and •in the first six months of fiscal 2022 and fiscal 2021, we paid cash dividends to our stockholders of$234.3 million and$185.7 million , respectively. InMarch 2020 andSeptember 2019 , we amended our Credit Agreement datedMay 29, 2018 , to, among other things, reduce the margin added to the interest rate on revolving loans under the Credit Agreement and amend certain negative covenants, including covenants that restrict our and our subsidiaries' ability to, among other things, incur subsidiary indebtedness, grant liens and enter into certain restrictive agreements. The amendments also allow us the option to factor receivables and certain related assets. The amendments lowered the Revolving Credit Facility thereunder to$3.57 billion from$3.60 billion . The revolving loan commitments terminate inMay 2023 and bear interest, at our option, at the base rate plus a spread of 0.00% to 0.75% or an adjusted LIBOR rate plus a spread of 1.00% to 1.75%, in each case, with such spread being determined based on the consolidated senior leverage ratio for the preceding four fiscal quarter period. As ofSeptember 30, 2021 , the principal amount of our outstanding indebtedness was$8.41 billion . AtSeptember 30, 2021 , we had$1.81 billion of outstanding borrowings under the Revolving Credit Facility compared to$2.35 billion atMarch 31, 2021 . During fiscal 2021, we used borrowings under our Revolving Credit Facility and proceeds from the issuance of our 0.972% 2024 Notes to repay all amounts outstanding under our Term Loan Facility. See Note 6 of the notes to our condensed consolidated financial statements for more information regarding our contractual obligations related to our long-term debt. The enactment of the TCJA imposed a tax on all previously untaxed earnings of non-U.S. subsidiaries ofU.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 a significant portion of our non-U.S. assets to theU.S. will no longer be subject toU.S. federal taxation. We intend to invest substantially all of our foreign subsidiary earnings, as well as our capital in our foreign subsidiaries, indefinitely outside of theU.S. in those jurisdictions in which we would incur significant, additional costs upon repatriation of such amounts. During fiscal 2018, we recognized a one-time transition tax on accumulated unrepatriated foreign 35
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Table of Contents earnings, of which we expected cash payments of approximately$290.3 million . This tax is payable over a period of eight years, with 8% of the transition tax payable each year for fiscal 2019 through fiscal 2023, and 15%, 20%, and 25%, respectively, payable during fiscal 2024, fiscal 2025, and fiscal 2026. As ofSeptember 30, 2021 , our transition tax payable was$197.4 million , of which$23.2 million is payable within the next 12 months. 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. AtSeptember 30, 2021 , we had no foreign currency forward contracts outstanding. We did not repurchase any shares of our common stock in the first six months of fiscal 2022 and fiscal 2021. As ofSeptember 30, 2021 , we held approximately 19.6 million shares as treasury shares. OnOctober 28, 2002 , we announced that our Board of Directors had approved and instituted a quarterly cash dividend on our common stock. A quarterly cash dividend of $0.2185 per share was paid onSeptember 3, 2021 in the aggregate amount of$121.2 million . A quarterly dividend of$0.232 per share was declared onNovember 2, 2021 and will be paid onDecember 3, 2021 to stockholders of record as ofNovember 19, 2021 . We expect the aggregate cash dividend for theDecember 2021 quarter to be approximately$129.0 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. We believe that our existing sources of liquidity combined with cash generated from operations and borrowings under our Revolving Credit Facility 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 Revolving Credit Facility 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, demand for our products, changes in industry conditions, product mix, competitive factors and our ability to identify suitable acquisition candidates. We may from time to time seek to refinance certain of our outstanding notes or Convertible Debt through issuances of new notes or convertible debt, tender offers, exchange transactions or open market repurchases. Such issuances, tender offers or exchanges or purchases, if any, will depend on prevailing market conditions, our ability to negotiate acceptable terms, our liquidity position and other factors. There can be no assurance that any financing will be available on acceptable terms due to uncertainties resulting from the COVID-19 pandemic or other factors, and any additional equity financing would result in incremental ownership dilution to our existing stockholders.
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