微晶片科技 (MCHP) 2006 Q1 法說會逐字稿

Good day everyone and welcome to this Microchip Technology first quarter and fiscal year 2006 financial results 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.

Thanks, Stacy, and good afternoon everybody.

During the course of this 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 would refer to you our press release of today as well as our 10-K for the fiscal year ended March 31, 2005, and our 8-K current reports that we have filed with the SEC that identify important risk factors may impact Microchip's business and the results of operations.

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

I will comment on our first quarter fiscal 2006 performance reviewing geographic data and discussing balance sheet and cash information, and then Steve will give comments on the results outlining our guidance for the September quarter and update other pertinent matters regarding our business.

We will then be both available to respond to individual investor and analyst questions as necessary.

Let's begin, then.

Our net sales for the June quarter were 218.5 million, up approximately 5 percent from net sales of 208.1 million in the immediately preceding quarter and up approximately 2.7 percent from net sales of 212.8 million in the prior year's first quarter.

GAAP net income for the June quarter was at record levels of $61 million or $0.29 per diluted share, an increase of 8.2 percent from GAAP net income of 56.4 million or $0.27 per diluted share from the immediately preceding quarter, an increase of 39.3 percent from GAAP net income of 43.8 million or $0.21 per share from the prior year's first quarter.

On non-GAAP basis the increase was 7.5 percent from net income of 56.8 million or $0.27 per diluted share from the prior year's first quarter.

Geographically sales in Asia and Europe grew by approximately 9 percent and 5 percent respectively with Americas essentially being flat for the prior period.

We established record gross margins for the June quarter of 58.3 percent.

This reflects the proprietary product positioning we have relative to pricing.

Our record manufacturing yields and efficiencies also helped to bolster margins as did our richer product mix.

Our operating expenses were 24.9 percent of sales in the June quarter compared to operating expenses of 24.6 percent in the previous period.

Research and development costs were 23.4 million representing 10.7 percent of sales, and sales and general administrative expenses were 31.1 million representing 14.2 percent of sales.

We're continuing to invest in our business to promote the growth of new products and technologies and infrastructure necessary to make our products successful in the marketplace.

The tax rate for the June quarter was in line with our guidance of 24 percent, and we're anticipating continuing at this rate for the balance of the current year.

The dividend declared today of $0.12.5 was an increase of 31.6 percent sequentially, and an increase of 172 percent over the same quarter in fiscal 2005.

During fiscal 2005, dividend payments totaled $43 million where the annualized dividend payment based on the dividend declared today would be approximately $104 million.

Microchip's total inventory position at June 30 was approximately 103.8 million, which was essentially flat with the prior quarter level.

Inventory turns at 3.5 with days of inventory representing 104 days.

This is three days lower than the level of March ending inventories.

Distribution inventory is at very moderate levels in all geographies.

As of of the end of June, our distributors held about 2.2 to 2.3 months of inventory.

Modestly lower than last quarter.

We are very comfortable with the level of inventory supporting our business overall.

This is our balance sheet and in the distribution channel particularly when the low levels of inventory at the distributors is factored into consideration.

Total inventory days are 145 days towards the low end of total inventories that have been in place over the last three years.

At June 30 Microchip receivable days were 47 compared with 48 days at the end of March.

Overall trade receivable balance increased approximately $17.5 million or 15.5 percent versus our revenue increase of 5 percent.

This reflects the predominant pattern of purchases of product purchases by the distribution channel partners during the quarter.

As of June 30, Microchip's cash and short term investment position was 815 million with $45.4 million of debt on the balance sheet.

During the quarter, Microchip generated cash flow from the business of 100.2 million prior to the dividend payment of 19.8 million.

Capital spending was approximately 14.8 million for the June quarter.

Depreciation expense for the June quarter was 27.8 million versus 29.2 million for the same quarter last fiscal year and 28.7 million in the March quarter.

There is no change to capital spending and depreciation in our forecast for the current fiscal year, fiscal '06.

We anticipate capital expenditures of 55 to 60 million and depreciation of 109 million.

With that, I will ask Steve to discuss the performance of our business, our guidance for September and update other business matters.

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, and finally discuss the guidance for the September 2005 quarter.

So, let's begin.

I am proud of our continuing excellent execution in the June quarter doing what remains as a relatively difficult period for the semiconductor industry.

We met our guidance with $218.5 million in net sales and 5 percent sequential growth, and we substantially exceeded our guidance for gross margins by achieving a record gross margin of 58.3 percent up by 90 basis points sequentially.

A combination of record manufacturing yields and efficiency, richer product mix and stable average selling prices resulted into record gross margins.

Recall that our earlier guidance was to be north of 58 percent gross margin by the end of this fiscal year.

We have achieved that result nine months earlier.

Earnings per share was $0.29, exceeding our guidance by $0.01 and meeting the old record set prior to the start of the inventory correction in September of 2004.

Now I shall talk about the product lines.

First microcontrollers.

Microcontroller business was strong and grew 5.3 percent sequentially.

Our flash microcontroller business was even stronger growing by a robust 9 percent sequentially.

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

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

Now two weeks ago, we also heard that NEC Corporation preannounced the results with negative guidance and partially blamed the microcontrollers.

We also heard that Semiconductor Industry Association is back with poor results in microcontrollers for May, and they're saying there may be a soft patch in microcontrollers.

I would like to thank our investors for understanding and remembering that NEC and SIA have never been proxies for our microcontroller business.

