微晶片科技 (MCHP) 2005 Q1 法說會逐字稿

Good day, everyone, and welcome to this Microchip Technology first quarter fiscal-year 2005 conference call.

As a reminder, today's call is being recorded.

At this time I would like to turn the call over to Microchip's Chief Financial Officer, Mr. Gordon Parnell.

Please go ahead, sir.

Thanks, Natalie.

And good afternoon, everyone, and welcome to today's conference call.

During the course of the conference call, we will be making projections and other forward-looking statements regarding future events or the future financial performance of the Company.

We wish to caution you that such statements are predictions and that actual events or results may differ materially.

We refer you to our press release of today, as well as our 10-K for fiscal year ended March 31st, 2004, and our 8-K current reports that we have filed with the SEC that identify important risk factors that may impact Microchips business and results of operations.

In attendance with me today is Steve Sanghi, Microchip's President and CEO.

I will comment on our first quarter fiscal-year 2005 performance, giving information by geography and product segment.

And Steve will then give his comments on the June quarter, discuss the product line performance, review the status of Fab 4 and outline our guidance for the September quarter.

We will then be available to respond to specific investor and analyst questions at that point.

Net sales for the June quarter were at record levels of 212.8 million, up approximately 11.1% sequentially, from sales of 191.5 million in the March quarter and up approximately 31.9% from sales of 161.3 million in the prior year's first quarter.

On a geographic basis, all areas grew sequentially.

Asia grew by 17.4%, Americas grew by 7.1%, and Europe grew by 6.5%.

The growth continues to reflect a well-balanced geographic penetration of our business.

Total revenue breakdown for the quarter resulted in sales for Asia representing approximately 42.6% of revenues, Americas were at 29.2%, and Europe at 28.2%.

Net sales for microcontroller products represented approximately 78.3% of revenue in the quarter.

Analog products represented approximately 7.5% of revenue, and memory products represented approximately 14.2% of revenues.

We achieved record earnings in the June quarter with GAAP net income for the period of 56.8 million or 27 cents per diluted share, an increase of 21.2% from GAAP net income of 46.8 million or 22 cents per share in the immediately preceding quarter and an increase of 69.5% from pro forma net income of 33.5 million or 16 cents per diluted share from the prior year's first quarter.

Our gross margins for the June quarter were 57.1%, establishing a new record level for gross margins for the Company.

The gross margins increased by over 160 basis points sequentially, primarily driven by increased absorption from our wafer fabs and increased activities at our assembly and test location.

We do expect gross margins to increase in the September quarter by an additional 50 to 75 basis points.

The tax rate for the June quarter was in line with our guidance of 24% and we are anticipating to continue at this rate for the balance of the fiscal year.

Operating expenses were 23.7% of sales in the June quarter compared to operating expenses of 24.5% in the previous period.

Research and development costs were 23.3 million, representing 10.9% of sales.

Sales and general administrative expenses were 27.2 million, representing 12.8% of sales.

Microchip's total inventory position at June 30th was approximately 90.6 million, a decrease of approximately 3.9 million from the prior quarter level.

Inventory turns at 4.0, days of inventory representing 91 days.

These levels compare to peak inventories of 134 days as of June of last year.

We have now reached the target levels of inventory for our business, achieving the goals we have shared with investors over that time frame.

Distribution inventory continues to be at very moderate levels in all geographies.

As of the end of June, we are at about 2.3 months of inventory, which is in the same range as of the end of March.

When you compare this to a higher 3.3 months of inventory at the peak of the last cycle, we feel that the overall total inventory supporting our customers is in excellent shape, reflecting the overall results of our efforts with the distributors that have held inventory levels to much more reasonable levels in this particular cycle.

It's also worth noting that any increase in inventory that we have discussed in distribution over the last several quarters has not been reflected in our reported sales performance, unlike many of our peers.

At June 30, Microchip's receivable days were 46, essentially unchanged from days outstanding as of the end of March, and this compares to receivable days of about 48 days a year ago.

Overall receivable balance increased approximately $3.3 million or 3%, obviously significantly lower than the growth we experienced in net sales.

This has resulted in strong cash generation for the June period.

As of March 31st, Microchip's cash and current investment position was 539 million with no debt on the balance sheet.

During the quarter Microchip generated free cash flow from the business after fixed asset additions, working capital costs, dividend payments, and treasury activities, which resulted in adding 87.1 million to treasury.

During the June quarter we invested 22.8 million through our stock buy-back program.

The net cash we added to the treasury balance was $64.3 million.

We expect to add $85 to $90 million in free cash flow in the current quarter before stock buy-back activity.

As I'm sure you're aware, the stock has been under pressure in the last couple of weeks due to the market environment and commentary on the sector of our business.

We have been active in stock buy-backs during that time and have purchased 1,150,000 shares at an average price of 26.26, equating to a total value of about $30.2 million.

Capital spending was approximately 13.6 million for the June quarter.

Depreciation expense for the June quarter was 29.2 million versus 27.7 million for the same quarter last year, and 28 million in the March quarter.

Capital spending for the fiscal year is expected to be approximately $75 million and depreciation for the year will be approximately 120 million.

With that, I will now ask Steve to discuss the performance of our business, both last quarter and current conditions, and our guidance for the September quarter.

Thank you, Gordon, and good afternoon, everyone.

First, I would like to reflect on the results of the June quarter, then comment on the product lines, then talk about the Fab 4 Ram, and finally, discuss the guidance for the September, 2004 quarter.

