微晶片科技 (MCHP) 2013 Q4 法說會逐字稿

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

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

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

Please go ahead, sir.

Good afternoon, everyone.

During the course of this conference call, we will be making projections and other forward-looking statements regarding the 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 operation.

In attendance with me today are Steve Sanghi, Microchip's President and CEO; Ganesh Moorthy, Microchip's COO.

I will comment on our fourth-quarter and full 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 be available to respond to specific investor and analyst questions.

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.

Net sales on the March quarter were a record $430.1 million and were up 3.4% sequentially from net sales of $416 million in the immediately preceding quarter.

Revenue by product line was $275.8 million for microcontrollers; $97.2 million for analog; $32.8 million for memory; $22.1 million for licensing; and $2.3 million of other.

Revenue by geography was $84.7 million in the Americas; $99.3 million in Europe; and $246.1 million in Asia.

On a non-GAAP basis, gross margins were 56.4% in the March quarter and above the high end of our guidance provided on February 7th of 56.25%.

Non-GAAP operating expenses were 28.6% of sales and well below the low end of our guidance of 29.25%.

Non-GAAP operating income was 27.8% of sales, and net income was $109.3 million.

This resulted in earnings of $0.52 per diluted share, which was $0.05 above the midpoint of our guidance and $0.03 above the high end of our guidance.

Our EPS guidance and the actual results included about $0.03 from the retroactive reinstatement of the R&D tax credit.

For fiscal 2013 on a non-GAAP basis, net sales were $1.606 billion and up 16.1% year-over-year.

Gross margins were 57.2%, operating expenses were 28.6% of sales, and operating income was 28.6% of sales.

Net income was $388.5 million or $1.89 per diluted share.

On a full GAAP basis, gross margins, including share-based compensation and acquisition-related expenses, were 55.6% in the March quarter.

GAAP gross margins were impacted by the sellthrough of $1.1 million of written-up inventory costs associated with our acquisitions, and $2.5 million of share-based compensation.

Total operating expenses were $182.3 million or 42.4% of sales, and include intangible amortization and special charges totaling $47.1 million, and also includes share-based compensation of $10.9 million.

The GAAP net income was $59.7 million or $0.28 per diluted share.

For fiscal 2013, on a full GAAP basis, net sales were $1.582 billion; gross margins were 53%; operating expenses were 41.7% of sales, and operating income was 11.3% of sales.

Net income was $127.4 million or $0.62 per diluted share.

In the March quarter, the non-GAAP tax rate was 4.5%, and was favorably impacted by $6.5 million from the reinstatement of the R&D tax credit relating to calendar year 2012.

The GAAP tax expense was impacted by the acquisition-related items and several nonrecurring events.

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.

Excluding any one-time events, we expect our longer-term, forward-looking, non-GAAP effective tax rate to be about 10.5% to 11.5%.

To summarize the after-tax impact that the non-GAAP adjustments had on Microchip's earnings per share in the March quarter, acquisition-related items were about $0.22; share-based compensation was about [$0.056]; nonrecurring favorable tax events were about [$0.046]; and non-cash interest expense was about [$0.06].

The dividend declared today of [$0.3535] per share will be paid on June 4, 2013 to shareholders of record on May 21, 2013.

The cash payment associated with this dividend will be approximately $69.6 million.

This quarter's dividend will be our 43rd consecutive quarter of making the dividend payment.

We have never made reductions in our dividend.

In fact, this quarter's increase marks the 37th occasion we have increased the dividend payment.

And when the dividend is paid, it will take our cumulative dividends paid to our shareholders to over $2 billion.

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 March 31, 2013 came down significantly to $242.3 million or 116 days.

Our internally-produced inventory is still a bit high, and our inventory purchased from foundries is low.

We will continue to work on rightsizing the various components of our inventory holdings.

We expect days of inventory at the end of the June quarter to be flat to up modestly, although we expect our internally-produced inventory to decline again.

Inventory at our distributors increased by three days during the March quarter from the record low levels we saw in the December quarter, and are now at 30 days.

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

At March 31, the consolidated accounts receivable balance increased to $230 million, driven by the back-end weighted shipments in the quarter associated with the Chinese New Year, and the inventory build at our distributors.

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

We had strong free cash flow generation in the March quarter of $123.3 million prior to our dividend payment.

As of March 31, the consolidated cash and total investment position was approximately $1.84 billion, and we had $620 million in borrowings under a revolving line of credit.

Excluding dividend payments, we expect our total cash and investment position to grow by approximately $100 million to $120 million in the June quarter.

Capital spending was approximately $15.5 million for the March quarter and $51.6 million for fiscal 2013.

The capital spending in Q4 was about $8.5 million below our forecast for the quarter, with these capital receipts pushing into Q1 of fiscal '14.

