微晶片科技 (MCHP) 2014 Q2 法說會逐字稿

Good day, everyone, and welcome to this Microchip Technology second quarter fiscal year 2014 earnings results conference call.

As a reminder today's call is being recorded.

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

Please, go ahead.

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, and Ganesh Moorthy, Microchip's COO.

I will comment on our second quarter fiscal year 2014 financial performance, and Steve and Ganesh will 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 Relation 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 affects of our acquisition activities and share-based compensation.

Net sales on the September quarter were a record $492.7 million and were up 6.5% sequentially from net sales of $462.8 million in the immediately preceding quarter.

Revenue by product line was $321 million for microcontrollers, $108.5 million for analog, $35 million for memory, $24.8 million for licensing, and $3.4 million of other.

Revenue by geography was $95.2 million in the Americas, $98.9 million in Europe, and $298.6 million in Asia.

I remind you that we recognize revenue based on where we ship our products to, which tends to skew some of the revenue towards Asia where a lot of contract manufacturing takes place.

On a non-GAAP basis, gross margins were 59% in the September quarter, and above the high end of our guidance of 58.7%.

Non-GAAP operating expenses were 27.2% of sales.

Non-GAAP operating income was 31.8% of sales, and net income was a record $136.4 million.

This resulted in record earnings of $0.63 per diluted share, which was $0.03 above the midpoint of our guidance.

On a GAAP basis, gross margins, including share-based compensation and acquisition related expenses, were 58.6% in the September quarter.

GAAP gross margins include the impact of $1.9 million of share-based compensation.

Total operating expenses were $171.4 million, or 34.8% of sales and include acquisition intangible amortization of $23.7 million and also include share-based compensation of $13.1 million.

The GAAP net income of $99.8 million, or $0.46 per diluted share, was the result in the quarter.

In the September quarter, the non-GAAP tax rate was 10.6% and the GAAP tax rate was 10.3%.

The GAAP tax rate in the September quarter was favorably impacted by $2 million of nonrecurring items.

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 September quarter, acquisition related items were about $0.11, share-based compensation was about $0.062, nonrecurring tax events were about $0.009, and non-cash interest expense was about $0.006.

Share-based compensation was higher in the September quarter and will also be at a higher level than normal in the December quarter, due to the vesting of performance-based awards to employees that had been on voluntary-pay reduction program from late Q3 fiscal 2013 through Q1 of fiscal 2014.

This performance award vests on November 15, 2013 due to Microchip's achievements of record non-GAAP earnings per share in the September quarter.

We believe this pay sacrifice allowed us to remain committed to our strategic programs by avoiding a layoff and helped us deliver the outstanding results you are seeing now.

Share-based compensation is expected to impact earnings by about $0.058 in the December quarter and then reduce to about $0.051 in the March quarter.

The dividend declared today of $0.3545 per share will be paid on December 5, 2013 of shareholders of record on November 21, 2013.

The cash payment associated with this dividend will be approximately $70.4 million.

This quarter's dividend will be our 45th consecutive quarter of making a dividend payment.

We have never made reductions in our dividends, and, in fact, this quarter's increase marks the 39th occasion we have increased the dividend payment.

Our cumulative dividends paid is almost $2.1 billion.

This program continues to be an important component of how we return value to our shareholders.

Moving onto the balance sheet, consolidated inventory at December 30, 2013 was $275.1 million or 123 days.

We expect days of inventory at the end of the December quarter to be flat to up about 8 days based on our revenue guidance range.

Inventory at our distributors increased by one day during the September quarter to 33 days, and remained at low levels compared to where they had been historically.

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 decreased slightly on a sequential basis to $230.5 million.

Receivables remain in great condition with excellent payment performance continuing from our customers.

We had strong free cash flow generation in the September quarter of $126.4 million prior to our dividend payment.

As of September 30 the consolidated cash and total investment position was approximately $1.98 billion.

We had $640 million in borrowings under our revolving line of credit.

Excluding dividend payments, we expect our total cash and investment position to grow by approximately $110 million to $130 million in the December quarter.

Capital spending was approximately $27.4 million for the September quarter.

