微晶片科技 (MCHP) 2013 Q2 法說會逐字稿

Good day, everyone, and welcome to this Microchip Technology second-quarter and fiscal year 2013 earnings results conference call.

And 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, Eric Bjornholt.

Please go ahead, sir.

Good afternoon, everyone.

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

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

We 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, who is joining us from business travel in New York today; Ganesh Moorthy, Microchip's COO, who is joining us from business travel in India today; and Gordon Parnell, Vice President, Business Development and Investor Relations.

I will comment on our second-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.

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 in a non-GAAP basis, prior to the effects of our acquisition activities and share-based compensation.

Non-GAAP net sales in the September quarter were a record $407.8 million, including $72.5 million of non-GAAP net sales from SMSC.

And we're up sequentially 15.7% from net sales of $352.4 million in the immediately preceding quarter.

Non-GAAP net sales were $24.5 million higher than GAAP net sales, as GAAP does not recognize revenue on the sell-through of product sitting in the distribution channel on the date an acquisition occurs.

On a non-GAAP basis, revenue by product line was $261.3 million for microcontrollers; $86.6 million for analog; $36.6 million for memory; $20.1 million for licensing; and $3.2 million of other.

Revenue by geography was $81.8 million in the Americas; $85.6 million in Europe; and $240.4 million in Asia.

On a non-GAAP basis, gross margins were 57.7% in the September quarter, and non-GAAP operating expenses were 28.5% of sales.

Non-GAAP operating income was 29.2% of sales, and net income was $97.7 million.

This resulted in earnings of $0.48 per diluted share, $0.038 of which related to SMSC's operating results.

On a full GAAP basis, net sales were a record $383.3 million; and gross margin, including share-based compensation and acquisition-related expenses, were 50.7% in the September quarter.

GAAP gross margins were negatively impacted by the sell-through of $22.7 million of written-up inventory costs associated with our acquisitions.

Total operating expenses were $186.1 million, or 48.6% of sales, and include share-based compensation of $17.9 million; acquisition-related expenses of $40.6 million; and a special charge of $11.5 million related to legal matters that were settled, associated with Silicon Storage Technology, that we acquired in April 2010.

The GAAP net loss was $21.2 million or $0.11 per diluted share, and was impacted by $29.7 million of nonrecurring tax charges associated with our acquisition of SMSC.

In the September quarter, the non-GAAP tax rate was 15.1%, and the GAAP tax expense was impacted by the one-time charge I mentioned above.

The non-GAAP tax expense in the September quarter was negatively impacted by $2.4 million of SMSC tax matters, and will continue in future quarters -- that will not continue in future quarters, excuse me.

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

Once SMSC is fully integrated into our business systems and operating structure, we expect our forward-looking effective tax rate to be about 13% to 15%.

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 that the non-GAAP adjustments had on Microchip's earnings per share in the September quarter, share-based compensation was about $0.083; acquisition-related items were about $0.323; the special charge related to the legal settlements was about $0.021; non-cash interest expense was about $0.006; and the one-time tax charge was about $0.145.

The dividend declared today of $0.352 per share will be paid on December 6, 2012, to shareholders of record on November 21, 2012.

The cash payment associated with this dividend will be approximately $68.5 million.

This quarter's dividend will be our 41st consecutive quarter of making a dividend payment.

We have never made reductions in our dividend, and this program continues to be an important component of how we return value to our shareholders.

Moving on to the balance sheet -- consolidated inventory at September 30, 2012, was $289.5 million, or 140 days, up three days from the prior-quarter levels.

The inventory balance at September 30, 2012, includes $26.2 million of SMSC inventory write-up costs required for purchase accounting.

Inventory at our distributors continued to be at historically low levels, at 31 days.

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

At September 30, the consolidated accounts receivable balance was $230.5 million.

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

As of September 30, the consolidated cash and total investment position was approximately $1.71 billion, and we had $600 million in borrowings under our revolving line of credit.

Excluding dividend payments, we expect our total cash and investment position to grow by approximately $80 million to $100 million in the December quarter.

Capital spending was approximately $15.9 million for the September quarter, including SMSC capital spending.

We expect about $15 million in capital spending this quarter, and overall capital expenditures for fiscal year 2013 to be about $50 million.

Depreciation expense in the September quarter was $22.3 million, also including SMSC.

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

Ganesh?

Thank you, Eric, and good afternoon, everyone.

Let's now take a closer look at the performance of our product line.

And let's start with microcontrollers.

Our standalone microcontroller revenue, without SMSC, was $227.4 million in the September quarter, down 5.5% sequentially, but slightly positive as compared to the year-ago quarter.

As we explained in our last conference call, Microchip classified SMSC revenue into microcontrollers and analog products.

Based on the partial quarter from August 2 to September 30, SMSC's total non-GAAP revenue was $72.5 million.

46.8% of this revenue, or roughly $33.9 million, was microcontroller revenue.

And 53.2%, or roughly $38.5 million, was analog revenue.

For the rest of my prepared remarks, I shall be using non-GAAP revenue in all of my commentary.

Combining the $33.9 million of microcontroller revenue from SMSC with Microchip's historical microcontroller revenue, Microchip's total microcontroller revenue for the quarter was $261.3 million, an all-time record.