So, let's begin.

This was the best quarter in the history of Microchip.

We exceeded all estimates externally, as well as internally for net sales, gross margin percentage, operating income percentage, and earnings per share.

Our net sales exceeded the high end of our already upwardly revised guidance.

We achieved 11.1% sequential growth.

We achieved over 160 basis points improvement in gross margin percentage to a record 57%, driven by the strong ramp of Fab 4, Fab 2 and our assembly and test facility.

Earnings per share exceeded our original guidance by 2 cents.

Operating profit exceeded over 33% for the first time in our history.

Now, for more than a year we have been guiding investors and analysts towards the business model that achieves over 57% gross margin and over 33% operating profit percentage.

Our target was to achieve this model by the end of fiscal-year 2005.

We are very pleased to have delivered this outstanding business model 9 months ahead of time, and we expect our business model to continue to strengthen with gross margin and operating profit percentage going even higher.

Nearly 3 quarters ago our lead times started to lengthen.

Therefore, customers started to give us longer-term backlog, resulting in very strong bookings.

Our book-to-bill ratio for the December quarter, 2003, was 1.26, and for March, 2004 quarter was 1.28.

During the June quarter, we ramped our Fab assembly and test capacity quite aggressively and the lead times stabilized.

Today Microchip's lead times on most products are in the 3 to 5 weeks range, with the lead times stabilizing our bookings stabilized also.

We see this as a very healthy sign because lengthening lead times are not necessarily good for the business.

In the June quarter, we achieved a book-to-bill ratio of 1.07 and grew our starting backlog for the current quarter by 7.7%, resulting into a starting backlog for the current quarter, which is an all-time record for the Company.

Now, while the net sales grew 11.1% sequentially, there's an important distinction for comparison purposes.

Many of our peers in the semiconductor industry recognize revenue on a sell-in basis.

If Microchip had reflected sales on this basis, our net sales would have grown an additional 6.7% over our reported results.

So, on this basis, our sales would have increased almost 19% sequentially.

And when we combine the record net sales with record gross margin percentage, record operating profit percentage, record net income, and record earnings per share, about high end of our guidance and the record starting backlog for the current quarter, I believe that this was another spectacular quarter for Microchip and our best quarter ever.

Now I shall talk about the product lines.

Microcontrollers.

Microcontroller business was very strong and grew 9.3% sequentially after growing by 7.8% in the March quarter.

Therefore, in the last 2 quarters, our Microcontroller business has grown by accumulative 18%, which is more than the total growth forecasted for the entire year for the 8-bit microcontroller market by many analysts.

This continues to prove my point that many of the analysts do not understand the 8-bit microcontroller market and keep on applying muslar [ph] to this market and forecasting market share to 16-bit.

We are continuing to see a very robust design activity with our 8-bit Flash microcontrollers and we are seeing a lot of new applications emerging, which are utilizing our products.

Last quarter we announced the words "smallest microcontroller housed in a 6-pin package."

We are especially very excited about the new doors it is opening.

We are very well-positioned to continue to gain market share in this segment.

I also want to point out that we have received numerous inquiries about Motorola spin-off Free Scale [ph] semiconductor being on the IPO road show.

They have made comments about them gaining market share over Microchip.

As to our knowledge, based on the numbers we have seen, Motorola's 8-bit microcontroller business was down last year, while Microchip's business was up, and in the first half of this year, we have grown accumulative 18% in 6 months.

Our last quarter was up 29% over the same quarter a year ago.

And from a new product standpoint, we have introduced about 50 new Flash microcontrollers in the last year versus Free Scale having introduced about 13, to our knowledge.

In fact, we have introduced about 3 times as many new products last year as any of our competitors.

Based on these results, Free Scale's comments are nothing more than many years-old rhetoric of a free-falling semiconductor company.

After so many years of continuous claims by Motorola, and then Microchip continuing to gain market share, I would think that investors would know by now which company to believe.

Anyhow, our numbers speak for themselves.

We are growing faster than any estimates of 8-bit microcontroller growth by any of the analysts or Semiconductor Industry Association or anyone else.

Now, [inaudible] just handed this: Free Scale just announced today their June quarter was up 4.6% sequentially and most of the growth was attributed to wireless business.

The TSB group, which has microcontrollers in it was up 1% sequentially and up 7% over the June quarter a year ago.

In contrast, Microchip's microcontrollers are up 9.3% sequentially and up 29% over June quarter a year ago.

We grew more in the last quarter on microcontrollers than Free Scale grew in the whole last year.

So go figure.

In addition, Microchip shipped 14,624 new application development systems to customers during the quarter, which is a new quarterly record for the Company.

The continued strength of our development system sales is an excellent indicator of the robust, new product introduction and design cycle we feel is underway.

Our total number of development systems shipped now stands at 319,624.

Analog products.

The analog products were exceptionally strong and grew 15.5% sequentially after growing 7.9% in the March quarter.

So, in the last 6 months, our analog sales have grown accumulative 25%.

We believe that our Analog strategy's working, the new products momentum is strong, the numbers of customers are growing, and we are starting to get name recognition in the analog industry.

I would like to believe that we have put to rest the investor and analyst concern about our ability to penetrate the analog market.

Last quarter we added approximately 500 new customers for a total of approximately 9,400 customers for our analog business.

The gross margin continues to be very strong.