I don't remember our results ever correlating with NEC or SIA, and there is no soft patch in microcontrollers.

Serial EE Memory products.

Serial EE Memory products net sales were up 4 percent sequentially.

The backlog going into the current quarter is quite strong.

On analog products, analog products net sales were up 4.3 percent sequentially despite relatively weak conditions in the industry.

The design momentum on analog products has been very strong, and we see continuing growth ahead.

16 bit microcontrollers.

Our dsPIC products continue to have a very strong momentum.

There are now 19 products in volume production, net sales in the quarter were up 70 percent, 70, sequentially from a small base.

Last week, Microchip held its annual MASTERS Conference in Scottsdale, Arizona.

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

At this conference, we had record attendance with over 1,000 engineers present from around the world.

At this conference, Microchip introduced two new 16 bit microcontroller families to its customers.

First was the product family PIC 24 which was Microchip's first pure 16 bit microcontroller family without a DSP integrated in it.

Recall that our dsPIC had a 16 bit microcontroller integrated with a DSP.

The PIC 24 family is a pure microcontroller and gives Microchip a very low cost and highly competitive entry into the entire 16 bit microcontroller space.

We expect this family to be in production by the end of this calendar year.

The second family we introduced was dsPIC 33.

This is the next generation family to our current dsPIC 30 family.

Our current dsPIC 30 family are essentially 30 MIPS devices, 30 millions of instructions per second devices.

DsPIC 33 is a 40 MIPS family and is more cost effective and has smaller dice sizes than the equivalent dsPIC 30 devices.

So, we get high performance and smaller dice sizes really together.

This family will also be in production by the end of this calendar year.

Overall, Microchip expects that it will have about 50 products in production in the 16 bit microcontroller and dsPIC space by the end of this fiscal year in March of 2006.

With these three families and 50 devices in production, and with powerful design momentum under way, we are well on our way to grow our ranking in the 16 bit microcontroller world.

And now I shall discuss guidance for the segment 2005 quarter.

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

First the direction of semiconductor industry is not clear to anyone.

On one hand, we keep seeing strong GDP and job growth numbers and our own bookings are quite strong.

On the other hand, everyone keeps talking about a slowing economy, high oil prices and the feds raising interest rates.

With so much conflicting data available, we tend to ignore all the data and make our call by doing a bottoms up analysis of our own business and by listening to our customers and channels.

We achieved very strong bookings in the June quarter with a book-to-bill ratio of 1.07, and we entered the September quarter with a sequentially higher backlog position than the June quarter.

September is also Microchip's seasonally strong quarter in Asia and the Americas, and at the same time, it is a relatively weak quarter in Europe because of a significant number of vacations.

Taking all of these factors into account and after checking and re-checking expectations from our direct as well as distributor channels, we expect our net sales in the September quarter to be about $227 million or up 4 percent sequentially.

Gross margins are expected to be about 58.75 percent this quarter due to continued increases in manufacturing efficiency and yields, [richening] product mix and relatively stable average selling prices.

We believe that our gross margins going out of current fiscal year will now be north of 59 percent, which is an increase in guidance from the north of 58 percent just a quarter ago.

With the upside we have achieved we are revising our gross margin guidance going out of the current fiscal year to be north of 59 percent.

We are maintaining guidance for long-term gross margin at 60 percent for now as we re-evaluate the substantial upside in gross margins that we have achieved and ways to balance gross margins with higher sales growth opportunities, and if there is any change in the long-term gross margin guidance, we'll come back to you in due course.

Operating profit is expected to be about 33.75 percent in this quarter, the September quarter, and earnings per share are expected to be about $0.30.

We expect to build approximately $106 million of net cash flow before payment of $26 million of dividends just announced today, and we look forward to sharing this cash with investors with another healthy increase in dividends in the next quarter.

So, before I take questions, let me summarize a few key points.

Our net sales are expected to be about $227 million, up 4 percent sequentially, gross margins to be about 58.75 percent, operating expenses to be about 25 percent, operating profit to be about 33.75 percent.

Inventories expected to be flat in days at about 104 days with distribution as well as our direct customers carrying relatively low levels of inventory we believe that our inventory is positioned properly.

Earnings per share are expected to be about $0.30.

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

Thank you.

Our question and answer session will be conducted electronically. [OPERATOR INSTRUCTIONS] And we'll go first to Adam Parker of Sanford Bernstein.

Hi.

The dividend growth here has been quite substantial.

How should we think about the growth beyond just the next quarter I know Steve you just mentioned you are going to increase it again handsomely.

Can you help us out a little bit more long-term here over the next few quarters how we should think about the dividend growth and then I have a follow up, please?

Well, what we have guided in general is that Microchip believes in sharing this cash with investors aggressively with a growing dividend every quarter.

Pretty much at every conference call we have talked about three different uses of cash, the acquisitions, stock buy back and the dividends.

We do not do acquisitions much.

We've done some in the past.

Very small acquisitions relatively and we have said to the investors that there is really no acquisition activity in the works right now.

We do not, in general, like stock buybacks except when there is real opportunity and we believe stock is substantially under valued, and that just leaves dividends and we have been aggressively increasing dividends every quarter and we will continue to do so.

Okay.

Any comments on beyond the next quarter or no?

In dividends?

Yes.

Dividends are approved by the board on a quarterly basis.

I could not give you a number, but you can expect another healthy increase next quarter also.

The other question, I had was just on the gross margins.

Clearly, you continue I think to sort of beat what your guidance is there on the margins.