We expect about $35 million in capital spending in the December quarter, and overall capital expenditures for the fiscal year 2014 to be about $115 million, as we are adding capital to support the growth of the Business and to bring in-house some of the assembly and test operations that were outsourced by SMSC.

Depreciation expense in the September quarter was $23 million.

One question we have received from investors is whether we are concerned about the level of the short interest in our stock.

In summary, we are not, and we wanted to pass along our assessment of the situation.

As you know Microchip has had a convertible bond outstanding since December 2, 2007.

The bonds are convertible into $43.4 million shares, which is about 22% of our outstanding common shares.

According to public sources, the aggregate short-interest position in our shares jumped from approximately 5 million shares to approximately 25 million shares when we issued the convertible and that number is roughly 20 million shares today.

This level is neither surprising nor troubling to us because the significant portion of the convertible bond market consists of arbitrage funds.

The general strategy of these funds is to hold convertible debt where it creates an economic long-stock exposure and then hedge this exposure with a short-position in the common shares.

It is worth noting that this hedging objective is very different from the strategy of activists or directional short-sellers.

In any event, the size of the short position arising from a convertible will correspond to the level of equity exposure in the bonds and the percent of the bonds being held by arbitrage funds.

We know that a sizable amount of our convertible is held by arbitrage funds, and we believe that their activity represents the majority of the overall short interest, which has generally remained in the 15 million to 25 million shares range since 2007.

Other companies that have similar convertible bonds outstanding also have high levels of short interest in their socks.

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

Ganesh?

Thank you, Eric.

Good afternoon, everyone.

The September quarter was one for the ages with strong growth in each of our product lines and new records in most events.

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

Our overall microcontroller revenue grew a strong 6.9% sequentially in the September quarter to achieve an all-time record of $321 million in revenue.

Microcontroller revenue was also up 22.9% versus the year-ago quarter.

As we projected in our July conference call, our 8-bit microcontrollers did set a new record in the September quarter, as did our 16-bit and 32-bit microcontroller businesses.

Microcontrollers represented 65.2% of Microchip's overall revenue in the September quarter.

Sometime in the month of November, we expect to ship our 13 billionth cumulative microcontroller, a milestone that will occur just seven months after we shipped our 12 billionth microcontroller back in April of this year.

Our 16-bit microcontroller business was up 10.9% sequentially in the September quarter, achieving a new record for revenue.

16-bit microcontroller revenue was also up 48.1% over the year-ago quarter.

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

Our 32-bit microcontroller business was up 24% sequentially in the September quarter, registering another strong quarter of growth to also set a new record for revenue.

32-bit microcontroller revenue was also up 53.4% over the year-ago quarter.

We are continuing to expand our new product portfolio.

Next month, we plan to announce a number of blockbuster solutions that will further enrich our 32-bit microcontroller platform offering.

In the meanwhile, we are continuing to win new designs and we are expanding into new applications to enable further growth in revenue and market share.

Our overall microcontroller results, as well as each of our 8-bit, 16-bit and 32-bit results are clearly outperforming the market, with sequential and year-over-year growth rates well above the market and what we have seen reported by our competitors in their results.

We are gaining significant market share and have the new product momentum and customer engagement to continue to gain even more share as we further build the best performing microcontroller franchise in the industry.

Now moving to our analog business, this business grew 5.1% sequentially in the September quarter, the eighth consecutive quarter of sequential growth to also achieve a new record.

It continues to perform exceptionally well.

Analog revenue was also up 25.2% from the year-ago quarter.

Analog revenue now represents 22% of Microchip's overall revenue in the September quarter.

At close to $434 million annual sales run rates, it remains one of the best performing analog franchises in the industry.

We are continuing to develop and introduce a wide range of innovative and proprietary new products to fuel the future growth of our analog business.

Moving to our memory business.

Our memory business, which is comprised of our Serial E2 memory products as well as our SuperFlash memory products was up 2.9%.

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.

Our memory business represented 7.1% of Microchip's overall revenue in the September quarter.

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

Steve?

Thank you, Ganesh.

Good afternoon, everyone.

Today, I would first like to reflect on the results of the fiscal second quarter of 2014.

Then, I will provide guidance for the fiscal third quarter of 2014.

I will also provide guidance for our long-term model, which we are revising upwards.