Our standalone 16-bit microcontroller business was down 7.8% sequentially, and up 28.8% from the year-ago quarter.

Coming on the heels of several strong growth quarters, and the achievement of record revenue in the June quarter, the softness seen in the September quarter is reflective of the weak macro environment.

Combining the 16-bit microcontroller revenue from SMSC with Microchip's historical 16-bit microcontroller revenue, this business achieved an all-time record for revenue in the September quarter.

Our standalone 32-bit microcontroller business was down 0.5% sequentially after being up a whopping 71.5% sequentially in the June quarter, which was a record.

This business was also up 97% from the year-ago quarter, demonstrating continuing strong share gains.

Combining the 32-bit microcontroller revenue from SMSC with Microchip's historical 32-bit microcontroller revenue, this business also achieved an all-time record for revenue in the September quarter.

Moving to development tools -- we shipped almost 47,000 tools in the September quarter.

Cumulatively, we have now shipped close to 1.39 million development tools.

And development tool sales remain an excellent leading indicator of continued strong design in activity and acceptance of our solutions by our customers.

Now let's move to our analog business.

Microchip's standalone analog business, without SMSC, bucked the trend and grew 1.9% sequentially to achieve a new record, and perform exceptionally well in the current environment.

Our analog business was also up 13.7% as compared to the year-ago quarter.

The innovative new products we've been introducing for a while now are scaling to above-average growth for analog business; and we have more new, innovative products in our development pipeline that will be coming soon.

As an example, next week, we will be launching two new products -- two new families of analog products.

The first is a portfolio of high-efficiency discrete power MOSFETs specifically tuned for power applications.

The second is a family of analog power controllers that offer higher voltages and deliver excellent power conversion efficiencies.

Both product families expand our served available market for existing customers and applications, as well as enable us to penetrate new customers and applications, and nicely complement our dsPIC Digital Signal Controllers, which already have a leadership position in the power conversion market segment.

Combining the analog revenue from SMSC with Microchip's historical analog revenue, our analog business in the September quarter represented 21.2% of Microchip's business, almost 3 times the proportion of Microchip's business that analog was just a few years ago.

Moving out of the memory products -- our memory business, which is comprised of our Serial E-Squared memory products, as well as our SuperFlash memory products, was down 10.2% on a sequential basis.

While this business has had some drags on our growth as we avoid chasing the profitless prosperity of growth with no profit, our memory business is becoming a smaller percentage of our overall business, and was down to 9% of our combined revenue in the September quarter.

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

Before I wrap up, a quick update on how the SMSC integration is progressing.

The effort to combine the operational and business systems of both companies as always a massive post-closing effort.

As a follow-up to the plan we outlined at our August conference call, I'm happy to report that all SMSC products are on track to ship from Microchip's operational systems no later than January 1, 2013, and all business systems are on track to convert by the first calendar quarter of 2013.

We have also identified several areas of operational synergy that can exploit our assembly and test infrastructure in Thailand.

We have also gone through our combined supply chains and identified a number of opportunities where we can harness the best cost that either company had, as well as opportunities to leverage our combined volume to lower costs.

These opportunities are being actively worked to realize the savings that they represent.

The SMSC business divisions are also well into the integration process.

We have already identified a number of synergy opportunities in the area of IP acquisition and development, CAD infrastructure, reference designs, joint marketing, and joint development.

In the coming months, we expect to find many more synergy opportunities.

On the sales front, we continue to maintain a separate focus on the different product lines to ensure customer focus and continuity.

In the meanwhile, the sales team are working together to cross-train and enable more cross-selling opportunities as time goes on.

We have also combined the distribution network to both companies; and in the process, franchised Arrow, who only had SMSC products, to also sell Microchip's products; as well as franchised Future Electronics, who only had Microchip products, to also sell SMSC products.

With these changes, all three global distributors -- Avnet, Arrow and Future Electronics -- are franchised for our complete product line on a global basis.

This now makes Microchip the only supplier of microcontrollers and analogs that has franchised the three largest global distributors on a worldwide basis.

We're also well into the process of franchising our 80-plus regional distributors in Europe and Asia on the SMSC product line, which will further add to the sales reach for these products.

Last but not least, we have expended considerable time and energy of many Microchip managers to guide SMSC employees in matters related to our unique culture and guiding values, and to be personally visible during the integration process at the different SMSC locations, so that everyone understands the goals and is pulling in one direction.

We are thankful for the extra effort invested by many Microchip's employees, to execute and support the integration; and proud of the SMSC employees who are embracing our culture and unleashing their full potential towards the business of the combined companies.

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

Steve?

Thank you, Ganesh, and good afternoon, everyone.

Today I would like to first comment on the results of the fiscal second quarter of 2013.

Then I will provide guidance for the fiscal third quarter of 2013.

Our September quarter results were slightly lower than what we had guided during the last earnings call, and consistent with the preliminary results we announced on October 15.

The shortfall was entirely attributable to the macro environment, which was very weak.

The negative effects of Europe, and weaker economic activity in the US and China, led us to finish the quarter slightly lower than the range of guidance for net sales and earnings per share.

Our consolidated results, including SMSC, had several major highlights.

First, our microcontroller business achieved an all-time record, at $261.3 million revenue.

