微晶片科技 (MCHP) 2013 Q1 法說會逐字稿

Good day, everyone and welcome to this Microchip Technology first quarter and fiscal year 2013 earnings 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. Eric Bjornholt.

Good afternoon, everyone.

During the course of this conference call we will be making projections and other forward-looking statements regarding future events for 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 releases 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 first quarter of fiscal year 2013 financial performance and Steve and Ganesh will then give their comments on the results, discuss the current business environment and discuss our guidance.

We will then provide an update on our acquisition of SMSC and be available to respond to specific investor and analyst questions.

Before I jump into the details, I want to remind you that we are including information in our press release and this conference call on various GAAP and non-GAAP measures.

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

I will now go through some of the operating results including net sales, gross margin and operating expenses.

I will be referring to these results on a non-GAAP basis, prior to the effects of our acquisition activities and share-based compensation.

Non-GAAP net sales in the June quarter were $352.4 million, and were up 4% from net sales of $338.9 million in the immediately preceding quarter.

Non-GAAP net sales were about $250,000 higher than GAAP net sales, as GAAP does not recognize revenue on sell-through of products sitting in the distribution channel on the date of an acquisition.

This $250,000 difference relates to our April acquisition of Roving Networks.

We expect we will have larger differences in the coming quarters in our GAAP and non-GAAP net sales due to the acquisition of SMSC.

On a non-GAAP basis, gross margins were 59% in the June quarter, and non-GAAP operating expenses were 26.3% of sales.

Operating income was 32.7% of sales, and net income was $96.9 million.

This resulted in earnings of $0.48 per diluted share, which is at the midpoint of our guidance.

On a full GAAP basis, net sales were $352.1 million, and gross margins, including share-based compensation and acquisition related expenses, were 57.7% in the June quarter.

Total operating expenses were $106.7 million, or 30.3% of sales, and include share-based compensation of $8.7 million, and acquisition related expenses of $5.5 million.

GAAP net income was $78.7 million, or $0.39 per diluted share.

In the June quarter the non-GAAP tax rate was 13.3%, and the GAAP tax rate was 13.4%.

Our tax rate is impacted by the mix of geographical profits, withholding taxes associated with our licensing business and the tax effect of various non-recurring items.

We expect our forward-looking effective tax rate with the combination of Microchip and SMSC on a non-GAAP basis to be about 13% to 14%.

And I remind you that this is without any benefit from the R&D tax credit, which has currently expired and has not yet been reinstated.

To summarize the after tax impact the non-GAAP adjustments had on Microchip's earnings per share in the June quarter, share-based compensation was about $0.043, acquisition related items were about $0.04 and non-cash interest expense was about $0.006.

The dividend declared today of $0.351 per share will be paid on September 5, 2012, to shareholders of record on August 22, 2012.

The cash payment associated with this dividend will be approximately $68.2 million.

Moving on to the balance sheet.

Microchip's inventory at June 30, 2012 was $221.5 million, or 136 days, down 1 day from the prior quarter level.

Inventory at our distributors continued to be at historically low levels at 31 days, flat to the prior quarter.

I want to remind you that our distribution revenue throughout the world is recognized on a sell-through basis.

At June 30, Microchip's accounts receivable balance was $174.7 million, an increase of 2.6% from the balance as of the end of March.

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

As of June 30, Microchip had a record cash and total investment position of approximately $1.82 billion.

During the June quarter we generated free cash flow of $101.4 million, prior to dividend payments.

Excluding our acquisition of SMSC, SMSC's cash flow and dividend payments, we expect our total cash and investment position to grow by approximately $100 million to $110 million in the September quarter.

Capital spending was approximately $10 million for the June quarter, and well below our original forecast of $18 million.

With some of the June capital plan rolling into September, we expect about $20 million in capital spending this quarter, excluding any SMSC capital expenditures.

We have reduced our overall capital expenditure forecast for the fiscal year from $70 million to $60 million, again, excluding any SMSC capital requirements.

Depreciation expense in the June quarter was $20.7 million, which was down from depreciation of $20.9 million in the March quarter.

I will now ask Ganesh to give his comments on the performance of the business in the June quarter.

Ganesh?

Thank you, Eric, and good afternoon everyone.

Let's now take a closer look at the performance of our product lines and let's start with microcontrollers.

Our microcontroller business was up 5.1% on a sequential basis in the June quarter, with all three microcontroller businesses up sequentially.

During the quarter, we marked another milestone as we shipped our 11 billionth cumulative microcontroller.

Our 16-bit business was up 23.7% sequentially in the June quarter and up 18.9% from the year-ago quarter, to achieve an all-time record.

After a pause in the March quarter, our 32-bit business was up a whopping 71.5% sequentially in the June quarter, to achieve another new record.

Our 32-bit business was also up 118.5% from the year-ago quarter.

Both the 16-bit and 32-bit microcontroller businesses continue to benefit from the many demand creation actions we have taken, as more customers who have selected the PIC microcontroller platform, either commenced production or ramp their volumes.

Our design win momentum remains strong and while we're not immune to the macro business conditions, we continue to outgrow the secular growth patterns for these segments.

Moving to development tools, we shipped over 47,000 tools in the June quarter.

