微晶片科技 (MCHP) 2006 Q2 法說會逐字稿

Good day, everyone, and welcome to this Microchip Technology second-quarter and fiscal year 2006 financial results conference call.

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

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

Please go ahead, sir.

Thanks, Amica.

Good afternoon, everyone.

Just for starters, we did move the call as many of you are obviously aware from our original start time of 2:00 Arizona time to 3:00 to really accommodate a very, very busy schedule in the financial calendar today.

We realize that it's getting late back on the East Coast and apologize if this is any problem for our investors or analysts back on the East Coast.

So with that, let's get started.

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 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 that may impact Microchip's business and results of operations.

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

I will comment on our second-quarter fiscal 2006 performance, reviewing geographic data and discussing balance sheet and cash information.

And Steve will then give his comments on the results, outline our guidance for the December quarter, and update other pertinent matters regarding our business.

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

Net sales for the September quarter were at record levels of 227.3 million, up approximately 4% from net sales of 218.5 million in the immediately-preceding quarter and up approximately 3% from net sales of 220.7 million in the prior year's second quarter.

GAAP net income for the September quarter was at record levels of 65.7 million or $0.31 per diluted share, an increase of 7.6% from GAAP net income of 61 million or $0.29 per diluted share from the immediately-preceding quarter, and an increase of 8.6% from GAAP net income of 60.4 million or $0.29 per share from the prior year's second quarter.

This marks our 60th consecutive quarter of net income obviously at record levels for the current period.

And Microchip's achieved approximately $1.2 billion in cumulative earnings over the life of the Company.

Geographically, sales in Asia and Americas grew by approximately 9% and 3.5% respectively, with Europe being down 2.7% in this seasonally-weak period for that territory.

Asia achieved revenues of approximately $101 million for the quarter; this represents about 44% of our total revenues.

Getting beyond the important milestone of $100 million is a tribute to our customers, distribution and sales force in Asia as well as US and Europe, where some of the designs originate.

I am certain that growth in this territory will continue as we look forward.

We established record gross margins for the September quarter of 59.2%, reflecting the proprietary product positioning relative to pricing, world-class manufacturing yields and efficiencies and richer product mix.

Operating expenses were 24.3% of sales in the September quarter compared to operating expenses of 24.9% in the previous quarter.

Research and development costs were 23.6 million, representing 10.4% of sales.

Sales and general administrative expenses were 31.6 million, representing 13.9% of sales.

We are continuing to invest in our business to promote the growth of our products and technologies and the infrastructure necessary to make our products successful in the marketplace as we look forward.

Tax rate for September quarter was in line with our guidance of 24%, and we anticipate continuing at this rate for the balance of the current year.

The dividend declared today of $0.16 was an increase of 28% sequentially and an increase of 208% over the same quarter in fiscal 2005.

During fiscal 2005, our dividend payments totaled approximately $43 million, while the annualized dividend payment based on the dividend declared today would be approximately $132 million.

Microchip's total inventory position at September 30 was approximately 110.2 million, an increase of 6.4 million from the prior quarter.

Inventory turns are 3.4, with days of inventory representing 108 days.

Distribution inventory is at very moderate levels in all geographies.

At the end of September, distributors held about 2 months of inventory; this is down from about 2.1 months as of the end of June.

When we combine inventories on our balance sheet and in the disty channel, days of inventory as of September were 146 days; this is essentially flat with levels as of the end of the June period.

At September 30, Microchip's receivable days were 48 compared to 47 days at the end of the June quarter.

Overall trade receivable balance decreased approximately $10.9 million or 7.7% versus our revenue growth of 4%.

Another question on the minds of some investors is the filing of bankruptcy by Delphi.

A vast majority of Microchip's business with Delphi is international locations and which are not impacted by the bankruptcy filing.

Microchip's exposure to US receivables from Delphi is negligible; actually, it's only $15,000.

A related question will be what impact it may have on the ongoing revenue stream.

As far as we have seen and heard so far, Delphi is continuing to build and ship product to meet the needs of their customers, and we have seen no change in our business as a result of the bankruptcy.

Our cash position as of September 30 in cash and short-term investments was $902 million, with $45.4 million in debt on the balance sheet.

During the quarter, Microchip generated from cash flow from the business $140 million prior to the dividend payment, which was $26 million in the quarter.

Capital spending for the period of September was $10.4 million, and depreciation expense for September was 27.6 million versus 30.9 million for the same quarter last fiscal year and 27.9 million in the June quarter.

For the fiscal year, we anticipate capital expenditures of $60 million and depreciation of $110 million.

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

Thank you, Gordon.

And good afternoon, everyone.

First, I would like to reflect on the results of the September quarter, then comment on the product lines and finally discuss the guidance for December 2005 quarter.

I am extremely pleased with our continuing excellent execution in the September quarter, which I will describe as a record quarter in every respect.

We met our guidance in net sales and exceeded our guidance in gross margin percentage as well as earnings per share.

Net sales were $227.3 million, which was an all-time record, and 4% sequential growth.

Gross margin percentage of 59.2% was also a record and was up by 90 basis points sequentially.

Recall that just two quarters ago, our guidance was to be north of 58% gross margin by the end of this fiscal year.

We have now achieved gross margin north of 59% already, and there are further gains ahead.

Our operating profit was 34.9%, an all-time record.