Our analog business also reached a new record, at $86.6 million revenue.

Our analog business now represents 21.2% of our total sales.

Our total business made a new record, at $407.8 million revenue; and, for the first time, crossed a $1.6 billion run rate.

Last but not the least, on non-GAAP basis, the September quarter was our 88th consecutive quarter of profitability.

Now I will provide guidance for the fiscal third quarter of 2013.

We are continuing to see very weak macroeconomic environment in the US, Europe, Asia and China.

We believe that the world GDP growth is decelerating.

We are seeing weakness in SMSC business; as well as Microchip's microcontroller, analog and memory businesses.

However, the December quarter will have three months of SMSC business versus two months last quarter, which is expected to take our net sales to a new record high at the midpoint of our guidance.

We expect Microchip's total net sales, including SMSC, to be $396 million to $426 million.

This includes approximately $87 million to $94 million of SMSC net sales.

Given the continuing weak macroeconomic environment, we are no longer comfortable with the high inventory levels we have in our business.

Therefore, we have decided to cut the wafer starts in our fabs.

We are putting the Fab personnel on a rotating time-off schedule.

This was the same technique that we deployed in early 2009, and it worked very well at the time.

It reduces factory output, but at the same time keeps the staff employed for reduced work hours, and gives us that the flexibility to ramp rapidly should the need arise.

This will have a negative impact of about 200 basis points on the gross margin from the September quarter.

We expect to be on this rotating time-off through the end of June 2013.

We expect the inventory to be corrected by then.

And with some recovery in the business, we expect to start normalizing the production wafer starts and the employee work hours.

On a non-GAAP basis, we expect our consolidated gross margins to be between 55.5% to 56% of sales.

We expect operating expenses to be between 30.5% to 31% of sales.

And we expect operating profit percentage to be between 24.5% to 25.5% percentage of sales.

And we expect non-GAAP EPS to be between $0.37 to $0.41 per share.

This EPS includes about $0.04 to $0.05 accretion from the acquisition of SMSC.

In the August conference call, we had guided December quarter accretion from SMSC to be $0.06 to $0.07.

The difference is all related to the business downturn and lower sales projections for the September quarter.

For the March 2013 quarter, we expect the accretion from SMSC to increase to about $0.05 to $0.06 per share.

And for the June 2013 quarter, we expect the accretion to be $0.06 to $0.07 per share.

For fiscal year 2014, we expect to be in the full range of accretion of about $0.08 to $0.09 per share per quarter, by the end of fiscal year.

These numbers remain subject to the suite of integration efforts and the help of the underlying economy in general.

Given all the complications of accounting for the acquisition, including amortization of intangibles, restructuring charges and 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 analyst continued to report their non-GAAP estimates to First Call.

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 are implementing substantial business process improvement to improve gross margin percentage, lower operating expenses, and substantially increase its operating profits.

Our long-term model for the combined company remains 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 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.

This, together with one of the highest dividends in the semiconductor industry, will continue to generate excellent shareholder value.

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

(Operator Instructions).

Chris Caso, Susquehanna Financial Group.

Just to start, if you can comment a little bit about what you're seeing with the macro conditions.

I think what you guys are talking about is not too far different than what we're seeing from others.

To what extent is this -- your customers taking down inventory levels further -- to what extent is it demand hitting a new lower level, in your opinion?

The distributors have taken down inventory.

And as Eric pointed out, the distribution inventory is a record low.

As far as the customers are concerned, there is really a demand shortage.

Any time the demand falls, then any can inventory customers have becomes more, based on the run rate.

So there is always an element of inventory correction to that lower demand number.

But the predominant issue is really the macro weakness, where we have record number of design wins, lots and lots of new customers going to production.

If you look at total number of designs we're shipping into any given customer is increasing.

But they're all taking less dollar amount and less unit amount for designs, which is not a whole different commentary than we have seen with many of the competitors.

That is what we are seeing.

Okay.

And as a follow-up -- and I think you commented on this last quarter -- with respect to what the seasonality of the business looks like as we incorporate SMSC.

Wondering if you could talk about that again, given you have a little more time under your belt, and maybe a little better feeling for the SMSC business, in terms of seasonality.

We don't really have that much more to comment.

The thing is, we have changed the SMSC calendar to be Microchip fiscal calendar.

Their quarters ended on May and August and November.

So if you look at a quarter like December, and then March -- in their February-ending quarter, they will pick up December, which will usually be weak, and then pick up the Chinese New Year.

And on Microchip calendar, Thanksgiving and December fall in one quarter.

And the Chinese New Year falls in another quarter.

So there are a lot of moving parts.

In parallel with all that, with commentary you are seeing from all the PC guys and others, there is a substantial demand contraction in the business, along with an inventory correction.

So with so many moving parts, I don't think we're ready to establish a new seasonality.

I think I would actually say that there is no pattern of seasonality anymore in the business.

It's just whatever happens.

If you look at a lot of different companies and you simply try to predict a quarter based on their seasonality for the last five years, you don't get a good, meaningful result.

We will have a better feeling about a year after we have run SMSC on our clock, and some of our seasonality might change.

But even if you look at our own business, we hardly ever have weak September.

September is usually a fairly strong quarter for us.

And we have just experienced a very weak September, so I think the old seasonality models are really out the window.