Can you talk about some of the major levers that are contributing to that over the next couple of quarters and why you wouldn't maybe guide a bit higher?

Are you just trying to be a bit conservative or why you wouldn't guide them a little higher than albeit a record margin number, why you wouldn't guide higher than 58.75 for September and maybe you can talk about if there are any headwinds there or if you see, it seems like there are a couple years ahead of you of further margin expansion.

Can you take us through the income statement, the gross margin levers for the next couple years?

Well, I think if you look at the margins, with one quarter into the fiscal year we are already higher than what our earlier guidance was for the end of the year, so we're substantially ahead.

Right.

And we are guiding up again to 58.75 percent.

So, we think it is really healthy gross margin guidance, and what we got to do as a management team is look at what point in time that should be balanced with possibly higher top line growth in taking business to a slightly lower margin so we still continue to increase the gross margin and increase it quite aggressively.

But rather than trying to reach 60 percent rapidly if that can result into higher growth on the top line probably would be a better result ,and that's a delicate balancing exercise that we continue to evaluate.

And quarter after quarter we seem to be able to post the top line as well as beat the gross margin like we did just the last quarter.

But looking at all of that, we believe that's really what our guidance is right now and we'll see how it actually pans out.

Okay.

Great.

Thanks.

In terms of your second part of your question was the moving parts.

There are a large number of moving parts, there's obviously absorption in our factories, record efficiencies in yields, and I think some of the seeds of gross margin upside were sown back in January, February time frame when the industry went into inventory correction.

Lots of companies went into re-trenching in their fabrication factories and laying off people and cutting back and shut downs and all of that, and we came to you at that time and we felt that our inventory was not very high.

We felt pretty comfortable and we’re going to run factories at that rate.

And then bring the inventory down in the growth.

And that was a somewhat controversial decision.

Some people thought we should probably shutter down the factories, and I think when you shutter down the factories and three, four, five months later grow the factories back you lose six months of improvement in your factories in yields and shrinks and training of people and so on and so forth.

So, our seeds of gross margin were sown back when the decision we made in January and you're seeing a record performance today.

Factories have very high morale.

They're putting out record output, world class efficiencies in yields, our products and cost reductions are ahead of schedule and that's really where you're seeing a lot of improvements and we expect that to continue in the foreseeable future.

We're also getting a richer product mix, as you see our flash microcontrollers were up 9 percent sequentially versus other products were less so we continue to get really leverage there.

Thanks a lot.

We'll go next to Michael Masdea of Credit Suisse First Boston.

Thanks a lot and great job on the operational front.

First question really is just about your book-to-bill 1.07.

You said inventories are fairly lean out there.

Any impact on lead times your customers are giving on you or any concerns from them, and I have a quick follow up.

Lead times on most products right now continue to be 3 to 4 weeks.

Some products are available off the shelf, but, in general, lead times are anywhere from 2 to 4 weeks.

They're not going any longer short term.

They're not going any shorter.

Seems to be stable.

As Gordon mentioned, inventories in the quarter expected to be flat.

So, we're basically staying in place.

The demand is good, our bookings are strong.

But it is not [INDISCERNIBLE] to the point where the lead times are pushing out.

Great.

On the analog side, is there any reason why we’d see a little bit of the coupling with your microcontroller business and your analog and should we start to see that analog business start to out grow the microcontroller at some point?

Well, you know, there is coupling on a portion of the business.

And a couple of years ago we gave you percentage of analog business which was tied or bundled with the microcontroller.

At that number at its peak was about 70 percent.

We stopped really giving that number because investors started to expect that number to go higher and higher.

So, 70 percent, 80 percent, 90 percent, and that would not have really been a good result.

We do not want to sell analog only with our microcontrollers.

We want to be successful with our analog products outside of our microcontroller business.

We want to be successful even outside of the microcontroller business, so a couple of years ago we entered into a phase two of that program.

The phase one was to sell our analog products around our microcontrollers.

Phase two was to sell our analog products with anybody's microcontrollers, so if a given application we do not win the microcontroller, we still want to be able to sell our analog, and we're doing quite successfully in that today.

The phase three which was overlapping and has begun already is to be able to sell our analog anywhere.

With DSB, SBGA or anybody else who wants the stand-alone analog.

So, we're essentially selling analog every where our business was up 7.5 percent in the March quarter sequentially.

About 4 percent last quarter.

So, at that rate it is running at about 22 percent growth, something like that for the year based on the last two quarters.

We don't think that's shabby.

Great, thank you.

Our next question from Tore Svanberg of Piper Jaffray.

Hi, good afternoon.

This is actually Jeremy calling for Tore.

My first question relates to CapEx.

Looks like your CapEx right now is spinning at the rate of about 50 percent of D&A.

I was wondering if add some color about how long this might be sustainable and, at some point, do you expect I guess CapEx to kind of increase to catch up over time?

We actually said in the last guidance call that longer term, we expect CapEx ratio to be about 10 percent of sales, but in the short term when we're talking the next couple of three years we expect that with the capacity available in Gresham being able to bring that into play that we would continue to see our CapEx in the range of 60 to $70 million which is as you say substantially lower than we see in depreciation at this point in time.

And that is beginning to reflect itself overtime in our depreciation costs which is another factor that's helping us to continue to grow gross margins even during these periods when essentially inventories are flat and therefore obviously absorption levels are essentially in that same range.

Great.

Next question relates to the new 16 bit MCUs.