We expect about $35 million in capital spending in the June quarter, impacted by the rollover of capital from the March quarter, as well as $12.5 million and a building purchase in India to support our growing R&D operations in that location.

We expect overall capital expenditures for fiscal 2014 to be about $80 million.

Depreciation expense in the March quarter was $22.4 million and was $88.4 million for fiscal 2013.

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

Ganesh?

Thank you, Eric, and good afternoon, everyone.

Let's now take a closer look at the performance of our product lines in the March quarter, starting with microcontrollers.

Our microcontroller revenue grew 3.7% sequentially in the March quarter to achieve an all-time record of $275.8 million in revenue.

Microcontroller revenue was also up 20.5% versus the year-ago quarter, and for fiscal year '13, our microcontroller business was up 12.4% as compared to fiscal year '12.

Microcontrollers represented 64.1% of Microchip's overall revenue in the March quarter.

And, by the way, in April, we also shipped our 12 billionth cumulative microcontroller.

Our 16-bit microcontroller business was up 7.7% sequentially in the March quarter, achieving a new record for revenue.

16-bit microcontroller revenue was also up 93%, versus the year-ago quarter, and for fiscal year '13, our 16-bit microcontroller business was up 74% as compared to fiscal year '12.

Fiscal year '13 also marks the eighth consecutive year of revenue growth and new revenue records for our 16-bit microcontroller business.

We continue to expand the breadth of innovative 16-bit solutions that we are offering and customers that we are serving, as we continue to gain market share in this segment.

Our 32-bit microcontroller business took a pause after three consecutive quarters of strong double-digit growth, and was down 16.6% sequentially in the March quarter, although it was up 527% over the year-ago quarter.

For fiscal year '13, our 32-bit business was up 475% as compared to fiscal year '12.

And fiscal year '13 also marks the fourth consecutive year of revenue growth and new revenue records for our 32-bit microcontroller business.

We are continuing to win new designs and expanding into new applications to enable further growth in revenue and market share.

Gartner Dataquest has released a microcontroller market share report for 2012.

While we remain in the number two position for 8-bit microcontrollers, we continue to gain share versus the 8-bit market at large and versus our nearest competitors.

Two years ago, it took the combination of three Japanese semiconductor giants, NEC, Hitachi, and Mitsubishi, to knock us off the number one spot for 8-bit microcontrollers.

We assured you at the time that we would work relentlessly to gain market share and to wrest back the number one spot in the coming years.

Over the last two years, we closed the gap between us and the number one supplier, Renasus, and doubled our lead -- we closed the gap by 50%, and we doubled our lead over the number three supplier, Atmel.

And you can expect more of the same in the coming years.

And unlike many of our competitors, we achieved these results while maintaining a focus on profitability.

In the 16-bit microcontroller market, we were again the fastest growing 16-bit microcontroller supplier among the top 10 suppliers in 2012.

We moved up from the number eight spot in 2011 to the number seven spot in 2012, and expect to continue to gain share and move up the rankings in the coming years.

In the 32-bit microcontroller market, we moved from the number 17 spot in 2011 to the number 12 spot in 2012.

And, once again, we were the fastest growing major 32-bit microcontroller franchise.

Now, Gartner Dataquest report is a backward-looking indicator where we are performing very well.

Now let's look at a forward-looking indicator.

Within the last month, EE Times released their results of the annual embedded market study.

Once again, Microchip was rated by embedded system design engineers as their number one choice for new designs using 8-bit, 16-bit, and 32-bit microcontrollers.

So in all categories, we were number one.

We are honored by the overwhelming preference for our solutions and see this as a positive sign for future growth, especially for our 32-bit microcontroller franchise, where there has -- where some of you have had questions about our choice of core.

Our 2012 market results, as well as the 2012 design engineering preference results, echo market confirmation of our belief that what customers care about is that we offer a PIC microcontroller solution and all the attendant brand promises, and that the choice of core is really not important.

Moving to our analog products, our analog business grew 4.1% sequentially in the March quarter to also achieve a new record, and continues to perform exceptionally well.

Analog revenue was up 124.4% versus the year-ago quarter; while for fiscal year '13, our analog business was up 89.4% as compared to fiscal year '12 -- easily one of the best performing analog businesses among our peer group.

Analog revenue represented 22.6% of Microchip's overall revenue in the March quarter, and it's -- that's the highest proportion of our revenue ever.

Moving to memory products, this business, which is comprised of our Serial E squared memory products, as well as our SuperFlash memory products, was up 1%.

While this business has had some drag on our overall growth, our memory business is becoming a smaller percentage of our overall business, and was down to 7.6% of Microchip's overall revenue in the March quarter.