Right.

Okay, thank you.

Brendan Furlong, Miller Tabak and Company.

Good afternoon.

Thank you very much.

If I look at the 24 million -- the difference between GAAP/non-GAAP revenue in the September quarter, is there any way you can give us a rough breakdown of what that is between the MCU and analog?

I don't know if we have broken that out.

I don't think that is something that we're ready to share here, in terms of breakdown of analog and microcontroller.

But the issue there, Brendan, it's just -- any inventory that sitting in the distribution channel on the date of the acquisition, we don't get to recognize as sell-through for that.

So, that is something that we can follow up on.

But I don't have a number for you in terms of the micro/analog split, unless Gordon has something he would want to share.

No, I don't have that available.

Okay.

Okay.

I'll follow up with you guys after the call.

Looking at the utilization, inventory correction part of the thing that you're talking about through the June quarter -- and, typically, Steve has a good take on the overall semiconductor cycle.

Are we looking at basically things being pretty tough going here through the June quarter?

Or what do you think -- are we going to bottom in the March quarter?

Or what's your take on it?

You generally have some sort of outlook on that.

Well, let me take a crack at it.

Basically, I think, along with you guys, us and everybody else is concerned about the fiscal cliff.

It's having a negative impact on the business now, and it will continue to have the business into probably the first quarter.

Nobody knows whether the fiscal cliff is going to get resolved.

If it does get resolved, then it takes a while for it to get into the system.

Meanwhile, lots and lots of our small customer are strapped with credit and living hand to mouth, and not launching their products, and taking lower revenue, and seeing economic contraction.

And all those things are continuing.

There is a big power change going on in China with the new President and the new Premier coming in.

Nobody knows the impact of that.

Usually, most people's say that will have a positive effect.

But, again, it takes some time for it to incur.

So, there are a lot of cross currents.

When I mentioned through the June of next year, it's just cutting wafer starts for about a 7.5 month period, which we think will correct the inventory to the point where we will feel comfortable.

The growth in the business between now and then will actually accelerate or bring the inventory down, and the action may end earlier.

It's more driven by the wafer starts -- how long we need to correct the inventory -- than it is a commentary on that I expect the business to be not good through June.

Okay.

And if I could have just a very quick follow-up on the gross margin side.

Because you're cutting wafer starts, you're going to keep these wafer starts low for seven months.

So we could expect your gross margins to stay at current low levels for the same period; or hit bottom in the December quarter and tick up a little bit?

No, I think they will stay at that level.

And it will modulate based on if we see any revenue growth or strength in business or distributor start building inventory.

And then if we modulate these wafer start cuts -- we're cutting at a 30 level.

If we cut less, then the margin will improve.

If we don't cut, then -- if we cut, and keep it at the same level, then the margin will stay in this range through the June.

Okay, great.

Thank you.

Appreciate it.

James Schneider, Goldman Sachs.

Good afternoon.

Thanks for taking my question.

I was wondering if you could comment on the end market behavior you're seeing going into Q4.

I mean, clearly, things are weaker across the board, but any notable pockets of weakness outside of PCs, or any pockets that you think did relatively better?

Ganesh, do you have any comment to make on that?

Clearly, the market that are in -- related to PC, consumer electronics, I would say go through the December quarter, are the ones that tend to have a market change that is associated with the December quarter.

So, those are the markets I would say that are performing or behaving like they are.

And some of the other ones, which are the industrial markets, et cetera, are not quite as pronounced as that.

There are small changes, but at the end, most of our business tends to have -- it's a large base of customers.

We have new customers, new applications, that are also in the mix.

And we don't see as much of a Company-wide effect that we can decode down to end markets in any given quarter.

Okay, thanks.

And then, as a follow up on the earlier question on factory loadings -- I just want to clarify.

It sounds like you're saying that if business conditions don't get any worse, you want to keep these loadings at this level until roughly the June quarter, and that should be enough to bring the inventory down.

Is that correct?

And any other thought around what would prompt you to bring the factory loadings up earlier than that point?

Well, there are always a large number of moving parts, so business conditions don't improve, but distribution tends -- the inventory has gone too low; 31 days is really extremely low, a record low.

And if the distribution builds back some of the inventory, getting prepared for the -- any upturn or improvement in business conditions, then that would be a positive.

There's a large amount of mix across memory, analog, microcontroller products.

And you can always have the mix change, which could drive -- that you had to build a certain number of products, and some different products will take a little longer to bleed out.

So there are a lot of moving parts, but I think that's the general thing.

That's helpful.

Thanks so much.

Terence Whalen, Citi.

Good afternoon.

Thanks for taking the question.

Thanks, also, for the level of detail separating SMSC and Microchip.

So the first question is in regards to the Japanese market.

Obviously, a lot of the Japanese analog and microcontroller suppliers are having difficulty, given the tough times internally in the Japanese market and given currency -- well, I just want to just understand how competitively you've seen their behavior change, given some of the distress that they're facing.

Thank you.

Ganesh?

It's not something that has just happened.

For a while, now, the larger semiconductor companies in Japan have been trying to figure out how to restructure.

Some have been at restructuring now for seven, eight years and really have made progress, very, very slowly.