We are very pleased with our execution in the September quarter.

Our actual net sales exceeded the high end of our guidance.

The 59% gross margin we achieved was 100 basis points better than June quarter and exceeded the high end of our guidance as we increased factory output to meet the increased sales results.

Our operating profit percentage reached 31.8%.

We're making excellent progress towards what our long-term goal of 32% operating profit was, which we will revise higher later in this call.

Non-GAAP earnings per share also exceeded the high end of our guidance and beat our guidance by $0.03 per share.

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

Our total net sales, microcontroller net sales, analog net sales, and our licensing business all achieved new records.

Individually, 8-bit microcontrollers, 16-bit microcontrollers and 32-bit microcontrollers all achieved new all-time records.

Our record 8-bit microcontroller revenue further validates what we have been communicating to investors and analysts, which is that our 8-bit MCU business is very healthy, growing and very profitable.

Our 8-bit MCU business is continue to gain share from competitors who have either moved away from 8-bit or are otherwise uncomparative and cannot make money the 8-bit market.

We are also continuing to gain market share in the 16--bit MCU, 32-bit MCU and analog.

We mentioned on our last conference call that Microchip has an outsized exposure to housing, industrial and automotive sectors.

These have been some of the strong sectors of the economy this year.

While we do not break out our business by these sectors, just looking at some sample customers we saw significant strength in customers that sell products for housing, industrial and automotive.

Last but not least, the September quarter was our 92nd consecutive profitable quarter, which is 23 years of making profit every quarter.

I want to thank all the employees of Microchip for their contribution in making this an outstanding quarter in every respect.

I also wanted to compare our results of September quarter versus the year-ago September quarter.

September quarter this year was up 20.8% over the September quarter last year.

Last year, September quarter had two months of SMSC in it.

If we add the third month of SMSC and then compare, the September quarter this year was up 11.5% over September quarter last year.

This was the best performance among our peers and competitors, and many of whom were flat to down in September quarter over the year-ago September.

Our outstanding results were also recognized by Selling Power magazine, who recently named Microchip to its annual 50 Best Companies to Sell For for 2013.

Microchip ranked 19th and is the only semiconductor company on that list.

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

The December quarter is our seasonally weakest quarter of the year.

The December quarter in 2010 and 2011 averaged a sequential decline of 3.5%.

Last year was impacted positively by an additional month of revenue from the SMSC acquisition.

We are expecting the December quarter this year to be seasonally normal, and our guiding for net sales to be flat to down 6% sequentially.

On a non-GAAP basis we expect our gross margin to be between 58.8% and 59.2% of sales.

We expect operating expenses to be between 27% and 27.5% of sales.

We expect operating profit to be between 31.3% and 32.2% of sales.

We expect non-GAAP earnings per share to be between $0.57 and $0.63 per share.

As I said earlier in the call, we are revising our long-term model upwards.

You may recall that after the acquisition of SMSC we revised our long-term model downwards.

This was driven by the lower gross margin, higher operating expenses and lower operating profit of the SMSC business.

We are revising the business upwards due to three reasons.

Number one, our microcontroller and analog businesses have performed very well.

With improving factory utilization, our margins in microcontrollers and analog have recovered very nicely.

We believe that we have further upside as the factory utilization continues to approach the old record and eventually exceed it.

Number two, while we had countered on significant improvement in the SMSC operating model, we have substantially exceeded our own internal goals.

SMSC operating model is now approaching the traditional Microchip model.

The longer-term synergy actions are also now starting to bear fruit.

As one example, I just returned from our Asia-wide distribution conference, the opportunities that our sales and distribution network have identified on SMSC products is truly impressive.

As these opportunities move down the sales process and get to the order stage, we will see substantial growth and our profitability model will continue to prove.

Number three, our licensing business just achieved an all-time record and is at nearly $100 million run rate.

At 100% gross margin, its net effect on gross and operating margin is very accretive.

Based on these three factors, we are revising our long-term model for Microchip upwards.

We are revising the midpoint of gross margin to be 150 basis points higher.

We are revising the midpoint of operating expenses to be 100 basis points lower, and we are revising the midpoint of the operating profit to be 250 basis points higher.

