微晶片科技 (MCHP) 2010 Q4 法說會逐字稿

Hello.

Good day, everyone and welcome to the Microchip Technology fourth quarter fiscal year 2010 earnings results conference call.

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

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

Eric Bjornholt.

Please go ahead, sir.

Good afternoon, everyone.

During the course of this conference call, we'll 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 recent filings with the SEC, that identify important risk factors that may impact Microchip's business and results of operations.

In attendance with me today are Steve Sanghi, Microchip's President and CEO, Ganesh Moorthy, Microchip's COO, and Gordon Parnell, Vice President Business Development and Investor Relations.

I will comment on our fourth quarter fiscal year 2010 financial performance, and Steve and Ganesh will give their comments on results, discuss the business environment, and discuss our guidance for the June quarter, including information on Microchip's stand-alone operations, as well as our expectations for the operations acquired from SST.

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

Net sales for the March quarter were a record $278 million, up approximately 11.2% from net sales of $250.1 million in the immediately preceding quarter, and up 60.5% from net sales of $173.3 million in the March 2009 quarter.

The March quarter represents the first time in Microchip's history that we have achieved four quarters in a row of double-digit percentage sequential revenue growth.

On a geographic basis, revenue in the Americas was up 12.5% in the March quarter, Europe was up 22% and Asia was up 5.6%.

All geography surpassed our initial expectations for the quarter, and delivered growth above normal seasonality.

The growth in Asia with the backdrop of this being the quarter of the Lunar New Year is exceptional.

Asia continues to be our largest geographic region representing 49.6% of sales in the March quarter.

The Americas were 24% of sales and Europe was 26.4% of sales.

These measurements are based on where the product is delivered for manufacturing purposes for our customers, but does not necessarily represent where the design activity is taking place or where the end product consumption is occurring.

Net sales for fiscal 2010 were $947.7 million, up approximately 4.9% from the fiscal 2009 levels.

We are continuing to include information in our press release on various GAAP and non-GAAP measures.

We have posted a full GAAP to non-GAAP reconciliation on our Investor Relations page of our website at www.Microchip.com, which we believe you will find useful when comparing GAAP and non-GAAP results.

Non-GAAP net income for the fourth quarter of fiscal year 2010 was $86.7 million or a record $0.46 per diluted share, an increase of 23.6% from non-GAAP net income of $70.1 million or $0.38 per diluted share in the immediately preceding quarter.

The after-tax impact on the March 2010 quarterly earnings that have been excluded from our non-GAAP results include $8.5 million in share-based compensation expense, $1 million in noncash interest expense associated with our convertible debt, and $1.5 million in charges associated with our acquisition activities.

GAAP net income was $75.7 million in the March quarter or $0.40 per diluted share.

For fiscal 2010, non-GAAP earnings per share were $1.32 compared to $1.27 in fiscal 2009.

It is worth noting that EPS was negatively impacted by about $0.06 in fiscal 2010 compared to fiscal 2009, as a result of lower interest income due to the depressed market interest rates being applied to our cash and investment balances.

The offerings per share were $1.16 for fiscal 2010, compared to $1.31 for fiscal 2009, and include on an after-tax basis $32.2 million in share-based compensation expense, $8.5 million from a favorable tax settlement with the IRS, $4.6 million in gains on trading securities, $3.8 million in noncash interest expense associated with our convertible debt, $3.9 million in charges associated with our acquisition activities, and $1.1 million associated with the acquisition of a patent license.

I will now go through some of the operating results for the March quarter.

I will be referring to gross margin and operating expense information on a non-GAAP basis prior to the effects of share-based compensation and acquisition-related expenses.

Gross margins were a record 61.63% in the March quarter compared to 59% in the December quarter.

The 260 basis point quarterly increase in gross profit margin was driven by a variety of factors including higher production activity in our factories and continued cost reduction efforts from our global manufacturing operations.

With the increase in revenue, we were able to achieve operating leverage from the business with total operating expenses of 25.8% of sales in the March quarter, compared to 26.2% in the prior quarter.

Research and development costs were $30.3 million compared -- representing 10.9% of sales.

Sales and general administrative expenses were $41.4 million representing 14.9% of sales.

Our non-GAAP operating expenses as a percentage of sales are now lower than they were in our previous peak earnings quarter of September 2008.

On a full GAAP basis, gross margins, including share-based compensation and acquisition-related expenses, were 60.6%.

Total operating expenses were $80 million or 28.8% of sales, and include share-based compensation of $7.2 million and acquisition related expenses of $1.7 million.