Cumulatively, we have now shipped close to 1.35 million development tools and development tool sales remain an excellent leading indicator of continued strong design-in activity and acceptance of our solutions by customers.

Now moving to our analog products.

Our analog business was up strongly with 9% sequential growth, to also achieve a new record and performed exceptionally well in the current environment.

The synergy of selling more analog content around our high end microcontrollers, combined with innovative new products and demand creation actions we have taken, are fueling the growth of our analog business.

We remain pleased with the design win momentum our analog business has shown and have a strong pipeline of more innovative new product lines that we will be unveiling over the next few months.

Now moving to our memory business.

This business, which is comprised of our (Inaudible) core memory products as well as our SuperFlash memory products, was down 2.4% on a sequential basis.

We continue to run our memory business in a disciplined fashion that maintains consistent profitability, enables our licensing business and serves our microcontroller customers to complete their solutions.

Let me now pass it to Steve for some general comments, as well as for our guidance going forward.

Steve?

Thank you, Ganesh and good afternoon everyone.

I am speaking to you from SMSC headquarters in New York today, where we are excited to have completed the acquisition of SMSC this morning.

Today I would like to first comment on the results of the fiscal first quarter of 2013 and then provide guidance for the fiscal second quarter of 2013, including comments on the integration plan for SMSC.

Our June quarter results were consistent with what we had guided during the last earnings call.

The quarter started out strong but the negative effects of Europe, weaker economic activity in US, and weakening economy in China led us to finish the quarter slightly lower than the midpoint of our guidance in revenue.

Gross margin was up 85 basis points sequentially, leading to an improvement in operating profit, which was about 32.7% of sales.

Our licensing business was down 4.8% sequentially.

Our licensing business tends to trail industry manufacturing output by approximately one quarter and reflects the manufacturing inventory correction by foundries and IDMs over the prior two quarters.

However, we did sign two new license agreements with two major foundry customers last quarter.

Both of them will be the users of SSD Flash for the very first time and will help us expand our penetration in the use of SSD Flash in the embedded world.

We continue to build a strong foundation for future growth with these two new significant license agreements signed in the June quarter.

I will now provide guidance for the September quarter, including SMSC revenue.

Our guidance is based on economic data points we are getting that say that US economic recovery has stalled, Europe will continue to be in the doldrums and is made worse so by the summer holidays and China, which has been the engine of growth, is starting to slow down.

In preparing our guidance, we have done bottoms-up analysis region-by-region, distributor-by-distributor and by major customers.

We have also included SMSC revenue from today to the end of the quarter as we understand it.

We expect our net sales in the September quarter to be between $412 million to $430 million, which is up 17% to 22% sequentially.

It includes about $65 million to $70 million revenue from the sale of SMSC products.

We expect non-GAAP gross margin to be 58.5% to 59% of sales for the combined company.

We expect non-GAAP operating expenses to be about 28.5% to 29.5% of sales for the combined company.

And we expect the combined company non-GAAP operating profit to be between 29% to 30.5% of sales, and non-GAAP earnings per share to be $0.50 to $0.52 per share.

Now we will provide you some updates on SMSC acquisition.

We're excited to close the acquisition and begin the process of integration to drive shareholder value.

We want to welcome all SMSC employees on this journey.

In Microchip culture, employees are our greatest strength.

Today we would like to cover four subjects before I open the call for questions.

First, I will explain to you how the revenue of SMSC will be consolidated into Microchip's SEC revenue reporting.

Second, Ganesh will give you an update on the integration planning.

Third, Eric will give you guidance on the accretion we expect to get from this acquisition.

And finally, I will update Microchip's long-term financial model, which will now include SMSC.

So let us begin with how the revenue of SMSC will be included in Microchip's revenue reporting.

As you know, Microchip breaks its revenue reporting in five different reported product lines.

Microcontrollers, analog products, memory products, licensing and others.

Over the last three months, we have studied SMSC's products.

SMSC breaks down its revenue into five reported product lines.

Automotive, wireless audio, USB, industrial networking and computing.

More end market based rather than product determined.

Many of SMSC's products are built on a microcontroller core.

They're in fact special purpose microcontrollers for automotive, wireless audio or computing applications.

These are not any more specialty microcontrollers than touch controllers are for mobile phone applications that many of our investors are very familiar with.

In SMSC's 10-Q filing on June 10, 2012, SMSC reported $103 million of revenue for the quarter ended May 31, 2012.

If such revenue had been on Microchip's clock, we would have reported 43% of the revenue as microcontroller product revenue.

The remaining 57% of the product are mixed signal analog products, which we would have added to our analog product revenue.

SMSC's mixed signal analog products sell into many markets like automotive, PC, industrial, and consumer and we expect they will benefit from Microchip's broad penetration and a large horizontal customer base.

Similarly, we expect Microchip's microcontrollers analog and memory products, will find homes in more automotive, wireless audio and computing customers of SMSC.

As of today, we do not expect that the acquisition of SMSC will create any additional reportable product lines.

SMSC's revenue will be included with Microchip's microcontroller and analog revenue reported product lines.

There is perhaps too much made of Microchip of being a horizontal market company and SMSC being a vertical market company.

Over the last decade, Microchip has added vertical market resources in the area of automotive, home appliances, medical, smart energy, digital power, motor control, lighting and several other market segments.