Sounds like more functionality, better performance at a smaller dice size.

Is it fair to say these can also command better than average gross margins?

Well, these are much higher functionality and larger dice sizes part than 8 bit microcontrollers, so they command much higher almost 3X higher average selling prices, but there cost is much higher too, there in average larger package size, testing cost is higher, advanced technology, you know, the dice size are larger.

The gross margin model isn't really very different than the 8 bit microcontroller model.

As it compares to the dsPIC, is that right it is a smaller dice size?

The pure 16 bit microcontroller, the PIC 24 family I talked about are very cost effective devices and much smaller dice sizes than the dsPIC, but the prices are lower and the dice sizes are lower.

The model is very similar.

Great, thank you very much.

We'll move next to Chris Danely of J.P. Morgan.

Thanks, guys, you talked about a strong book-to-bill.

Can you say how July has gone so far and what sort of turns you need to do to get to the guidance?

And then I have a follow up.

Well, if you recall, we stopped giving turns guidance a quarter or so ago.

We have said for many years now that the amount of turns requirement never correlates to Microchip's end results.

The business is largely proprietary.

It gets driven by the run rate of products customer needs in a given quarter whether that business is available on the first of the quarter or not really has no correlation to Microchip almost ever, and we started giving that guidance of how much turns had needed.

The other part of your question was what, how had July gone?

July is continuing quite good.

As we saw the bookings last quarter.

I guess I will try a different tack here.

On the margins, just wondering with 5 percent growth for the last couple quarters why the OpEx wouldn't trim down a little bit.

It seems like SG&A crept up a little.

How should we think of OpEx going forward and also how long do you think it will take to get to 60 percent gross margin?

That's it.

Well, you know, in our various discussions with investors and the discussion of cash, how are you going to invest cash, many investors have even asked us and guided us that you're so good in making investments in your business and business is so much more profitable.

Why are you not investing more in the business?

We essentially invest in our business to a model to really sustain very high operating margin and have never really made R&D or SG&A investments which are really not paid by the products and dividend gross margin.

And the last couple of quarters here we have even seen very, very substantial upside in gross margin.

I believe our gross margins are up close to a couple of hundred basis points here in the last couple quarters.

We felt it was quite prudent and even listening to investors questions we thought it was quite prudent to really take a little bit of that and invest it in our operating expenses activity to grow certain elements of our sales force in other places to really grow our business better.

And then on the gross margins?

What's the question?

How long do you think it will take to get to the 60 percent target?

Well, I can't give you the American number, but I am already saying north of 59 by the end of this year, so I think 60 is probably achievable in fiscal year '07 which is in the next six quarters.

Calendar or fiscal for what you're talking.

Fiscal.

Basically in the next six quarters or so I think.

Six, seven quarters, it is do-able.

Thanks, guys.

Maybe faster if everything else goes well.

And our next question comes from Chris Caso of Friedman, Billings and Ramsey.

Hi, thanks.

Steve, I just wonder if you could give more color relative to the bottoms up investigations you were dealing with your customers.

I think that would be quite helpful for us.

Just in general you talked about seasonal strength in Asia and the U.S. and some seasonal weakness in Europe.

Could you maybe give us a sense of how things are going along the lines of typical seasonality, and as a follow onto that, given what your lead times are now right now is that having any effect on the visibility your customers are giving you going into the September quarter.

In the second part of your question the lead times are quite stable now for quite a while.

All through this calendar year we've had lead times in this range, two to four weeks and that was a lead time last year, so there is really no dislocation on lead times they’re not going longer or not going shorter.

In terms of the bottom up analysis, don't think of this as something new we have done.

We do this analysis every quarter and every time we come to you we give guidance.

We always get questions why the guidance is not higher, why is it not lower, you have so much turns requirement.

Why are you giving such good guidance, we get opposite questions and everybody tries to go off really a very short term indicator of really what somebody heard yesterday.

We have a methodology and our methodology is essentially we connect with every large customer and then we look at what level of business we did with them last quarter and the quarter before, and which programs are falling and which programs are going up and assess really what the level of business we’re likely to do with them this quarter which has nothing to do with how much business is on the backlog because that never correlates.

We connect with every single distribution channel around the world in about what 70, 80 distributors we do business with around the world and assess what the design activity is, what's in the funnel, where designs are coming in and it is not all done by me, there are a large number of people in the respective geographies working with these channels and then data gets built up from the bottoms up.

Each person reporting by the region to the regional manager, to the VP of that region to VP of sales and coming in and then we cross correlate it with how the divisions feel regarding what they can do out of existing products, how many new products are coming in and we build a bottoms up model.

And the process is as long as as old as we have been public .

We've done it for about 60 quarters now, and the history says we have only missed about five quarters in those 60 quarters and each one of those quarters essentially coincided with a major mega event of the industry like the SARS or like the inventory correction or like the tech bust of 2001.

But outside of these mega events, we essentially have made every quarter.

Our guidance was controversial last quarter in June.

It was controversial in March, and we made both of those quarters, so I think we know how to do this.

Our formula hasn't changed.

We do this very systematically, methodically and usually we come out pretty right on.

Okay.

But relative to typical seasonality speaking with all those customers, could you give us some sense of how they sound relative to perhaps where they sounded this time last year or the year before to give us a sense of sort of better than normal or about typical seasonality?