On a non-GAAP basis, the tax rate for the March quarter was 10.4%, the GAAP effective tax rate for the March quarter was 9.8%.

The difference in the GAAP and non-GAAP tax rates was driven from the higher tax rates that applies to the noncash interest expense on our convertible debt.

And our tax rate is impacted by the mix of geographical profits and a percentage of our cash that is invested in tax advantage securities.

We expect our forward-looking non-GAAP tax rate to be between 12.5% and 13%, and we expect our forward looking GAAP tax rate to be between 12% and 12.5%.

The dividend declared today of $0.342 per share will be paid June 30, 2010, to shareholders of record on May 20, 2010.

The cash payment associated with this dividend will be approximately $63.5 million.

Moving on to the balance sheet, Microchip's inventory balance at March 31, 2010, was $116.6 million.

An increase of $3.8 million and representing approximately 97 days, which is down from two days from the prior quarter level.

Inventory at our distributors was about flat at 41 days, compared to 40 days at the end of the prior quarter.

Deferred income on shipments to distributors increased only 1.4% sequentially in the March quarter and is actually down 4.4% from the level of our prior peak earnings quarter of September 2008.

I would like to remind you that Microchip recognizes its distribution revenue on a sell-through basis in its worldwide distribution channel.

At the end of March, the combined inventory on Microchip's balance sheet and at its distributors was 138 days or down one day from the prior quarter levels.

During the March quarter, we continued to aggressively increase our manufacturing outputs so we can continue to satisfy the needs of our customers by providing industry-best lead times.

We expect inventory days on our balance sheet to be about flat in the March quarter -- in the June quarter and remain well below our internal target of 115 days.

At March 31, our receivables were $137.8 million, an increase of $24 million or 21.1% from the balance as of the end of December.

The increase in receivables in the March quarter is due to the back-end weighting of shipments due to the Lunar New Year holidays in Asia.

Receivable balances are in great condition with excellent payment performance continuing from our customers.

As of March 31, Microchip's cash and total investment position was approximately $1.53 billion.

Our cash generation from the business was $94.9 million prior to the payment of a $62.9 million dividend.

Our cash generation continues to be strong, and our total cash and investment position is projected to grow again in the June 2010 quarter, excluding the cash used to fund the SST acquisition.

Capital spending was approximately $19.2 million for the March quarter, and our fiscal 2010, capital expenditures were $47.6 million.

We are continuing to invest in equipment to support the revenue growth of our new products and technologies, and our capital expenditure forecast for fiscal 2011 is about $90 million.

Depreciation expense for the March quarter was $21.3 million, which was down from depreciation of $21.6 million in the December quarter.

I will now ask Ganesh to give his comments of the business in the March quarter.

Ganesh?

Thank you, Eric, and good afternoon, everyone.

Let me now comment on the individual product lines.

All three of our product lines, microcontrollers, analog, and serial EEPROMS delivered another quarter of outstanding growth in the March quarter.

Our strategy to stay invested in our new product development and demand creation initiatives during the global recession is paying off handsomely as you can see from the continuation of our differentiated revenue growth and operating profit results quarter after quarter.

Let's now take a closer look at each of our product lines starting with microcontrollers.

Our microcontroller business delivered superb results, with revenue up a strong 10.3% on a sequential basis and up 58.2% from the year-ago quarter, achieving a new record.

The March quarter was the fourth consecutive quarter of double-digit sequential growth for the microcontroller business.

Flash microcontrollers represented 81.5% of our microcontroller business in the March quarter.

Our 8-bit microcontroller business had another excellent quarter, as all segments of our 8-bit product line again experienced very strong growth.

Our 16-bit microcontroller business achieved another record for quarterly revenue with strong sequential growth of 23%, and up 133% from the year-ago quarter.

On a fiscal year basis, our fiscal year 2010 16-bit revenue was up an impressive 86% over fiscal year '09.

New customers and new designs going to production continued to help drive significant growth as the number of volume 16-bit customers grew by 284 customers to 2,573.

Our 32-bit microcontroller product line, meanwhile, also continues to make good progress, with 36% sequential growth from a small, but rapidly growing base and building upon the 44% sequential growth we had in the December quarter.

We now have 222 32-bit microcontroller customers in volume production, up from the 173 we reported last quarter.

Moving to development tools, we had another record quarter here, too, with 45,057 development tools shipped in the March quarter; the fourth consecutive quarter of record development tool sales.

As you have seen from our growth in recent quarters, development tool sales are an excellent leading indicator of continued strong design and activity and acceptance of our solutions by our customers.

And the continued strength of record development tool sales should bode well for future growth.

About a month ago, Gartner Dataquest released the microcontroller market share report for 2009.