We see the acquisition of SMSC as a natural addition to Microchip's continued growth and penetration into certain vertical markets.

The addition of SMSC will add wireless audio and computing as two additional vertical markets for Microchip.

The automotive market is already a significant area of focus for Microchip.

It's not something we break out, but we have broad automotive penetration and we do business with nearly every Tier 1 automotive manufacturer.

Microchip has devices in many hundreds of car and truck models around the world.

For example, there are over 20 Microchip microcontrollers on the current model of the Mercedes S Class car.

So I will now pass it on to Ganesh who will give you update on our integration planning.

Ganesh?

Thank you, Steve.

Since the announcement of the acquisition, we have engaged in extensive discussions with the management of SMSC to understand their business, organization, and systems.

We have developed a detailed integration plan that we have begun to execute starting today.

SMSC currently runs five product groups, the automotive products group, the wireless audio product group, the USB product group, industrial and networking product group, and the computing group.

Microchip will continue to run these five product groups.

At Microchip, we call the product groups divisions, but essentially they're the same and there's no difference between a product group versus a division as the two different companies have called them.

There could be some movement of specific products from SMSC divisions to Microchip divisions, or vice versa, as we fine-tune the organization and look for synergies in execution.

We have also studied the business systems of both companies.

We have laid out a plan that will combine the best of both systems of the two companies.

The two companies will operate on a single set of business systems and we estimate that this transition will be completed sometime in the calendar first quarter of 2013.

In regards to manufacturing, SMSC is a fabless company and uses many of the same wafer foundries that Microchip uses for acquiring some of our wafers.

We do not expect that Microchip will bring any SMSC products to our in-house wafer fabs.

SMSC subcontracts 100% of its assembly and 90% of its tests.

Many of the packages that SMSC uses are different than Microchip's packages.

The final test systems that SMSC uses are also different than Microchip's test systems.

Therefore, we expect that the majority of the assembly and test of SMSC products will remain with subcontractors.

We will continue to do a make versus buy analysis with newly developed products and expect to shift the mix to Microchip assembly and test when it is cost effective.

Microchip will, however, combine the manufacturing system.

These are wafer ordering, assembly and test management, shipments and warehouses.

We expect that all SMSC products will be shipping from Microchip's manufacturing systems by the start of the new year on January 1, 2013 or earlier.

Regarding field sales and applications, we have done a thorough analysis of the sales and application structure of SMSC.

Over the last decade as Steve said, while Microchip had a predominantly horizontal sales force, we have selectively added vertical marketing capability in several areas like automotive, home appliances, medical, smart energy, digital power, et cetera.

We believe that SMSC's sales force will help us expand our vertical market capabilities further in the areas of wireless audio and computing.

We are, therefore, planning to keep SMSC sales and applications engineers and add them to our vertical market sales force, in conjunction with the horizontal sales force that we have.

Many of the large, multinational customers may see a combined effort by the two sales forces.

Many other accounts will continue to be called on by either the Microchip or the SMSC salesperson, with many cross-selling opportunities.

We also plan to combine the distribution network for the two companies.

Many of the distributors to the two companies are the same, but many are also different.

And our goal is to achieve expanded distribution capabilities for the products of both companies.

Finally, in regards to human resources, we expect to combine the human resource systems as well.

This includes the compensation plans, medical and dental benefit plans, equity plans and all other benefit plans like 401-K, vacation benefits, et cetera.

This combination of plans could take some time and certain combinations will be more convenient from the beginning of the new calendar year.

Meanwhile, SMSC will continue to operate with their current plans.

And with this, I will now pass it on to Eric who will provide guidance for accretion from the SMSC merger.

Eric?

Thanks, Ganesh.

With the rate at which we expect integrations to progress, we currently expect the SMSC acquisition to be accretive in the current September quarter by about $0.03 per share on a non-GAAP basis.

During our acquisition announcement on May 2, 2012, we had said that we expect the acquisition to be accretive in the first full quarter after close.

We have now pulled the accretion schedule in and expect the acquisition to be accretive starting the partial September quarter on a non-GAAP basis.

We now expect that the acquisition will add approximately $0.06 to $0.07 per share to Microchip's non-GAAP EPS for the December 2012 quarter.

For the March 2013 quarter, we expect the accretion to increase to about $0.07 to $0.08 per share and for the June 2013 quarter, we expect to be in the full range of accretion, which is expected to be about $0.08 to $0.09 per share per quarter.

These numbers are preliminary and depend upon the speed of the integration efforts and the help of the underlying economy in general.

Given all the complications of accounting for the acquisitions including amortization of intangibles, restructuring charges and the inventory write-up on acquisitions, Microchip will continue to provide guidance and track its results on a non-GAAP basis.

We believe that non-GAAP results provide more meaningful comparisons to prior quarters and we request that the analysts continue to report their non-GAAP estimates to First Call.

With that, I will pass the call back to Steve who will provide you Microchip's long-term model, including SMSC.

Steve?

As you very well know, Microchip has maintained a premium financial model for gross margin, operating expenses and operating profit for a very long time.

Every time we do an acquisition, where the target's operating business model is not at par with Microchip, there is substantial speculation regarding what the acquisition will do to Microchip's combined business model.