Typical seasonality, you know, Europe is getting ready to go on holidays and so they tend to give a lot of bookings before they leave, and the bookings are sort of front end loaded a little bit and then it dries up in August and comes back very strong in September when they come back, and Asia rises into the quarter so every month is better and they start building huge amounts of products around Christmas, around September for Christmas builds which has to get shipped to the U.S. on ships and has to really arrive on a six-week journey here before Thanksgiving, and America is sort of kind of normal.

It’s a seasonally normal quarter.

So, there is really no change we're seeing either way.

Okay, thanks.

Okay.

We'll go next to Eric Gomberg of Thomas Weisel Partners.

Nice quarter and commitment to increasing dividends.

Thanks.

Could you talk a little bit about the flash base microcontroller market that grew, as usual, faster than most of your overall 8 bit?

Can you give us a sense of where that is in your overall 8 bit mix and what you see is the market opportunity at this point, how deep the penetration is now of flash base 8 bit?

As we mentioned before, the flash microcontroller business is about half of our total microcontroller business.

And I usually get a follow on question.

So, let me answer that.

The field programmable microcontroller business is virtually all of our business in high 90s, but the flash micro control is about half and every quarter it is growing more than the average, the average was up 5.3 percent, flash was up 9 percent.

It's gaining a little bit but still in the range of about 50 percent.

The other part of your question was where do we see these designs?

We're seeing them in every market -- consumer, industrial, automotive, telecom, PCs, in ever geography of the world.

I mean it's the main line of our business.

It is 50 percent of our microcontroller business and microcontrollers are 80 percent of our business and so that's a very, very large portion of Microchip's overall business and it is everywhere.

Okay, I just want to follow on.

You made a number of very encouraging comments on the 16 bit market and what sounds like some increasing momentum that's fairly consistent with what we're starting to hear out there.

You had 70 percent sequential growth off the low base.

Was that kind of lumpy or would you expect you're going to be able to continue to have kind of hyper growth sequentially in the 16 bit market for a number of quarters to come?

We should continue to see hyper growth in that market for many quarters and really as long as the base continues to be small.

We have grown 100 percent in some quarters before, so the number is going to be quite high for awhile.

With the development system sales and certainly with the new products that Steve spoke to today; these are all just more reinforcing factors that are going to help us to penetrate that market.

The other piece of it is you as well as the competitors would love to know what that base is.

They would like to know probably worse than you would like to know and nobody else breaks out that number so we think it is really not in our best interests to break that numbers and give a feeling to anybody how that momentum is, and maybe at some point in time a couple years out we might consider that but short term we'll give you anecdotal information like we're giving you today.

We have 285 microcontroller products in the 8 bit which has taken us 15 years to build.

By the end of this fiscal year, we'll have 50 products in 16 bit microcontroller which would really grow very, very rapidly.

We're very, very rapidly filling up the product base, getting large number of design wins, all the channels and customers are engaged, we are out to repeat our performance in that market segment.

Thank you.

Our next question comes from Ambrish Srivastava of Harris Nesbitt.

It's already been asked, thanks.

We'll move next to Joe Osha of Merrill Lynch.

Congratulations, you're now the highest dividend yielding semiconductor company out there still.

I hope some other people follow your lead.

Thank you, Joe.

In terms of the competitive environment obviously in the 8 bit space it is Freescale, as you scale more into the 16 bit market I am wondering who you’re finding yourself encountering more competitively and maybe if you can make a comment as to who is tough and who is not and how Freescale is doing?

And then I have a follow up.

Well, many of the 16 bit competitors are the same as the 8 bit competitors.

Many of them are same and a couple of new ones.

I think there is a little more Infineon presence in the 16 bit, they have virtually no presence in the 8 bit.

Anybody else comes to mind?

ADI.

A little ADI on the DSP side and a little bit of TI also that we see more on the 16 bit and the DSP side when the parts are integrated.

Both TI and ADI really have no presence in the 8 bit space.

Most of the other competitors are same Freescale and Renaissance and NEC and others and, incidentally, somebody attended Freescale's conference call on my behalf and the report I got was there was not a microcontroller word used in their conference call and you or nobody else really asked them a single question about microcontrollers.

I don't know why everybody always asks us about Freescale but you don't ask them.

Their people are hung up on their wireless business.

I am curious as to how you your impression of how they're doing competitively at this point.

We don't really see anything different.

Our business is continuing to do well.

There were how did that division do?

Flat?

Same?

Up one percent?

Up marginally.

It was up like 0.9 percent or so.

Our flash micros was up 9, total microcontrollers are up 5.3 percent, so we're continuing to gain significant market share and we don't really see any change there.

Okay.

Sounds good.

Second question is if I look, there is some of the big vertical companies, most notably TI, and to some extent, the PC companies to seem able to say fairly up beat things about the third quarter, but some of the more broadly based companies the PLD companies, you, Linear, very high quality broadly based companies seem to be more cautious.

You have seen a number of business cycles.

What do you think is happening and why this somewhat unusual divide with the higher quality companies offering fairly cautious comments about where the third quarter is going?

Well, you know, I think that's really on your side of the seat to figure out what the differential is.

I don't understand Zarlink and Altera and TIs and others and I don't have the time to try to understand them.

Our business is very global, it’s seasonal, and we're seeing the effect of Europe and by market, we don't tend to see some differences.

So I would really be speculating it is possible that there’s a strong cycle on the way on cell phones and my son is going to college and wants a new cell phone with a bunch of features in it, and I don't think he needs one, so I guess he is going to cause some revenue for TI.

But other than those kind of phenomenas, I am really not sure why the difference is there.