Serial EEPROMS.

Serial EEPROMS business was up a whopping 20% sequentially, reflecting strong market conditions.

We had guided the investors that we were seeing competitors allocate capacity away from the Serial lease [ph] core market and we expected strong growth.

ASB stabilized and moved up in certain cases.

The lead times from competitors have now come down somewhat and are now in the 8 weeks range.

We expect this business to continue to grow steadily in the quarters ahead, but not by the kind of growth we saw in the June quarter.

Now, let me talk about the Fab 4 ramp.

Fab 4 has executed a flawless start-up and ramp.

I am very pleased to announce that during the quarter Fab 4's wafer costs matched that of the fully-utilized Fab 2 facility.

During the quarter we also ramped our Fab 2 facility, which is now nearly 100% utilized.

Our gross margin increased by 160 basis points last quarter to a record 57.1% and well above the guidance we had provided at the start of the quarter on gross margin.

We expected gross margin to improve by another 50 to 75 basis points this quarter.

I will now like to update you about a development in our litigation with Philips.

We have had a legal dispute with Philips Corporation of Holland, which is over 11 years old.

It is a dispute over the use of [inaudible] patent that Philips holds.

The predecessor of Microchip, General Instruments, had a license from Philips, which Microchip inherited, and we believe that we do not owe Philips anything.

Philips disputes that license.

Microchip and Philips have been in litigation on this issue since the year 2000.

This has been extensively disclosed in all of our 10-K's and 10-Q's.

Just a few days ago in July, Philips had made us a settlement offer, which could avoid costly litigation and dilution on management's time.

Although we could considerably continue to litigate this matter in court, we believe that a window of opportunity exists where we can settle this matter.

Many details need to be worked out so the likelihood of a settlement and the amount, if any, that might ultimately be paid, cannot be easily assessed.

While we do not wish to disclose the amount right now for confidentiality, as well as negotiating reasons, I can share with you that the amount, if any, will be less than 5% of our cash balance and less than a single amount of free cash that Microchip is generating every month right now.

So, this would not have a material impact on Microchip's financial conditions.

In all likelihood, if it settles, it will be a September quarter matter, but in the unlikely event that the agreement is concluded before we file our 10-Q, then we will have to include it in the 10-Q for the June quarter.

And now, I shall discuss our guidance for the September, 2004 quarter.

As we look at the September quarter, we took several factors into account.

We entered the September quarter with the best backlog position in over 3 1/2 years.

September quarter is also Microchip's seasonally strong quarter in Asia, our largest market.

However, September quarter is seasonally down in Europe because of summer holidays.

Also, we are seeing some varied sentiment in the industry and the analyst community that seems to have developed in the last few weeks.

We believe that this sentiment is coming from the companies that recognize sales at distributors based on sell-in.

For example, our distributors built about $13 million of inventory last quarter, but we did not recognize it in our net sales.

This quarter we do not expect distributors to build a significant, additional inventory, but unlike sell-in recognition, it will not negatively impact our net sales.

It would negatively impact the sales of those companies who recognize revenue based on sell-in.

So taking all these factors into account, and after checking and re-checking expectations from our direct, as well as distributor channels, we expect net sales in the September quarter to grow by approximately 5% sequentially to an all-time record net sales of approximately $223 million.

As I said earlier, gross margins are expected to move up by another 50 to 75 basis points to a record of between 57.5 to 57.75%.

Operating profit is expected to exceed 34% for the first time in our history.

And earnings per share expected to be another record, about 29 cents.

Finally, one more thing.

I was just reminded by a phone call from my daughter an hour ago that today happens to be my birthday.

My 49th birthday.

I would like to take this opportunity to thank the 3,800 employees of Microchip worldwide who could not have given me a better birthday present than this spectacular and the best-ever quarter for Microchip.

With that, Natalie, would you please poll for questions?

Yes, thank you.

The question-and-answer session will be conducted electronically today.

If you'd like to ask a question, please signal by pressing the star key, followed by the number 1 on your touch-tone telephone.

If you're using a speaker phone, make sure that your mute button is turned off to allow your signal to reach our equipment.

In order to respond to as many questions as possible, we ask in that you please initially limit yourself to 1 question and then you may queue again for a follow-up question.

Again, it's star 1 to ask a question.

And we'll pause for just a moment.

We'll go first to Mark Edelstone from Morgan Stanley.

Hey, Steve, happy birthday and very nice quarter again in a challenging environment, at least on Wall Street's perspective.

Just one question for you on the stock buy-back that you mentioned.

You mentioned what the buy-back was.

I thought in the June quarter that you also mentioned 1.15 million shares being purchased.

Would those purchases that took place here in the month of July?

Yes, they were.

Okay, great, thanks guys and best of luck going forward.

We'll go next to Chris Caso with Schwab SoundView.

Hi.

Thanks.

Steve, I wonder if you could expand a little bit, I guess regarding the bare [ph] sentiment you're talking about, and specifically perhaps what you might have seen from the month of June and, obviously, the month of May went fairly well for you guys.

You raised your guidance.

Maybe you could talk about what the bookings patterns were through the month of June and into early July?

Bookings were stronger -- higher in May than April.

Our bookings were higher in June than May.

Our bookings pattern we thought was pretty consistent with our lead times.

As I mentioned, we very aggressively ramped our factories because our lead times, you know, were stretching out slowly and we like to keep our lead times in the 3 to 4 weeks time frame.