We now expect the long-term gross margin to be 61.5% plus or minus 0.5%.

We now expect long-term operating expenses up about 26.5% plus or minus 0.5%.

We now expect operating profit up about 35% plus or minus 1%.

All of these numbers are non-GAAP.

This takes our long-term operating model back to what it was prior to the SMSC acquisition.

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 poll for questions.

(Operator Instructions)

Chris Caso, Susquehanna.

Taking into consideration the revised margin targets, what should we expect with respect to the gross margins, operating margins, as we go through the cycle?

I think that during the last cycle, your gross margins bottom of 56%.

Would you also assume that we -- obviously, we don't know where revenue would trough during the next downturn, but would you expect to see higher troughs for the same reasons that you had mentioned?

It seems like the jist of your question implies revenue continues to go down here and troughs somewhere.

Our expectation is that December quarter is seasonally very normal.

As you have seen in the past, December quarter is seasonally down and then the March quarter is seasonally up.

We usually grow low-single digits in the March quarter and our current expectation is that that will not be really any different.

Sure.

The nature of my question wasn't really near-term.

Obviously, it is a cyclical business.

As you go through the length of a cycle, really that was what I was getting at.

I am not seeing the recession in front of us.

Recessions come in various forms.

There are unit recessions, demand recessions, inventory driven recessions, financial crises and everything is different depending on what we do with our fabs, what we do with our assembly and tariffs, what actions we take.

It's very, very difficult to guide on something we don't see today on really what our actions would be in response to that recession.

Maybe I would add to that.

Now that a larger portion of our business is relying on foundry, that has less of the ups and downs in the gross margin area because it's not impact by our own factory utilization.

But, like Steve says, each cycle is different.

Okay, just a quick follow up.

With regard to the plans to build inventory, could you talk a little bit about the reasons behind that?

Perhaps that has some connection to where your lead times are now?

I will give your general opinion on inventory.

We don't manage the inventory.

We don't manage our factories in a way that we constantly take them up or down to try to manage into a very tight range of inventory.

You can go back in our history, we have never done that.

The companies who do that, they're either constantly laying off people and cutting production and then hiring untrained people and desperately trying to grow and making mistakes when the times grow stronger.

Our desire through the cycle, usually, is to run our factories in a much more constant fashion and allow the inventory to fluctuate up or down.

Now, the very long lifecycle of Microchip products, microcontroller, analog, and memory products historically has always allowed us to manage it in that fashion and not take any large inventory write offs.

You could go back in history, there is no record of Microchip coming to you and saying we wrote off $100 million of inventory like some other competitors may have done.

We run the factories much more normally and we allow the inventory to fluctuate.

As Eric mentioned, in more recent past we now have 40% of the business coming at our foundries because of significant large acquisitions and others, which allows you to really control inventory rapidly by cutting the staffs on the outside factors.

When you put it all together, til just a month and a half ago, we were expediting products and trying to improve production and adding capacity because we -- the midpoint of our guidance for September quarter was 4%.

We produced 6.5%.

If you manage to tightly on the inventory, you cannot produce that kind of upside in a very short time frame.

Now, the December quarter is seasonally down.

We expect March quarter to be up.

In that kind of environment, we don't really take any actions.

So, the inventory driven by global revenue will be higher in December, and we'll decrease some in March.

We'll take those actions over the next two or three quarters, allow the revenue increase to naturally adjust inventory.

Having said all that, there've been couple of times in our history, one was after the financial crisis of 2009 and may have been a tech bust or some of these mega events in the industry can cause a situation where you have to take precipitously some strong actions otherwise inventory would grow way too high.

Other than that, with these small one quarter perturbations, within our business, more constantly and not go up and down.

Sorry for the long answer.

Understood.

Thank you.

Jim Schneider, Goldman Sachs.

Steve, I was wondering if you could maybe comment on the overall bookings environment?

This time last quarter you talked about very strong bookings environment and later in the quarter you guided to the narrow to the midpoint of the range and then you ended up doing much better than that.

I'm just curious, have the bookings pace moderated at all at this point?

Or, do you still expect a fairly strong book to bill, and then the December guidance is more of just -- a little-bit more tempered by the normal seasonality?