Based on Gartner's Report, for the fourth consecutive year Microchip retained the number one position for 8-bit microcontrollers.

We gained market share again, and we continued to put more distance between us and the second-place competitor.

Microchip is now 26% larger than the number two eight-bit competitor.

Our outstanding growth in 16-bit microcontrollers enabled us to break into the top 10 of 16-bit competitors for the first time.

In fact, in 2009, not only did we gain share in the 16-bit market, but we were the fastest growing provider of 16-bit products by a very wide margin.

And 2010 is off to a solid start as you have seen, based on our 23% sequential growth in the March quarter.

Moving to our analog product, here, too, we delivered outstanding results with very strong sequential growth of 19.3%, and 91.6% growth versus the year-ago quarter to achieve another record for revenue growth.

We also marked the fourth consecutive quarter of double-digit growth for our analog business.

On a fiscal year basis, our fiscal year 2010 analog business was up 21.3% over fiscal year '09.

After breaking through the $100 million annualized revenue run rate for the first time just last quarter, our analog business rocketed past $125 million annualized revenue run rate in just one quarter.

Growth was especially strong in the linear, interface, mixed-signal, safety and security product lines.

We are very pleased with the design win momentum and revenue momentum our analog business has shown.

We continue to introduce a steady stream of innovative new products that we expect will contribute to continued strong growth in the coming quarters.

Moving to our serial e-squared memory business, this business was up 9.3% sequentially.

We were pleased to solid growth in this area of our embedded control products and we continue to run this business in a disciplined fashion that maintains consistent profitability and serves our microcontroller customers to complete their solutions.

About four weeks ago, we closed the acquisition of SST.

The integration work is off to a good start, and Steve will provide more color on the acquisition in his remarks.

We continue to press our advantage with industry-leading lead times as most of our competitors struggle to maintain lead times of 20 to 30 weeks.

Microchip's investment in inventory, decision not to lay off manufacturing employees, or shut down manufacturing facilities during the recession, as well as our ongoing operational excellence, has enabled us to offer industry-leading lead times to our customers.

We're capitalizing on the strength to further grow our market share as we are better able to respond to rapidly rising demand from our existing customers, rescue new customers who have been marooned by our competitors' inability to supply product, as well as instill confidence in all customers as to who they should commit new designs to so they are best assured of excellent product delivery and superior service to help them achieve future success.

Let me now pass it to Steve for some general comments as well as our guidance for the June quarter.

Steve?

Thank you, Ganesh, and good afternoon, everyone.

Today I would like to first to reflect on the results of the March quarter, and I will provide an update on our acquisition of Silicon Storage Technology.

Finally, I will talk about our guidance for the June 2010 quarter.

By reflecting on the March quarter, it is quite clear that we hit the ball out of the ballpark.

I want to thank the entire Microchip team for delivering an outstanding quarter in every respect.

We made more records in the last quarter than we have in a long time.

We achieved records in microcontroller sales, 16-bit microcontroller sales, 32-bit microcontroller sales, and analog product sales.

We also achieved a record in non-GAAP gross margin percentage, record non-GAAP operating profit dollars and record non-GAAP EPS.

All these numbers are exceeded by a wide margin of original guidance, as well as our positively devised guidance for the quarter.

It's also the first time ever that we have achieved four consecutive quarters with over 10% sequential growth in net sales.

We have now been profitable for 78 consecutive quarters, and the June quarter will be our 79th.

I also wanted to highlight the comparison to SIA numbers that were recently released.

While Microchip does not participate in SIA and short-term SIA numbers are often suspect, many of the investors and analysts follow those numbers.

Based on SIA data, March quarter 2010 industry sales for eight plus 16-bit microcontrollers were up 2.3% sequentially.

Microchip's eight plus 16-bit sales for the March quarter were up 10.2% sequentially, showing significant market share gains.

Next, I would like to discuss the seven major drivers of growth for Microchip.

First, is our multi-year demand creation program in which we added 28% additional sales and applications personnel 3.5 years ago, and then we retained them through the global financial crisis of last year.

They have created a steady stream of new customers and new design wins that are turning to production, adding to our growth.

Number two, we have an industry-leading design engineering awareness of our 8, 16, and 32-bit microcontroller solutions.

In survey after survey, in our 8, 16, and 32-bit microcontrollers rank at or near the top of choice by designers for microcontrollers of similar features and functionality.

Number three, we have significantly expanded our server available market with the introduction of over 400 new products in the last three years, covering several key trust areas like extreme low power, touch send, USB interface, advanced graphics, high performance analog, internet connectivity, auto connectivity, motor control, and digital power supply.