And as the lead times became stable, then people do not have as much need to continue to place orders out in time farther and farther out, and therefore the bookings stabilized, the lead times stabilized, we had a very strong bookings in the quarter, 1.07 book-to-bill ratio.

Record backlog.

So you know, our business continues to be consistent.

I wanted to add some information for the month of July so far.

We started the quarter with 68% of the quarter, September quarter, in the backlog, and the first 20 days that number is now up to 81%.

And if you compare that to when we spoke to you last quarter, you know, we entered the quarter with I think 63 or 64% in the backlog.

It was about 80% on the day we announced earnings.

The day we announced earnings they were 80%, but the earnings announcement was a couple days later that quarter than today.

Right.

So we're doing fine.

The quarter is continuing to fill up to our expectations, and July continues to be fine.

So, I'm sorry, would that imply that July then, the bookings would have accelerated versus June?

Not really.

I mean, you have to consider that we are going into a period where August is certainly weaker in Europe, and you have to take that into account in looking at the quarter.

So, I think these are just indications of continuing to see good business conditions rather than individual points that can be extrapolated to conclusions that might be not reasonable, Chris.

Okay.

That's fair.

Happy birthday, Steve.

Next we'll go to Michael Masdea with Credit Suisse First Boston.

Hi, this is Siji DeSilva for Michael.

Can you give us the book-to-bill numbers by distributor?

For distributor?

We have no clue what those are.

We don't retain that information.

We work with, you know, 60 different reporting points around the world.

Okay.

There are too many distributors.

You know, with 65% of our business in distribution, I don't know if it would be significantly different.

I actually don't have the book-to-bill for direct distribution to hand, but I would expect it to be pretty much in the same range.

In the same range, okay, great.

Another question on -- given you talked about the geographic Europe versus Asia.

What do you expect the linearity of 3Q bookings to be?

The linearity of the Q3 bookings?

Yeah, seems like it's been fairly linear up until this quarter.

How do you expect it to play out this quarter?

I think, you know, traditionally you have some softness in the month of August driven by holidays in Europe and August has 1 week off actually in parts of Japan and Korea and some other places.

So other than the seasonal holiday pattern, I think the bookings should be really fine.

Okay, great, thanks.

Happy birthday, Steve.

Thanks.

Next we'll go to Jeremy Kwan with Piper Jaffray.

Hi, good afternoon.

Looks like your, as you mentioned, the analog and microcontroller businesses grew pretty nicely, are there any applications that you can highlight specifically?

Our business is so broad with 43,000 customers that no single application makes a large portion of our business, and we always have the same answer to this question.

We're really not -- we can't focus on a single application, it's a very ubiquitous business and it just goes everywhere.

We introduced hard-hitting, feature-rich, standard products that somebody could design them in a consumer appliance, somebody else could put them in an automobile, somebody else can use them in a battery charger and somebody else can put them in a meter.

These are very standard feature-rich products that have applications in a very, very broad set of applications.

You know, we have talked about in our Analog business the wireless component and how that's really not an area of specific focus for us over the 3-plus years we've operated this business, and in this quarter, at least our initial information here, has the wireless segment declining from about 12, 13% of business down to about 7% of business.

And so the growth in analog is really driven from the broad-based type of business that is our business where we can defend those positions much more aggressively and actively, which is really one of the main areas that we see for continuing growth in that segment of our business.

Great, thank you very much.

One of the questions that often comes always is automotive, and you know, I read -- probably seem to read 10 times in a year that their automotive inventory is in.

You know, they seem to correct 10 times in a year.

Starting the month of, basically late July and August,all automotive companies essentially go to a new model year, the following model year, 2005's show up in the show rooms.

So right now is a very heavy building stage for those new model year cars, and the prior model year always goes on sale and is always slightly higher inventory on them, and factories have to build a larger number of cars to re-stock up all dealers essentially all around the world with a new model year.

This phenomena happens every year and I've never been able to understand why every year it is a news and every year automotive inventories are high and every year later on the numbers come in, Microchip does find we have huge penetration into the new model year cars and this quarter is always strong driven by that, and you know, this month has been no different.

We have heard from a number of investors, reports that the auto inventories and Microchip would be affected, and you know, this is the 10th time in 10 years.

Thank you.

You're welcome.

Moving on we'll go to Tom Smith with Standard & Poor's.

Yes, hi.

I saw that the inventory turnover was a little bit higher than it's been in past quarters and that your inventories are actually a little lower.

How does that sit with where you need to be in the third quarter?

We're kind of getting into the target range of inventories, you know.

We started off a year ago with inventories that admittedly were higher than we actually would have liked to have seen at 134 days, and we've brought those down every quarter from that point, arriving at about the 90 to 91 days of inventory.

And that feels like a very good target range to run our business.

We have very long-lifed products in both microcontrollers and analog.

It enables us to maintain a very good lead time based on the majority of our products being in die stores and being able to satisfy our customers.

So we feel we're in a very good balanced position here.

As we look forward, you know, we won't be bringing inventories down, we'll be maintaining them at these levels and obviously, our production needs will reflect that.

Okay, thanks.

If I may, go on about the Gresham Fab.

When you get fully ramped, can we expect CapEx to steady off?

Between the 2 factories we can do between 1.3 and $1.5 billion annually in revenue.

Based on today's results, we're you know, 850 million.

That's rather a long way in the future to be able to forecast what's happening from a CapEx perspective.