Our track record has shown that Microchip has been able to improve the business model of its acquisitions and our combined business model has remained virtually unchanged.

In the case of SMSC, we expect to implement substantial business process improvement to improve gross margin percentage, lower operating expenses, and substantially increase its operating profit.

Our long-term model for the combined Company will be a gross margin of about 60%, plus or minus 0.5%, operating expenses of about 27.5%, plus or minus 0.5% and operating profit of about 32.5%, plus or minus 0.5%.

All of these numbers are non-GAAP.

This long-term model will continue to be a premium model in the semiconductor industry and will drive substantial shareholder value.

With this, Operator, will you please poll for questions.

Thank you.

(Operator Instructions).

James Schneider, Goldman Sachs.

Good afternoon.

Thanks for taking my questions.

Steve, I was wondering if you could give us a little bit of an outlook in terms of what you're seeing from customer order rates by different geographies, whether you expect -- which geographies you expect to be up or down in the next quarter.

If you recall the guidance we provided on sales, all the growth is coming from the partial SMSC quarter added to our numbers.

If you take the midpoint of our guidance minus the SMSC revenue of $65 million to $70 million, Microchip is flat to up just 2.3% or so.

In terms of geography, Europe geography is very weak, made worse so in summer quarter as we said.

So that will definitely be down and the other geographies of US and Asia will largely make up for the drop in Europe.

Fair enough.

Then as a follow up, can you maybe address the R&D line in terms of absolute dollars?

I understand what you're talking about in terms of long-term percentages.

Can you maybe talk about whether you expect R&D to drift up or whether you'll try to rein that in over the next two quarters and that is the dollar basis?

If you add substantial R&D of SMSC together with Microchip, then those numbers will trend down as we gain synergies and make some restructuring changes.

If that's what your question is.

But if you compare it to a Microchip R&D number as we had it last quarter, of course numbers will go up because there's substantial R&D from SMSC being added.

Of course.

But the combined R&D should float down over time in terms of dollars?

Should go down short-term in dollars and long-term in percentages, yes.

Right.

So we're not giving any specifics of the breakout of the operating expenses at this point in time, Jim.

So we shared the long-term model on what we expect this quarter, so that shows that operating expenses should trend down, but we haven't given specifics on any particular line item.

We have a partial SMSC this quarter and then there will be full SMSC next quarter, so the total operating expenses including R&D, or R&D itself, are going to rise in September and rise in December because of SMSC.

Understood.

Thanks very much.

Christopher Danely, JPMorgan.

Thanks, guys.

Steve, on SMSC, to achieve the targets, do you think you'll have to get rid of any of the businesses or do you think that you can get it to those targets with the current mix of business that they have?

So there is no selling of the business involved in getting to those targets, but there's a definite restructuring within the business itself using the combined energy of the two companies, using synergy in R&D, synergy in sales, synergy in operations, IT, finance and other things.

Great.

And for my follow-up, would you care to give us any sort of long-term revenue growth target for the combined company?

It's too early.

We just started today.

Okay.

That's fine.

Thanks.

John Pitzer, Credit Suisse.

Steve, just a follow-up to Chris' follow-up.

Relative to understanding when you can get the revenue synergies, clearly the accretion guidance makes the financial rational for this acquisition readily apparent but as you think about either trying to leverage your distribution channel or SMSC's distribution channel, vice versa or customer base, when do you start to think you'll see dividends on the top line for that?

Nearly all of their products are proprietary and a very high portion of Microchip's products are proprietary, and you know that proprietary products take anywhere from low as six months for design win to as long as a 1.5 year, two years in design before they go to production.

So on some of the low-hanging fruit from distribution, from each of the distribution and customers, we could get that in six to nine months.

But some of it will take longer.

And it's also by project.

We take much longer in automotive for us to sell into their customers, for them to sell into our customers.

But it will be quicker in consumer.

It could be quicker in the PC segment, some industrial segments, especially the USB products and Ethernet products are very, very good products for our broad horizontal customer base.

We sell to 70,000 customers.

Those are easier products to get designed in also relative to automotive.

That's helpful.

Maybe, Ganesh, as a follow-up, could you just remind us how much of SMSC's business was done through distribution and what percent do you think is distribution overlap versus new distribution opportunity when you look at the revenue stream?

I'm going to hand that to Eric.

Eric, do you remember the percentages of their existing business in distribution?

I believe it's somewhere between 25% and 30%.

I don't have the exact numbers in front of me.

I don't know if Gordon might.

It's closer to 30%.

Thank you.

You're welcome.

Thanks, guys.

Uche Orji, UBS.

Thank you very much.

First of all, congratulations on closing the deal.

I know you're planning to keep the product groups and the divisions, but are there any overlaps you see at this point, areas of easy consolidation by way of eliminating one to help create synergy and how much is that?

There isn't much product overlap, per se.

It's like they don't make horizontal general purpose microcontrollers.

43% of the business is microcontrollers, but they're specialty microcontrollers for automotive, for wireless audio, for computing embedded control and things like that.

But there is a substantial overlap in the R&D development because to do a specialty microcontroller, you have to do a large amount of R&D to really build the panel, build the iOS, build the analog, have an extensive analog library.