And earnings per share were $0.31, exceeding our guidance by $0.01 and setting another all-time record.

We are also pleased to be increasing the dividend paid to our shareholders by 28% to a record quarterly dividend of $0.16 per share.

Our dividend rate was already at the highest level in the semiconductor industry.

With this increase, our dividend payout now is around the average dividend rate of S&P 500 companies.

Now I shall talk about the product lines.

First, we experienced growth in all of our product lines in the September quarter.

Microcontrollers, microcontroller business grew 3.2% sequentially.

Our Flash microcontroller business was very strong and grew by a robust 10.3% sequentially and 30% over a year-ago quarter.

We are continuing to experience strong design activity with our 8-bit Flash microcontrollers, and we're seeing a lot of new applications emerging which are utilizing other products.

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

It is becoming too much of a repetitive drill when every month, SIA, Semiconductor Industry Association, publishes the results and reports poor microcontroller shipments.

The investors and analysts get nervous, and stocks show unneeded volatility.

SIA has never been a proxy for our microcontroller business.

I don't remember our results ever correlating with SIA.

I would like to thank those investors and analysts who remember that every time their reports come out.

And others would benefit by ignoring the monthly SIA numbers on microcontrollers.

Serial EE memory products.

Serial EE memory products' net sales were up 8.2% sequentially.

The backlog going into the current quarter is quite strong.

Certain Serial EE competitor hinted deemphasizing that segment of their business.

While we cannot be sure of the reasons behind our competitor's decisions, our Serial EE business continues to look very healthy.

Analog products.

Analog products' net sales were up 5.4% sequentially despite relatively weak conditions in the industry.

Our analog business in the last three quarters has grown 7.5%, 4.3%, and 5.4% respectively.

This makes a cumulative increase of 18% in the last three quarters and is higher than the cumulative growth of any major analog semiconductor company.

The underlying broadbased analog business has been growing like this for about three years.

But at the same time, we were managing the decline out of the cellular phone segment, thus keeping the topline relatively flat.

The cellular phone segment is now a very small portion of our analog business, and therefore the topline growth is now more visible and is healthy.

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

Our backlog for analog business going into this quarter is quite strong, and we expect a growth of about 8% sequentially in the analog in the December quarter.

This would make December quarter on analog up approximately 28% over December quarter of last year -- clearly exceptional by any standards.

16-bit microcontrollers.

Our 16-bit microcontroller business was flattish in September quarter after growing a whopping 70% in the June quarter.

Several customers took a breather; some of it was seasonal due to summer.

At the end of last quarter, we had 199 customers in production versus 165 in June quarter and 108 in the March quarter.

So by this metric, their growing customer base -- the customer penetration is proceeding as expected.

We have now shipped 10,629 development tools of 16-bit.

And based on the momentum with the customers we see, we expect that our 16-bit microcontrollers business will be up approximately 25% sequentially in the December quarter.

Just last week, Microchip announced three new families of 16-bit microcontrollers.

First was the product family PIC 24F, which was Microchip's first pure 16-bit family without a DSP integrator in it.

Recall that our dsPIC has a 16-bit microcontroller integrated with the DSP.

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

The performance of this family is 16 MIPS.

The second family we introduced is PIC 24 EDGE.

The performance of this family is 40 MIPS, and this is the highest-performance 16-bit microcontroller family on the market.

The third family we introduced was dsPIC 33; this is the next-generation family to our current dsPIC 30 family.

The current dsPIC 30 family are 30 MIPS devices.

DsPIC 33 are 40 MIPS devices, and they are more cost-effective and have smaller die sizes than the equivalent dsPIC 30 devices.

Overall, Microchip expects that it will have about 50 products in production in the 16-bit microcontroller in dsPIC space in the next six months, with a total of four families and 50 devices in production.

And with powerful design momentum underway, we're well on our way to grow our ranking in the 16-bit microcontroller world.

And now, I shall discuss our guidance for the December 2005 quarter.

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

Our December quarter historic sequential growth rate is about 2%.

And December quarter is usually a seasonally-weak quarter for Microchip.

But we achieved good bookings in September quarter, with a book-to-bill ratio of approximately 1.

And the bookings so far in October look fairly strong.

So taking all these factors into account and after checking expectations from our direct as well as distributor channels, we expect net sales in December quarter to be about $234 million, a sequential growth of about 3% -- slightly better than seasonally normal.

The gross margins are expected to be about 59.5% this quarter.

We believe that our gross margins going out of current fiscal year will approach 60%.

We see further upside to these gross margins, but we are maintaining guidance for long-term gross margins at 60% for now, as we continue to reevaluate the substantial upside in gross margins that we have achieved and ways to balance gross margins with higher sales growth opportunities.

Operating profit in December quarter is expected to be about 35%, and earnings per share are expected to be about $0.32.

We expect to build approximately $100 million of net cash flow before payment of 34 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.

Now as we look at our results with record sales and compare those to others in the semiconductor industry, we find only a small handful of other major semiconductor companies producing record sales.

Many of the other semiconductor companies are still well below their records achieved before.

So as we reflect on our record sales, record gross margins, record operating profit percentage, record earnings per share, strong free cash flow and record dividends, we find the performance of our stock quite disappointing.

The stock is down about 20% from its record of about $36 made in December of 2003.

And in the last eight quarters, our net sales are up 35%, earnings per share are up 82% and dividends are up 433%.