We continue to run our memory business in a disciplined fashion that maintains consistently high 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 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 fourth-quarter of 2013, then I will provide guidance for the fiscal first-quarter of 2014.

We were very pleased with our execution in the March quarter.

In our last conference call, we told you that the December quarter was going to be our bottom quarter for this cycle, and we will see growth in the March quarter.

We have more than delivered on that guidance.

Our net sales were higher than the midpoint of our guidance.

We managed the operating expenses extremely well, with operating expense percentage coming in 115 basis points below the midpoint and well below the lower end of our guidance.

All of the financial metrics, like gross margin percentage, operating profit percentage, and non-GAAP earnings per share, all exceeded the high end of our guidance.

We beat the midpoint of the guidance on earnings per share by $0.05.

I want to thank all the employees of Microchip, including the new employees from SMSC, for their contribution in making this an excellent quarter.

We made several new all-time records in the quarter.

Our total net sales were a new record, and our total microcontroller, as well as analog net sales, achieved all-time new records.

Individually, 16-bit microcontrollers also achieved a new all-time record.

There is no doubt that Microchip has continued to gain market share in microcontrollers as well as analog.

Had a chance to compare Microchip's microcontroller reserves with the SIA data for the March 2013 that was just released.

We are pleased that Microchip continued to gain market share in microcontrollers.

For March 2013 quarter, our total microcontroller revenue was $275.8 million.

Our overall microcontroller market share increased from 7.6% in March 2012 quarter, and 8.25% in calendar year 2012 to 9.7% in the March 2013 quarter.

So, again, 7.6% in March of 2012 quarter, it was 8.25% in the calendar year 2012.

And in the March quarter just finished, 9.7% market share.

Last but not the least, the March quarter was the 90th consecutive profitable quarter.

Now, we will not break the SMSC numbers out past this quarter and in the new fiscal year, but for the March quarter, the classic Microchip divisions without SMSC achieved an impressive 4.9% sequential growth.

The SMSC division's net sales declined by 1.7% sequentially, mainly driven by the computing products division and the PC market weakness.

While we cannot control the PC market, we would like to point out that the SMSC business delivered an impressive $0.085 accretion, which was up from [$0.065] accretion in the December quarter and higher than the $0.07 to $0.08 accretion that we had guided.

There are lunchtime celebrations planned tomorrow throughout the SMSC site and the combined Microchip SMSC integration teams for a job well-done.

My thanks and congratulations go out to the entire team.

Now looking at the results of our fiscal year 2013, it was a record year for net sales and sales for microcontroller as well as analog products.

In November last year, we reported that we instituted a rotating time-off program for our fab employees, and substantially reduced the wafer starts in our factories to reduce inventory.

The inventory has come down substantially to 116 days, well below the guidance of 123 to 129 days that we provided.

We are starting to reduce the amount of the rotating time-off, but not completely, because the internal component of the inventory is still a bit high, while the outsourced component of the inventory is low.

We expect to end this rotating time off starting July 1. Our longer-term goal for inventory continues to be 115 to 120 days.

In November, we also announced that we instituted a 5% pay cut for all executives, and we then requested other employees of the Company to join the executives in a voluntary 5% pay reduction through June 30, 2013.

Approximately 2500 employees had voluntarily stepped up to take a 5% pay cut.

We call it shared sacrifice.

I want to thank all of the dedicated Microchip employees who volunteered for this pay cut.

The participation level exemplifies the strength and uniqueness of the Microchip culture.

Tomorrow, in a companywide communication meeting, I will be announcing a reduction in this pay cut from 5% to 2.5% starting the next pay cycle.

And the pay cut will go to zero on July 1. I will also be announcing a special bonus as a shared reward for the employees who made an investment in the shared sacrifice.

This bonus is included in the March quarter results, and the reversal of pay cuts is included in our guidance for the June quarter and beyond.

Now I will provide guidance for the fiscal first quarter of 2014.

We have continued to see exceptionally strong bookings and expedite requests in our business, driven by strong demand in our design win pipeline.

The bookings were an all-time record in the March quarter.

The starting backlog for June quarter was significantly higher than the starting backlog for the March quarter.

However, because of lead times, many new bookings will be scheduled beyond the end of this quarter.

Taking all these factors into account, we expect Microchip's total net sales in the June quarter to be up between 2% and 6% sequentially.

We are ramping our back-end facilities in assembly and test to meet the increased demand of our customers.

Our back-end facilities have switched from lowering finished goods inventory to now rebuilding finished goods stock to reduce lead times, and meet the increased demand of our customers.

This switch from lowering finished goods to replenishing finished goods is causing our back-end facilities to grow their units produced by 11% sequentially.

On a non-GAAP basis, we expect our gross margin to be between 56.5% to 57% of sales.

We expect operating expenses to be between 27.75% to 28.25% of sales, and we expect our operating profit to be between 28.25% to 29.25% of sales.