We certainly have more than sufficient capacity and the equipment that we bought in Gresham continues to give us tremendous opportunity to ramp that facility on a cost-effective basis and utilize what we bought for essentially 10 cents on the dollar.

For, you know, several more years we can expect to keep our CapEx in this range, just maybe minor growth based on scale or something.

And you know, you're talking about $400 million of positive cash flow per year or so, you know, growing from there.

So we're talking about a huge machine, you know, for the $180 million facility we bought, we're just throwing a huge amount of free cash flow, the order of $400 million or so per year.

Good, that's rather what I had thought, that you had paid the dues, the machine is up, and you're ready to go for a while.

They've really done an outstanding job in yields and efficiencies in the last several quarters here to bring it to the levels they have.

The team in Gresham has just done an outstanding job.

And as I mentioned in my commentary, last quarter on a comparable technology Fab 4's, Gresham's wafer cost actually matched the cost of our fully-facilitized Fab 2 facility, and that was only the third quarter of production.

And rarely, rarely ever done in the industry, you know, on a brand new fab.

Thank you.

Could you remind us what CapEx was in this quarter?

It was 13 million in this quarter, and we're projecting 15 for the September quarter and 75 for the year.

Great, thank you very much.

You're welcome.

From Morgan Keegan, Harsh Kumar.

Yeah, hi, guys.

Congratulations first of all and, Steve, happy birthday.

A couple of questions.

Can you talk about Asia was up very strongly.

Was there anything specific there?

Or was the growth pretty uniform and spread pretty well through Asia?

It was nothing that I would, you know, make it stand out.

It was pretty broad-based.

It was in lots of different countries.

We did well in China, Taiwan, Hong Kong, Singapore, Korea, you know, everywhere it was in all product lines, analogs did very well, microcontrollers did very well, memory was very strong.

So nothing that stands out.

Okay.

And, Steve, can you maybe take a minute or so and talk to us about the seasonal trends you typically see in your business in the second half as opposed to the first half, specifically with respect to your end markets?

If you can provide any color on that.

I rarely have any commentary on the end market, other than saying that our business is very broad, spread over 43,000 customers over thousands of applications and 65%-plus of the business going to distributors, so you know, we don't really have much color on the end market.

That's somebody else's business, where maybe 10 customers could make up all the business and contributed out the end market.

So without talking about the end market, you know, June quarter is usually a good quarter for us, and this was clearly an outstanding quarter.

September quarter is usually strong in Asia, you know, it's weak, usually we have a negative growth in Europe because of the holidays in August, and Americas usually is okay.

So combine those 3 things, you know, together, September usually is a reasonable quarter and that's the guidance we're giving.

And then December quarter, December quarter and March quarter are usually 2 slightly weaker quarters.

Got it.

Thank you.

2004 wasn't really weak.

We grew very, very strong in the March of 2004.

Adam Parker from Sanford Bernstein is next.

I apologize if someone asked this.

I switched off for a minute here.

Given you achieved your profitability targets a few quarters earlier than you expected and the fundamentals are already at record levels and getting better, did you want to share any new medium or long-term profitability goals in terms of gross and operating margins?

Not today.

The numbers are so fresh that, you know, we need some more time on it, but we probably would do that at a conference during the quarter, maybe wherever the opportunity may arise after we've done some modelling.

What we can say right now is that the numbers are still headed higher because Fab 4 has much, much more to go.

It's only running at a fraction of its capacity, and with the Fab 4 wafer costs only matched that of Fab 2 last quarter, the Fab 4 costs would be lower than Fab 2 as we speak, and therefor,e we're guiding towards another 50 to 75 basis points improvement in gross margin and operating profits over 34% this quarter, which already will exceed our lower guidance in our model.

And the numbers should continue to grow higher.

But the acceleration slows down here because I think we're pretty much up there.

Okay.

Steve, besides the comments you made on Free Scale and the share -- the share issues.

Maybe just from your perspective over the last decade, and more, why do you think your stock's been weak recently?

Well, because many of the analysts don't get it.

As simple as that.

They keep on applying the, you know, how many times, how many years we have to do it?

The answer always is well, you did it in the past, but can you continue to do it?

And, you know, for whatever reason, Free Scale and Motorola say something and it raises all these questions and takes us a while to relay the questions back and back them up with the data.

So the last quarter was great, but the questions are always there for the next quarter.

Around this time there are always questions about automotive.

Some other times there's always questions about something else.

You know, you guys get paid for worrying about these things, so there's a constant worry, but you know, business is doing very, very well.

You know, we got the 8-bit market licked, we understand it better than anybody else, and I do not know any study on 8-bit that appropriately represents Microchip's penetration in that market.

Nobody's ever forecasted it right.

You can look at many of the numbers for the next year, the numbers are so low going into this year, what was projected as a growth of the 8-bit microcontroller market in 2004, we have already exceeded those in the first 6 months.

Okay.

So it's just kind of same old, same old.

It's basically same old, same old, and we are best served by just continuing to deliver these hard-hitting numbers, and let you guys do the job in explaining them, and you know, over time get to believe them, but there's always -- there's a lot of churn in the business, there's lots of new investors, there are lots of new analysts and people don't understand the history of, you know, years and years of really what we have done and what makes this company you know, run.

Producing 33.3% operating profit.

That's higher than our competitors gross margins.