We are generating over $350 million of free cash flow on a yearly basis.

The stock is selling at a very deep discount to the free cash flow valuation.

We have been patiently waiting for the market to recognize our leadership results, but that really hasn't happened.

So as we find our stock to be really undervalued, Microchip has been active buying back our shares in the last few weeks.

So let me summarize a few key points.

Our net sales expected to be about $234 million, up 3% sequentially; gross margin to be about 59.5%; operating expense is to be about 24.5%; operating profit to be about 35%.

Inventory is expected to be flat in days at about 108 days with the distribution as well as direct customers carrying relatively low levels of inventory.

We believe that our inventory is positioned properly.

And finally, the earnings per share are expected to be about $0.32.

With that Amica, would you please poll for questions?

(OPERATOR INSTRUCTIONS).

Adam Parker, Sanford Bernstein.

Steve, maybe just if we think out long-term about your business and over the next few years or five, six years, whatever it is as your revenue doubles -- whatever the growth rate, it is long-term -- how much of the incremental revenue do you think will come from 8-bit?

In other words, if you're 850 million revenue company plus or minus now, your next 850 million, how much of that is going to come from 8-bit in your mind at this point?

Well, Adam, you know, as we have spoken at these conference calls before, we are not going to break those numbers.

If you can get our competitors to break their numbers in 8, 16, 32, I would comply.

But otherwise, it is competitive information on where our trusts are and where the next major revenues come from.

And when you have the business making 35% operating profit, you know, higher than certain competitors' gross margins and equal to some other competitors' gross margins, then you have to protect it with everything you got.

I am not going to give any information (multiple speakers) --

Let me ask you a different way -- ask you a different way.

Are you more optimistic today about the sustainability of your addressable 8-bit market than you were a year ago even?

And if so, what has given you that increased confidence?

Because it seems to me that you certainly are just as confident as you were about the 8-bit growth rate going forward as you were a year ago.

My confidence has not changed because I look at where the customer designs are happening and continued growth of our 8-bit microcontroller business, especially Flash.

I will talk about investors' confidence and certain analysts' confidence, who no matter what we say always seem to doubt it.

And SIA comes up every month and shakes their confidence.

So those are the ones you ought to be talking to.

My confidence is solid.

Most of the dollar growth in the last quarter, it came out of 8-bit.

It showed that smaller businesses will grow higher on a percentage basis, and 16 will do that over time.

But a lot of the dollar growth is really coming out of 8-bit.

One other question about the margins.

Obviously, you don't want to set the bar too high with your long-term margin goal.

But you did about 80% incremental gross margins this quarter.

And I guess your guidance is sort of about 70% or so if you just net it out for the next quarter.

And obviously, there is quarter-to-quarter volatility.

But what type of incremental gross margins do you expect over the next year as you fill the factory up more, as you get a depreciation tail wind?

Can you be a 70% incremental gross margin company from here?

Or I don't know if this is for Gordon or you, Steve, but how do you think about the incremental gross margins over the next year plus?

I always find it fascinating when I hear these incremental numbers usually at this call.

There are too many moving parts in the business.

There is manufacturing, there's loading, there are pricing, there are long-term contracts, there are some regular price reductions to customers over time around the business coming from the direct, there are product lines with various margins.

I am not really sure that I'm going to peg a number.

If you peg a number of 70% incremental gross margin forever, eventually numbers will go to unsustainable levels.

What I'd like to say is that I want to keep an option as a CEO -- I'm going to keep an option to be able to take some of the wonderful gross margins we are achieving and the ability to produce those kind of incremental gross margins that you're talking about and sometime be able to trade it off for higher growth or certain low-margin strategic opportunity or whatever the case may be.

These margins are so rich, higher than we ever told you we could do them and are so much higher than any of our competitors that I believe I'm going to leave some room for myself to manage.

Romit Shah, Lehman Brothers.

It looks like your book-to-bill is positive again.

Orders have been strong, and you're guiding above seasonality.

Does the demand you're seeing today point to improving lead-times out of this quarter or around the corner?

We are really not seeing any change in lead-times.

I believe we have plenty of product available.

Our lead-times are relatively short.

We don't see them growing longer; we don't see them going shorter.

A majority of our products are available in three to five weeks' timeframe.

So what I will be guiding has really no change of lead-times dialed in, either going up or going down.

We are basically just doing a bottoms-up analysis, and we see a demand a tad stronger than seasonally normal; although, you are basically splitting hairs.

Could you just comment on the growth you're seeing in your analog business and progress in selling those products on a stand-alone basis?

Well you know, if you look at my financial conference presentations for the last year or longer, I have been showing a slide in which I show -- and it may still be on the Web -- in which I am showing our cell phone business and analog declining and the non-cell phone business growing.

I have commented that non-cell phone business has been growing about 22% or so per year for the last three years.

However, unless you peel the onion that way -- if you just look at what is our total analog business then comments I in general hear from investors and analysts is -- well, analog business has been okay and really not growing much or not doing this because the business was in transition.

The business we inherited from our telecom four years ago, five years ago, pretty heavily into cell phone.

And that's not the business -- that is not Microchip's model.

We like large number of customers, small customers, going through distribution in small designs and duplicating that success 47,000 times rather than a few large customers.

So we have been modulating that business to a Microchip type of business.

