微晶片科技 (MCHP) 2017 Q3 法說會逐字稿

Welcome to the Microchip Technology third-quarter and FY17 financial results conference call.

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

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

Please go ahead, sir.

Good afternoon, everyone.

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

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

We refer to you our press releases of today as well as our recent filings with the SEC that identify important risk factors that may impact Microchip's business and results of operation.

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

I will comment on our third-quarter FY17 financial performance and Steve and Ganesh will then give their comments on the results, discuss the current business environment, as well as our guidance and provide an update on the integration activities associated with the Atmel acquisition.

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 in 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 on 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 actives and share based compensation.

Non-GAAP net sales in the December quarter were a record $881.2 million.

They were well above the high end of our guidance and were up 0.8% sequentially from net sales of $873.8 million in the immediately preceding quarter.

We have posted a summary of our revenue by product line and geography on our website for you reference.

On a non-GAAP basis, gross margins were 57.8% in the December quarter and significantly above the midpoint of our guidance, which was 56.9%.

Non-GAAP operating expenses were 25% of sales, significantly below the midpoint of our guidance range of 26.7%.

Non-GAAP operating income was an outstanding 32.8%, well above the midpoint of our guidance of 30.15% and very close to reaching our prior long-term operating model goal of 33%, which we had previously guided investors that we would achieve in the March 2018 quarter.

Non-GAAP net income was a record $246.5 million, resulting in record earnings per diluted share of $1.05, which was $0.145 higher than the midpoint of our guidance of $0.905, up 11.6% on a sequential basis and up 64.9% as compared to the same quarter last year.

On a GAAP basis, net sales were $834.4 million.

GAAP net sales were $46.8 million lower than non-GAAP net sales because for GAAP accounting purposes, we began recognizing revenue on a sell-through basis for the Atmel Asia distributors on October 1, 2016.

And the inventory sitting in the distribution channel on that date was not recognized as revenue in our GAAP financial statements when it was subsequently sold by the distributors.

Sales to all Atmel distributors are now being recognized based on sell-through revenue recognition.

GAAP gross margins including share based compensation and acquisition-related expenses were 55.8% in the December quarter.

GAAP gross margins include the impact of $3.5 million of share-based compensation, $26 million of gross margin impact from the distributor revenue adjustments I mentioned earlier, $12 million in acquired inventory valuation costs, and $3 million of manufacturing shutdown costs associated with the Micrel fab.

Total operating expenses were $347.2 million and include acquisition and tangible amortization of $82.8 million, share based compensation of $18.7 million, $4.2 million of acquisition related and other costs, and special charges of $20.9 million consisting primarily of charges associated with our acquisition, integration activities.

With all the purchase accounting adjustments, the Atmel acquisition related charges and the related tax impact, GAAP net income from continuing operations was $107.2 million, or $0.46 per diluted share.

In the December quarter, the non-GAAP tax rate was 8.3% and the GAAP tax rate was negative 28.5%.

We expect our longer-term forward-looking non-GAAP effective tax rate to be between 8% and 9%.

The large difference between our non-GAAP and GAAP tax rate relates to the differences in the specific pack rates that apply to the charges that are excluded from our non-GAAP results.

Moving on to the balance sheet, our inventory balance at December 31, 2016 was $419.6 million.

Microchip had 104 days of inventory at December 31, 2016, up one day from the end of the September quarter.

Inventory at our distributors was at 31 days and at the same level as the September quarter.

The cash generation in the December quarter, excluding our acquisition and divestiture activities, our dividend payments and changes in borrowing levels under our revolving line of credit was a record $258.8 million.

As of December 31, the consolidated cash and total investment position was $699.7 million.

Our borrowings under our revolving line of credit at December 31, were $1.683 billion, up $5 million from the prior-quarter levels.

Excluding dividend payments, changes in borrowing levels and our acquisition-related activity, we expect our total cash generation to be approximately $230 million to $250 million in the March quarter.

We continue to make good progress on our leverage with our net debt to EBITDA ending the December quarter at 2.47.

This is down from 2.91 at the end of the September quarter.

We expect our net debt to EBITDA to be under 2.1 by the end of the fiscal year, which ends March 31, 2017.

And that's well below the last forecast that we provided to investors of 2.35.

Capital spending was approximately $15.7 million in the December quarter.

We expect about $38 million in capital spending in the March quarter and overall capital expenditures for FY17 to be about $90 million, compared to our previously communicated FY17 capital forecast of $110 million.

We are selectively adding capital to support the growth of our production capabilities for our fast growing new products and technologies and to bring in-house more of the assembly and test operations that are currently outsourced.

Deprecation expense in the December quarter was $29.7 million.

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

Ganesh?

Thank you, Eric.

Good afternoon, everyone.

We are pleased with how each of our product lines performed in the December quarter and how the combined assets of Microchip and former Atmel working in harmony are producing differential growth results.

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

Our microcontroller business in the December quarter held up well in a seasonally slower quarter and was up 0.3% sequentially as compared to the September quarter, setting a new record in the process.

We continued to experience broad based growth in our business as each of our 8-bit, 16-bit and 32-bit microcontroller businesses met or exceeded our expectations for the December quarter.

Customers using microcontrollers originating from Atmel continued to gain confidence in Microchip's commitment to those products and began to see how powerful the combined microcontroller roadmaps going forward are.

As a result, we are seeing continued growth in our designing funnel and expect this to drive future growth as these designs progress into production over time.

