微晶片科技 (MCHP) 2015 Q1 法說會逐字稿

Good day, everyone, and welcome to this Microchip Technology first-quarter and fiscal-year 2015 financial 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, sir.

Thank you and good afternoon, everyone.

During the course of this conference call, we will be making projections and other forward-looking statements regarding future events for the future financial performance of the Company. We wish to caution you that such statements are predictions and that actual events or results may differ materially. We will 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 first-quarter fiscal-year 2015 financial performance, and Steve and Ganesh will then give their comments on the results, provide some additional information on our acquisition activities, and discuss the current business environment, as well as 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.

Non-GAAP net sales in the June quarter were above the midpoint of our guidance at a record $531.3 million, including $20.2 million of non-GAAP net sales from Supertex, and were up 7.7% sequentially from net sales of $493.4 million in the immediately preceding quarter. Non-GAAP net sales were $2.5 million higher than GAAP net sales, as GAAP does not recognize revenue on the sellthrough of products sitting in the distribution channel on the date an acquisition occurs.

Revenue by product line was a record $343.8 million for microcontrollers, a record $127.8 million for analog, $33.4 million for memory, $20.4 million for licensing, and $5.9 million of other. The Supertex non-GAAP revenue was $17.6 million of analog and $2.7 million of foundry services revenue, which we classify in the other category.

Revenue by geography was a record $103.3 million in the Americas, $109.7 million in Europe, and a record $318.3 million in Asia. I will 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 above the high end of our guidance at 59.8% in the June quarter. Non-GAAP operating expenses were at the low end of our guidance at 26.6% of sales. Non-GAAP operating income was above the high end of our guidance at 33.2% of sales and net income was a record $151.6 million. This resulted in record earnings of $0.68 per diluted share, which is at the high end of our guidance and $0.02 above the midpoint.

On a GAAP basis, net sales were $528.9 million and gross margins, including share-based compensation and acquisition-related expenses, were 58% in the June quarter. GAAP gross margins include the impact of $2.1 million of share-based compensation and $7.8 million of charges associated with the sellthrough of written-up inventory from our acquisitions of Supertex and EqcoLogic.

Total operating expenses were $190.6 million, or 36% of sales, and include acquisition intangible amortization of $36.6 million, share-based compensation of $11.3 million, $0.9 million of acquisition-related expenses, and special charges of $0.3 million.

The GAAP net income of $89.9 million, or $0.40 per diluted share. GAAP net income includes nonrecurring unfavorable tax events of $4.5 million, which were primarily associated with integrating Supertex into Microchip's corporate structure.

In the June quarter, the non-GAAP tax rate was 10.7% and the GAAP tax rate was 16%. The GAAP tax rate was unfavorably impacted by the $4.5 million of nonrecurring tax events that I mentioned before. Our tax rate is impacted by the mix of geographical profit, withholding taxes associated with our licensing business, and the tax effect of various nonrecurring items. Excluding any nonrecurring events, we expect our longer-term forward-looking non-GAAP effective tax rate to be about 10.5%.

To summarize the after-tax impact the non-GAAP adjustments had on Microchip's earnings per share in the June quarter, acquisition-related items were about $0.195, share-based compensation was about $0.053, nonrecurring unfavorable tax events were about $0.02, and non-cash interest expense was about $0.07.

The dividend declared today of $0.356 per share will be paid on September 4, 2014, to shareholders of record on August 21, 2014. The cash payment associated with this dividend will be approximately $71.4 million.

This quarter's dividend will be our 48th consecutive quarter of making a dividend payment. We have never made reductions in our dividend and, in fact, this quarter's increase marks the 42nd occasion we have increased the dividend payment and our cumulative dividends paid amount to $2.3 billion. This program continues to be an important component of how we will return value to our shareholders.

Moving on to the balance sheet, consolidated inventory at June 30, 2014, was $264.5 million, or 109 days, compared to 118 days at the end of the March quarter. The inventory balance at June 30, 2014, includes $8.5 million of Supertex inventory writeup costs required for GAAP purchase accounting. Excluding the Supertex inventory and its associated GAAP writeup, Microchip had 108 days of inventory on its balance sheet at the end of the quarter.

We have taken steps to increase our capacity so our inventory days don't go significantly lower in the September quarter and support the needs of our customers.

Inventory at our distributors decreased by two days in the June quarter to 31 days and remains at low levels compared to where they have been historically. I want to remind you that our distribution revenue throughout the world is recognized on a sellthrough basis.

At March 31, the accounts receivable balance was $286.7 million, an increase by $44.3 million on a sequential basis, due to the acquisition of Supertex and the revenue growth we experienced in the quarter. Receivable balances remain in great shape.

The increase in Microchip's net cash and investment balance in the June quarter, excluding our acquisition of Supertex and our dividend payment, was $121.3 million. As of June 30, the consolidated cash and total investment position was approximately $2.29 billion and our borrowings under our revolving line of credit increased to $980 million.

The increase in Microchip's borrowing during the June quarter was driven by our acquisition of Supertex.