And we expect a non-GAAP EPS to be between $0.50 and $0.54 per share.

Remember that our March quarter non-GAAP EPS of $0.52 included a $0.03 credit from the recapture of past R&D credit.

Therefore, a midpoint guidance of $0.52 for June quarter is $0.03 above the actual for March quarter.

SMSC is now fully integrated into Microchip, but for reference, the accretion from SMSC will be about $0.09 to $0.10 for the June quarter, and between $0.40 to $0.45 for fiscal year '14.

This is well above the prior estimate of $0.38 to $0.42 accretion for fiscal year '14, and we have increased that estimate a couple of times before.

Now, we have already made significant progress in transforming SMSC's business model; SMSC's gross margin, operating expenses, and operating profits are already significantly better than what SMSC achieved during its full fiscal year prior to the acquisition.

SMSC's operating profit in the March quarter was 25.9%, well above the 12% operating profit SMSC recorded in fiscal year '12.

So more than double.

We expect that significant improvement in SMSC financial metrics will continue.

Our long-term model for the combined Company remains a gross margin of about 60%, plus/minus 0.5%; operating expense 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.

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

Given all the complications of accounting for the acquisitions, 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 comparison to prior quarters, and we request that the analysts continue to report the non-GAAP estimates to first call.

With this, operator, will you please pull for questions?

(Operator Instructions) Chris Caso, Susquehanna Financial Group.

Steve, just maybe to start, and given your vantage point in the industry and the number of your customers you touch, I think you guys are in a good position to answer this.

There's obviously a concern, and it's not just Microchip, it's the whole industry, and really the whole market, because of the downturn that happened the second half of the last two years.

Because -- I guess based on what you're seeing now, maybe you could help us by maybe comparing what you're seeing now in terms of the customer orders, the activity to the last two years.

And maybe talk about what you see different this year than perhaps over the last two years.

Well, if I could refer to one report I was reading, I don't want to name that report, but I was reading an analyst report from an investment analyst -- where I read that for my personal investments.

It said in the last two years, in both years, Fed drew the stimulus out of the market right around the April timeframe.

And last year, the Q2 ended and then they started it again in September or so with Q3.

And the year before, also the housing and bunch of other stimulus ended.

And this report, at least, pointed a significant finger towards really the reduction of that stimulus, which then resulted into a weakening of the market in the second half.

And actually, the GDP was already slowing down.

This year, as you look at it in the US market, at least, the GDP is actually up from the prior quarter.

It's accelerating and there is no sign, at least today, of any kind of stimulus to be withdrawn.

So that's not my analysis; I'm just reading the analysis from a different report.

As we see from our own data, the bookings are very strong.

They were very strong in the last quarter.

We mentioned this at the last conference call also.

And as we continue and finish the month of April, it was very, very strong.

So currently, there is no sign that this thing will really follow the pattern it followed in the last two years.

Okay.

Sure.

Just as a follow-up to that, maybe you can comment a bit about -- it sounds like you're getting some longer dated bookings now and some customers booking into the calendar third quarter.

Does that imply that your own lead times are starting to expand?

What's the incentive for those customers to start booking a little farther out right now?

So, you pretty much said it.

So one change that has happened in the Microchip business over the years, is, today, 40% of our business comes from wafers made in the foundry.

And this is a result of two acquisitions and Microchip's own strategy of really significant number of products that we are sourcing from outside.

100% of SMSC's products are bought from foundries.

100% of SST, Silicon Storage Technologies, products are bought from outside.

And many of Microchip products over the years, where, rather than adding expensive equipment inside, we have gone outside.

So that change in the mix shift has really added the complexity, where today, our lead times are anywhere from two weeks to 16 weeks depending on the product.

And we make 60,000 different product types.

So if you ask me what is your lead time, there isn't really one number.

It is anywhere from two weeks to 16 weeks-plus.

There are products which are in stock and you can take immediate delivery.

And there are other products you will be in line if you order them in less than 16 weeks.

So, yes, we are getting orders out in time for products that have longer lead time.

And any time that happens, there is a drag effect on the other products.

Even those products which are available on a much shorter term basis, Customer just reads it as those make a longer lead time also, or they place a bulk order and in a kit fashion for the outer months, and you tend to get bookings on all different products out in time.

Just to clarify, was -- if I look at it versus the second half of last year, was there any meaningful change in the lead times across your portfolio from the second half of last year?

Yes.

Very, very meaningful change, yes.

Obviously, SMSC was acquired in the second half.

It was acquired on August 2nd.

So all that impact was since then.

And many of our internal products, they have ramped significantly.

They were much newer products last year, contributed much smaller portion to our volume.

And a year later, they are in significantly high volume position.