In our business, I think we think business is seasonally normal.

Our business in June and September is about the same. 5 percent, 4 percent, we think that is reasonable.

We don't really see any reason for this quarter to be hyper quarter the kind Terry [INDISCERNIBLE] talked about.

Sounds good.

What's your capacity utilization is my last number?

Our capacity utilization calculation is not as simple because of the complex purchase of fab 4, so let's work through it.

If you look at our fab 2.

It is basically running at capacity.

It is in mid 90s to high 90s and we could squeeze out a little more.

But it’s basically running at capacity.

If you look at our fab 4, for competitive reasons we don't break out what portion of the fab 4 we utilizing today.

Because it is very cost effective, but whatever portion in fab 4 we are using it is lower cost already at a fairly low utilization than fab two.

The way we mention the fab 4 utilization number is a ratio of the equipment that's already turned on and is being utilized and that utilization is 100 percent, which means from the large amount of equipment we purchased whatever is depreciating, whatever we have turned on, whatever we are using it, we are utilizing at 100 percent rate.

The rest of the equipment is brown bagged and if the business ramps and we need that equipment, we can very quickly turn it on, re-characterize it, start depreciating it and put it in production and it would be immediately 100 percent utilized.

It makes no sense to take the other large amount of idle equipment that is sitting there to be using in utilization because it is not depreciating.

Understood.

Thank you very much.

You're welcome.

We'll go next to Gil Alexander of [Darseal] Associates.

Good evening.

You have answered my question.

Thank you very much.

On moving on, we will go to Craig Ellis of Smith Barney.

Thanks for taking the question.

I wanted to cycle back to the dividend issue.

It is a real positive part of the story.

If we think that the cash generated in the quarter of the 100 million is normalized, just for the sake of the discussion, at what level would you be uncomfortable perhaps raising the dividend further, or said differently, what's a reasonable pay out ratio to expect the company to get to given that you're a more stable company in a otherwise fairly volatile industry?

Craig, we don't know the answer to that.

We believe in not doubling, tripling the dividend in a single quarter and then keeping flat from there on.

And, remember, if the stock price drops, the dividend becomes on a percentage basis much higher, the stock price rises, dividend becomes lower as a percentage.

The return kind of fluctuates much widely with stock price.

We would rather be increasing dividend continuously every quarter for an extended period of time and at some [INDISCERNIBLE] trying to reach a number some day in the future, this way everybody who gets in the stock today, tomorrow, the next quarter, the next year has a positive experience with rising dividends and we can easily circumvent stock price fluctuation by increasing dividend enough so that it is always a higher percentage of the money invested.

Do you see that calculation roughly?

That's great.

Thanks so much.

That's really what our strategy is.

Next question comes from Sumit Dhanda of Banc of America Securities.

Good afternoon, guys.

A couple of questions.

Steve, if you think about it last quarter when you guided for revenues, your book-to-bill was roughly 1.0 but your backlog was up nicely in the beginning of the quarter versus the prior quarter, as you think about your guidance for September, your book-to-bill is 1.07, so a seasonally strong quarter.

Any reason other than conservatism why you're not guiding it a little higher and then I have a quick follow up?

Book-to-bill ratio and starting back logs in the quarter do not correlate to our end results.

They don't.

Book-to-bill could be 1.07, it could be 1.04.

It doesn't really make any difference in our business.

It is just a ratio of a few more customers, our distributors happen to place large orders on 25th of June versus the 5th of July.

It really absolutely makes no difference.

Do not read guidance into it that is conservative or aggressive or whatever.

Our guidance is built very methodically as I mentioned earlier in the call and we believe if you look at -- somebody just passed me a piece of paper about another company that announced today, Atmel, the guidance is slightly up.

The other guidances which are flat, Freescale guidance was zero to minus 6.

So, when you look at all of this competitive environment I think our guidance is solid.

Yes, I am not disputing that.

The other question I had was on your gross margins you indicated record yields and a richer mix helped it out.

Could you perhaps try to deconstruct which was the bigger contributor and which will be the bigger contributor going forward and I know you are running literally full utilization but potentially even higher utilization could help the margin number at this point?

The number.

There are too many moving parts.

The numbers are really very hard to decode.

But there are a large number of moving parts literally.

There is some product mix, there is some improving yields, there is some improving efficiency, there are some price reductions in our material business of the nominal type and some customers usually just getting volume discounts and stuff like that, so there is that.

There is a higher volume that we ship the business was higher than the prior quarter.

When you combine it all altogether, and an improvement of 90 basis points of margin try to break into 8 or 9 pieces with a lot of overlapping factors, it is impossible.

Now, if you look forward, you know and one thing I didn't mention, is some of the depreciation is rolling off as we go over the next two or three years you should continuously see that the equipment we put into production five years ago, seven years ago is still going strong and we're using it and producing record yields and efficiency out of that equipment.

But when the depreciation rolls off it has a positive impact on gross margins.

So, you see some of that.

There should be more yields, more efficiency.

Higher utilization of fab 4 .

As we start to put more and more of that idle fab 4 equipment into production, you get some scaling effect from the fixed infrastructure, and you should continue to see higher and higher flash, less non-flash and most flash products are smaller dice sizes, higher value, better prices which are mix.

A large number of moving parts you're trying to average this over 6 or 700 products Microchip ships mass types per quarter.

Okay, thank you very much.

We'll move next to Paul Leming of Soleil Securities.

Good afternoon.

I have got pretty much the same question I had a quarter ago.