Excluding dividend payments and our acquisition activities, we expect our total cash and investment position to grow by approximately $160 million to $180 million in the September quarter.

Capital spending was approximately $44.6 million for the June quarter, and we expect about $50 million in capital expenditures in the September quarter and overall capital expenditures for the fiscal-year 2015 to be about $175 million, as we are adding capital to support the growth of the business and to bring in house more of the assembly and test operations that are currently outsourced.

Depreciation expense in the June quarter was $23.3 million.

I want to remind our investors and analysts that as Microchip's stock price changes, there is a diluted share count impact from Microchip's outstanding convertible debt. There is a table on the supplemental financial information section of Microchip's investor relations site that walks through the level of dilution at various stock prices that you may find helpful.

The diluted common shares outstanding presented in the guidance table in today's press release assumes an average Microchip stock price in the September 2014 quarter of $46 per share. However, we make no prediction as to what our actual share price will be for such period or any other period.

I will now ask Ganesh to give his comments on the performance of the business in the June quarter and provide an update on the Supertex and ISSC acquisitions. Ganesh?

Thank you, Eric, and good afternoon, everyone. Let's take a closer look at the performance of each of our product lines, starting with microcontrollers.

Our overall microcontroller revenue grew strongly at 5.3% sequentially in the June quarter and was up 14.5% versus the year-ago quarter, achieving a new revenue record. All three microcontroller segments, 8-bit, 16-bit, and 32-bit, experienced sequential growth in the June quarter and all three microcontroller segments achieved record revenue in the June quarter. Microcontrollers represented 64.7% of Microchip's overall revenue in the June quarter.

We normally don't provide much color on our 8-bit microcontroller business, but I'm going to make an exception this time because the results are exceptional and don't always get the attention they deserve. Not only did our 8-bit microcontroller revenue achieve a new record in the June quarter, the cumulative revenue in the last four quarters of our 8-bit microcontroller revenue was up 11.5% over the cumulative revenue in the prior four quarters.

We continue to gain significant share as competitors have defocused in this area, while we have continued to introduce a large number of innovative new products that have captured the imagination of a broad range of customers who have designed them in. In fact, demand for our innovative new 8-bit microcontroller products introduced over the last three years have been so strong, it has outstripped our ability to ramp manufacturing fast enough. Steve will talk more about that later in his section today.

Our 16-bit microcontroller business was up 0.6% sequentially in the June quarter, also achieving a new record for revenue. 16-bit microcontroller revenue was up 26.5% versus the year-ago quarter. While the 16-bit microcontroller business took a bit of a pause in the June quarter, this business continues to be an important engine of ongoing growth for us as we continue to find and serve new customers and new applications with our expanding portfolio, and we expect strong growth in the September quarter.

Our 32-bit microcontroller business was up 21.5% sequentially in the June quarter, also achieving a new record for revenue. 32-bit microcontroller revenue was also up 59.8% versus the year-ago quarter. This business is now at a size and growth rate where it is making meaningful contribution to our ongoing growth. We are continuing to rapidly expand our new product portfolio, win new designs, and expand our presence in fields of play, like the Internet of Things, to enable further growth in revenue and market share.

Overall, we continue to gain significant microcontroller 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 let's move to analog products, and before I comment on the analog business, let me reiterate what Eric said in terms of how we will be reporting the Supertex business, as this is the first time we are including it in our results. Approximately 85% to 90% of Supertex revenue consists of proprietary analog products, which will be consolidated into our analog reporting segment. The remaining approximately 10% to 15% of Supertex business consists of providing specialty foundry services for customers to have their proprietary designs fabricated by Supertex, which will be consolidated into our reporting segment classified as other.

All of what we have reported in the other category historically has been our specialty high-reliability assembly and test services business that we inherited as part of our acquisition of MMT in Thailand about three and half years ago.

Now let's get to the performance of our analog business. Including Supertex analog products, our analog business grew 18.9% sequentially in the June quarter and was up 23.8% from the year-ago quarter. Including Supertex analog products revenue, our analog business represented 24% of Microchip's overall revenue in the June quarter and we crossed a key milestone with over $500 million of annualized analog products revenue. We continue 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, which is comprised of our Serial E-Squared memory products, as well as our SuperFlash memory products, this business was sequentially up 0.7%. 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 6.3% of Microchip's overall revenue in the June quarter.

Now a short update about Supertex and where we are in the integration process. Effective July 1, Supertex operations, spanning from order entry to manufacturing to shipments to billings, are fully integrated into Microchip's business systems. Supertex had a small subscale assembly and test operation in Sunnyvale, California, for a small percentage of their manufacturing. The Sunnyvale operations have been closed and the manufacturing done there has been absorbed into Microchip's Thailand facility.

Supertex has a leased six-inch fab in San Jose, California.

Prior to our acquisition, Supertex had already started to qualify many of their products at foundries for better competitiveness. After completing a detailed assessment, we have begun qualifying at Microchip's fabs some of the products that were planned for movement to the foundries. We're also studying the long-term scalability and cost effectiveness of Supertex six-inch leased fab and expect to conclude our study by the end of this quarter.