But as they go through their troubles, we find more opportunities where customers are uncomfortable with their supply -- whoever they have in their supply base -- are increasingly inviting us to be part of that base.

And I don't think it is a very quick transition.

But I think over the long run, there are more opportunities for Microchip; both in Japan but also outside of Japan, where these same companies sell their products, where Microchip should be able to find more homes and more served markets that we can go after.

That's very helpful.

And then, as a follow-up question, this one regarding SMSC and the computing market.

As we look at for the transition toward Haswell in mid-2013, what do you see it in terms of opportunities, perhaps for you, in that business?

Thank you.

So, SMSC is very well-positioned for the Haswell architecture because Intel has chosen SMSC as a partner for providing the embedded controller for Haswell.

One of the main things Haswell architecture brings is a term called standby connectivity.

Today, you lose the connectivity when you close your PC.

And the Haswell architecture will provide very low power, significant savings in power; and you can have it on a standby and still you're connected, getting e-mails, getting stuff, things downloaded and all that stuff.

So it requires very, very low power.

And we are the partners.

So I think the content goes up when Haswell is in volume production.

Does that answer your question?

It did.

Thank you.

JoAnne Feeney, Longbow Research.

Yes, thanks.

Just had a question about the guidance.

And I may have missed this, but did you break down for us the non-GAAP versus GAAP revenue guidance?

And if not, could you please?

Or could you give us some sense of how much is left in distribution that you will not be able to put in your revenues over time?

Steve, I'll take that.

So, JoAnne, there's no difference in GAAP and non-GAAP revenue in the December quarter.

So all the inventory that was in the SMSC distribution channel essentially flushed through during the September quarter.

So we do have, in our guidance table in the press release, GAAP and non-GAAP guidance and on revenue line of the same.

Okay, sorry.

Thanks.

I appreciate the reminder.

Okay, and then, just tell me pace of orders.

We've been hearing different patterns on the microchip side -- or, microcontroller side of analog.

Could you give us some detail about what you've seen so far, early here in the December quarter, for the order pattern on both those sides of your businesses?

The order patterns in the business continued to be weak, consistent with what we have guided, and I don't believe there is any noticeable difference on analog versus microcontrollers.

Okay, thanks.

Harsh Kumar, Stephens.

Just a quick question on December gross margins.

Is it all rotating time off that's affecting the gross margin number as such?

Or are there other things that are built in?

Can you just clarify for us?

Eric, let me comment, then you can add to it.

So, I think there are two factors.

The biggest impact is coming out of cutting wafer starts.

The rotating time off is just one way of managing the wafer start cut.

The gross margin decline is not coming out of rotating time off.

It's coming out of lower utilization by cutting wafer starts.

Some people lay off the people to build and manage, reduce activity.

Instead of laying off, we give everybody a shared sacrifice cut.

So you have the people employed, trained, working on new processes, ready to increase their hours when we need it; so very quickly increase the activity when we need it.

So, just a clarification, that the gross margin impact is coming out of starts cut, not the rotating time off.

Rotating time off is just one way of managing reduced hours, work hours.

But there is also a second impact on gross margin, which is coming out of SMSC revenue being three months now, versus two months last quarter.

Great, thanks, Steve.

Very helpful.

Please, Eric, something if you need to add.

No, you covered it, Steve.

That's good.

Thanks, guys.

And as a follow-up, if I can ask, guys -- are most of the OpEx cuts at SMSC that were supposed to happen -- are you guys done with most of that?

If some of it still left?

Just any kind of update you want to give us.

It's not all done.

As Ganesh pointed out, all the products that are supposed to ship from Microchip's IT and business systems by January 1. So it's really not all completed yet.

Thanks, guys.

Thank you.

Lowest-hanging fruit, early on, has been done.

But there is some more hard work ahead.

Thanks much.

(Operator Instructions).

Steven Eliscu, UBS.

Yes, thank you.

First question regarding the new added distributors for parts of your business, with Arrow and Future.

With the addition, when you added Memec and focused that effort on generating additional design win growth.

Clearly, you learned something in terms of how that benefited your business.

And given the material addition, in terms of the apps people on the street, how do you -- do you expect a material increase with this addition, in terms of demand creation and future growth?

Well, yes.

We see a meaningful difference in the number of design wins and the registrations and all that created.

But it's a very design-win-driven business.

And the incubation period for design wins is nine months on the earliest, and up to two years.

So, you could get a little bit of revenue it in there from jump balls, and some on the analog product, and some on the commodity memory product.

But real design win revenue is a little out in time because of the incubation period.

Okay.

So, as a follow-up to that, you're saying that there will be a delayed effect.

But, based on what you learned from the demand creation from Memec, you do expect some material increase in demand creation from adding Arrow and Future to the respective parts of the business.

Yes I do.

But, Eric, roughly what portion of our business our global distributors?

Steve, it's probably -- we have to look at a full run rate for SMSC, but it's definitely less than 20% of the overall business.

It's probably closer to 15%.

Yes.

So, as we have described many, many times before, we have 80-plus regional distributors, which are strong demand creators in the largest geography we have, in Asia; and also lots of them in Europe.

Global distributors are good contributors.

But all of them combined are in that range.

It's a positive thing to really add and expand the channel.