And while in the last four years or so, our gross margins and analog went from 40 to 60.

And all the business we transitioned from running in foundries to running in Microchip factories, so there were a lot of highlights to talk about.

If you just look at the pure revenue dollars in analog, it was flattish.

But the desirable revenue dollar was growing incrementally very nicely.

And what I have been saying in the last -- especially last couple of quarters is that now the cell phone business has declined to very low levels.

And you should now see the growth of analog business really showing on the topline for analog.

And we have demonstrated that for three quarters now this year.

And with the current quarter guidance for December, this should be a year-over-year increase of 28% in analog.

We are doing very nicely.

We are growing in a lot of different areas.

We think the business is very healthy.

The strength in analog, has that contributed -- you mentioned record gross margins and a richer product mix contributing to that.

Is that partly due to the strength you've seen in your analog business?

Well, you know, analog business is still about 7% of our business, which grew last quarter 5.4%, with the rest of the Company growing 4%.

So you can do your own math.

Its impact is now (ph) going to be very, very large.

And analog margins are about 60, and all of our margins are about 59.2.

So it's not just a huge difference from that standpoint.

The gross margin is just driven by hundreds of moving parts, everything just going in the right direction.

Manish Goyal, Press Investments (ph).

Actually, my question has been answered.

Thank you.

Chris Danely, JP Morgan.

Thanks, guys.

Great quarter.

I actually just had a few real quickies here.

Steve, you talked about the 16-bit expectations.

Can you give us any sense of how big the revenues are?

Are we talking like $5 million here, or is it starting to get material yet?

I don't know whether you were listening to the answer I gave earlier to I think Adam Parker's question.

We are not going to break those numbers out.

Tell my competitors to break it out;

I will consider.

That's fine.

You guys break out analog in that 7% of biz, so can we assume it's pretty far below 7% of business?

Yes, you can assume that it's below 7% business.

But it's not the size issue.

It's really not the size issue.

Analog is a different business segment than the microcontroller.

The 8 and 16 are really the part of the microcontroller business.

Freescale doesn't break it out.

Atmel doesn't break it out.

ST does not break it out.

Other companies don’t break it out; why should we?

It is competitive information.

We don't break out the individual families within EBIT as an example.

So this is really just the same pieces we've had in reporting our overall microcontroller revenues all along.

That's fine.

Then you guys -- you said that backlog was very good for EE and analog, which I assume means -- means up nicely is -- is backlog up for your microcontroller business too?

It was nothing notable in there.

We are guiding up 3%, dividing it in four product lines.

Serial EE was slightly better than normal, and analog was better than normal, and microcontroller was fairly average.

And the 1.02 -- or the parity book-to-bill and the 1.02 in indirect, that was spread pretty evenly across all of our businesses.

Again, the law of small numbers, where you see in analog because of the 7% side, a smaller increase obviously is going to drive better results and make them more apparent in that particular area.

(OPERATOR INSTRUCTIONS).

Shawn Slayton, SG Cowen.

Nice quarter.

Maybe for Gordon.

Gordon, you mentioned in the press release that the distributor book-to-bill was less than one, owing to tight asset management in the channel.

Can you expand on this?

This has been going on really for many, many quarters.

As the earnings picture in the distribution channel is becoming more compressed, as they try to find how they can bring value.

But obviously it is a tough proposition for the distribution business overall.

They're looking at working capital control, and they're aided by the fact that most semiconductor companies have very short lead-times at this point and can satisfy their demand.

So we have seen the inventory in the channel decline by about a tenth of a month over the last three or four quarters on an overall worldwide basis.

And that’s represented itself obviously in the bookings that we have received from our disty partners.

So you could consider this perhaps structural, and this might not change for many quarters to come (multiple speakers).

That is our belief.

Certainly as we are focused on sell-through, that's where we want to manage our business.

Our business is reflective of the point-of-sale and the income customer demand in the disty channel.

It is that area that is much more important to us.

Just one more quick question, and I will try to hop back in the queue.

Can you remind us of what your overall exposure as a percentage of revs is for the North American automobile market?

I'm assuming it is something less than 10%.

But can you verify that?

Yes, it is less than 10%.

Our overall automotive is 18%, and that is split between North America, Europe, Asia and some aftermarket business.

So it is split in many ways.

Tore Svanberg, Piper Jaffray.

A couple questions, first for Steve.

Steve, if you look at your analog business, it's obviously become much more diversified now.

Could you just give us a flavor of some of the key end markets that your analog business sells into now?

It is the same five end markets, where we sell all of our products -- consumer, industrial, automotive, office automation and communications.

So the same five markets, I have not broken out the analog business in those five markets.

We have broken out the whole Company but not the individual product segments.

Microcontrollers are surrounded by analogs on all sides, converters and OPins and power management and DTOAs and temp sensors.

And we are succeeding everywhere.

We are getting designs in automotive.

We are getting designs in commercial/industrial systems, in office automation systems.

It is very, very broadbased.

Last quarter, in the June quarter, I mentioned that we crossed 10,000 stand-alone analog customers.

I did not get that number prior to this call today; we will have to give that maybe in another financial conference.

But I'm sure that number grew further.

So we continue to grow the analog customer base quite significantly, so it's very, very broadbased -- over 10,000 customers.

Very well.

I know you don’t want to talk about any new gross margin target.