Some of the IT you may have to buy or build from inside or outside, Ethernet, USB converters, flip-flops, on and on and on.

There are hundreds of circuits that are developed and then you take those circuits and put them together to build a chip.

So there is a substantial synergy in developing that library because we develop it today at Microchip and they develop it at SMSC.

Now, some of it comes very quickly but some of it takes a little bit of time because number one, two companies may not be at the same foundry or in the same process node.

So the current products will continue where they're being developed but as we look forward, only even three or six months forward, the new product design starts, we will try to converge them on similar processes at the same foundries.

So these libraries have synergies.

There is a large amount of library developed at Microchip at foundries where SMSC is bringing some of their products.

So they could be immediate users of our libraries.

Similarly, we are going to certain foundries for some of our products where they're already present, so we can use their library.

That's where the R&D synergy comes from.

Let me ask you separately, if I look at the 60% long-term gross margin target, can you help me rank order the -- whatever you are comfortable with -- by end market or by product group, how the gross margin contribution will come.

And I'm asking this question specifically, when I look at areas like USB for the computing product areas that may generally carry lower gross margins and I'm wondering how that fits into long-term vision of the combined company, especially given the gross margin target?

Your information is not correct that they carry lower gross margin.

A lot of people looking at some of our competitors also think microcontrollers carry lower gross margins or 8-bit carry lower gross margins, or those assumptions have been wrong regarding Microchip also.

We know how to make gross margin.

SMSC actually did very well in gross margins.

Their actual last quarter already was about 58%, I think.

So I think the numbers you quoted have low gross margin is incorrect.

It may be correct in general, if you look at a lot of the people that build commodity products, their business, but they were building a lot of proprietary products.

Overall gross margin is very good for the Company, it's very good for Microchip and our gross margin has been down a little bit because of absorption, because revenue has been down because of the recession.

When our fabs fill up again, as the business comes back, you know our gross margin goes into low 60s, again, like always.

And their gross margin is very well.

The guidance we gave you on overall gross margin of 60% is solid.

Thank you very much.

Good luck.

Chris Caso, Susquehanna Financial Group.

Thank you.

Just first a question on SMSC.

Now that obviously you've done a lot more homework on the integration now and presented the plan, as you look prior -- compared to when you do due diligence as you announced the deal, what's the biggest surprises that you've seen, either on the positive or negative, now that you've had a chance to dig in deeper?

The negative surprise largely has been the time it took to get approval from China.

Although the people, lawyers working on it have told us it's very rare that a company gets approval in phase one in China and this is the fastest a company has gotten.

I think TI's deal took five, six months.

But with all the deals that we have done, public deals and others, the negative surprise was it took about 30 days longer than we would have liked.

The positive surprises, I think we just have peeled more of the onion and understand it better and original assessment was hedged and we are more confident as we have closed the deal and risk of when the deal closes has gone away.

As we have looked into the IT systems, the financial systems, the R&D, understand the libraries, the processing, where they do business and all that, and I think we feel very confident and very, very good about it.

And as we work with very good talented employees, many of them we have worked with for the last three months, with obviously a fair amount of restriction and really what we could get because the companies had to operate independently.

But we are very positive and very confident that as we engage in the coming weeks, this thing will be a great acquisition.

Okay.

Great.

As a follow-up, just with respect to the core Microchip business, I for one have been surprised that things have slowed down on the macro as they have.

Can you talk about what you guys are doing from a manufacturing standpoint, perhaps from a cost standpoint, to deal with the current situation and where we go from here?

Our current situation isn't drastic like it could be for some other people.

We have a solid gross margin.

Our inventory days are flat.

Actually, they were down by one, one day.

So we don't really consider our situation to be anything that really needs correction.

Business grew in the March quarter.

It grew in the June quarter.

Maybe not as much as we wanted to, but sizable growth.

Our microcontroller business was up 5%.

Our analog business was up 9%.

The reductions came from licensing and some of the other memory businesses, some of it was subcontracts.

So our fabs are doing well and I think our plan is to run the factories flat, both in the front end and back end.

And inventory will continue to come down slowly.

And eventually there will be an upturn and factories will fill up again.

Just the final point, with running the factories flat in the near term, what do you expect your own inventory to do in the near term as a result of that?

At the last quarter's production, our inventory went down by one.

So if nothing else changes, then our inventory should go down maybe by another day, although the distribution is a different equation.

So the distribution inventory was nearly all-time low.

It's 31 days.

31 days.

And normal has been between 31 to 45.

At any point in time, if distribution starts to rebuild inventory, then our inventory will come down substantially.

And largely will not appear because the distribution has been keeping very low inventory and when distribution keeps low, we want to keep it high so it's available to the channel.

Having said all that, going forward our inventory gets mixed with the SMSC.

So the inventory numbers we will report next quarter will have two months of SMSC and then three months of SMSC.

So it's going to be impossible to compare it to really what happened in the prior quarter.

It's a new baseline.

Understood.

Good color.

Thank you.

Brendan Furlong, Miller Tabak.

Good afternoon to everybody.

Thank you.

Question for you on SMSC going into the December quarter.

SMSC is kind of tough with the -- they had an off quarter and they had a very strong November and a weak February quarter.

I'm trying to figure out if you could lend us some color on how we should think about the seasonality of SMSC business on what is now a calendar December quarter.