There always seems to be some hair tick in the crowd that comes out with a information and the Street seems to react to that much more so than the 1 positive that may come out, which is strange, but you know, it's our business to run Microchip and it's your guys' business to understand how the Street's doing.

Fair enough.

Take care, guys.

Thanks.

Next we'll go to Gill Alexander with Garfield & Associates.

Congratulations.

Your development system new record this year, can you put that in perspective over what's happened the last 2 or 3 years?

Because it seems important.

The number of development systems has continued to increase every year.

I believe last year we shipped a record of over 30,000 systems or so, and this year we'll probably make a new record, because in the first quarter we shipped 14,624, which was a new development systems record for the quarter.

You know, the number basically all relates to an average momentum of number of new products being introduced, the number of new designs or customers going to utilize the microcontrollers, because the first thing a customer buys when he's considering using our product is to buy a development tool.

Then he uses the development tool to design our product into his end-product application.

So there's a very, very direct correlation of number of development systems to really the momentum, and having shipped a record number of development systems this quarter, and you've got to look at it in some sort of rolling number.

The quarter's important, but you could have a good quarter if the numbers fall off, you know, on both sides of it, then it's not important.

But every year we've been shipping more and more 2's, and that really means more and more products and more and more designs and more and more customers, and it projects the number, usually about a year ahead.

The development systems bought this year will start producing revenue about a year from now.

And we have no doubt in our mind that the momentum we see with our products and with our development tools will have a very good next year.

All right, thank you.

Can I just ask 1 question on automotive?

Sure.

I have no idea now what your automotive sales are, and I was just wondering, how much more penetration do you have room for with the new products you have coming out?

Well, our automotive sales are about 18% of our business, so on an annualized $850 million run rate, if I were just to do the math for you, it will roughly mean about $153 million a year.

And it's really nothing.

Our automotive penetration actually is less than the penetration we have in the other market segments.

Some of our competitors, like Motorola and NEC and others have a larger portion of the business in automotive.

So automotive continues to really present as a pretty good opportunity, because over time we are having -- every year we have more chips in the following year model car than we have in the prior-year model car.

And the number of cars built in a given quarter has seems to never correlate to Microchip's financial results, never once even.

And yet, it really seems to drive a lot of Street sentiment and all the way to the automotive inventory and the announcements from GM, you know, while they may be a fairly small portion of our overall automotive sales, because we're shipping to Europe and Korea and Taiwan and China and everywhere else, the numbers coming from Detroit always seems to create volatility around, you know, short-term announcements.

But, you know, I think longer-term Street gets it right always and longer-term's dark and the numbers have done well and our automotive business has continued to grow.

My congratulations and happy birthday.

Thank you.

Next we'll go to Jeff Rosenberg with William Blair.

Hi.

First I just wanted to -- if I was remembering correctly, I think you had said that you expected the wafer costs from Gresham to approach the Tempe Fab when you got to about 30% of the ramp, is that right?

Or is that about what it took in order for you to get to that point?

If you recall, you know, I withdrew that number, but you don't seem to give that number up.

It has nothing to do with it.

It was a slip by somebody.

It has no correlation to 30% ramp.

We have not given officially that number, and we do not want to convey where it becomes even and where it becomes less, because I think that would be competitive information.

Okay, so you don't want to break out sort of how much of your production right now is coming from Gresham?

No, we don't.

Okay, all right, that's fine then.

You kind of touched on this earlier, let me take it a different way.

What's your feeling right now -- I mean, I know you don't have a definitive answer -- but as to whether or not you can really leverage the incremental cost savings that you're gonna get, going to lower wafer costs you get going forward versus the opportunity to bring those cost savings to the market to help drive, you know, additional revenue growth?

Well, you know, a lot of our microcontroller business and our analog business, those 2 together will make up, you know, 86% of the business.

It's a value-added pricing, really basically what the market will bear based on the features and products and all that and it really doesn't have anything to do with the cost.

We don't really lose microcontroller or analog business because, you know, our cost is too high on something.

You know, the relationship to cost is much more of a memory equation, which is 14% of our business and it's really not the business the business you want to build a company on.

The business is doing well.

It's very profitable.

It's growing and it's great, but we don't want to take it to 30, 40% of our business.

So I think a good portion of the cost reductions really go to the bottom line, but over time as we go to the business cycles, you know, if there is any cost pressure, we have the ability to handle that cost pressure also.

Okay, and I wanted to switch gears and follow up on what you were saying before about about lead times relative to visibility.

My understanding was you had lead times before on the microcontroller and analog business, that it stayed no worse than 6 weeks, kind of 3 to 6 weeks, but you were asking and getting the customers to give you 8 to 12 weeks of visibility.

Are you saying they're a little less willing to do that now in terms of giving you visibility out beyond your lead time or could you maybe add some color to that comment?

Okay.

Yeah, lead times were in the 3 to 6 weeks and during the early part of the quarter on certain products may have gone longer than that for a period of time, but as the aggressive capacity ramp came in, most lead times are now closer to 3 to 4 weeks, although we're seeing 3 to 5 because some products are there.

So lead times are in very, very good position, driven by strength in capacity.

The lead times are always unpredictable because, you know, lead times are a function of demand, and when there are a few thousand product types, a combination of masks and packages and temperatures, you know, we sell 6,000 to 8,000 different SKUs.

The lead time on any given SKU could go up very rapidly if you have 1 customer come in and buy a big portion of really what you had for the next few weeks.