Bookings are still good.

If I look at the overall long-term backlog and the bookings that are coming in are still good.

Bookings, a large amount of bookings are aging into the next quarter.

Some are aging into this quarter, but based on -- at the rate they are aging and the amount of nine weeks or so left in the quarter, it was brushed into the guidance that we provided.

The overall rate of the bookings are still strong because lots of bookings are coming into the next quarter, which is seasonally stronger quarter for us also.

I understand, that is helpful.

If you think about the upward vision to your gross margin target, how much do you think is being driven by the licensing business versus the mix of products you are expecting to have versus utilization?

Any way to put some kind of rough sense on that?

They were really in that order.

The best performance we are getting is really out of our own microcontroller and analog businesses.

There was a concern from the street on our 32-bit business.

There was a concern on our 8-bit business.

There was concern on our 16-bit business that we'll get squeezed by 8 and 32.

There was concern of 8-bit business because everybody else is going away from it.

There was a concern on our 32-bit business because we are not Ohm.

I think over many years now we have demonstrated that are 8-,16-, 32-bit, that all those three businesses are grew at a tremendous wind.

They are all going and they're all making records.

They are all high margins and so on and so forth.

So temporarily, during last year, our gross margin went down because essentially factory utilization.

It affected, significantly, internal businesses, the ones we run inside our fabs because those were the ones mainly impacted by lower utilization.

As that utilization has continued to improve, and especially by beating these numbers, last three quarters we have beaten our revenue guidance.

The utilization is getting quite healthy, but there is more to go.

As we are seeing the utilization improve, our internal margins are back to historical margins.

Either they are where we can project them going forward as the utilization proves a bit more.

The second effect is SMSC.

When we purchased SMSC, its full-year operating margin in the year prior to our acquisition was only 12%.

Til the time we were breaking it out, I think we had told you, quarter or so ago, that we had more than doubled that operating profit.

We're no longer breaking it out because the numbers are very intertwined.

Operating expenses are very hard to figure out, what division they are going into.

Based on our own assessments, internally, that business now is performing as well as our own businesses are.

This is how much we've improved them.

Some of the long-term attrition is underway and yet to come.

Every quarter, as it goes by, higher and higher portion of their product is entering into our factories for assembly and test purposes.

The ultimate accretion really comes from the marketplace where we are seeing an enormous sales opportunities from them develop in selling SMSC products allowing Microchip's consumer, industrial, automotive customer sockets, which are sales and distribution network has identified an enormous opportunity.

Some of them, we'll see them in the later part of next year and some are longer term.

All those are very high margin into a Microchip business system.

A lot of them will be coming from Microchip's ecosystem into the factories and all that.

It will be very, very high margin.

That's another thing that's accretive.

Third, other effect is the licensing business.

That is helpful, thank you very much.

John Pitzer, Credit Suisse.

Congratulations on the strong results.

Steve, clearly on of the core competencies that you guys have proven over the last several years are finding and integrating these acquisitions.

I'm curious relative to the answer to your last question.

Any way to qualify either through incremental TAM or incremental growth rate, do you think these acquisitions have added to the core Microchip business?

I guess more importantly, are you now at a TAM level or expected growth rate level longer term that you are satisfied with, or do you see other opportunities to hone in on acquisitions and integration?

It's difficult to put numbers on that, nor are we usually comfortable in putting numbers on it.

Because, one, it projects too much.

Secondly, it tells everybody else what we are doing, our competitors and others.

In general, I am always uncomfortable in giving that kind of data, but let me give you one.

If you look at our December quarter guidance, despite the December quarter being guided down 3%, our December quarter at that guidance, midpoint of the guidance, will be up 15% from December quarter of last year.

14.9% to be exact.

And, there's no acquisition in between.

The December quarter last year had full SMSC in it.

So, December quarter last year to December quarter this year, at the midpoint of the guidance, will be up 14.9%.

Who is up 14.9% right now?

Most companies are down year over year, and guiding down further in December quarter.

You are seeing the result of our internal core strength in 8, 16, 32 and analog.

You're seeing the effect of acquisitions.

You're seeing our ability to take these acquisitions and digest them, and then be able to create more business out of them across our customers in sockets and all that.