Supertex subcontracts 100% of its assembly and over 60% of its test volume. We have identified and started transferring some of the products currently outsourced by Supertex into our internal assembly and test operations in Thailand. We are also studying the long-term scalability and cost effectiveness of Supertex Hong Kong test facility and expect to conclude our study by the end of this quarter.

As I had mentioned in our last conference call, we are retaining Supertex sales and applications engineers and have begun cross-training them, as well as our existing sales force, so that we can find revenue synergies. We have also begun to combine the channel partners of both companies with the goal to achieve expanded distribution capabilities for the products of both companies.

Lastly, a short update on our acquisition of Taiwan-based ISSC, which we announced on May 22. As you saw in our press release of July 14, we completed a very successful tender offer and now have majority ownership of ISSC. We purchased 83.5% of the outstanding shares as part of the tender offer and have another 10.5% of outstanding shares pledged to us that we will buy when they are past a lockup agreement that expires on November 27, 2014.

The full merger will take place sometime in December 2014, but we are moving ahead full speed with integration planning and integration, as the full merger is a mere formality at this point. Since the announcement of the acquisition on May 22, we have spent considerable time understanding ISSC's business, organization, and systems. We have begun developing detailed integration plans and have begun execution of some of these plans this quarter.

In regards to manufacturing, ISSC outsources 100% of its manufacturing. The fab processes used are more advanced than what Microchip has in house and will therefore remain at the professional foundries where they run, which happen to be the same foundries that Microchip also runs at. We're doing a make-versus-buy analysis and evaluating whether some of the assembly and tests currently outsourced by ISSC can be brought into our internal assembly and test operation.

Microchip will transition all ISSC backend manufacturing systems, like wafer ordering, assembly and test management, shipment, and warehouses, to our systems. We estimate that this transition will be complete sometime in the fourth calendar quarter of 2014, at which time all ISSC products will be shipping from Microchip's business systems.

Regarding sales and applications, we are planning to retain ISSC's sales and applications engineers and will cross-train them, as well as our existing sales force, so that we can find revenue synergies.

We also plan to combine the distribution network for the two companies. A few of the distributors for the two companies are the same, while most are different, as almost all of the ISSC business was done in Taiwan and China. Our goal is to achieve significantly expanded distribution capabilities for ISSC's products.

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

Thank you, Ganesh, and good afternoon, everyone.

Today, I would like to first reflect on the results of the fiscal first quarter of 2015, then I will comment on the progress of some of our acquisitions, and then provide guidance for the fiscal second quarter of 2015.

We are very pleased with our execution in the June quarter. All of the non-GAAP financial metrics, like net sales, gross margin percentage, operating expense percentage, operating profit percentage, and earnings per share, were better than the midpoint of our guidance. Without including Supertex results, our non-GAAP gross margin was 60%, achieving a milestone again, and our non-GAAP operating profit was 33.5%.

We also made excellent progress on improving Supertex operating results. Supertex non-GAAP gross margin was 54.5% and non-GAAP operating profit was 24.5%. I remind you that Supertex standalone non-GAAP operating margin in the full calendar-year 2013, before the acquisition, was 17.2%.

Combining Supertex results, our consolidated non-GAAP gross margin was 59.8% and non-GAAP operating profit was 33.2%, and we are making excellent progress towards our long-term goal of 35% operating profit. Consolidated non-GAAP earnings per share was a record $0.68 and was $0.02 better than the midpoint of our guidance.

We also made many new all-time records. Total net sales were an all-time record. In microcontrollers, 8-, 16-, and 32-bit microcontrollers all made new records individually and collectively. Analog product sales also achieved new all-time record. Geographically, our net sales in Americas and Asia each made all-time new record, and in the non-GAAP financials, our gross margin dollars, operating profit dollars, net income dollars, and earnings per share all made fresh all-time records in the quarter.

Last, but not the least, the June quarter was our 95th consecutively profitable quarter. I want to thank all the employees of Microchip for their contribution in making this an outstanding quarter.

Now on April 1, we closed the acquisition of Supertex. Ganesh highlighted the status of our integration on Supertex. We have obviously honed our skills and experience through several very successful acquisitions.

Supertex contributed $0.013 accretion for the last quarter, which is above the $0.01 accretion that we had guided. Now $0.003 may be a small difference on Microchip numbers, but it was a substantial bead on the Supertex contribution.

Now I will provide guidance for the fiscal second quarter of 2015. We are seeing a seasonally normal business environment with strength in many of our end markets, like industrial, automotive, housing, consumer electronics, and personal computing. We are seeing exceptional strength in some of our new products and technologies, which are growing at double-digit percentages sequentially.

As a result, our product delivery lead times have stretched out, and we are selectively capacity constrained in fab, wafer sort, assembly, and test operations, particularly on our newest products and technologies.