Okay.

Great.

Thank you.

Welcome.

Simit Dhanda, ISI Group.

Just a couple of questions.

The SG&A performance, you came in below the low end of expectations.

Could you help us understand what exactly drove that performance?

Go ahead.

No, it's really just great expense control across the board.

We indicated that how we share information with our employee base about the state of the industry and expense control, and I'd say all employees across the Company really stepped up and helped us deliver much better performance in the operating expense area.

So not much else I could share outside of that, other than it was a collective effort of the entire Microchip team.

When employees are on their pay cut and staff employees are on their rotating time off, there's a culture where everyone thinks it's their money.

If you spend some money on something superfluous -- just want a new computer while the old one still works, you're really spending your own money, because the bonuses and pay cut reversal and RTOs and all that depend on the performance.

So it's really one of the best cultures, and it creates employees to then really go out of the way in watching expenses and making it an efficient OpEx operation.

Got you.

And then just following up on the -- on your commentary around lead times, how do we reconcile the fact that your own internally-produced inventory is at a reasonably high level, but your lead times are still expanding?

In other words, is the mix so out of kilter with how the demand requests are coming in?

Or help us understand what the disconnect might be.

So a lot of the longer lead times, not from in-house produced products.

A lot of the longer lead times are from foundry products, but a lot of the in-house produced products, we are holding all the inventory in the dye stores, where we have really, in the last many quarters, cut back on the production in assembly and test to not really add further value when the inventories were quite high.

And as the demand has come very, very strong, we have to move that dye to assembly and test.

And that's where some of the challenges are in acquiring new capacity, new handlers, new testers, and other stuff.

And the third piece is on a good number of select number of products, the demand has exploded and the products were built inside.

But the inventory on those new products were not very high, and the demand has exploded so we are expediting them even inside the factories.

So, just to add on to that real quickly, I want to really emphasize the point that Steve made earlier about 40% of our products being from outside foundries, and lead times from our foundry partners have expanded also.

So that has compounded this.

And we have taken a appropriate steps to build that inventory back up in the June quarter, and you can see that in our guidance for inventory; even though the internal inventory is coming down, the foundry products will go up and allow us to have competitive lead times.

So the mix is not out of kilter.

If the mix was out of kilter we would be writing off inventory because lots of products would have inventory write-downs, while the other products are short.

So the mix is really not out of kilter.

It's -- any time when large surge in demand happens, lots of new designs take off, and those new designs, even though you couldn't predict how much customer is going to buy because the newer designs and they were in incubation.

And many of those are 32-bit microcontrollers and many of them are DS PIC and 16-bit microcontrollers.

That's where the demand has exploded.

Okay.

Thank you very much.

Very helpful.

You're welcome.

Jim Schneider, Goldman Sachs.

Good afternoon and thanks for taking my question.

This is Gabrielle Borges on behalf of Jim.

I was hoping you could give us a little detail on the puts and takes to growth margin guidance in the quarter.

How should we be thinking about utilization versus last quarter, given more modest inventory reductions?

And are there any impacts from mix shift or other factors that we should also be thinking about?

Thanks.

So, there's many factors that influence gross margin, including the mix of revenue from our various product lines, fixed cost absorption, factory loading levels, inventory reserves, and just general competitive and economic conditions.

So after considering those various gross margin factors for the June quarter, we are guiding non-GAAP gross margins to be up to 56.5% to 57%.

As our inventory position gets rightsized, we can increase our factory output, which will help us improve our gross margins, and we will see some margin improvement from SMSC over time.

So long-term margin stays intact at 60%, plus or minus 0.5%, and we will get back to those levels as we increase utilization over time.

That's very helpful.

Thank you.

And then as a follow-up, if I could, I was hoping you could talk about growth drivers in the 16-bit MCU portfolio, given the strong result in the quarter and over the last year?

How should we be thinking of the growth profile of this business going forward?

And are there any particular applications you're targeting for [second]?

Ganesh, you can take that one.

You know, there are a broad suite of applications in which we are designed in that are continuing to grow.

We are getting multiple designs in these applications, with these customers.

It's too broad of a range to be able to pick any one item to say that's what's driving all the growth.

And I think that's the strength of the business is, it is not dependent on any one application or any one customer for its growth.

It's pretty broad-based.

Okay.

Great.

Thanks for the color.

(Operator Instructions) Steven Eliscu, UBS.

Just had a question on your 32-bit PIC.

I mean, we have focused a lot in the past that the fact that you are not using ARM and how it could keep you out of bidding on certain deals.

I'd like to turn that around and get your opinion on how, when you are included on a deal, how the fact that you have a microcontroller that potentially has advantages versus an ARM core, how that's resulting in what may be less competition than what some of your peers are seeing?