I don't know whether that answers your question.

That's helpful, Steve.

As a quick follow on, historically you guys have given us revenue detail by product, less so by end market given how much goes through distribution.

I'm curious, as you think about exploiting things like the auto end market vertical, does the current distribution model work as well?

Or will you start having operationally more of an end-market focus to try to exploit some of these revenue opportunities?

We have always had selected end-market focus.

We told you that when we acquired SMSC one of the criticisms was that Microchip is a horizontal focused company and SMSC is a vertical focus company.

They don't fit, and it was a bad acquisition, if you recall.

Microchip has always run the automotive business in a vertical-market fashion for years, 12 years, 15 years plus.

Our automotive business does not go through distribution.

We do business with all large automotive companies and their suppliers.

That has always been handled by Microchip's direct sales force.

So, SMSC's automotive business fit very will along with that.

We have found substantial, incremental opportunity on SMSC's automotive sockets around really our business and vice versa.

Same is the case, we did business directly with number of large computing manufacturers, which we now go through distribution.

Same way, SMSC's business fit very well with that.

We have found sockets around each of those sockets and business units.

Microchip has always been a mixture of a broad-based long-tail horizontal company, yet executing on a large number of vertical focuses very well.

We have had a very vertical focus on automotive, home appliances, medical, energy, --

Touch and the interface stuff.

I would say -- a bunch of display driving in all of that.

Automotive and infotainment, it's a pretty broad range.

Automotive infotainment, motor control, connectivity, so there's number of large vertical application areas that we have really managed very will internally and really have a dual sales structure with centers of expertise in various markets that work together with our horizontal sales force.

John, maybe if you're assuming that because our distribution sales are quite large, that those are not customers we touch, there's a good portion of distribution revenue that actually is resulted from Microchip creating the demand, but we let customers choose what the best fulfillment channel for them is.

In many cases that is direct, and in some cases that is distribution, but distribution customers are not left just to distribution to create demand.

Thanks guys, that is really helpful.

Craig Hettenbach, Morgan Stanley.

This is Mike Rell.

I'm dialing in for Craig.

Microcontrollers have been really strong for the last few quarters.

Could you talk more about your 32-bit microcontrollers?

What applications are they seeing the stronger design traction?

Also, could you just compare your 32-bit product introductions this year related to last year?

Ganesh?

What was the last part of the question?

How do we compare the new product introductions this year to last year.

Okay.

Let me start with the second part of the question.

Obviously, we are accelerating native new product introduction.

As I mentioned, you're going to see some blockbuster announcements coming in the month of November.

It's an area where we have been continuing to increase investment over the last several years.

We are building out the portfolio to fill out the range of different memory sizes, functionalities, package sizes, et cetera, to build a strong portfolio that can be used in many, many different applications.

You'll see that as we move into 2014.

That breadth of products will continue to accelerate.

In terms of the applications themselves, they are often in the kinds of applications where our 16-bit microcontrollers are.

They are run-of-the-mill applications.

They can be in power supplies and human interface and motor control, in general.

Then, you'll find them in coffee machines, in cars, in broad range of applications, but where there is more needed, in terms of either performance, memory, features or otherwise, then what our 16-bit portfolio can provide.

We provide a seamless migration, in the way that we have planned our products, that customers can go up and down our microcontroller range of products.

In the case of 32-bit, most often from 16-bit products up.

There's nothing earth shattering about a brand-new application that our 32-bit is in that is driving our design.

It's pretty a broad range of designs, a broad range of applications that we are designed in to.

Got it.

That's helpful.

For my follow up, as a side light, SMSC integration is broadly complete and it's on the same target model now.

What is your appetite for additional acquisitions?

What is the biggest hold, currently?

Is it pricing?

Lack of targets?

What is it like going forward?

Our appetite is very good, but we don't have a target.

And, we're disciplined about how we approach it.

We're disciplined about how we approach it.

We have passed on a number of targets that we have looked at for various reasons, lack of fit, not priced appropriately, not synergistic with our business, for various other reasons.

If investors and analysts were to give us ideas, we would be happy to take them.

Don't expect feedback on them, where we are in the process after you give us that idea, but we do not have a target today.