Our inventory of 108 days is below our targeted level of 115 and is expected to go even lower this quarter. So we are ramping all of our factories, but we are limited by equipment lead times. We have increased our planned capital expenditures for fiscal-year 2015 to $175 million.

We also, just today, posted a Dear Customer letter on our website, www.microchip.com, informing our customers about the business environment, our capacity constraints, and our lead times. So you may want to look at that letter.

We're also mindful of summer quarter in Europe that is usually sequentially down.

So taking all these factors into account, we expect the September quarter net sales to be up 5.4% to 8.4% sequentially. This includes about $18 million of sales from ISSC, which are on our clock from July 18 to the end of the quarter.

So as Ganesh said, Microchip owns 83.5% of the shares of ISSC. Microchip will include the ISSC sales from July 18 onwards in its financial results and consolidate them line by line. We will then back out the profits for the minority interest.

I would also like to highlight that ISSC's revenue recognition through distribution is currently on a sell-in basis. As we integrate their business into Microchip's business systems, we will change the revenue recognition from distribution to a sellthrough basis upon modifying the contractual relationships we have with the distributors. We believe that this will happen in the December quarter and we will share the accounting impact of this with you in the next earnings call.

Continuing on the guidance, on a non-GAAP basis we expect our gross margin to be between 59.2% and 59.6% of sales. The short-term gross margin is slightly negatively impacted from the consolidation of Supertex, as well as ISSC. ISSC gross margin is currently about 45%. Longer term, we expect to improve Supertex, as well as ISSC, gross margin to Microchip levels.

We expect operating expenses to be between 26.3% and 26.7% of sales. We expect operating profit to be between 32.5% and 33.3% of sales, again slightly negatively impacted by Supertex and ISSC short term.

Longer term, we expect Supertex and ISSC's operating margins to be similar to those of Microchip's.

We expect non-GAAP earnings per share to be between $0.70 and $0.74 per share. This includes about $0.015 accretion from Supertex and about $0.01 accretion from ISSC.

Given all the complications of accounting for the acquisitions, including amortization of intangibles, restructuring charges, and inventory writeup on acquisitions, Microchip will continue to provide guidance and track its results on a non-GAAP basis. We believe that non-GAAP results provide a more meaningful comparison to prior quarters and we request that the analysts continue to report the non-GAAP estimates to First Call.

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

(Operator Instructions). Chris Caso, Susquehanna Financial Group.

I guess our first question, perhaps we could talk about the production constraints you mentioned in your prepared remarks. Does this imply that there is some business that you are not able to address right now? Are you meeting the customer delivery requests in general on some of these products that have stretched out?

And as a follow-on to that, if you could talk about the steps you can take, when lead times start to stretch out and you have seen these constraints in the past, how you make sure that customers aren't ordering more than they need?

So definitely, we are leaving out some revenue due to supply constraints in the September quarter. We cannot really dollarize that number because we don't really know what other additional customer demand will come in for the fiscal Quarter 2 and what product mix that demand will come in.

In fact, I mentioned that we posted a Dear Customer letter on our website today, and this letter will start going out to our customers immediately, and hopefully we will have a much better idea of the supply constraints in the coming weeks.

At the same time, we are also working actually quite hard to improve the supply in expediting equipment from our vendors, so an accurate estimate would be difficult on a short-term basis, but we are definitely leaving out some revenue on the table.

The obvious question can be that are we losing any designs or market share because of that? Our microcontroller revenue in the June quarter was up 14.5% versus the year-ago quarter. As you know from really any market growth numbers, that far exceeds any market data for growth of microcontrollers. So overall, we are gaining market share and actually gaining substantial market share.

The products that we have constraints on are very special products with unique features and very high growth. The products that actually -- these products are killing the competition. The new designs will be in production in about a year or longer for anybody who is thinking of doing a new design with these products.

So short-term constraints, I don't think, are going to impact design wins because our customers know our track record for the last 25 years, and these are shorter-term problems and we will solve them quickly.

Okay, thank you. As a follow-up with respect to the gross margin, and I guess with -- you have given us the ISSC margins so we can figure out the impact of that on your margin guidance. But for the underlying Microchip margin, with production increasing next quarter, could you talk to us about how that works its way through the income statement, what sort of benefit you see there, and perhaps how long you'd expect that benefit to continue with the inventory down below your target levels? I suppose this wouldn't be something that you would get back to normal in just a quarter.

As I mentioned, the inventory this quarter actually will decline further, so actually taking inventory from the balance sheet and adding to your cost of goods sold. So I would say that core Microchip margins are in the same range where they were last quarter, plus some or minus some, but usually on the good side. And then, they are somewhat negatively impacted by integrating a 45% margin on about $18 million sales from ISSC.

And there is Supertex effect also because their margins at 54.5% are also slightly lower than Microchip, but they were in the numbers last quarter also and we're also picking up a fair amount of old inventory from Supertex that we are shipping now because of first in, first out.

So there are a large number of moving parts, but overall margin is in excellent shape.

Right, but as the production increases, once the capacity is in place, I guess that would suggest better fixed-cost absorption, improvement to margin, once that occurs?