Our 16-bit microcontroller portfolio now stands at 213 products and our 32-bit microcontroller portfolio now stands at 34 products.

Number four, our analog business is growing and gaining market share.

We are gaining by attaching analog to our microcontroller applications, as well as embedding analog functionality on the microcontroller dye.

We are also are getting traction in the embedded control market where the microcontroller may not be ours.

And we are also gaining momentum with our analog products outside of the embedded control market.

Our analog business in the March quarter was up 92% from the same quarter a year ago.

Number five, we're gaining share from large, but still financially strapped, competitors.

Number six, we're gaining share by maintaining the shortest lead time on the products in the industry.

Many customers who were marooned by the lengthy lead time of our competitors are turning to Microchip for relief.

History shows that we're able to keep many of these customers even when the competitive supply returns.

And we usually maintain the design position moving forward.

And number seven, we believe that the acquisition of Silicon Storage Technology will be substantially accretive and add to our revenue as well as earnings.

One concern that investors have is about inventory.

Our internal inventory went down by two days, and our distribution inventory went up one day last quarter.

Microchip's inventories, plus our distributor inventories combined, are in the lower end of historical days of sales.

We have always differentiated ourselves from the competition by maintaining short lead time.

If we could say anything about inventory, our inventory at Microchip is lower than we would ideally like.

We are continuing to make the necessary investments to bring inventories in line with customer needs and maintain the best lead times in the industry.

I will now give you an update about our acquisition of Silicon Storage Technology.

Microchip completed the acquisition of SST on April 8, 2010, after all the drama around the bidding process.

In the end, 91% of the shares voted were voted in favor of Microchip acquiring SST.

After closing the deal, we moved quickly to identify the core and noncore assets of SST.

We have slated the licensing business and 8051 microcontroller business as the core assets of the company, and the results from these operations will be reported in our results from continuing operations.

NANDrive, NAN controllers, smart card business, and wi-fi PA businesses of SST have all been slated as noncore businesses and are assets held for sale.

The results from these businesses will be reported in our results from discontinued operations until they are sold.

We are currently in active negotiations with parties on the sale of some of these business units.

The NOR flash memory business has several segments in it like serial flash, parallel flash, combo memory, and specialty memory.

Microchip will hold this entire business in its revenue as an asset held for sale, and report its results in our discontinued operations as we rationalize the various pieces.

We are in active negotiation with a couple of parties on the sale of some of these segments.

The R&D expenses associated with memory business are critical to developing the technology and then generating the licensing revenue.

Therefore, the R&D expenses of the memory business will be associated with the licensing segment and will be reported in our continuing operations as operating expenses.

Overall, the acquisition of SST will be accretive to Microchip's non-GAAP earnings starting the June quarter by about $0.03 per share.

We expect that the acquisition will be accretive to our non-GAAP earnings for the full fiscal year 2011 by about $0.14 to $0.18 per share.

I will now move to provide guidance for the June 2010 quarter.

First I will provide guidance for Microchip's stand-alone business without SST.

Microchip's book-to-bill ratio for the March quarter was 1.36, and we started the June quarter with an all-time record high backlog.

And this measured by a wide margin.

The bookings rate so far in the quarter has been exceptionally strong, considering all that we expect our net sales for the June quarter to be approximately $300 million or up about 8% sequentially, above what normal seasonality is for our business.

We expect our non-GAAP gross margin to be between 61.75% and 62%, which would be another all-time record.

And we expect our GAAP gross margin to be between 60.95% and 61.2%, and that is without the SST numbers.

Regarding earnings per share for the June quarter, we expect non-GAAP earnings per share to be approximately $0.49, and we expect GAAP earnings per share to be about $0.43, and that's a gain without the SST numbers.

Now, I will provide guidance for the SST portion of the business.

We expect revenue from continuing businesses which are licensing an 8051 microcontrollers to be about $18 million.

Gross margins and expenses related to continuing businesses versus assets held for sale are still a bit fluid.

But we expect that the continuing business will generate about $0.03 of non-GAAP earnings per share.

The assets held for sale will be reported as a single line which will say "Income or loss from discontinued operations." We expect that the operating results from the asset held for sale or discontinued operations will be moderately profitable in the June quarter, but will not be reflected in our non-GAAP results.

When we consolidate the results from Microchip and SST, we expect net sales in the June quarter to be approximately $318 million.

Blended non-GAAP gross margin is expected to be about 63.3% to 63.6%, and non-GAAP earnings per share is expected to be about $0.52.

It is difficult to give GAAP guidance because GAAP guidance involves a valuation allocation to various business segments, and the purchase inventory of SST.