And how it could also be resulting in better pricing resiliency, as we've seen 32-bit pricing based on the SIA data come down significantly over the past year?

Ganesh?

We never sell based on ARM versus MIPS or anything else on the core.

We are going into customers to understand needs.

We are identifying alternatives, and we propose solutions that are PIC microcontroller-based solutions.

That includes the product, it includes the development tools, it includes a roadmap, it includes our software, it includes our support.

What a customer buys is our ability to sell their needs for today and tomorrow.

And the talk of an ARM core versus a MIPS core versus some other core never comes up.

So you are saying you are winning because of all those attributes that you just said?

Yes.

There are 10, 15 different attributes that are important to the customer, and maybe a few for whom the core may be important.

But there's a lot more for whom their success is what's important.

That's helpful.

And then, on the SMSC integration, a couple-part question.

First of all, just trying to understand why the accretion is higher than you originally expected?

Is this just based on better IT integration and rationalization of the backend?

Or was there more to it in terms of being able to fix some of the product groups and product areas that you didn't necessarily see upfront?

And as the second part, now that also you have honed this M&A process with the last two acquisitions, and you've essentially said the SMSC integration is complete, are you now ready sooner, perhaps, to do your next major acquisition?

So the first part of your question regarding the SMSC accretion, I think we have revised these numbers up at least two or three times now.

Basically, the execution has been much better than any sand we had left in there.

When you first make the estimates, you're largely making the estimate from looking from outside.

And first estimate was actually based on the day we completed the acquisition.

So as you get in there -- as we got in there, we found significant more fat, significant more areas of efficiency, where microchip processes, business processes applied, related into significant more efficiencies.

So the gross margin is significantly higher than we originally imagined.

Operating expenses are much lower than we originally imagined.

Therefore, the operating profit overall is much higher at lower revenue.

So we had expected higher revenue before.

So despite lower revenue, mainly because of the computing market, which has been really weak, despite the lower revenue, all of the metrics have improved.

And a lot of the internal metrics we had regarding revenue per employee to operating expenses, about anything to gross margins to operating profit for employee and various other indicators of ranks of managers and VPs and Directors and others -- all these internal indicators are all turning green from bright red, when we started.

So I can't quite give you a pictorial view of that.

From the data is confidential on it, but I have a very good chart on how -- where the indicators were, where we started, and quarter after quarter, month after month, how many of these indicators have turned green.

And on the second part of the question?

So the second part of your question is, the SMSC acquisition is complete.

Are we ready for another major acquisition?

We have been ready well before even the acquisition was complete, because it's different people executing it versus people who are finding and doing the analysis.

Although, if you know of one that's ready and wants to do the deal, let me know.

I don't have one.

Okay.

Thank you for all that insight.

Yes.

Welcome.

Harsh Kumar, Stephens.

First of all, congratulations on the stellar guidance, stellar profitability and once again beating the numbers.

Steve, I had a question on 8-bit.

We are starting to hear US markets, emerging markets, the end demand recovering.

In your opinion, do you think it's possible for Microchip to take further share in the 8-bit market, particularly as Renaissance and some of the other guys sort of flounder around in profitability?

Well, I mean, yes.

I mean, our 8-bit share is increasing rapidly.

8-bit share is up, based on SIA data, substantially over Q1 last year.

It grew every quarter last year.

It's up substantially over Q4.

Some of the people that have broken the numbers out, including one we just heard yesterday, their 8-bit was down substantially sequentially.

Microchip's 8-bit was up sequentially from December to March.

So 8-bit is doing very, very well.

Don't think negative about 8-bit.

8-bit is resilient, doing very well.

We are getting tremendous share.

It has very high gross margins.

It's a tremendous contributor to profitability.

Got it.

Thanks for the color, Steve.

And then, as, again, things get better listening to your commentary, question on CapEx.

What are the puts and takes that you guys think about in deciding whether to go outside to a foundry versus going internal?

Does it come down at the end to technology or is it a total cost proposition?

Well, it's, basically, at the end, is a cost of ownership proposition, but a couple of factors that go into that.

One, we develop technologies around those business plans that are fairly large business plans, which means we will develop the mainline technologies on which we will do a lot of business.

But as the Company gets larger, you have a lot of small business plans.

We need a little DMARs, we need a little bipolar, we need something else.

I needed a high voltage.

I need something else.

So when you start to develop all these versions of technologies for all these splinter groups and small acquisitions, and all those in the Company, those are not cost-effective, necessarily, always for developing inside.

So we pretty much go find a foundry who is doing those technologies, and we get those.

And the second piece is, when you really go deep into lithography, where the equipment becomes very, very expensive into 12-inch wafers, then we are going predominantly outside.

Microchip's boat fabs are 8-inch and they will remain 8-inch.