Yes, the answer to that will be correct. Yes.

Great, thank you.

Jim Covello, Goldman Sachs.

Thanks so much for taking the question. I appreciate it. Congratulations on the good results. Question on the equipment. You mentioned some equipment has extended lead times. Are you referring specifically to testing equipment or packaging equipment? Could you give us a little more perspective there?

It is predominantly fab and test. There is assembly also, but there are a few challenges, but it is -- the majority of that is really the fab and test. Test in two places, wafer test, as well as final test.

That's helpful, thank you. And then, do you get the sense that your competitors are experiencing the same sort of issues when you talk to your customers or do you think your situation is a little bit unique?

We are not focused on our competitors. We are focused on our customers. I don't really know what competitors are experiencing.

Our growth rate is phenomenal. Some of the numbers I have seen on microcontroller growth rates and analog growth rates from some of the competitors who have announced in the earnings season, and sometime you have to look at the numbers rolling four-quarter cumulative over the similar four quarters prior because single quarter can play games. Everybody has different seasonality.

When you are shipping from -- when you are building product and shipping from inventory, it is the totality of it that counts. Our numbers are so far above the competition. I think the average, when I did the chart yesterday, that four-quarter over prior four-quarter comparison, the average of that was about 4.5%. And that number for Microchip is 15.2%.

So, we are doing phenomenal in our products, in our growth, in microcontroller, in analog, and that was not expected a year ago that we will have those kind of growth rates. And as a result, with long lead times and equipment, we are having some capacity challenges.

Very helpful. Thank you so much. Good luck.

Craig Hettenbach, Morgan Stanley.

This is [Anai] calling in for Craig. I had a question on ISSC. I think you indicated that your guide has $18 million in revenue. What is the related OpEx to that? And as you stop integrated Supertex, any negative or [posted] the prices that have come along?

So I think you can calculate that in dollars, but ISSC's current model is 45% gross margin, 26% expenses, 19% operating profit. That is what they're doing standalone and you can do the math on it, and we will improve it substantially on our clock, but always take some time.

Got it. And any negative and posted surprises over the last quarter on Supertex?

No, we did outstandingly. We beat our revenue guidance. We beat our internal gross margin. We did very well in managing expenses and our attrition was 30% better than what we guided, $0.013 versus $0.01. So you have to divide that by Microchip's 223 million shares, so the numbers become miniscule, but standalone, we did very well on what we set out to do.

Got it. That's helpful. And for my follow-up, automotive has been a growth engine, both for analog and MCU. Can you just touch upon the opportunities you are seeing and any new product introductions towards automotive, especially on the 32-bit side?

Go ahead, Ganesh.

We play in a broad range of automotive applications. We're not focused on any single item, engine control or whatever.

In many of the applications, we are the main microcontroller. Those tend to be associated with the body electronics, some of the networking inside of the car. In many of the other applications, we are the auxiliary microcontroller. There is somebody else that is micro which is a large high-performance microcontroller. So, there is no specific single application that is driving the growth.

Clearly, we are winning more than our fair share of applications and the number of cars being built is growing as well. So those are the two factors driving the automotive part of our business.

To add a little bit in the medical field for what Ganesh said, how broadly our products go into automotive and we are not really focused on really designing one product. If you go buy today an S-Class Mercedes, you will be buying 51 chips from Microchip. I think there are about 30 or so microcontrollers. There are some analog parts and there are some others. If you buy a Hyundai Genesis --

54 of them in (multiple speakers)

54 different chips from Microchip all over the car. So those are a couple of representative examples where we are not trying to win this by having one part that goes into the cars. We are trying to win it by having 30, 40 chips on a car from up and down the car, all different applications. And each of those applications be -- our part be the main part.

Got it, that's helpful. And congrats once again on a good quarter, guys.

Harsh Kumar, Stephens Investment Bank.

First of all, congratulations. These are exceptional numbers. I just had a couple of really quick questions. Steve, in your press release and in your script, you mentioned you are seeing exceptional strength at some of your newer products. I am curious if you could just give us some more color. Are these the products you were recently buying or is this products that are out in the last three to four years?

Let me make an attempt on it. The conventional wisdom has been that 8-bit microcontrollers is declining and all the customers want is really to convert to 32-bit microcontrollers.

And you have heard us over the years. We have disagreed with that conventional wisdom for many years. Our 8-bit, as well as our 16-bit microcontroller, businesses have performed extremely well, in addition to our 32-bit microcontroller, and Ganesh talked about all of them. In fact, all three microcontroller types -- 8-, 16-, and 32-bit -- made new records in the quarter.

Now, the growth in 16- and 32-bit microcontroller has been very good and a lot more predictable. We plan for those kind of high numbers and we are achieving it.

I think the surprise was on the 8-bit because nobody gives it the credit. When we talk to the Street, analysts, and investors, they are all interested asking about 32-bit.