So my advice to customers has been, you know, that to ensure that you don't have to pay any expedite charges or your production is not impacted, make sure you take off your requirements for 8 to 12 weeks and give us those orders.

Many of the customers, and most of the distributors are doing that today.

That's why we are starting the quarter with 68% in the backlog and as of today we have 81% in the backlog.

So, even though our lead times are now in the 3 to 5 weeks range, we're continuing to get backlog better than that, which helps us plan capacity and build a product in a much more batch fashion, which is more cost-effective, not brick set-ups every day, so on and so forth.

Okay.

And then in the past when we've had situations where your turns have gone to, you know, higher than 50% or certainly back up to 50%, I guess customers haven't been willing to give you that sort of 8 to 12 week visibility.

It sounds like you're not seeing any change in their behavior, they're not -- that they're sticking with that and will be willing to give you, so the environment really hasn't changed from your perspective, it sounds like?

Well, in the past cycles when they were not willing to do that, I think we didn't work that as aggressively and actively.

And this time I have personally done 4 memos directly to the senior management of the customers, we posted them on the web for your use, as well as our customers use.

Our sales people have taken it to them and essentially advice coming from an industry CEO regarding how you should deal with current times and make sure your business is not impacted, and many, many customers, I would say 30, 40, 50 letters that I have received from various customers around the world, have been very complimentary of my efforts in trying to reach to them and advising them of the marketplace, and many of them taking our advice actually, were not able to only do that for our products, they were able to order all of the other related products that go into their design kit.

And they were able to continue their production and they succeeded where in certain cases somebody else's product would have had long lead time.

So they have been complimentary of our efforts, trying to reach out and trying to really help them manage their business.

Okay.

That helps, thanks.

You're welcome.

Moving onto Shawn Webster from J.P. Morgan.

I'm calling on behalf, I'm Chris Stanley.

Good quarter, guys.

Actually most of my questions have been answered, but I had a couple of follow-up ones.

Did you talk about pricing at all from a segment perspective, how it was during the quarter and what your expectations were for the coming quarter?

Are you saying pricing by segment?

Yeah, your high level, your 3 segments, analog, microcontroller and memory.

The microcontroller and analog prices do not change quarter to quarter.

They barely change year-to-year.

They are very, very stable, they are really given at the time of design.

There's no spot market pricing usually on those because they are very design and driven products, so there's really no change in those 2 segments.

When you look at the memory product, the memory product pricing actually firmed up last quarter because of the lead times and some of the shortages and we did very well in that business and pricing basically stabilized, and that's really where it is today.

Some of the lead times have come down and prices, I do not think prices are going up anymore, but prices are relatively stable.

Okay.

And from a outlook perspective, you talked a little bit about the memory piece of your business.

What are you expecting in the way of growth from your other 2 lines?

I think within the 5% growth to, you know, guidance we gave.

I mean, all product lines should be in the same range.

Okay.

Great, thank you.

You're welcome.

As a reminder, please limit yourself to 1 question.

Next we'll go to Janet Ramkissoon from Quadra Capital.

Hi, Steve, happy birthday.

Some of us are believers, believe it or not.

A question about new product introductions.

Are we likely to see as many new product introductions within the next year as in the last or is that too much of a forward-looking statement?

Well, the new product introductions are very, very strong.

The pipeline that we have, like what you do not see today, but what would be coming out in the next quarter, the quarter after, what is in our design, what is in our fab, what is our characterization, what is the qualification, the new product pipeline is very strong, as good or stronger than what we have done last year.

What kind of attendance are you expecting at the text book conference this summer?

It's actually starting today, I give a keynote address tomorrow.

We have over 800 people in attendance, record ever.

I think the number is closer to 850.

And what was it last year?

I think it was about a little over, closer to 700.

Okay.

I'm reading this off the top of my head, so give or take some, but it's a record, record attendance this year.

Congratulations.

Thanks.

For those, you know, on the conference call that don't know what that question was, we hold a technical conference for our customers every year in July around this time.

It's called "MASTER's Conference."

It stands for Microchip's Annual Summer Technical Exchange and Review.

Our MASTER's conference is not free.

Customers pay to come here.

The temperature outside is 110 degrees, and we got 850 people from around the world, from all parts of the world here paying Microchip and attending in the heat coming to learn about our new products, given feed back and learning what we delivered last year and what we are going to deliver next year.

Very, very successful conference every year.

And next we'll go to Ruben Roy with Pacific Crest Securities.

Hi, thanks, Steve.

Most of my questions have been answered.

I had a quick one.

You mentioned a few times that in your automotive markets, your silicon content goes up.

Can you quantify that at all on average in terms of what ASPs you're talking about?

I think, you know, the balance will be 20 to 25%, somewhere in that range, and it's a little bit different every year and you don't always know which model year will become how much successful and, you know, how many cars will be built on a given model.

We have chips in close to 300 different models around the world.

So it's a very, very large number of moving parts, but I would say, you know, our penetration and content seems to have gone up in that range, 20 to 25% every year.

Okay.

Thanks.

And just really quickly, you mentioned competition a number of times, but it does seem like given the robustness of the 8-bit microcontroller market there have been new players kind of coming up and just more interest in the market.

I was just wondering if you think you're gonna see some changes to typical pricing trends as you look out 6, 12 months?

Thanks.

Well, you know, the new players hasn't changed in 10 years.