It's a very positive thing for SMSC to have Microchip's largest distributor, which is Future Electronics, to be engaged in selling and creating designs for SMSC products, also.

So I'm not taking it away, but I'm just -- I don't know what your model will say.

I'm tempering the enthusiasm.

Sure.

No, understood.

That's very helpful.

Just a different question on your experience with SMSC.

Based on what you said, it sounds like you're finding lots of opportunities for cost synergies as you really get into the business.

What I'm curious about is with SMSC being on the other side of the country, how you've been able to deal with that; if that has ended up making the logistics more difficult than, maybe, you expected.

And if you would be more cautious about future acquisitions that were so far away from your home base?

No, I'm stuck in New York in 32 degrees.

I'd rather be in Phoenix at 88.

With that said, we have a broad management team.

And myself and Ganesh and Gordon and others have been taking turns and really tag-teaming.

SMSC was absolutely -- we did great analysis on it.

We understood it well.

We are executing it very well.

We haven't found any major problems that we had not anticipated.

The entire integration is going very well.

It will turn out to be absolutely the right thing to do, and a very, very good acquisition.

We probably would have beaten the numbers for an accretion and all that in, how well, after being at it for a while, with the products and all that we see.

Unfortunately, we had not counted on this strong downturn in the business environment, two months after acquiring the company, that you have seen from every other semiconductor company.

It's not an SMSC-specific problem.

If this environment had waited another nine months, had given us through June or September of next year, we would have produced outstanding results.

You would have been proud of them.

And we still will.

But now it will take longer.

Because, short-term, all the improvements we're making on gross margin, and OpEx cuts, and business model improvement, finding the synergy -- all being overshadowed by the business environment and the drop in the revenue.

Because you can't get your way out of it.

So that's why we have lowered the December accretion from $0.06 to $0.07 we had, to now, a number -- I don't want to be wrong on it, Gordon.

Is it $0.05 to $0.06?

$0.04 to $0.05.

Yes, $0.04 to $0.05 now, versus what we had guided before.

And what we had guided before, we had upside.

So that is the unfortunate thing, which is -- nothing is with SMSC -- it just has to do with the environment.

But beyond that, New York is not the only place they are in.

They have a large center in Austin.

They have people in Irvine.

They have people in San Jose.

They have a center in Germany.

And Microchip has people in all those places, also.

So management team is spread out.

That is what we have to be able to do -- it's a global company.

Ganesh, actually, is attending this call from India, in Bangalore, where Microchip has 200 people; and SMSC has about 80 people who are moving into our facility at the end of December.

And I'm here in New York.

I was yesterday at the SMSC headquarters.

So, no, that will not change our desire to do these global acquisitions in the future.

There's absolutely no issue related to that.

It's working very well.

It's the environment that has taken some wind out.

That's very helpful, thank you.

Craig Ellis, Caris & Company.

Thanks for taking the question.

And I echo the earlier sentiment on the clear transparency, in terms of how SMSC impacted your business.

The first question is a follow-up to the prior discussion.

Steve, as you look at the SMSC business as it's coming in, it looks like the accretion targets are about $0.02 lower in the December through the June quarters, versus prior.

And you have been clear that that's a revenue impact.

But is there -- is the revenue impact that you're seeing there in any one particular part of the SMSC business, or parts of that business?

Or is it equally broad-based across all their businesses?

Well, I don't know if it's equal.

Nothing ever happens equally in our business also, but it's broadly distributed.

There are four divisions we are running in SMSC.

One is the automotive; one that is the computing; third is the USB and ethernet; and fourth is the wireless audio.

And there is downturn in all those four businesses.

Not dissimilar to Microchip, where we are seeing downturn in our analog, microcontroller, memory -- all businesses.

And then, as a follow-up, it looks like the new capital expenditure expectation for this fiscal year is about $10 million lower than what you've communicated three months ago.

Can you help us understand where it is that you're able to be a little bit more efficient with your capital spend?

Basically, when they business is not growing, usually it has enough capital.

So the capacity capital incrementally really goes to 0. And then you have, here and there, bottlenecks, new technologies, some new things that you have to invest in.

But driven by the lower revenue guidance, you're able to take some capital out.

The reduction actually is more than $10 million, because the older number was Microchip alone.

This is now includes SMSC, and their re-capital budget.

Can you say how much you're planning to spend, per the SMSC and the Microchip parts of the businesses this year?

We really have not broken it out.

And, as synergies are identified, if there is some capital that is needed to transfer something to Microchip factories at a lower cost, I am more than willing to spend that money.

If the cost is lower.

But, otherwise, all sorts of capital has been constrained.

So these are being identified as we go.

There's not a lot of it between now and the end of the quarter, because a lot of those programs are being identified and all that, and capital takes a little while to buy and make it productive.

Is there time for question to Eric?

Sure.

Thanks, Eric.

The companies effectively go into a shared sacrifice program in manufacturing to get output to the right level to rebalance inventory.

As you look at the weak environment that we're in, Microchip has historically been very strong at operating expense management.

How do you think about operating expense levels, given the uncertain backdrop in what sounds like uncertainty on the part of the management team over the next 2 to 3 quarters?

Is there an opportunity to take OpEx lower?

And if so, what would be the triggers to do that?

Well, Craig, we've got a variable compensation system at Microchip.