That's all, guys.

Congratulations, once again, on a solid quarter.

Thank you.

(Operator Instructions)

Rajvindra Gill, Needham & Company.

(Operator Instructions)

Let's go to the next one.

Terence Whalen, Citi.

Congratulations on the strong results.

My question, wanted to focus on licensing in particular.

It sounds like based on the increase in the target profitability model you're continuing to expect licensing to be a strong portion of that profitability.

I just wanted to understand, going forward, how we should think about modeling that line, whether that line can continue to grow or whether there are any certain expirations that we have to be aware of in terms of future cliff and licensing revenue?

Thank you.

The licensing revenue is very broad.

We essentially have most foundries in the world licensed, lots of large IDM customers are licensed.

There are many market segments, microcontrollers, SOCs, FPGAs, smart cards and others that run on using our process technology.

It's a fairly broad-based business, and really there is no really major lumpiness in it like you shouldn't expect one quarter you come and it goes down 50% or anything like that because of some expiree.

There are lots of different process nodes.

We're getting royalties all the way on .5, .35, .25, .18, .13, .11, and 90-nanometer and 55.

So, it's really a very broad and it is just -- a few things we go down and volume, while the newer nodes are going up.

So I think -- I don't know whether that answers your question, but you should be concerned about any major reduction of any kind.

And there are ongoing new licensees that are coming on board.

Okay.

So it's steady and stable it sounds like.

The quick follow up I had was a longer-term technology question.

As you evaluate the development of the Internet of Things, I know that is a very broad and loose term, but do you feel like you have the right capabilities?

Where do see the opportunities?

Do you have the correct RF technology in particular to pair with your controllers?

Thanks.

It's a market we have been in for a while.

There are several ingredient capabilities that are needed to enable customers who want to reach Internet of Things solutions.

If you look at, and fundamentally you need some form of microcontroller in these applications, often these are applications we're already designed in and a customer is now looking to extend the capability to connect to the internet.

Let's look at a thermostat, as an example.

If you take a standard thermostat, we've been in it for 20 plus years with analog functionality, microcontroller functionality, now customer who has a thermostat who wants to be able to connect to the internet takes advantage of our wireless capability.

In most cases it will be a Wi-Fi connection that we can enable and we have enabled using our Wi-Fi modules that we provide.

In other cases it might be a proprietary wireless that then has a way to get back into the internet.

The other big challenge that many customers have is, well, how do they manage the other side of this picture is the cloud itself.

Some customers are sophisticated and have the ability to manage how they have a set up on the cloud that can receive the data and then be able to do something with it.

We have many customers for whom that is new.

As you saw earlier this week, we announced a partnership with Amazon, actually it was last week that we announced, to be able to help host these capabilities and enable people to take advantage of existing solutions but get on the cloud with their applications.

So, we believe we have put together, with our existing solutions and with partnerships for the cloud, the ingredients that are needed for anybody who has an Internet of Things thought process and application that they want to get into.

Terrific, thank you.

Christopher Danely, JPMorgan.

Sean Bachey for calling in for Chris.

I just want to get your thoughts real quick on the various geodes, if you are seeing any particular areas of strength here as we look into the December quarter?

Thanks.

Typically, what we will see in the December quarter is that, due to the holidays, we'll see Europe and the Americas have some stress on the business.

Asia typically does okay.

It's not enough to offset the weakness that we see out of Europe and the Americas.

It's really a holiday driven phenomenon, just like we see in the March quarter with Asia being weak to the Chinese new year.

Okay, great, thanks.

Just as a quick follow up, as we look into the December quarter.

Can you give us the puts and takes in your guidance?

Are there any segments here that, MCU or analog particularly, that may be up or down a little but more than the others?

We don't really breakout by segment.

Okay.

We have 14 product divisions inside Microchip, internally, how we manage it.

There's just too many.

We look at them for you in 8 and 16 and 32, analog and all that, but it's much broader internally.

Some of them have multiple things in one division, so can't break it down any further.

Okay.

Fair enough.

Thanks, guys.

Gil Alexander, Darfil Associates

Congratulations.

Two question if I may ask.

Could you give us an idea of your factory utilization at this time?

Historically, we have not given a number on factory utilization.