We introduced a significant number of new 8-bit products, including a new very high efficiency 8-bit core and an entire family of products built on that core that can use C programming language like the higher-end 16- and 32-bit microcontrollers. We also introduced a category of core independent peripherals that allow our customers to run the peripheral functions without the microcontroller core engine running or without consuming the CPU power.

These have allowed our customers to expand the use of 8-bit microcontrollers dramatically and the demand for many of these products have really exploded. These products are built on our latest process technology, proprietary technology, that we run in our Gresham fab, so the demand for this process technology is growing at the rate of 15% to 20% per quarter, starting from a fairly large base.

The success of these and other 8-bit microcontroller products is unprecedented. It is unprecedented even measuring at a very successful microcontroller track record, even against that very successful track record at Microchip. We're also seeing that the entire competitive threat of trying to insert the M0 Cortex 32-bit ARM core into the 8-bit microcontroller socket really has petered out. These products had 32-bit engine, but otherwise no peripherals or features. They were largely bait-and-switch kind of products and customers have seen the hollow offering.

The result is that our 8-bit microcontroller business is extremely strong, making new records, and currently capacity constrained, but hopefully not for very long because we are growing capacity rapidly.

Appreciate it, Steve. That was very helpful. And then as my follow-up, if I can ask you with the new additions to your Microchip business, Supertex and ISSC, perhaps maybe help us think about how we should think of the seasonality. Is it still largely unchanged or will you see more of a consumer affect now in the December quarter?

Every acquisition modifies it a little bit; these acquisitions are not extremely large, but ISSC is very consumer-ish and it will change the seasonality a little bit. Supertex does not change it as much. They are similar to ours, much more industrial. SMSC did change the seasonality a little bit. They were a little more on PCs than we were, yes, so these all have impacts.

Fair enough, guys. Thank you and congratulations again.

JoAnne Feeney, ABR Investment Strategy.

Congrats, guys, on the nice quarter and the guidance. Follow-up question on the capacity constraint. So it sounds like from your last answer there that mostly this is hitting on the 8-bit side. Is it not possible for you at this point to change the mix and shift some of your capacity over to that which is being constrained? Or are you seeing a broader-based constraint that is really hitting all of your products?

And if you could just clarify, really, where those constraints are kicking in and why mix can't be changed or why it is not worthwhile to do that at this point, that would be helpful.

Many of the products that are growing 15% to 20% sequentially are built on our latest advanced technology, so you can't really use the older capacity for these. We have to add new capacity.

Within the products itself, obviously we're changing mix to build the products which are stronger, but I think they are all largely doing very well. We are constrained overall on the products on their technology. So even after changing the mix within, the entire number of wafers we got to run on that technology are 20%, 30% higher than, really, what I can run today.

Okay, that's helpful.

And we just made an increase just this last month. There is another one happening on August 1, which is tomorrow. We increased the wafer starts. There is another one scheduled for October 1, another one scheduled for January 1, so we're bringing these new equipment, adding it, and some of that has been in the works for months, if not quarters, and we have been constantly adding.

And we keep thinking that the demand will moderate, but from a fairly large base, the demand has continued, which is really the strength of the products. Everybody bad-mouths 8-bit and competitors have backed off and everybody wants to sell a core tax core. We defied that conventional wisdom. We were right. We are so successful at that, 8-bit is adding the largest dollar revenue in growth. And we are the only man standing, almost.

That's really helpful. If I could just get a follow-up in on the 16-bit side, obviously that has grown very strongly, as you said in the trailing 12 months year over year. I am wondering if you could elaborate on what you think the pause was. Is this just a timing issue of particularly design wins that aren't starting for a bit or is this a specific end market that might be weak or a specific application, and why you're confident that is going to pick up again in this quarter.

There are small changes quarter to quarter when people's timings, et cetera, of when they want to purchase may be adjusted.

But if you go back and look, it's had a very strong quarter before that. We're expecting a strong quarter. So what falls into any one 90-day period isn't reflective of the business. I think if you look at it over a 12-month period of time, it evens all that out, and so we see the design wins, we see the customers ramping, we are confident of the product line going forward.

We have seen the same thing on 32-bit. 32-bit did very well last quarter, but if you look at the quarter before, 32-bit had a very low single-digit growth. So these smaller product lines, 16, 32, although they are fairly sizable, their growth rate doesn't seem to match the corporate and the seasonality.

Overall, both are doing very well year over year, but quarters are uncertain. So on 16-bit, our current quarter backlog is up by double digits. I am not saying it will end there, but I think it will end very well.

That's very helpful. Thanks for the clarity.

William Stein, SunTrust.

Thanks for taking my question. I'm hoping you can give us a little bit more granularity or detail to try to understand the degree to which these lead times -- the stretch lead times or the storages are felt broadly across the portfolio. Is it a relatively narrow number of products that are affected or is it broadly speaking? And maybe if you can quantify to what degree you have seen lead times stretch. Thank you.

The letter we posted today, it says our lead times are from six weeks to 18 weeks, plus, and Microchip sells over 100,000 SKUs, so it's really all over the place. Anytime people want a headline number, our lead times are X weeks. There's really no such thing. When you have 100,000 SKUs, there are parts that you can get off the shelf because in any mix situation, there is always some parts available.