This valuation a has not yet been completed.

As the purchase inventory of Sst is shipped, GAAP accounting awards essentially zero gross margins to those sales until the inventory is replaced.

There will also be a valuation location to intangible assets, the amortization of which will impact cost of goods sold, and operating expenses on a GAAP basis in the future periods.

So, given all the complicates of accounting for a large acquisition like many other companies have done, Microchip will provide guidance and track its results on non-GAAP basis.

We will still report GAAP results, but we believe that non-GAAP results will provide more meaningful comparison to prior quarters, and we will request that analysts report their non-GAAP estimates to first call.

With that, Operator, will you please poll for questions?

Certainly.

(Operator Instructions) We do ask that due to time constraints, please limit yourself to one question and one follow-up.

(Operator Instructions) We'll take our first question from John Pitzer with Credit Suisse.

Yes.

Good afternoon, guys.

Congratulations.

Steve, I was wondering if you could go back to book-to-bill on the March quarter of 1.36.

I guess given your lead times being relatively short vis-a-vis the competition, how do you read into that book-to-bill?

And clearly you're guiding revenue growth significantly below where the bookings growth is.

I'm just trying to get a sense of the deliveries around the bookings you received in the March quarter.

Well, you know, the book-to-bill ratio, as we calculate it, is total bookings received divided by the billings in the quarter, and some of those bookings don't age in the quarter.

But the billings are all for the coming quarter.

So some of the bookings we received in the March quarter aged outside of the quarter and edged into April, May, June, and even beyond.

Can you give us a percentage, Steve?

Or could we just figure it out from the revenue growth that you're projecting for the June quarter?

Well, so book-to-bill ratio was 1.36.

And we started the June quarter with a very, very strong backlog, significantly above the backlog we started for the prior quarter.

So a large number of bookings were in the quarter.

But a fair amount of bookings were even outside of that quarter.

John, if you're trying to reconcile the lead times, customers respond to overall broad lead times.

They're not trying to place lead times specific to Microchip.

Versus saying everybody's lead times, if you look in general, they're seeing very long lead times.

So, they place all the orders at the same time.

Yes.

So when a customer sits down with a bill of material for a given design, lead times are all over the place.

They don't really differentiate as much.

Got it.

That's helpful.

I guess as a followup, just on the analog business, you talked about attached and embedded analog sales versus stand-alone.

I'm curious, when you look at your analog business how much do you think is being pulled through by your microcontroller business versus stand-alone analog sales?

I guess as your analog peers start to grow capacity, how susceptible is that part that's not being pulled along by the microcontroller?

Well, I mean, we have very successfully competed with all these guys for years.

It's not really a current phenomenon.

Our analog business was $40 million or so in 2001 and has grown significantly.

So we're doing very, very well again head on with competitors with many innovative products and the best in class products.

So every year one or two microcontrollers -- Microchip's analog products have been named as finalists, (inaudible) and others.

So, there is really no issue there.

All of our nearly 90%-plus of our microcontrollers have large amount of analog functionality on it.

So, when we approach the customer, we approach with the whole package.

And customer makes the decision whether he wants his -- would his supervisor to use the embedded supervisor on the microcontroller or he needs a stand-alone part.

Customers basically need both kinds.

So, I don't really see that as an issue at all.

It's not capacity issue.

Analog designs tend to be very proprietary.

There's no switching back and forth that goes on.

So we're not standing capacity from somebody else eroding our analog business.

Steve, just so I'm clear.

You said that 90% of your microcontrollers have some analog.

I'm curious, when you look at the way you guys define the analog bucket, how much of that is being driven by microcontroller sales versus just a stand-alone analog part that you're providing to a customer?

I confuse you.

The analog revenue that Ganesh reported is pure stand-alone analog in direct competition with linear (inaudible) and others.

The analog, which is on a microcontroller dye, is reported in our microcontroller number as it is for everybody else.

Perfect.

Makes sense.

Thank you.

We'll go next to Brendan Furlong with Miller Tabak.

Good afternoon.

Thank you very much.

You're essentially buying SST, you're buying the IP portion with a small portion in the microcontrollers.

Roughly, you said before, like roughly 10% of Microchip's revenue is foundry.

What is so critical, if you can give us on a strategic basis, of why you're buying this IP if you will?

Well, number one, the licensing is a very profitable business.

There are four billion-plus microcontrollers a year being built on SST's technology, and Microchip was also already using SST's technology in some foundries.

Being the owners of SST, now it gives us an access to much broader base of tools in SST, much more advanced technology capability, many more foundry options, much more IP end blocks and others.