The problem is that there is a tendency then to draw a straight line and try to figure out every point of utilization means what on gross margin and track and expect that as utilization goes up or down.

What we have seen is historically leads to wrong conclusions because in the one quarter unfair portion of our growth may come from foundry products, and other time may come from internally, and not all products have same gross margins and depending on what you are running in a given quarter.

It's a very complex mix.

We are, in general, not comfortable with trying to tie a given utilization to a given gross margin.

Our utilization has not peaked yet compared to what it was before.

There is a significant more accretion to go.

Several more quarters, as we continue to increase the utilization for the gross margin to continue to really grow higher and eventually utilization will grow beyond that.

But, we are not running all the equipment we have in our factories flat out, which means utilization still has a way to go.

All right, thank you.

My second question, on your return from Asia, can you give us any reasonable reading of the Chinese economic growth?

Our China business did enormously well.

In fact, that is one, we break it out, in the queue.

We break out the percentage of the total revenue and it is approaching 29% of the total now.

If you break it out in percentage, they can configure out the dollar.

Yes

So, what did it grow quarter over quarter, sequentially?

I do not have that in front of me.

It was very strong growth.

So, 6.5% overall growth.

The highest growth, I think was close to double-digit.

I recall seeing it.

China did very well.

The China GDP numbers in the latest reports were slightly revised upwards, so despite what you hear in China, China business is very solid.

Thank you very much.

Kevin Cassidy, Stifel Nicolaus.

This is Dean Grumlose calling in for Kevin.

I was wondering if your could describe how the 32-bit market may differ from 8 and 16 in terms of perhaps what customers are looking for or the product needs?

As a follow up, how you would view your progress in this market so far compared to the previous markets?

I want you to think of 32-bit as not a separate market.

It's one continuum of microcontroller markets for which different products serve the needs of that market.

There is a range, performance, memory size and features at which the 32-bit is a right product to be able to use in those applications.

Often at the boundary between 16 and 32-bit you can have 16-bits that are in 32-bit type of applications and vice versa.

Our own progress here has been outstanding.

You can take a look at the last many years over which we have reported our sequential, as well as our year-over-year growth.

It's significant.

Obviously, several years ago it was growing off of a very small base, but it has continued to grow into a reasonably sized business for us.

Product portfolio has expanded in that time frame.

The served available market that we can target has grown with that.

Perhaps in that continuum of 8, 16s, and 32, the largest change is really the software intensity that is involved in these applications.

In addition to the silicon level products, there is a significant software investment that we have to make in being able to enable solutions.

We have done that, and we expect to be doing more of that along with our Silicon products in 32-bit in the coming months and years.

That is very helpful, thank you.

Harsh Kumar, Stevens.

This is Richard in for Harsh.

Good job and congratulations on a solid quarter.

I wanted to get your sense on seasonality?

You talked about the seasonality in the December and March quarter, but have you seen any changes in the June and September quarters with the addition of SMSC?

No, actually did not seem to have changed our seasonality.

June and September quarters were very strong.

March quarter was good.

June was excellent, September was excellent.

December is seasonally normal.

We are expecting March to be seasonally normal, which would be up low-single digits.

Great.

Thanks.

My follow on relates to SMSC as well.

Have you seen any benefits from the backend integration yet?

If not, when do you expect to see those benefits?

Yes, we have seen benefit from a backup integration at the backend.

There was some in the June quarter, much more in September quarter, to be even more in December, so it's really continuing.

Also requires capital investment to bring some of it in, and we are doing it at a controlled pace.

Great, thank you for that and congratulations.

Thank you.

This does conclude today's question-and-answer session.

At this time, I'll turn the call back to our moderators for any additional or closing remarks.

Okay, we want to thank everyone for attending this call.

We'll be at some conferences.

I believe the next one is?

The next conference we will be at his Credit Suisse Conference in Phoenix.

We'll also be at the NASDAQ conference in London, and some marketing throughout the quarter.

We will certainly see some of you at the CSAT conference in Scottsdale.

I'll promise a great weather here.

It's our hometown, so please come and see us.

Thank you.

This does conclude today's conference call.

Once again we would like to thank everyone for your participation and have a wonderful day.