But from here on out, should we assume the gross margin improvements to come from mix or more from cost controls and manufacturing efficiencies?

Well, there are all the 100 different parts still at work.

There's mix; there is manufacturing efficiencies.

There are some cost shrinks.

Remember many times when you're able to do a cost shrink on a proprietary product, it is also into margin improvement.

Because even if you pass a portion of that saving to your customer, you can still get a higher margin.

There is absorption.

There is some depreciation roll-off.

Over time, there is going to be more absorption, much more absorption in Fab 4.

So it's just lots of little, little things.

There's no one element.

We grew 90 basis points.

I can't find a single item which would be responsible for 20, 30 basis points out of that.

It's 5, 10 basis points, lots and lots of different items.

Fair enough.

And just a last quick one for Gordon, Gordon, could you let us know where the utilization rates are standing right now for your fabs?

Gains from an overall perspective, you know we could do about 1.3 billion, $1.4 billion between the two wafer fabs on an annual basis.

And most of the headroom there, as Steve indicated, is in Gresham.

Great quarter.

Michael Masdea, CSFB.

Steve, you mentioned that you might use some of this profitability to go after some other areas, which makes sense from a cash flow perspective.

Any areas in particular you would highlight?

Or is it just existing areas with a little bit lower profitability?

Well I wouldn't signal before I go into it.

All right, that's fine.

Next question, you talk about a pause in the 16-bit.

Is that just because we're pretty early in that product cycle and you have some customer concentration?

Or is that -- help us understand why you would see a pause that early in a product ramp.

Well, you know, we're dealing with about 165 customers, and it’s always an 80/20 rules.

So top few customers who bought a little bit more the prior quarter, then we grew sequentially 70%, it could easily have that pause.

I see that on the individual products, and I see that on individual product lines.

We've had similar things in analog over time.

And 8-bit is a huge business, so you kind of don't see it.

But individual product lines are the size of the 16-bit.

I see those kind of positives all the time.

When you have a smaller business, smaller revenue, it tends to be lumpy.

You gave some growth rates for analog and 16-bit.

Can you give us the 8-bit and Serial EE for the fourth quarter?

The microcontroller growth rate was 3.2.

I can't give you 8-bit because I don't want to break it out.

He is asking for the December quarter (multiple speakers). 8-bit microcontrollers are still going to be the largest component of the growth.

It's going to basically be the same as the overall Company to a large extent.

Yes, you don't have to lose much out of the average.

If the Company grows 3%, and you lower the microcontroller by 0.1 or 0.2, it's enough revenue to fund a very high growth for everything else.

I guess the last question, with the analog and some of this moving away from the cell phone, is there anything from an OpEx side or a design team side you can do to cut costs?

Or you have done to cut costs there?

Or do you even feel like you need to do any of that?

We are operating at 35% operating profit, 24.3% expenses.

This is extremely efficient.

I agree with that, but is there anything -- you're changing your -- moving away from the handset side there.

Is there any ramifications for--?

(multiple speakers) We would want to reinvest that in other parts of our analog business.

This is an embryonic business; it's growing very, very nicely.

There is no reason to cut off the investment in that business.

As Steve says, overall OpEx in great shape and want to nurture our growing businesses.

(multiple speakers) I think you may have got an impression that we are cutting out something from the handset side; that was done four years ago.

So those R&D expenses are no longer in our stream.

After we bought TelCom, we transitioned the business in saying -- these are the areas we're going to grow to go from 1,000 customers to 10,000 customers and not going to invest that much on the cell phone side.

So there's really no such restructuring needed today.

Mark Edelstone, Morgan Stanley.

Nice job on the quarter, guys.

Steve, I was wondering if you could just give a little bit more color on 16-bit overall and maybe just kind of compare and contrast what the ramp looks like there versus what you would have seen when the 8-bit market for you was in a similar position.

You obviously have a good amount of data now in terms of the number of customers that you've engaged with and the number of toolsets that are out there.

Maybe you could just give a little bit of a comparison and then what we might expect as we look out over the next several years there.

Well I think many of you ask basically the same question -- different, different ways.

You're asking me to break it out, and it's just not going to happen.

I want you to look at microcontroller business basically as one business as you do for every single one of our competitors.

I don't really see anybody else breaking it out.

It makes no sense for Microchip to break it out and show where we are succeeding and where we are not and have the competitors, who have much, much larger 16-bit microcontroller business find ways to put more obstruction than they would put otherwise.

There is really no benefit to Microchip in doing that, and we are just not going to do it. (multiple speakers) We believe more than ever that it's doing very well.

The number of customers are growing.

We have given you some sequential growth numbers; we are after small base obviously.

And over time, it might change.

But I don't know if I can give you any more flavor.

Large number of investors and analysts that we talked to over the quarters at conferences and other times, you know, tend to still apply Moore's Law to this business.

How will I -- a question will come.

How are you doing in converting your 8-bit business to 16-bit?

Or how is your 8-bit businesses converting to 16-bit?

Or in which segment is your 8-bit business converting to 16-bit?

And we have said that for years, we do not see any conversion happening in our customer base.

Therefore, our 8-bit business is continuing to grow.

We see 16-bit as an incremental business; there are newer customers or different divisions of same customers and that is what we are finding.

And our competition obviously has less success in 8-bit.

So they have moved in some cases their resources and people and customers over to 16-bit.