That's a very, very good question.

That's something we have pondered with ourselves.

Their quarter ended November and then February, so in their February quarter they picked two very bad months.

One is usually the month of December that has lots of holidays and then January usually starts out slow after the holidays, and then you get Chinese New Year.

You all get that in the one quarter.

So that was a very weak quarter.

And I think now on our clock in December you'll pick up the December weakness in the December quarter and the Chinese New Year will go with ours.

We'll have to get some cycles of learning.

I think you can look at the prior data and do some averaging.

Give us some time on our clock and I think we'll be able to help you more, but today it's our first day and I think I would just be guessing.

Okay.

Thank you.

I'll ask you that next quarter.

The other question I have for you, it looks like your 8-bit revenue was down slightly, sequentially in the quarter.

Incorrect.

Our 8-bit revenue was up sequentially.

It was up sequentially.

Call it slightly -- I'll look at my data on that, thanks.

As a lead indicator, 8-bit and Steve's general comments on the cycle that he's given us in the past, I'm looking if you could give us your opinion on what you think on the cycle and demand going forward here for the next couple of quarters.

The September quarter, we've given you guidance already and December quarter usually is a weak quarter for Microchip historically, if you look at it.

So this quarter and next quarter, given the backdrop of the economy, the fiscal cliff rating, elections coming, Europe in doldrums.

I think the hope is on China.

There is some activity in China to try to come up with a few fiscal package.

When China comes up with fiscal packages it's really to promote, usually home appliances and automotive and other stuff for their consumers to buy.

We benefited very well when that happened the last time.

There is some talk of that right now.

If that happens, we'll do very well.

China is the largest geography now.

We ship more in China than in US.

But Europe will be weak and US is anybody's guess, I think.

If there is no breakthrough in Washington, US will continue to be what it is, more of the same.

Thank you.

I'll take a conservative approach to December then, thank you.

(Operator Instructions).

Kevin Cassidy, Stifel Nicolaus.

Thanks for taking my questions.

Can you say what some of the customer feedback has been on the merger, acquisition?

So when the deal was first announced, obviously some customers get nervous regarding what Microchip might do and a lot of that nervousness is actually deferred, fear, uncertainty and doubt created by either the competitors or the analysts.

Honestly, and I'll tell you why.

It is to competitors' benefit to go to major customers and say, Microchip is a high margin company, they're this and that, look at their profitability, they're not going to support this, they're not going to support that.

I expect them to do so because if I'm the competitor of somebody, I'll do the same.

The analysts with lack of information, very little information is available on May 2 when we announced it, a lot of the reports come out, some guessing we'll sell the USB, we'll do this, we'll do that, we'll not support this, we'll not support that.

People read that too and that makes them nervous regarding the programs the Company may have won.

SMSC worked very well together.

Their management, kudos to them, reached out to us when there were some significant large customer concerns and we made some joint calls to the customers to make them feel comfortable.

And then today's call as people are hearing officially we're going to keep all the divisions and all the products, keep the sales force, should really alleviate any remaining concerns.

Actually there haven't been concerns after the initial ones, which were satisfied.

Thanks for that color.

Also, are there customers maybe in the automotive with your larger scale that you would be able to 1 plus 1 could equal 2.5 or so?

Yes, absolutely.

Even in the last three months I have visited Microchip's automotive customers where they also wanted to talk about SMSC.

In most cases we could not because anti-trust issues and all that when it wasn't clear.

But there is very high interest in SMSC's customers.

Microchip is a very good supplier to them.

I gave you an example.

We have over 20 microcontrollers in Mercedes S Class car.

There's a great relationship there with their suppliers and all that.

So obviously they want to talk to us.

Thank you.

Sumit Dhanda, ISI Group.

Steve, first question I have for you is there any color you can offer up on when exactly you start to see the weakness in your business in the June quarter?

And then in July, has that just stayed low, flat at a low level exiting Q2, has there been any pick up or deterioration?

Any color you could provide would be appreciated.

So, if you look at it, we largely made that quarter.

Our guidance was 3 to 7, midpoint of 5 and we came in at 4. So slight weakness.

And I think most of that came in second half of the quarter.

At our earnings call, which was on May 2 or May 3 time frame, we had given that guidance.

So far at that time we were okay.

And the weakness developed later on.

I think the last month, especially June, was weak and late part of May could have been weaker.

Any color on July?

It's continuing at that pace.

That's why we're guiding roughly flat.

And then as my follow-up, growth in your 16-bit and 32-bit businesses is obviously very impressive.

But seems like although 8-bit grew, it probably grew very modestly.

Any thoughts there on, at least compared to some of the other guys reporting their 8-bit business, which was a little better, is it a timing issue in your opinion, or an exposure issue from an end market or product cycle basis?

It could be anything.

It could be end market exposure, more exposed to automotive, which is a stronger segment.

It could be geography.

It could be where the business is.

We had substantial growth in 16, 32.

Our 8-bit business also is larger than most of those, so the 8-bit business is smaller.

So it could be a size issue.

I can't compare to other people's numbers because I don't know what happened in their business.

Okay.

I appreciate that.

Thank you.

Harsh Kumar, Stephens.

Hi, guys.