But in any reasonable volume, we can do it in as little as six weeks and many other 18 weeks, plus. But these constraints are fairly significant, I would say.

Following up on that, perhaps you can give us a sense as to when you expect that supply will be more in line with demand. You talked about adding capacity. I think tomorrow you said you are adding some new capacity and then you have something planned for, I think you said, January. When would you expect to see a relative balance between supply and demand?

The supply/demand balances are hard to predict. I know what additional supply we're bringing in because we know the wafer start ramp and similar ramp in the assembly and test.

Now matching it against what demand may materialize, that is a difficult one. So we don't know what demand does in December quarter and then March quarter of next year. Will the rate of growth of these products continue?

It looks like we dramatically beat our own internal expectation; a year ago, what we predicted regarding these products will do, we were wrong. They are doing significantly, extremely better than that. A year ago, I would have told you that the 8-bit can grow in double digits. You wouldn't have believed it. So, I can't tell you exactly the timeframe when the problems get resolved, but we're adding a lot of new capacity and they will get better.

If I could just sneak one more quick one in, you are known as the cycle maven in semi. You have done very well predicting this for all the investors in the past. It feels very much now like the market is telling us that something is going to roll over soon. Your results certainly don't seem to foretell that.

To what degree does this to you feel like the last run before the tightness gets resolved and suddenly you wind up having a positive demand versus more beginning stages of extended improving demand?

I carry heavy burden on my shoulders for semi vision, but I'm not seeing any rollover right now. I think wind is on our back.

All right, thank you.

Ray Rund, Shaker Investments.

Thank you for taking my question. Steve, actually most of my questions have been answered. I was just curious if you could just repeat what the breakdown was in terms of the different revenue by product area that you went through at the beginning. You did it pretty fast.

This is Eric. I can do that. So microcontrollers were $343.8 million, analog was $127.8 million, memory was $33.4 million, licensing was $20.4 million, and other was $5.9 million.

Okay. As a follow-up question, you mentioned that the analog, excluding Supertex, was up very -- I think less than 1% sequentially. Is there any reason why analog has slowed down the last couple of quarters?

Like we mentioned for our 16-bit product line, if you -- I think quarter to quarter, there are going to be sometimes a larger-than-expected growth and sometimes a smaller-than-expected growth. This isn't the totality of how it's been doing year over year on an annualized basis, and you will find that the analog business has had fantastic growth throughout this time.

That's quite true.

It was not 1%, by the way. Our analog business was out to -- Supertex grew 2.6% sequentially.

Okay, I misunderstood, then. Okay. At any rate, let me add my congratulations on an excellent quarter. Thank you very much.

Rajvindra Gill, Needham & Company.

This is Josh in for Raji. Congratulations on the quarter and thanks for taking my question. Most of them have been answered, but could you please give us some color on end markets? I know you mentioned a little bit with auto before, but more color there would be helpful.

So I think I mentioned we are seeing strength in industrial. We are seeing strength in auto. We are seeing strength in housing. We ship a lot of parts into all sorts of housing appliances, garage door openers, security systems, and all that kind of stuff.

We are seeing strength in consumer electronics and kind of things we do. We don't go into the cell phone, but the other consumer electronics, and the unique one is personal computing. I think if you listened to the Intel commentary and their results, the PCs are going through a refresh cycle, so our PC exposure has gone up with the acquisition of SMSC; in fact, two different divisions of SMSC, one that does the embedded controller for the PCs and the other division does Ethernet and LAN and USB and all that. We have seen that market strengthening also.

So we are seeing strength in many of these end markets.

I believe the market that has been weak was the smart phones, and that's where Microchip doesn't have exposure, so I think we have done well largely because we tried to stay away from that market. We don't like its margins. We don't like its customers. We don't like a number of things about it.

Thank you. That's very helpful. And then, lastly, on the SMSC, last quarter I think you mentioned you thought you were about halfway to the point where it was -- had reached its full potential for accretion. Can you maybe update us there on where that progress is? Has it been complicated at all by Supertex (multiple speakers)

So I will let Ganesh respond to that, but what we said last quarter is we were halfway there on integrating backend assembly and test manufacturing.

That is exactly what we said, and so -- and we were actually a little less than 50% at that point in time.

Those are -- not everything that is outsourced makes sense to bring in house. We do that case by case. And there is some accretion in SMSC that over time will come as we sell those designs to a broader set of customers using Microchip sales, teams, and all that. But SMSC has done exceedingly well and better than what we had expected in its contribution to Microchip.

So SMSC's gross and operating margins are now at the Microchip level.

Okay, great. Thank you. Congratulations again.

And further improvements are possible as we bring some of the small stuff in, but already SMSC's gross and operating margins are right on the top of Microchip.

(Operator Instructions). [Gill Alexander], [Darful Associates].

Congratulations again. Could you update us on your long-term model and what you would like to have your gross margins at and your operating expenses? And you mentioned your operating profit goal is at 35% now?