And the Moore's Law truly may apply to them, but it does not apply to us.

We have been consistent in that our 8-bit business is providing a majority of the dollar revenue growth, and it will continue to do so for a foreseeable period of time.

All smaller businesses are growing higher in percentage terms but obviously less in dollars.

All other businesses combined in dollars are providing less growth than 8-bit business is providing by itself.

I am with you, Steve.

I was just really hoping to get a sense for what the overall revenue funnel was looking like for 16-bit vis-à-vis what you'd seen as you were ramping the 8-bit business years ago.

But understand your point of view.

Cody Acree, Legg Mason.

This is Blake Fischer on for Cody.

Just had a brief question -- going back to an earlier question on the disty book-to-bill on the inventory level and what we are seeing as far as the short lead-times or the stable lead-times.

When we see that inventory internally has gone up four days quarter on quarter, can we say that that is more related to direct customer demand?

And also with that question, what right now is your current breakdown between disty and direct customer?

Well, our total disty business is about 65% of our overall business.

Our inventory is really not apportioned into direct or disty customers.

And certainly the fact that the distribution channel is not taking as much inventory has an effect on our overall inventory position.

That's why it's obviously better to look at it from a total perspective of what's in that channel and on our own balance sheet.

And so, we will look at the combination there and look at our ability to continue to supply to not only our disty partners but to our direct customers on a quick basis with stable, short lead-times in the current environment that we have today.

Let me add to it.

Three years ago or so, our distributors were carrying nearly three months of inventory.

Today, they are carrying two months of inventory.

And if it is 65% of your business and if you are simply recognizing revenue on a sell-in basis, then you can really see it would have substantial impact on your revenue.

Microchip does not recognize a dollar of revenue anywhere in the world.

In all geographies, we are pure sell-out; basically, it's not sell-in basis.

So therefore, the amount of inventory the distribution carries really does not impact our revenue.

We do not really care.

What has happened is with a lot of the supply chain maturity of the supply chain programs and all that, distribution is able to manage their business now with two months of inventory rather than three months of inventory.

So all it does is really -- it makes us carry higher level of inventory because we're still responsible to our end customer.

And when a customer comes in, wants to buy a product from distribution and distribution because of the tight management of assets cannot find the product for him, then we want to be able to deliver it very quickly -- either deliver it directly or deliver it to another distributor or give it to the distributor who then gives it to the customer.

So as a result, we look at the overall inventory at Microchip and in the channel that is available to manage the business of our end customers worldwide.

And we're seeing that inventory basically flat.

So as distributors are carrying a lower amount of inventory, we are carrying slightly higher inventory.

And the four days of change that you saw last quarter is really statistically insignificant.

If distributors had not lowered their inventory, it would've been under four days.

We basically are carrying what they don't want to carry.

And with our cash assets and with our profitability, carrying slightly more inventory is really not a problem at all, especially when it is readily available for the end customer in the short lead-time environment.

Thank you very much and congratulations on a good quarter.

Chris Caso, Friedman Billings Ramsey.

I wonder if you could just give a little more color regarding the comments you made on the long-term margin model.

And it sounded like you were evaluating a couple of options in putting together long-term margin strategy.

Maybe you could kind of share what some of the options may be.

Is it a case of perhaps there are some businesses now that are lower margin relative to where you are now that you might look to shed?

Or are there some businesses -- margins in the 50s that you may want to pursue more aggressively?

Could you just give some more color on that?

Well, there are no businesses we are shedding.

So there is no such restructuring coming.

So rest on that particular issue.

There are no really unhealthy businesses at Microchip.

Everything we are doing is profitable; everything is good.

When I talk about margin management, I am simply talking about comparative bidding on a larger design project, where Microchip would walk away from a margin level of x.

And I may go a point or two below that margin level of x because I have incrementally higher gross margin coming from a score of other factors that we talked about -- absorption and mix and so on and so forth -- and still be able to maintain 60 plus gross margins.

That is all we're talking about.

We are not trying to get into any other business that we are not in.

We are not going to go make Flash EPROMs or dynamic RAMs or static RAMs.

We are not going to start making boges (ph) or anything.

We are not doing anything crazy.

We are focusing on our core business.

But as we go and engage with 45, 46,000 customers worldwide to get this kind of gross margin, you have to look at it in a way -- if we have 15% or so market share in 8-bit microcontroller, we lose 85% of the business, right?

I am just doing math, so don't jump off the handle.

Right?

If we have whatever market share somebody has, 100 minus that market share they lose every day.

And I want to be able to get more portion of that by using price as a leverage and still be able to deliver 60 plus gross margins.

That's all we're talking.

Okay, understood.

If I can just follow-up with something on the 16-bit market.

Could you talk to us about what percentage of the 16-bit TAM[TF1] that you guys addressed today with the product lines that you have launched so far and how we might think of that expanding the TAM as you come out with new product lines?

That is a very good question.

It is largely about TAM expansion, and that I am much more comfortable in answering.

Not numerically because I do not really know.

If you look at a $3 billion or so market it is, today, we have about 20, 21 products in production.

We have 285 or so products, close to 300 products in production on 8-bit.

So as you introduce larger number of products, you increase essentially your served available market out of that 3 billion.

And you start to dramatically increase the hit rate.

Every time you engage, you find a better match and you can win.