So when we really need really deep lithograpy, that's only available on 12-inch, we're going outside.

Got it.

Very helpful and congratulations, guys.

Gil Alexander, Darfil Associates.

Congratulations.

Two questions, if I may ask.

Is the body.com technology important or it takes a few years?

Ganesh?

So body.com is a new innovation.

We are working with a set of customers to get it adopted and implemented in production.

But, like most embedded solutions, they take time to be a adopted, to be designed in, to go to production.

So don't expect an instantaneous spike in revenue from body.com.

It will take time, but it will be like many of our other solutions we brought over the years, where we bring them to market, help customers be successful, and ramp the volume.

Steve?

Yes.

You've been very good at making economic projections.

Can you give us a reading as to degree of slowdown in the Chinese economy?

Well, I don't know if I can claim expertise on the Chinese economy.

I read the same data that you read.

I have a little more view from our own business standpoint or in better control regarding what's happening.

And the quarter for China was slow, driven by just a weak economy, Chinese New Year, which is always a down quarter, and the change of government 10 years -- a decade change -- every decade the government changes their -- which has recently come in.

Now what they are talking about are really a new round of stimulus and really trying to accelerate the economy somewhat.

And when China does that, a fair amount of money often goes into the hardware goods where our products are.

A lot of it goes into appliances, household appliances, TVs, automobiles, and other stuff, which really has a lot of microchip consumption.

So if anything like that happens, which it looks like it's likely to happen, then we will be a significant beneficiary.

Thank you very much.

You're welcome.

William Spine, SunTrust.

Thanks for taking my question.

Can you talk about your internal utilization now?

I think it's in the high 50s on the front end.

Is that right?

And perhaps you are more constrained on the back end.

Can you comment on the differential there?

Yes.

We don't break out a specific capacity utilization percentage.

We do have plenty of capacity in our factories to support both the short-term and long-term requirements of the business.

It's just quite a mix today.

We talked about earlier about 40% of our business being outsourced in wafer fab, and what we're doing internally coming off the rotating time off schedules, effective July 1. So there's just a lot of moving parts.

I can assure you we have plenty of capacity growing to internally, though.

That's helpful.

And then, there's another area of your business where I think you've done some smaller acquisitions, and people -- investors, I think, don't generally think of Microchip as a company with a strong position in touch and gesture and proximity controls, but I think you've developed some products there lately.

Can you talk about the traction you've made there?

Well, I mean, you know, we have a very good touch business.

We do business with over 1000 touch customers in production; always has been.

But our business characteristics are such that Microchip defends a very, very broad beachfront.

We are not a touch company.

We are not a motor control company.

We are not a computing company.

We are not a cell phone company.

We participate everywhere with a very, very broad set of characteristics.

So therefore, we don't really talk about any single application because there are just too many to talk about.

Every once in a while, we throw something out, and most people just think, hey, that's our focus and we have a large portion of the business in that area, which is not true.

The difference in touch is, without touch, we are not pursuing cell phones and pads.

Our touch is in the automotive.

Our touch is in industrial.

Our touch is in printers and touch screens, on various buttons and wheels and stoves and industrial equipment and household equipment.

That's where our touch is.

Margins are two times higher than our competition or more.

They are smaller volumes in a given design.

They are support-intensive but Microchip is structured around being able to provide that.

We don't go compete in 20 million unit designs in a cell phone, but we sell well over 20 million units in lots of small, small, and mundane applications in the industrial and automotive and consumer world.

Thank you.

You're welcome.

Christopher Danely, JPMorgan.

This is Sean Bahi calling in for Chris.

Thanks for squeezing me in here.

I wanted to circle back real quick on a pretty well-publicized letter you guys put out, I think, in the first week of February to your customers.

Can you talk about what kind of impact that letter had on your order rates throughout the quarter?

And maybe talk about the last time you had to issue a similar letter and what it did to order patterns?

Well, the letter is not to create an order pattern.

The letter is in response to an order pattern.

So for several weeks prior to the letter, we were getting a large amount of orders, and some of the lead times had pushed out and we talked about lead-time earlier in the conversation, regarding products made in foundries to some other products which are ramping very hard.

So when that starts to happen, the letter is essentially giving all of our other customers a notice, because Microchip has a very broad, 80,000-customers, very broad customer base.

So it's to give a notice to every other customer and saying, this is what's happening in the industry.

This is what we are seeing.

Please make sure that you have your orders in, either at your distributor or at Microchip, where we buy the parts from, and take notice that this is happening.

And usually we didn't see change in the pattern after that, but the pattern continued for quite a while and is continuing.

It is possible that without the letter, the whole thing could have -- softened a little bit.

I mean, maybe after those customers were placing the orders have placed their orders.

But then when the other customers will come later on, they wouldn't have the orders in line and they would go delinquent their lines down.