Let me remind everyone, we haven't changed it, so our long-term gross margin model is 61.5%, plus/minus 0.5%. Our operating expense target is 26.5%, plus/minus 0.5%. And our operating margin target is 35%, plus/minus 1% if you just look all the low and high.

What is really -- what is holding us back a little bit are really the acquisitions. It is very difficult to go out and find an acquisition that is performing at Microchip kind of financials today. In fact, we have found none. So the acquisitions we buy, SST, SMSC, Supertex, ISSC, they are all in the gross margins between 45% and 55%, operating margins in teens, pretty much all of them, and SST was worse than that. It wasn't making any money.

And then, we take on the task through pruning and expense reduction and margin improvement and moving them to our factories and choosing what to make and not to make and selecting the product lines and getting our sales and applications infrastructure to go sell them better to get them into our operating profit. We did that with SST. We did that with SMSC. We are making huge improvement with Supertex, as I mentioned. Their operating margin was 17 and now it is 25. And we got to go the rest of the way, and ISSC, we have just begun. We closed the deal about a week ago.

Thank you. Could you give me an idea of how much money you have overseas?

A lot.

Yes. The vast majority of our cash and investments balance is offshore, and that's why we are borrowers in the US. We manage our US balance to keep our borrowings as low as possible, but the vast majority of cash is offshore.

And your estimated depreciation (technical difficulty) for fiscal 2015?

It depends on the capital that we are bringing in and how that ramps on, but it is probably going to be somewhere between $97 million and $100 million, so it will be up year over year.

Okay. Could you remind me what ISSC's sales are?

So one is the public number for the last quarter, which is known, which is what?

The last public number is for the June quarter, and I know in NT dollars, that is TWD638 million.

So, about 21.

$21 million.

About $21 million, and I think their last calendar year, they were about $70 million, $69 million?

Yes, just over $69 million.

So the June quarter, publicly-announced sales were about $21 million, and this quarter would be higher than that, but we have to ratio the sales from July 18 to the end of the quarter and that we have guided to be $18 million.

Thank you very much. Appreciate it.

John Pitzer, Credit Suisse.

Thanks for letting me sneak in a question here at the end. Steve, a lot of them have been answered, but as you guys integrate more and more of these acquisitions, thinking about the core Microchip revenue as becoming harder and harder, but when I look to the September guidance, if you look at the -- take out the acquisition revenue, I'm getting to a flat core sequential growth. One, is that right? And two, even if it is not, I'd just be curious, given the capacity constraints, how much better could the September guidance have been if you didn't have some of the capacity constraints? Thank you.

The answer to your first question, I think Microchip core business is growing quite substantially, so I don't know where you are coming up with flat. If you did that just for a quarter or so, I don't know, but if you look at four quarters over four quarters, or fiscal-year 2014 over fiscal-year 2013, we have had very, very substantial growth net of acquisitions.

Steve, I was talking more sequential June to September.

June to September.

That's up 3.5%.

The midpoint of that guidance is 3.5%, plus the $18 million coming on from ISSC.

So Supertex was -- and that may be the confusion -- so Supertex was closed on April 1, so the entire Supertex was included in our June numbers. So including Supertex, June to September, the midpoint of our growth is 3.5%, not flat. And then, add 18% on the top of that.

Yes, $18 million.

$18 million, which takes the overall growth to about 6.9%.

What could the 3.5% have been had you not had some of the capacity constraints that you do?

I can't tell you that. I don't know.

Thanks, guys.

Kevin Cassidy, Stifel.

Thanks for letting me get one question in. The ISSC, how much of their product will be attached, do you think, to your microcontrollers or will be similar to when you first came into the analog market? And eventually this will sell on its own or do you expect that 1 plus 1 equals 3 with your microcontrollers plus ISSC?

Clearly, we expect many of their products will marry up with a microcontroller, sometimes with our memory, as well as sometimes with our analog. The applications they go into in many cases we have served, but without the solution that ISSC has brought.

But I think the large opportunity in ISSC also is to take it outside of Taiwan and China, which is where the predominant revenue for them is all coming from, and there, we have our sales channels and customer relationships where existing products that customers are building, but missing the components that ISSC builds, automatically becomes a quick addition that we can make.

So we're expecting that many, many ISSC products will be sold next to our microcontrollers.

Okay, great. And can you give us an idea of what the cost split is between front end and back end? You say you're going to move the back-end portion [I think] to internal manufacturing?

We don't break that out, and even the timeline for when it can be done, not everything that ISSC manufactures will make sense to move in house. So we go systematically, item by item, with the objective of making sure that we get to a lower cost bringing it in house, and a percentage of what they do will make sense and some of it will not. But that analysis is not complete and we don't break out the backend versus front-end components of that.

Okay, thank you. Congratulations.

There are no further questions in the queue.

Okay, thank you very much for attending our conference call. We will see some of you on the road as we are doing conferences. Otherwise, we will talk to next quarter. Thank you.

That does conclude today's teleconference. We thank you for your participation.