And then the 8051 microcontroller business you talked about, and we're further continuing to evaluate all the technologies' indications in Microchip's memory business as well as getting advance access to Microchip's advanced microcontrollers.

Okay.

And a couple of followups from that.

On this -- on the IP, will you continue to work with Grace and Powerchip now that essentially you're not running any revenues through them?

Or will you port it over to your own existing foundry partners?

Well, I really shouldn't answer specific questions about specific companies.

But I can say in general that none of SST's revenue will be ported over to Microchip's fabs.

Our fabs are not very, very leading edge technology that SST is using.

So we'll largely use SST's revenue from the foundries.

Okay.

My last question is on R&D and the opex, how much in proportionally -- you don't have to tell me what it is -- of the opex is an R&D interviewing team being brought over from SST?

Brought over where?

From SST, for the opex guidance that you've given just for SST in the June quarter.

What proportion of that is R&D related?

In other words, the engineering team you're bringing over with you or some of the engineering team you're bringing with you.

Well, a large portion of the engineering team which is the memory design team, technology team, licensing team, so essentially all of it.

The ones that we have not included are with the NANDrive and the wi-fi pieces of those assets held for sale.

On the balance of the memory and licensing engineering team is being reported above the line.

Okay.

Thank you very much.

Uh-huh.

We go next John Barton with Cowen.

Mr.

Barton, your line's open.

Please check your mute button.

Thank you.

Steve, you talked about assisting marooned customers.

Outside of memory for the most part, the product like is certainly proprietary.

Are you insinuating that actually you have customers going out and redesigning boards to use your microcontrollers because of other people's extended lead times?

Absolutely.

Ganesh will expand on it.

Yes.

On multiple cases with customers faced on not getting product for five, six, seven months depending what the length is, necessity is the mother of invention and people will work to make conventions hop.

We are helping those customers with our resources to effect those conversions and have seen such customers not only do the work, but actually convert and go to production with our products.

And back on the SST licensing business, what percentage of the current revenues are related to microcontrollers from a span perspective, how much of it's microcontrollers?

Where I'm really going with the question is how do you think your competitors are going to feel continuing a licensing arrangement, being the fact that are you a competitor?

Well, I can't break that down much because it's proprietary.

But essentially we have firewalled the licensing business, th information inside, which is the competitive information.

So that information is not available to Microchip's microcontroller operations regarding what competitors are working on, how much is the licensing fee per competitor, things like that.

So it's a separate division that's been firewalled.

But Microchip has access to advanced technologies and foundries significantly ahead of time than we had before.

And we had the knowledge of what SST's advanced memory cells are, and we can choose to take any one of those and try to implement it in one of the foundry and accelerate the microcontroller program, which we intend to do.

But in doing so, we don't use any of our competition's information.

We only use SST's information in taking their advanced cells.

Okay.

So it's largely been okay.

We wrote a letter to all the competitors after we bought it, and I feel largely the concerns have been satisfied but some probably will linger on.

It happens in the industry.

Microsoft does business with its competitors, Cisco does business with its competitors, and other people do business with their competitors.

This happens all the time.

We did business with Motorola when free scale was part of Motorola.

We've done business with TI system groups when they were part of TI.

We did business with Phillips, when NXP was part of them.

We sell it to the Japanese when they had large houses.

We do business with Samsung, we compete with them in Samsung microcontrollers.

So, it's really, in a way, I don't think it's an issue.

Some competitors would take it as an issue, but I think it can be managed.

And last question, if I could.

Last November you came out, certainly earlier than most, talking about a very strong 2010.

And your statements if anything have turned out to be too conservative.

Just curious what you're thinking for six quarters out now.

Well, I'm trying to execute the wonderful opportunity we have in these quarters, and not thinking six quarters out.

But you are absolutely correct.

It was hard to get people to to pay attention to what we were forecasting, and we were only conservative.

And I said that back then, that we were being conservative, actually.

So, no stab at a similar forecast?

No, not right now.

Thank you, Steve.

Yes.

Next to James Schneider with Goldman Sachs.

Good afternoon, thanks for taking my question.

I was wondering if we could return to the lead time question for a minute.

You talked about your lead times being substantially lower than the rest of the industry.

Could you quantify your lead times and what change they saw in the quarter?

Did they go up, down, or stay constant?

And then maybe if you could quantify just roughly any kind of revenue amount you think you're capturing from other competitors because they have longer lead times and can't deliver.

Some of that information is not necessarily public information we want to have.

But I'll tell you that our lead times range between eight and 12 weeks.

It's a little longer in the memory products, a little shorter on the microcontroller products and the analog products.