So it's a notice to the other customers, which then customer after customer then get on the bandwagon and they are placing their orders, and which keeps the momentum rolling for an extended period of time, which is really what has happened.

Okay.

That's helpful.

Thanks for the color.

And just as a quick follow-up along the same lines, can you talk about where your lead times are today versus the beginning of the year and when you plan on bringing goes down?

I don't know whether you were on the call earlier on or you just signed in, but we talked quite a bit about the lead times.

Microchips' lead times are anywhere from two weeks to 16 weeks-plus and there's no single number I can give you for lead-time.

Across the 60,000-plus products we make, the lead time is really product dependent, depending on where the product is made, whether it's made in foundries, whether it's made inside, whether we have die inventory on that product, only have to test it, do we have to start from scratch, making wafers.

So the lead times are all over the place.

Lead times have not changed since the start of this year.

Okay.

Very helpful.

Thanks and congrats.

John Pitzer, Credit Suisse.

Congratulations.

Steve, in your prepared comments, you give us a metric that you usually don't give.

I think you talked about the backend perhaps building units up 11% sequentially in the June quarter.

Was the intent there to give us a sense of what you think underlying consumption could be if you could meet it all?

Is it expectation of future growth into September?

What was the point of that data point?

The point of that data was that in the prior quarter, we shipped more units than we built.

So we were in an inventory depletion mode.

And now, with the growth guidance we have given, you have to build more units, plus I can't deplete them anymore.

Inventory is already low in our back end.

I have to build more units to grow the inventory, plus I have to make up for the units I depleted last quarter.

So it's just to give you a feel for ties into lead times also a little bit.

We are having to grow the units 11% just to provide the growth we have guided, plus the units we depleted last year from last quarter from the finished goods, replenish those, plus not deplete any more and actually build some.

And we have given you a range of guidance.

So any time we build, we build, so that we can provide more than the middle point of the guidance.

And then, Steve, on the SMSC accretion that you guys have raised a couple times now, it sounds like a lot of that is coming on the cost side.

I'm kind of curious now that we are a few quarters into this, what kind of revenue synergies you might have uncovered?

And then, quickly and lastly, just given the yen situation, how do we think about yen relative to your business?

We don't really think much about yen.

We don't really buy stuff from Japan.

We don't have any factories there.

We ship product in Japan, but pricing to our distributors is in dollars.

So our products may become cost-effective or less cost-effective as to the yen.

So if a customer has our design versus NS's design, you might see that difference, but most of our products that are selling to Japan are all proprietary.

So it's not been a major discussion at Microchip when yen changes.

Helpful.

And then on the SMSC, just accretion, what kind of revenue synergies have you guys uncovered?

Well, you know, quite a bit.

So we are finding that SMSC, USB and ethernet products and other common products have homes in lots and lots of Microchip sockets where we are shipping our microcontrollers, Serial and other products.

And they were either using somebody else's ethernet or they can add additional capability by having that connectivity.

In addition, lots and lots of USB sockets, where they have large customers, many of them we did not do business with.

And we are finding that they need a memory or they need on analog or they need a microcontroller.

A lot of these things have design cycles.

And the design cycle for anything these days is about a year, year and a half.

So SMSC acquisition is less than a year old.

So there is not a lot of revenue, although there is some, but there's a lot more coming in future.

Perfect.

Thanks, guys.

Welcome.

Harsh Kumar, Stephens.

Following up on that question, Steve, maybe if I remember estimates, you had a pretty strong and dynamic automotive line.

I know there's a time to get in that kind of business and a little bit longer than most, but I was wondering if you could shed some light on how long it may take to see some benefits of cross-selling there for that particular business?

Ganesh, you want to comment on that?

Yes, I mean, I think you are right.

SMSC did have a strong automotive product line and a very proprietary one at that.

They also have the added advantage of influencing designs at an architectural level with the carmakers, and not just working with the Tier 1's, where most semiconductor companies work with.

But with the Tier 1's customer -- end customer, who are OEMs.

And in that, we are getting insight into how those platforms are evolving over time, and how other Microchip solutions can be proposed and included as the early stage design of platforms are taking place.

But as you noted, these are long design cycles.

You won't see any of it in the next one, two, three years.

It will take time before they are done, go into production.

But, slowly but surely, as with all of our other embedded models, these are long-term growth initiatives.

Great.

Thanks, guys.

And with further questions in the phone queue, I would like to turn the call back to Steve Sanghi for any additional or closing remarks.

Well, we just wanted to thank all the investors and analysts for joining this call.

We will see some of you on the road this quarter at some of the sell side conference and all that.

Otherwise, we will talk to you next quarter in another earnings call.

Thank you.

This does conclude today's conference.

We thank you for your participation.