You've done a great job raising the dividend every quarter but as fast as you raise the dividend, the cash on the balance sheet grows that much faster.

You've answered some questions today about acquisitions and you're not a very acquisitive company.

Can you just talk, at least in general or conceptual terms, about what you see the end strategy being for the cash on the balance sheet?

Do you grow it another 400 million this year and then you’re at a billion two?

What can you do to put a very, very low returning asset to productive work or are you really content with the billion dollar asset generating a couple of percent after tax?

Well, it is a fairly complex question.

It is a simple question but a fairly complex answer.

If you look at the cash on our balance sheet first of all, it is you know, it’s not high compared to most of the competitors if you look at other high class companies like us, Maxim and Linear and others, you will see a much, much larger amount of cash.

Having said that, your statement is correct that it is a low performing asset.

Despite that building $400 million of cash per quarter is a high class problem.

The worse would be a big problem.

It is a high class problem.

We are trying to give it away back to you whom it belongs as quickly as possible, but what we do not want to do is double or triple it every quarter and very quickly get rid of that cash and then really not have a continuing positive experience for the new coming investors we would rather be increasing it continuously.

With that strategy, you're correct in saying that we will continue to build additional cash.

So what happens with that, what happens to that is some day in the next two or three years it will be another opportunity and nobody is buying stock and they throw the baby with the bath water.

So buy 600, $800 million of stock.

That's what we've said before and that's what we're prepared to do.

One could argue that I am getting too cute with this statement but there really is an implication in there, though, that you think repurchasing your stock at today's price that the stock is fundamentally over valued.

No.

I am not making that statement.

I have said before that I have seen companies purchase billions of dollars of their stock.

Nothing to show for it for the shareholders.

I own plenty of stock in plenty of companies that have invested billions of dollars of the cash on their balance sheet in buying back their stock and I, as an investor, only own the stock and it is less value than when I purchased it.

So all we are trying to do is we're returning the cash to you and letting you make the decision.

If you believe that a stock is good value, go buy more.

And the result to you, the investor, would be exactly the same as if we had bought back the stock which means you own a higher percentage of it.

On the other hand, if you happen to be a investor who believes our stock is overvalued, then you can take that stock and invest in anything else you would like to do.

We are giving you a choice.

How could we be wrong at that?

We're giving you the choice to make a decision.

Rather than you asking us to make a decision because managements usually do not make good decisions on their cash.

The history shows it.

Managements blow their cash in acquisitions, we're not doing that.

Managements blow their cash in stock buy back.

There is absolutely an implicit statement in there that not taking the cash at today's share price and buying back stock we think that is a bad investment with our cash.

Sir, I think I answered your question and if you're repeating the same statement, then you have your mind made up and I will tell you that I am letting you make the call whether the stock is under valued, over valued or correctly valued rather than having you ask the management to make that call.

My job is not to manage the stock.

My job is to manage the company and for you and analysts to value it, so I am giving the cash back to you, whom it belongs.

And then, sir, you can place your money where your beliefs are.

And we will go to our next question from Ruben Roy of Pacific Crest Securities.

Hi, thanks, Steve, I have a couple quick ones for you.

The dsPIC you mentioned some strong momentum there.

Is that coming from brand new customers for Microchip, some old, some new and what kinds of end markets, please?

It is really all of the above that are some existing customers, some new divisions of existing customers which were higher end and we did not do business with them before, many new customers, it is all of the above, it’s all regions of the world.

It is all end markets.

There is really no one.

It is our business is that kind of business.

You know, we do business with 47,000 customers worldwide in every part of the world and making everything from soups to nuts in our 16 bit microcontroller and our DSP business should not have any different flavor.

Thanks and then I think it is similar question on the flash or the 8 bit flash products when you talked about new applications.

Would these more or less be field programmable sockets you're replacing with flash microcontrollers or any there any other technologies that you're placing there?

Well, all of the above also.

There are new applications, there are existing applications, converting from EEPROM- based field programmability to flash based to market share gains.

There are several areas where there are new, emerging applications where the microcontroller was not used before.

The work was done either with an electro mechanical control or done by discreets or whatever.

We are showing the customer how to add value through the use of a microcontroller.

And in many of these search applications we are essentially getting 90 to 100 percent of the market share in small niches of those applications, and we can't mention those what they are for competitive reasons, but the overall impact on the size of the growth of the market may be trivial.

Let's take an example, it is a 5.5, $6 billion market.

If we find a 30 or $40 million niche in which we show the customers how to take all of that and add in microcontroller add value, with a $0.50 microcontroller, adding $30 million to a $6 billion market really makes no difference in 8 bit microcontroller, but a few of those niches we own 80 to 100 percent of the $30 million is a substantial increase in our business.

That's why you're continuing to see excellent results from Microchip.

Last year we were up 24 percent industry was up 11.

This calendar year in the two quarters gone by we already grown what, about 10 percent or so.

In micros?

Yes.

We just know the last quarter.

So, we've grown 5.3 percent which is a rate of over 20 percent annually.

Okay.

That's helpful.

Thank you.

The 8 bit market is growing at that rate.

We are growing enough applications, new applications.

If we now start to break down the applications then there is more competition in them.

Right.

Thanks.

You're welcome.

Next to Mark Edelstone of Morgan Stanley.

Good afternoon, guys, nice job on the quarter.

Steve, I was hoping you could give a little bit more insight into the expenses.