And the exact lead time is a function of what package product combination it is and it's in that range.

Okay.

Fair enough.

And then maybe just a followup on the dynamics in the microcontroller market itself with respect to pricing.

Obviously, I think pricing seems to be pretty benign.

But when we get to a more normal pricing dynamics as things settle out, what do you expect to see in the 8 versus 16 versus 32-bit markets?

What's the premium you expect to be able to command on 16 versus 8, and 32 versus 16 in the future?

We don't really discuss our pricing strategies with anybody.

That's what we are good at.

It reflects in our margin.

So, we don't want you to understand that.

Okay, thank you very much.

Yes.

We'll go next to Sumit Dhanda with Bank of America Merrill Lynch.

Yes.

Hi, a couple of questions.

First on the European business up 22%, was it more than just having more working days in the first calendar quarter that contributed to it?

It was -- so what we indicated, Sumit, was that obviously it is the largest working day quarter or shipping day quarter in that channel.

But all of our geographies performed above and beyond what is seasonal strength.

So, Europe was no different being up 22%.

I think if you look back at history, that's going to be the largest percentage growth that we've seen out of Europe for many, many years and maybe -- maybe all time.

I'd have to go back and look at that specifically.

Europe's strongest quarters.

So, and we did even better than that.

Was it pretty broad based across your markets, or you don't have that level of granularity?

Pretty much as we look at the straight up distributors and direct customers and by country it was strong all over.

Okay.

And then just a quick question on the licensing piece.

The $18 million that you're guiding to.

Is substantially all of it licensing revenue, or could you break out that piece versus the 8051 business?

We are not willing to provide much information on that yet.

Okay, that's all I had.

Thank you.

Thanks.

Go next to Kevin Cassidy, Thomas Weisel Partners.

Thanks for taking my questions and congratulations on a great quarter.

I was just wondering with the growth of the 16-bit and 32-bit and as that becomes a more significant part of your business, is there a higher attach rate with analog to those products?

Absolutely.

That's absolutely true.

There is a significant higher analog content around the applications that are using 16-bit and even more which are using 32-bit.

So, as our mix migrates upward, we are seeing increasing amount of analog opportunities.

Okay, great.

And-- and as these, again, as these markets grow for you, do you expect it will change your -- I guess quarterly seasonality?

Well, seasonality -- we don't even know what seasonality is right now.

There used to be a seasonality and then the crash of the late 2008 and then just the hyperactivity of 2009, we don't really know.

And so much of the business geography-wise now, Asia is a much larger portion of the business than US and Europe is.

And I think it has to be re-established over the next couple of years.

Okay.

Thanks for taking my questions.

Welcome.

We'll go next to Gil Alexander with Darfil.

Congratulations.

With your acquisition, if it's -- is it too early to ask you what your new gross margin targets are?

Should we assume that they should be at least 63%?

Well, it's certainly 68 in the range we have guided before with the large amount of licensing business, as well as some attrition in it.

And then the rest is this rationalization, what sorts out and what stays and so it's really quite fluid.

Remember, we've been in it for only 3.5 weeks.

I know --

It's kind of early.

But as we said before, when we announced the acquisition, that we feel that we will get SST to Microchip's business model.

And after 3.5 weeks, I can tell you emphatically that we can very, very safely get back to Microchip business model.

I don't know exactly what the revenue would be.

And all these pieces that we are selling and some stay, some go, and as we're rationalizing it.

So just give us some more time on that.

Thank you.

Our next to Chris Danely with JPMorgan.

Thanks.

Close enough.

Hey, Steve, as you guys continue to integrate SST, I know you don't want to give a gross margin target.

Can you give a sense of what the margin leverage would be on a gross and operating side as we continue to go through the recovery here?

Well, the leverage inside of Microchip or including SST, or --

It would be great if you, talk about including SST.

Yes.

So, leverage clearly we believe we can achieve substantial cost reduction on a fair number of products inside of SST because they are completely -- we're not bringing the fab products in as I mentioned earlier.

But there are possibilities for reducing costs in assembly and tests with the help of Microchip, we have substantial infrastructure at Microchip on various different things.

There are some consolidations where we will gain some.

We are also expediting a number of things.

Currently SST is spending a fair amount of investment in assets which we consider noncore assets.

So, as we are able to dispose of them if the next six months or so, and I'm in active negotiations with many buyers, we have to completely focus our energy on cost reduction of existing products.

We believe we can substantially improve the gross margins.

We also see broader possibilities in the licensing business beyond what we've been able to do so far.

So, I think I see revenue levels, I see operating expense leverage, I see gross margin.