And we've used that, historically, to manage through these difficult times.

So, with that, we look at those things.

We have worldwide communication meetings where we talk about spending, and how -- act like this money is your own, and employees latch onto that.

So, we get the whole employee population involved in the process.

And, just as in prior downturns, we will do an excellent job of managing expenses this go around.

We want you to know that, starting Monday, my management team already knows that -- our management team, all VPs, directors, corporate fellows -- they're all in a 5% pay cut starting Monday.

The Microchip leadership team steps up first to make the sacrifice, when we're asking anybody else to do anything.

Earnings are down substantially.

Operating expenses have popped up, driven by lower revenues.

So the entire management team -- and it's been a voluntary program -- and pretty much everybody will step up.

Thanks for that additional color, Steve.

John Pitzer, Credit Suisse.

Yes, good afternoon, guys.

And, again, thanks for all the details.

Steve, I apologize if I missed this, but did you throw out either -- on an absolute dollar basis, or days basis -- what target inventory levels you're looking to get to by June?

And if by the off-chance, end demand surprise on the upside, can you just remind me, cycle time through the Fab and how quickly the Fab network can respond?

Well, no, I didn't throw out any numbers.

I never want to be limited to, or pinned down, to any number.

It's a complex business, where it depends on how much inventory is in distribution.

If inventory in distribution goes to 40, then I'm comfortable with one set of numbers; if it's 31, I'm comfortable with another set of numbers.

So, no, I have not thrown any number out.

But I think, historically, we have talked about if that distribution inventory was average -- which clearly it is not -- if it was average, then we are comfortable in the 115 to 120 range.

Obviously, I have not reevaluated it with SMSC in there.

And the reason we haven't reevaluated it is inventory calculation is really messed up right now, with this purchase accounting.

And when you had $26 million or so, write up the inventory to a full price -- sale value, which the GAAP accounting requires -- it's really messed up.

So we've got to flesh it out in the next few months, and really be able to have a more meaningful indicator that you can latch onto, and analyze the business, and look at what the longer-term inventory would be.

So, I'll give you guys a number in the future.

But for Microchip alone, that number in the past was 115 to 120.

and with SMSC it will change.

And, Steve, cycle time to the Fabs?

That we don't publicize.

We're very good at it, and we don't want the competition to know.

Got it.

And as my follow-on, either for you, Steve, or Ganesh -- good understanding of some of the cost synergies with the acquisition.

I'm just curious, now that you're a little bit deeper into this, whether or not you have identified some more tangible revenue synergies.

And given the more historic, maybe, end-market focus of SMSC, help me understand the go-to-market now, with the complete portfolio of both the IP from you guys and SMSC.

Go ahead, take that, Ganesh.

I might add something later.

The revenue synergies are obviously different, depending on which of the businesses of SMSC we're talking about.

The USB and ethernet type of products probably have the greatest synergy, in terms of what we can do to help using our broad channels.

And they tend to be closer to some of the traditional Microchip applications and channels, et cetera.

Some of the more other ones are more targeted by customer; there, it will take more time.

We have identified that SMSC has a very deep platform-oriented approach into those markets in areas like automotive and computing and wireless audio.

And there, that platform carries many other products that are similar to what Microchip's traditional microcontrollers and analog products are like, and memory products are like.

And as those platforms come up for redesign, we will influence those platforms to take advantage of solutions that the traditional microcontrollers, analog, and memory can provide.

So, the work is going.

There's a lot of cross training, as I mentioned, between our sales teams, between the divisions.

People are excited to look at the platforms again.

And also people are working hard on the channel side, to enable the channels who have a broad customer base to access, to take advantage of those products that are more appropriate there.

But these are all design-in products.

They're all proprietary products.

And, as Steve mentioned, these things will take time to show in the revenue.

But it has to start at the design end of things.

And that's where we are, started right now.

A broad-based effort that moves the needle will take some time.

But I'm pleased to say that some of the very first designs have already been won with Microchip product in the customers where SMSC designs were.

In some cases, we caught it at the right time -- and the designs were just going to completion, and we were able to replace either the microcontroller or analog or memory.

I think there were a couple of examples of analog already; just an example, the microcontroller and memory.

So it does work.

Just, on a broad base, it will take time.

All right.

Thanks, guys.

(Operator Instructions).

Kevin Cassidy, Stifel Nicolaus.

Hello, this is [Dean Gromlos] calling in for Kevin.

Thank you very much for taking my call.

I was wondering if you could get some extra light on exposure to end markets following the SMSC acquisition, particularly in the automotive space.

We're not going to break out in the end market, like we historically don't.

Our business remains very broad-based.

We have 70,000-plus customers.

A large portion of our business still is through distribution, where it's much harder to break out where, really, the end customer is.

So that's not something we're not going to break out.

Okay.

Would it be fair to assume that automotive exposure has increased, without breaking out any numbers?

Yes, automotive exposure has increased.

It was about 25% of their business.

And it was not that much of our business, so it has slightly increased.

In percentage terms, based on their business being a lot smaller than ours, it's not a big needle mover.

But, yes, it has increased.

That's helpful.

Thank you very much.

Blayne Curtis, Barclays.

Good afternoon, guys.