I know you answered a question already, but as I just look at the last year or so, we've had R&D pretty flat in dollars and this is now the first quarter in a while where we've actually seeing a pretty good increase in SG&A.

A couple questions, one, can you talk about what the increase in SG&A was driven by here in the first quarter, and then just conceptually as you look out over the next one to two years do you expect to see the growth rate of your expenses track something closer to revenues or do you think there is still more leverage here?

Well, the short term growth that you're seeing in expenses are targeted investments that Microchip has made to grow our business.

They are strategic investments.

They are not producing results today because they have been recently added.

But if you look out nine months a year out as many of these investments are there investments around the world and infrastructure, and sales and marketing and applications, and as Microchip’s products are multiplying the entire 16 bit, the dsPIC, the analog, you know, we need infrastructure.

We need specialists.

We need people trained in these disciplines to be able to go sell the products, so we're strategically adding investments which are clearly giving results and they will be giving results.

As far as going forward is concerned we expect that you should see expenses as 25 percent of revenue, give or take some.

Okay.

And just two other quick questions.

You've obviously got your inventories in really good shape both on your balance sheet and in distribution.

When do you think you'll start to grow inventories again on your own balance sheet either in dollars or in days?

We look at inventory largely in days.

The dollars just result from the revenue.

We do not want to grow the inventory in days.

We're guiding it to be flat.

And anytime you say flat, give it plus or minus a couple of days.

There is no intent to grow the inventories from here.

We're at a healthy level.

We don't need to grow it.

If anything, over -- if the business were to grow stronger than it is growing right now, what we're guiding, then you should see a decrease in inventory.

Okay.

Then just one quick one for Gordon.

Gordon, was there any one-time items in the other income here in the quarter?

The majority of the other income related to interest income it was about $7.3 million in the quarter, no, excuse me, $6.5 million in the quarter.

There was a sale of fixed assets which was a couple of hundred K and a sale of one of our smaller investments which was about 5 or 600 K.

Great. 6.5 million was roughly the interest income in the quarter?

It was.

Thanks a lot, guys, nice job.

Thanks.

Our next question comes from Jeff Rosenberg with William Blair.

Hi.

In all the discussion of gross margin and where it is headed, did you talk about whether you're increasing wafer starts in Gresham in this quarter?

We did not talk about it and we don't specifically kind of need to say the outcome and the quarter is still ahead of us and we are watching our business, we are watching bookings, we are watching backlog if you need, to we can do it very quickly.

Okay.

The guidance for gross margin is based on what we believe the average will come out, which will probably be slightly higher output but we don't really have an American number.

And if you heard numbers yet final numbers for the last year for Dataquest and update there in terms of how market share looks from their point of view?

Well, they haven't published numbers yet.

I think we saw a preliminary revenue numbers come out a few months ago, and we were up 24 percent in revenue and Freescale was down 1 percent and the industry was up 11.

Last numbers we saw for 2004, and then we haven't seen a lot more detail of that.

The report is not out yet.

I guess it comes a little bit later every year.

In terms of just overall new product introductions, could you tell us what the overall number was for the quarter and maybe what you're -- if it is appropriate, to sort of talk about what the target is for the year relative to last year's 78 new products?

I have the Vice President of microcontroller division here, can you comment on that.

Ganesh, can you comment on that?

I don't have the exact number for the quarter.

We would be happy to get it to you.

But, I think you will expect that in fiscal year '06 the number of products we'll have will be slightly ahead of the products number products we did in fiscal year '05, and especially as you see the acceleration in our 16 bit product introductions, that adds to the existing momentum in the 8 bit products that we have.

Okay.

Thanks a lot.

We'll go next to Chris Danely of J.P. Morgan.

Thanks, Steve, just two quick questions.

The first one is what did the EE pricing do during the quarter and what do you expect it to do this quarter?

EE pricing saw a nominal price decrease sort of a [INDISCERNIBLE] type and we expect that to be again this quarter.

We're not seeing any major dislocation of any type either up or down.

So, normal business conditions and then the next question might be for Ganesh, just if you guys could talk about the PIC 24 line, and I guess what do you see as the need out there?

What do you see as the main advantage.

I guess, for example, you guys looked at we need to combine MCU and DSP and you came out with a dsPIC.

And that's done well.

Is there a certain segment that the PIC 24 is going for?

Can you talk about the 3, 4, 5 main advantages it has over the competition?

It is a microcontroller architecture that will fit into a very broad set of applications, so no, we're not targeting a given specific application.

One of the large needs that it will fulfill is it provide the path for our existing 8 bit microcontroller customers who are looking for more memory, more performance, more peripherals or just pure 16 bit capability.

It provides the path for existing dsPIC customers who are looking for lower cost solutions that may not require the entire DSP performance in their applications, so it is very much related to the kinds of applications, kinds of customers that we have sought with our current 8 and 16 bit microcontrollers giving them more options now of the types of products they can use in their design.

So, it would have the same set of advantages that the PIC 17 or 15 has in terms of lower costs and higher performance and lower power consumption, et cetera?

As our entire product lines do, yes.

Got it.

Great.

Thanks a lot, guys.

You're welcome.

Mr. Sanghi this is all the time we have for questions.

I will turn the call back to you for closing remarks.

Thank you Stacy and thank you everyone for attending the call today, and we look forward to talking with you next quarter and meanwhile we'll be seeing some of you in the various travel and some of the conferences we’ll be going to.

Thank you very much.

Bye bye.

That does conclude today's conference.

Have a great day.