First of all, congratulations on closing the deal.

And thanks for the accretion schedule.

That's very helpful.

Just a quick question on that, Steve.

Are you just assuming cost cuts at this point in time with the accretion schedule that you gave us or are you building in some sort of cross-selling and if so, could you give us an idea of how we should think of cross sales?

The accretion schedule that I have given you for now through March and June does not really have revenue synergy in it.

As I mentioned earlier, if I win a design tomorrow, it will be nine months to production at least.

Those are the fastest schedules and most will take longer.

So the accretion schedule we have given you is largely through synergy and cost savings and all that.

Got it.

Thanks, Steve.

And another follow-up question for you was SMSC, obviously lower gross margins, lower operating margins compared to Microchip.

I'm not asking for numbers but I'm just curious if qualitatively you could give us a hint or some idea of what areas do you see the most improvement and would it be COGS, would it be OpEx and any kind of color would be helpful.

I cannot break it down much for you.

I think based on SMSC's public numbers and ours, you might be able to do some triangulation.

I was giving you synergy and you model in odd numbers.

For me to further break it down, I think it will be telling you guys before the employees have heard it and all that.

Got it.

Thanks.

Thank you.

JoAnne Feeney, Longbow Research.

Yes, thanks.

I was hoping you could provide a little more detail on how to think about the new employee stock plan for the SMSC guys and how that would affect the non-GAAP to GAAP translations.

So all vested stock options of SMSC were cashed out, essentially at the deal price.

All unvested equity was assumed.

And what we have in a share count, I believe the guidance table has a note at the bottom that shows about 700,000 shares dilution.

Diluted shares from that.

That's not the number of shares that come into the plans.

Yes.

But there's 700,000 shares added to Microchip's otherwise share count for September quarter because of the options we're assuming.

Is your question related to this inducement plan that we filed today.

Yes, that was the one.

Okay.

So SEC -- I'm sorry, SMSC had a share appreciation rights plan, which was cash settled.

So an employee gets a certain number of SARs, which are good for 10 years and after they're vested, they can really, at any point in time, exercise it and from strike price to the fair market value they get cash from SMSC.

All the vested ones -- SARs were cashed out also.

The unvested ones are being converted to this inducement plan and there's about 440,000 shares in that plan.

So that's the number, 440,000.

The dilution is not all of them because there's a strike price also.

So the dilution is already in the 700,000 shares.

Whatever comes out of the SAR dilution is already included in the other 700,000 number I gave you.

Perfect.

You can basically ignore this new plan we filed.

That's more -- we didn't have a plan like that to convert so we put a plan like that.

But the number that's important to you is already in our guidance table, that fully is inclusive of all invested equity.

Thanks for the clarity.

Appreciate that.

If we could go back to how you're responding to this global weakening.

I'm wondering if you're doing anything about plant shutdowns or if there are any natural days off this quarter because of vacations?

Those seem to have come to an end last quarter, so I'm wondering perhaps summer vacations are giving you a bit of latitude there to allow utilization rates to fall.

Could you provide some hint as to that?

There's nothing we need to do and there's nothing we are doing.

Like I said earlier, we don't feel that our inventory's alarming.

It's not 160 days or something.

Inventory's probably high by 15 days or so, to what I will feel l comfortable with, 120, and it's 133, 13 days.

I don't need to do -- I have enough on my plate to get accretion from SMSC, manage the business, restructure it, get synergies from other things.

So we don't really need to do any shutdowns, we don't need to do anything.

I think if the business falls off, for any reason, further, which we're not expecting, we don't have a crisis at hand.

We're not [in crisis], the business isn't down like some of the other companies.

It's really doing fine.

Our business, compared to a year ago, was down --

5.9%.

5.9%.

That's just -- the framework you guys are in, when you're reading what other people are doing and so you're asking us what we're doing, the business is only down 5.9% versus a year ago.

Our company gross margin is 59%.

Operating profit is 32.7.

At those kind of numbers, we're not in a crisis situation.

We don't have to do anything.

Okay.

Thanks for the clarity.

Thanks.

Terence Whalen, Citi.

Thanks for fitting me in.

This question is a little bit of a higher level question and that is how long will it take to unify some of the design tools so that a client will be able to use both Microchip blocks and SMSC blocks together in a unified development environment?

How long will that take?

And will that present more of a significant opportunity to then recognize revenue synergy from the merger?

Thank you.

I'll refer that to Ganesh.

I think he has looked at it more closely.

I think for some time to come, the tools are going to be different.

They're not impediments for the customer.

In many cases, the customer was doing a design with a set of tools.

It will take us some time to assess what combination of tools makes sense.

It doesn't make sense in all cases and we'll make those changes as appropriate.

I don't see any impediments to customers to adopt either our product, if they're an SMSC customer, or an SMSC product if they are an existing Microchip customer, using the tools we have today.

And it's just we can make enhancements and they will be improvements we go along.

There are no impediments.

My one follow-up was a broader economic question.

I think, Steve, in the past you talked about Microchip seeing inflections in the economy a little bit earlier than peers.

It sounds like you really haven't seen improvement in your order rates yet.

Yet there's some other peers who are seeing stronger second half due to application exposure and whatnot.

My question is, based on your experience, would you have expected to have seen improvement in the economy by this point?