And more people are interested now because you provide a broader mix.

So what I said is that we are going to go from about 20 products we have in production to nearly tripling that over the next six, seven months and continue to then really double again in the following year.

Do you have an order of magnitude as you go and triple those products percentage-wise what that does to your TAM?

There is an order of magnitude increase in the serial available market, yes; but the core is the thing.

Remember, we've got a very solid core now with two dsPIC families and two 16-bit microcontroller families.

So core is on all the tools like compilers and debuggers, and everything is available.

So we've got the infrastructure very good and healthy and ready.

What you have to do now is proliferate because somebody wants a USB and somebody wants an Ethernet and somebody wants your higher density and somebody wants some Opins on the chip.

And somebody wants this -- somebody that.

It is that permutations and combinations which really creates the proliferation of the exact product for a customer, which we have to do over the next two, three years.

Does that make sense to you?

That was very helpful.

Thank you.

(OPERATOR INSTRUCTIONS).

Joseph Osha, Merrill Lynch.

Congratulations.

I'm not going to ask you about market size.

It does seem to me like as I think about your 16-bit business, I can kind of expect that just sort of steam ahead and take 0.5 point, 1 point or so of market share each quarter much -- excuse me, each year -- much as your 8-bit business has done.

Is that based -- obviously, I've got to do my market sizing, but does that seem like a reasonable way to think about it?

Well, it's a reasonable way to think about that we'll each year, yes, take some market share.

I haven't really done the calculation of the exact percentage yet.

Okay.

But that's a reasonable way to think about it, okay.

Secondly, I love the dividend leadership here.

I guess the question would be, given the fact that the market doesn't appear to be responding much to stock buybacks, why do it?

Why not just continue to do what you have been, which is take the dividend higher?

Well you know, that is an extremely good question.

And we've been generating so much cash that is really not one or the other.

The vast majority of people that we talk to are applauding our dividend strategy -- really what we have done.

There is a small minority that continues to somehow like the stock buyback.

We're not doing it to really please that small minority either.

I have said that before that we will only do stock buyback when we really think the stock is really undervalued and market isn't listening.

As the stock went from 33 to 27 or something, we believe that market lost something there.

It was an excellent opportunity for Microchip to invest some of their dollars.

I look at companies that haven't bought billions of dollars of stock.

Intel bought $7.5 billion of stock last quarter; their stock is down.

So stock buyback doesn't seem to be working.

We've done some; we might do some more.

But that is not going to replace continuous increase of dividend because that's the only way I can insure it's real cash in an investor's pocket that they can count on their return.

Well, you are echoing my sentiments exactly.

Third and final question, I know you accelerated vesting.

Obviously, there may be some additional options grants.

Gordon, how should I think -- I know it's a couple quarters out -- but how should I think about the run rate for FAS 123 once it does hit your next fiscal year -- between 5 and 10 million a quarter, perhaps?

Well, our dilution has been -- are you asking for the share dilution or you're (multiple speakers)?

No, the FAS 123 number.

Obviously, that is a ways out, but we're beginning to try and think about that number.

I see that for your most recent filing, it was 5 million.

I assume it will ratchet up a bit.

So again, as I begin to try and factor that in for your FY '07--?

We can give you the range of EPS dilution.

I think the range that you see in our filings and our Ks and Qs are in the range that you should expect.

Our level of dilution has been about 1.5 to 2% and really has been in the low end of what most of our peers -- you have seen from our peers.

So there is no reason to expect us to change from that -- from that basis.

From an EPS basis, do you have a number yet?

No, I don't have other than what we've got in our Ks and Qs, I think --

You disclosed about $4 million in your most recent Q. So if that is a quarterly run rate, we can think about that perhaps as a reasonable bogey?

Well I think as we proceed and we've got the longest break because our fiscal year being at the end of March.

I don't know how it happened.

Company with our kind of fiscal year got the longest break in terms of when we have to start expensing it.

You will see very positive results.

You will see that how responsibly we have managed the option program for years and years and years.

Average dilution has been about 1.5, maybe somewhere in that range.

Many companies have given it much, much higher -- and even though they're trying to lower it, even their lower numbers are really higher than ours.

So I think you will be quite pleased.

We've done some analysis.

Are we prepared to give an EPS number yet or will we--?

No, not at this point.

We are still modeling that.

That's why I say I think history is somewhat indicative of what you can see, what Joe is speaking to is the net income in fact that we've put in our footnotes at this point, which is -- it's a reasonable place to jump off from.

Jeff Rosenburg, William Blair.

My questions have been answered.

Samit Gonda (ph), Banc of America Securities.

A couple of questions -- first, Gordon, could you remind us again what percentage of the total microcontroller business was Flash dollars?

And then second, perhaps we use the -- are there any distances that you could point to in terms of sales process you're ramping up your (technical difficulty) dollars versus the 8-bit controllers.

Any way you feel like you have an advantage versus the competition?

Our Flash-based business is over 50% of our total microcontroller revenues at this point.

Your second question was?

The second question was, if you're ramping up your 16-bit business, are there any fundamental differences in terms of the sales process, etc. versus your 8-bit business?

Any way that you feel that because of that you have a fundamental advantage versus your competition?

Well, we certainly do not want to give any advantage we might have and broadcast that.

But you know, it is a microcontroller business.

We understand how those customers work.