I feel bad asking, because you did provide a lot of detail on the deal.

But I'm assuming you're going to continue to break out 8, 16 and 32-bit going forward.

So I was just wondering if you could dial in the base in this quarter, of that roughly $35 million from SMSC.

I don't know if I understand the question.

(Multiple speakers) it 32-bit growth, yes, they will include SMSC in future.

I'm sorry, I think --

We are not providing the dollar breakout for the SMSC businesses for the last quarter.

Yes.

I was just curious, so is there -- is there no 8-bit revenue, and it just goes into 16 and 32?

And I was just wondering -- if you don't want to give the absolute dollar, that's fine.

I was just curious.

There is 8-bit revenue.

There is 16-bit revenue.

There is 32-bit revenue.

Okay.

Fair enough.

I thought I would figure it out.

Then, on the OpEx side, I just want to make sure I heard this right.

It sounds like -- and given the accretion that you're talking about on the deal being a little bit lower, and your comments that you're pulling back the core OpEx in the quarter and then -- it sounds like, just given what you just said about cuts, that cuts continue into the March quarter as well for the core OpEx, outside of even what you're doing with SMSC.

I don't know what you mean by cutting the core OpEx.

Cutting the core OpEx; when you say core, you mean Microchip without SMSC, right?

Correct.

Okay.

So, in the OpEx of Microchip without SMSC, cuts are basically coming from three areas.

One is the pay cut for the management team I talked about.

Second is available bonus program, where bonuses will be quite low in this environment.

And a third is in the any accretion; we may decide not to replace.

Or any additions that we were planning, we may very carefully look at it and drag our feet on it.

Those are the three areas they will come from.

The cuts in the OpEx of SMSC will come in all those factors, plus the results of integration with certain functions that will be consolidated.

Right.

So, in aggregate, I guess this is a way of asking, when you look out into March and June, you've historically been very good about dialing back your OpEx when there is uncertainty.

Do you see this OpEx line moving further down?

I don't know if it moves down from March to June.

At this point, we haven't given any guidance for revenue for March or anything else.

I think we'd just like to hold off on that for now.

Fair enough.

Thanks, guys.

Ruben Roy, Mizuho Securities.

Thank you.

Steve, I just had a follow-up on the commentary that you have around the June, with the utilization levels, et cetera that you're bringing down.

And I'm wondering why you're giving us an outlook to June on the factory loadings.

Is that because you have visibility out to June?

Or is it because you are being conservative at this point, given what you're seeing out there?

If you could give us a little detail around the reasoning for giving us that detail.

Thank you.

The reasoning for giving you that detail is, I need to give some finality to the employees.

I can't just put them in a rotating time off and really not have them know what does it mean, when does it end?

At some point in time, people want some predictability in their life on how many hours I'm working as a full-time job.

If it's forever, then they should go try to find a full-time job.

If it is for a short period of time, these are long-term, committed Microchip employees that'll make the sacrifice and go along with it.

So when we model it, without a lot of revenue growth, we correct our inventory problem by the end of June.

And with distribution building inventory and having more reasonable growth on the revenue, the time period could cut short.

So, that's what I'm telling the employees, that we expect this RTO, rotating time off, to go through about June.

And that's what I'm telling you.

Great, okay.

Well, that's that makes a lot of sense.

Thanks, Steve.

And then just a quick follow-up around OpEx.

If we do assume sort of a flattish revenue growth environment over the next several quarters, and you're running at around 30.5% to 31%, non-GAAP OpEx as a percentage of revenues, the integration efforts that you're talking about completing in Q1, around the Q1 timeframe -- will those create a step function down towards -- toward your longer-term goal of 27.5% of revenues?

Or is it going to take more time to bring OpEx down to that type of level?

Again, assuming a flattish revenue environment.

Yes, the 27.5% is not achievable with flat revenue from here, and I think if that's what you model, it probably would just be way too conservative.

Just the inventory being that low in this environment, is pretty much at the bottom here.

So if you assume flat revenue and use that for several quarters, then you are probably modeling it way, way too conservative.

There will be revenue growth.

Because without the revenue growth, you can't get to our models.

Okay.

Well, that's helpful.

Thank you, Steve.

The other thing is, if the revenue doesn't grow in your model, then even if I bring the inventory down, I cannot still run full production.

Then I still don't get the full gross margin recovery.

So there has to be some business recovery, either through new products or the number of new products we are launching.

Ganesh talked about a couple of product lines in the analog growth.

Similarly, we have in the microcontroller growth; revenue coming from some of these synergies realized with SMSC.

We absolutely will grow revenue next year.

Right.

I apologize, Steve.

I guess I drew the wrong conclusion on your commentary around the rotating work schedules out to June, and what you had said around the flattish revenue environment driving that.

So, you answered during the first part of the question.

My mistake.

Thank you.

And, ladies and gentlemen, that does conclude our question-and-answer session.

I'd now like to turn the call back over to Steve Sanghi for any additional or closing remarks.

Well, we want to thank you, everybody, for attending this conference call.

Some of the Microchip management will be on the road show attending some of the conferences.

So we'll see you on the conference circuit.

And we'll talk to you again in the next conference call.

Thank you.

And, ladies and gentlemen, once again, that does conclude today's call.

We do appreciate everyone's participation.