But when I look at all these factors, the company is break-even plus, only slightly profitable.

So, we're seeing we're going to get it to 35%, 36% type profitability.

That's a huge improvement.

If you're looking at the leverage, we'll be total get it better than what we were at before, I think you're asking for a lot.

But what we said before was we can get it to Microchip's operating model and right now we believe we can.

And maybe overall slightly better.

And just to clarify, you think you can get rid of the -- of those discontinued operations in about six months?

Well, six to nine months.

Yes.

It can happen faster.

And depending on if the deals I'm working on right now pan out, it may take longer to begin.

But these things are unpredictable.

But certainly it would be all done by going out of the calendar year.

Great.

And as my followup, when do you think it will be profitable on a GAAP basis, the consolidated?

Well, I mean, GAAP accounts, you take the inventory that you buy and then when you sell it, you get zero gross margin.

So you have to refill out all the inventory and replenish and get new inventory to get that.

Secondly, all the valuation allowances and all have to be done, to refigure out what is GAAP doing.

GAAP is really difficult on the accounting of any purchase businesses.

That's why we see many large companies when they buy large business, usually you look at the business in non-GAAP terms.

That's the only way you can understand it.

Otherwise you're taking all these intangible amortization, inventory charges, and other stuff.

Which are really noncash.

All of them.

Okay.

If you want to try to understand our business, we recommend that you look at non-GAAP.

Yes.

So probably six to nine months then on a GAAP basis?

Well --

We don't know yet, Chris.

Because the valuation hasn't been completed yet.

There's a lot of moving parts at this point.

Yes.

Okay.

That's fine.

Thanks.

Next to Terence Whalen with Citi.

Hi, two questions.

The first one is, Steve, I think you mentioned your investing aggressively in capacity to maintain the lead time advantage.

Can you give us an understanding of -- in terms of dollar revenue capacity, how much you're adding over the next couple of quarters?

I don't think we can do that.

But we're looking at adding close to $90 million in this year in capital, right?

Yes.

In the fiscal year 2011.

It's fairly front-end loaded because a lot of the constraints are now, our revenue guidance would be better if there were no constraints and lead times are even shorter.

Even though we've given strong guidance of about 8%, it would have been even better.

So, some of the capacity is front-end loaded in the June quarter so we can put the capacity in place and really have even stronger output in the following quarter and beyond.

But I don't think we can do that, really turn that into revenue capacity terms.

Okay.

And then as a followup question, I just wanted to verify my math was correct.

So, on the $18 million incremental SST, if I used the mid-points of your non-GAAP operating margin, you're implying a 90% gross margin on that business.

Is that the correct gross margin to assume going forward?

Thanks.

Well, that is correct from the business we have currently characterized above the line.

Which is large amount of the licensing and a small amount of 8051, but there's a large amount of revenue which is below the line which is being rationalized.

Pieces being sold, pieces being discontinued.

That's still a fluid situation.

Longer term the numbers could move a little bit.

Longer term, as the other pieces grow, some of the other pieces we want to keep, that margin you have above the line of 90% may not stay 90.

But we believe that the overall gross margin for Microchip combined with SST would still be in the 62, 63 range.

Okay.

Thanks.

And congratulations.

Thank you.

We'll take our next question from Ray Rund with Shaker Investments.

Thank you for taking my questions.

I'm just curious, you're keeping the SST 8501 business, and I'm wondering if, are there any special capabilities of their products that interested you, or are these pretty much plain vanilla 8051s?

It came with SST purchase.

We didn't have a choice and had to take it, and it's profitable.

It makes good gross margins.

So we decided to keep it.

It's just that simple.

There is not a new investment going in.

We're not designing new products.

I haven't spent much time on it in 3.5 weeks.

But we'll study it more.

If we see further opportunity, there are things we can do with it.

But right now's just running the product line and working it and it's very profitable.

I see.

I know that some of your competitors who have souped up versions of the 8051 sell it for mixed-signal applications and for specialty applications that need kind of a fast processor.

Do you see that becoming a part of your product line of the 8051?

Are you going to just pretty much keep it at the 40 or the 33 megahertz type of speed range?

We're not going to talk about any strategy of what we might do.

Okay, thank you very much, Steve.

You're welcome.

We have no further questions at this time in the queue.

We'd like to turn the conference back to the speakers for any additional or closing remarks.

Okay.

Thank you, everybody, for joining us.

And we'll see some of you on the road as we attend some conferences this quarter.

Thank you.

Thank you, ladies and gentlemen, this does conclude today's conference.

We appreciate your participation.

You may disconnect at this time.