And another way of asking that, of the peers who are seeing improvement in the second half, do you think it's just a seasonal build and they're yet to see a contraction again in the first half of next year?

The economy's at the low point and for all we know it could get further worse with what's happening in Europe.

I don't know if I completely understand your question.

The question I would have expected is why didn't you see the weakness earlier that we always see.

You're asking that question, why didn't we see the improvement.

I'm not sure businesses are improving right now.

The question I expected, I'd like to answer is, why didn't we see the weakness earlier this time.

We always see the weakness a quarter earlier.

We would have seen the weakness a quarter earlier if our superior growth of 16-bit, 32-bit and analog and positive sequential growth on analog, both June quarter and March quarter, hadn't overcome it.

That's why we didn't see it.

So if we had a normal level of growth on 16, 32, and if 8-bit business was flat to down, then we would have seen the weakness compared to the industry earlier.

We did see lower run rates, customers correcting for inventory, lack of confidence, but number of new designs going to production on 8-bit, 16-bit, 32-bit and analog overcame it.

And now the question you're asking is why we're not seeing the improvement earlier.

I don't know who's seeing it.

I'm watching results from many of our competitors.

Businesses are bad.

Appreciate the insight.

Thanks.

Craig Ellis, Caris & Company.

Thanks for taking the question and congratulations on your biggest deal ever.

Just from a financial reporting standpoint, it's very helpful to get the product detail that you provide, the 16-bit business, 32-bit business, analog.

Will we be getting the same thing for the SMSC business in the future?

We haven't exactly figured out what we're going to provide you.

I think for reporting, as we said, the SMSC business will break into two pieces.

Microcontrollers and analog.

Microcontroller will be added to our microcontroller number, analog to our analog number.

To the extent that microcontroller has 8, 16, 32-bit components, which they do, they will add to our respective 8, 16 and 32.

If that was your question.

Yes, that's the question, Steve.

So in this transition period there will be an adjustment where you add those in and will you be giving us some mapping to tell us how much of the SMSC business went into of these segments for modeling?

I think we'll do some of that, yes.

Not enough for you to be able to decode the 8-bit.

Touche.

Follow-up question for Eric.

Eric, it sounds like the accretion assumptions are all expense-based and there's not a revenue contribution there.

Is that correct?

Yes, that's --

In terms of what you provided so far.

That's correct.

We've assumed that the revenue synergies take longer.

Thanks, guys.

You're welcome.

Ray Rund, Shaker Investments.

Thanks for taking my call.

Taking my questions.

I had a couple of questions.

One is can you give us the breakdown of what your revenue was by the various product areas as you usually disclose in your 10-Q?

Sure.

Sure, we can do that.

So microcontroller revenue was $240.594 million Memory was $40.718 million.

Analog was $47.184 million.

Licensing was $20.282 million.

And other was $3.608 million.

Those are non-GAAP numbers.

Those are non-GAAP numbers.

Yes.

It was a $250,000 non-GAAP difference, I think some of it went into analog and some of it went into micro.

It's small.

I don't have those numbers in front of me right at the moment.

It's a small difference.

If you want to follow up with me I can get them to you.

Also, it sounds from just taking a quick look at what your guidance is that unless the non-GAAP SMSC numbers are widely different from the GAAP SMSC numbers, it looks like you're going to see your non-SMSC revenue go down sequentially in this coming quarter.

Is that correct or did I miss something in my computation?

I think you missed it.

If you back the numbers out of the $65 million to $70 million in growth, I think you'll see that it is a midpoint that's slightly above flat, but it is relatively flat.

Midpoint of the guidance and subtract $67.5 million out of that, you'll get a Microchip number which is slightly north of our last quarter.

Okay.

Thank you.

I must have been adding the wrong numbers or gotten the wrong sum I needed.

Okay.

Thank you very much.

You're welcome.

Suji De Silva, ThinkEquity.

Two quick questions hopefully.

First of all, Steve, you talked about the China appliance market potentially being an uplift in the second half.

Do you have any insight to whether the incentive programs are going to come and if they come back, the timing and what exposure to that market would be, rough terms?

I don't have the data [claiming to premier] for sure.

No, I do not know what the status of those programs are and whether they will be implemented.

Are you seeing anything in the order patterns that might indicate people building up for that?

No.

The second question really is around synergies with SMSC.

Should we think, all things being equal, the revenue synergies are more from SMSC's autos business and consumer businesses versus their computing businesses or is that not a fair statement?

No, that's not a fair statement.

We expect to be able to sell their USB, industrial products into our customers and computing and automotive also.

And we expect to sell some of our products into wireless audio, data CMC, automotive customers, computing customers, large computing customers and some of their consumer customers, both ways.

Very good.

Thanks, guys.

That concludes our question-and-answer session.

I'd like to turn the call back over to our presenters for any additional or closing remarks.

So just wanted to say thank you all for attending the conference today.

It's been a very busy day for us here today, closing the acquisition and doing this call at the same time.

Although, it kind of worked out because after closing we were able to give you a lot more information than we could have given you if the closing was next week or next month.

So we'll see many of you in the conferences that will happen this quarter and we'll be at some of those.

Thank you.

That does conclude our call for today.

Thank you all for your participation.