There were new players 8, 10 years ago, and the new players today -- if I go back to '95 and '96, there was ZILOG, there was National, there were some Japanese, there was a couple of Taiwanese, and if you look at more recently 4, 5 years ago Cyprus started.

If you look at more recent, it's been Silicon Labs and, you know, they're constantly entry of new players, and this kind of business model that we're producing with over 33% operating profit, you know, certainly draws flies to it, but none of those new players has been able to really make much of it.

I mean, all of those new players' revenue combined wouldn't exceed $20, $30 million, so it's really, it's not been an easy market to penetrate.

And, you know, people, a lot of the reports will write the name of you know, Silicon Lab and somebody else and XYZ, 2 or 3 competitors, you know, sort of like they're the size of Motorolas, [inaudible] and Toshibas.

They're not.

They're nit [ph], their numbers round off.

It's just nowhere.

That's helpful.

Thanks.

From Banc of America Securities, Sumit Dhanda.

My questions have been asked and answered.

Thank you.

You're welcome.

Next we'll go to Ambrish Srivastava from Harris Nesbitt.

Good afternoon, it's William Tell calling for Ambrish.

Just a quick question, with regard to a 16-bit microcontroller, I was wondering when do you expect it to contribute meaningfully to your revenue and if you'll be able to provide a percentage by the end of the year or next year overall?

Thank you.

Well, on the 16-bit dsPIC, we currently have 8 products in production in the market.

We are sampling another 2 or 3, I think, which will be in production in the next month or so.

We're in volume production, we're shipping product, we've got lots of customers, there's a heavy activity, but we are not going to break those numbers up in short-term, because I think that will be more competitive information, you know.

Our goal is to achieve on 16-bit microcontrollers what we have achieved in 8-bit, and last thing we want to do is give the strategy away and how we're going to do it, what segment is it happening, where is it happening and how the revenue's ramping.

So you, the analyst and investor community are going to have to be patient and trust us.

We're not going to break it out short term.

Thank you very much.

You're welcome.

Next we'll go to Brandy Brandon from Eaton Vance.

Thank you.

Happy birthday.

My questions have been answered.

Very good.

Thank you.

Next we'll go to Jason Sam from Seidler.

Hey, guys.

Steve, just a quick question.

A few quarters ago, you know, you had mentioned that, you know, the distributors were going into aggressive inventory build and a couple of quarters later they have and the inventory, channel inventories have increased and business have been good all around.

Now that, you know, even though the channel inventory at 2.3 months is less than the cycle, the previous cycle peak of 3.3.

One is do you think it's likely to stabilize around this area?

And if it has, you know, do you think that it's a result of more of a seasonality or just a level that they're comfortable with or is it more that they're cautious because the Street is cautious?

Any insight into that?

Looking into it, number 1, the inventory has already stabilized.

Our inventory distributors now is 2.3 months and a quarter ago it was 2.3 months.

So although it has risen from the bottom several quarters ago of 1.9, it is now stable, and since we do not recognize revenue to distributors at sell-in, we really have no built-in incentive to really build that inventory.

So, as a result, we aggressively work with the distributors to keep that inventory stable.

In fact, many of our -- especially our Asian distributors, have tanked us very recently in the last few weeks, saying that Microchip worked with us in keeping our inventory stable last quarter.

In many cases when they were giving us large orders, we showed them why they had enough product and they did not need to do that.

The other companies who were taking revenue based in sell-in would deliver them all that product, take that as sales and now those distributors do not need to place orders on those other companies because they have enough inventory.

So, that's really where you see that if you have a sell-in recognition, you tend to balloon up your sales by, you know, jamming or stuffing the channel and then the distributors slow down afterwards.

In our case, I think the whole quarter has been stable and the distributors are continuing to place orders because it did not build it too much inventory before.

So then, I mean, from your conversations with them, then, have they seen any kind of changes in their demands or are they putting much more of a inventory adjustment kind of a situation?

They're seeing changes on other companies where they have higher inventory, because other companies indiscriminately shipped a lot of product last quarter.

Microchip did not.

I could give you a feel.

We work with our distributors around the world to essentially convince them not to take somewhat approximately $20 million of product.

Right, Gordon?

Yep.

$20 million of product that the distributor did not need to keep, which would have taken their distributor inventory from 2.3 months to something higher, 2.5, 2.6.

We didn't ship it to them.

We asked them they didn't need.

We made them schedule it into the current quarter.

So these were very proactive steps to really not have us to build that inventory, you know, at a overtime price or a premium price to build it and then sit it in their inventory doing nothing.

So then, you know, based on your feel then, do you think that at the 2.3-month level, that should be fairly stable going forward?

We expect should be very stable.

In fact, we're forecasting that -- and we're working with them really to keep this inventory in that range, and they're all above -- they're not trying to lower it, they're not trying to increase it.

Sales will increase somewhat, so the inventory will go up a little bit in the dollars, but very, very similar in months of sales.

Okay.

Great, thank you.

Unfortunately, that is all the time we have for questions today.

Mr. Sanghi, I'll turn it back to you for any closing comments.

Okay, I'd like to thank everybody for participating in the conference call and letting us share with you another, you know, spectacular and the best quarter ever for Microchip.

If you have any other questions, we'll be here at the Company, so call on our investor line and we'll be happy to answer any other individual questions you might have.

Thank you.

That does conclude today's conference call.

Again, thank you all for your participation.

You may now disconnect.