It's very similar to how you win a design on 8-bit.

The 16-bit tag designs take longer to go to production because on the average, it is a more complex design.

It takes longer for a customer to really prototype and go to production.

And that's really one thing we have learned over the last two or three years that where an 8-bit microcontroller could go to production in 9 months to 1.5 year, and 16-bit microcontroller is at least 6 months longer than that.

So maybe it's 1.5 years to 2 years almost.

Other than that, processes are very similar.

Whatever advantages we have on 8-bit, why we keep winning business, those advantages should accrue on 16-bit.

Harsh Kumar, Morgan Keegan.

Stephen, Gordon, congratulations on a good quarter.

I just have one simple question.

Can you give us the utilization rate for Fab 4, how much is it loaded?

We don't split out Fab 2 and 4 individually.

What I gave earlier was the overall utilization rate for our fab capabilities.

So in total, we're capable of doing 1.3 to 1.4 billion between the two wafer fabs.

Eric Gomberg, Thomas Weisel Partners.

Nice quarter.

Just two quick housekeeping items and one other question just for Gordon.

Could you tell us what D&A is expected to be for next quarter?

And also why other income was down modestly this quarter?

Next quarter should be roughly the same for depreciation.

So it is in the 27, $28 million range for December.

And I’d have to go look at the other income.

I think it must just be off fairly modestly.

I believe last quarter there was a small one-time event from the sale of equipment that I noted last quarter.

But certainly, our other interest income is continuing to grow with our cash balances.

So I think they offset each other essentially in the current quarter.

I commend you as well on the continuous and significant dividend increases.

Just wondering philosophically, how much further you think that could go?

Clearly, you have guided that next quarter, you'd expect after dividends to still be adding close to $70 million of cash to the balance sheet.

So how should we think about that over the next few quarters?

It is going to go higher than anybody thinks it's going to go.

In my view, I see that as -- other than the stock price going up, which I can’t control, giving higher and higher dividends is the most desirable way that I can control returning the cash back to the shareholders.

It's going to go a lot higher in my mind and in the Board's mind -- the Board is the one who approves it -- than any kind of simple analysis you could do in where you think we might stop.

Shawn Slayton, SG Cowen.

Let me ask you a question a little bit off the beaten path here.

Steve, you and Gordon, you often speak of the proprietary nature of your products.

And in the past months, you've gone after competitors for patent infringement; it is public knowledge.

Can you help us understand your view from an IP perspective, what Microchip can do that the others cannot?

Or said another way, is there a manufacturing technology or a special circuit architecture related to PIC that is one of the key cornerstones of your proprietary advantage in the low pin count, 8-bit/MCU market?

I think the answer is in the aggregate.

You know, if you build a business on a similarly differentiating factor, your products are faster or they're cheaper or they are in smaller package or they have lower power or you've got some better scheme with the distributors or tariff mine (ph) in a given segment or something -- you can't sustain them for 15 years.

When multibillion dollar corporations have gone after us in the last 15 years, as you have known, company after company after company that have tried -- if you build your business on flimsy one or two legs, then it really can't be sustained.

Because you can make products faster, you can make products cheaper, you can make better development tools.

Everything can be duplicated.

But when you put it all together into an aggregate system that we have developed in which we have enhanced from the state-of-the-art of whether it is selling or technology or low power or smaller package or better development tool or better relations with the customer -- the answer lies really in that aggregate.

I know for years that people are always looking for a simple answer -- why can you do it?

And if the answer simply was, we've got a talent on this PIC and nobody else can do it and we are the only ones who can do it, then the answer would be much, much simpler.

But if the answer was much simpler, it wouldn't be sustainable for 15 years.

Okay.

Fair enough.

Do you anticipate with maybe some smaller players recognizing the attractive nature of the 8-bit Flash market -- do you anticipate going forward maybe having to be a little more aggressive in protecting your IP?

That's all I have.

Thanks.

Well that is really what we have done when you see our public filing of a patent suit.

We think Microchip has the intellectual property in those products, which we believe are being violated.

And you don't wait for it to have damage in the marketplace.

These products are infringing, and they should not be built.

Again, I would really say that who could have thought 10 years ago or 5 years ago that building 8-bit microcontrollers, the old Ford Model T, and building Serial EEPROM products?

You could build a company that is producing third-best operating margin in the industry -- 35%.

You're not going to find a simple answer; otherwise, they could have been duplicated.

It's really a very, very complex web of the excellence we have put together in hundreds in areas of the Company, each expanding the state-of-the-art and delivering, whether it is in cash flow or it is in margin or it is in cost or it is yields or it is capital utilization -- which is giving these results.

I just finished writing a book, and the title of the book is "Driving Excellence."

In fact, you can order your advanced copy from Amazon.com if you search for "Driving Excellence."

It is not out yet, not out till about March or April.

But when it comes, you can read some of that.

But it doesn't tell you enough for a competitor to be able to execute it.

But you see the excellence in culture, how many of these things are put together.

Otherwise, you know, building these products, you cannot produce 35% operating profit.

And there are no further questions at this time.

Okay.

Thank you very much.

If you have any other questions, call us here.

Otherwise, we will see you next quarter, or we'll talk to some of you at the various conferences we're going to go to this quarter.

And that does conclude today's conference.

We thank you for your participation.

You may now disconnect.

[TF1](It stands for Total Available Market)