We have also seen many examples of how the joint sales and business unit teams are able to find and win more opportunities using our broader basket of analog connectivity, security and memory products to garner a larger share of the available content in an application.

This in turn we expect will help drive incremental growth over time in all our product lines.

Microcontrollers had over $2.2 billion in annualized revenue representing 63.1% of Microchip's overall revenue in the December quarter.

We remain pleased with the performance and the competitiveness of our 8-bit, 16-bit and 32-bit microcontrollers in the broad based market, which have been augmented by the addition of Atmel's portfolio.

We continue to gain 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.

Our analog business was up 1.4% sequentially in the December quarter as compared to the September quarter and also set a new record in what is normally a seasonally weak quarter.

At well over $900 million in annualized revenue, our analog business represented 25.9% of Microchip's overall revenue in the December quarter.

As I mentioned earlier, we are successfully finding more opportunity to attach Microchip's vast portfolio of analog products to Atmel microcontrollers at multiple customers and applications.

This effort will pay dividends over time as new design wins go to production.

We continue to develop and introduce a wide range of innovate and propriety new linear, mixed signal, power, interface, timing and security products to fuel the future growth of our analog business, as we march relentlessly towards making analog a greater than $1 billion revenue business for Microchip.

Moving to our memory products, our memory business was about flat in the December quarter as compared to the September quarter.

During the quarter, we introduced a new memory solution called an EERAM, which offers unlimited endurance and safe data storage should a power loss occur.

That is ideal for a broad range of applications.

This gives us one more opportunity to add to the content we can win in our customers' application as we deliver total system solutions to them.

A quick summary of where we are with the Atmel integration.

We had already made significant progress with the business unit integration by the end of the September quarter and completed this activity in the December quarter.

Our sales integration continued to progress well with extensive cross-training of our direct sales teams as well as our channel partner sales teams.

The sales integration is now largely complete.

The pricing changes we have discussed before continue to roll-out during the quarter and we will have further changes that take place in the March and June quarters.

On January 1, 2017, we went live with Atmel's business systems transitioning to Microchip's business systems.

This was a significantly complex activity to plan and execute.

The transition is going as planned with a small number of normal issues that are being rapidly resolved and where we are at this point of the transition to our systems is about where we have been at the same point with prior acquisitions, which is quite positive given the size and complexity of the Atmel business and business systems.

The integration work to take advantage of our internal manufacturing capability to lower the cost of packaging and testing products that are currently outsourced has just started and will continue for many quarters to come.

All in all, the third quarter of integrating Atmel has progressed on or ahead of our plans.

Our profuse thanks go out to our many employees across the globe who have gone above and beyond to contribute to the rapid integration.

Their tireless efforts on multiple fronts helped deliver synergy results that well ahead of forecast.

Let me now pass it to Steve for some general comments about our business, our guidance going forward, and more about the tremendous results from the Atmel integration.

Steve?

Thank you, Ganesh.

Good afternoon, everyone.

Today, I would like to first comment on the results of the FY17 third-quarter and then provide guidance for the fourth-quarter FY17.

I will also make comments on the progress of integration of Atmel.

Our December quarter financial results were extremely strong.

I would say that we hit the ball out of the ballpark.

Our non-GAAP net sales, gross margin percentage, operating profit percentage, and earnings per share, all exceeded the high end of our updated guidance.

Non-GAAP earnings per share was an all-time record and was $0.145 per share better than the midpoint of our guidance and up 64.9% from the December quarter of a year ago, due to improving sales, gross margin percentage, operating expense leverage, and successful execution of our core business, as well as accretion from our acquisitions.

I want to thank all the employees of Microchip, including acquired employees from Micrel, Atmel and other acquisitions world wide for delivering a record quarter in every respect.

This was also our 105th consecutive profitable quarter.

As I reflect on the calendar year 2016, we had outstanding financial results in every quarter, and closing out the calendar year with explosive earnings, was a befitting tribute to the year.

In the last quarter's conference call, we shared with you our 200-day assessment of what we have done to correct Atmel's weaknesses.

Today, I will provide a 300-day update on where we are in correcting these weaknesses, and this will probably be the last update on that topic.

First, lack of pricing discipline.

Average Atmel prices continue to go up and we are seeing it in the improving gross margins.

Atmel gross margin improved another 50 basis points sequentially.

We mentioned in the last conference call that on the distribution front we caught a lucky break as one of our largest competitors has changed their distribution program, where they will be using distribution only for fulfillment and are terminating the registration program under which the distribution earned higher margins for demand creation.

This has continued to have a very positive effect on Microchip as the distribution sees a very strong portfolio from the combined Microchip and Atmel franchises and it increases their commitment for demand creation for Microchip.

We now have a long list of customer design sockets, where the distribution has been converted their design from this large competitor to Microchip.

Number 2, high operating expense culture, Atmel had a culture of high operating expenses which routinely ran over 40% of sales.

We have now corrected Atmel's operating expenses, as well as the culture related to operating expenses.

Number 3, swinging for home runs and getting large customers at low margins, this has now been corrected as we are aligning Atmel sales focus to be consistent with that of Microchip.

Number 4, accountability, Atmel had a culture of poor accountability with a broad-based implementation of Microchip type of bonus plans, which are based on overall Company growth and profitability.

We are rapidly changing that culture.

In our presentations, communications and classes at Atmel, we are teaching that at Microchip management is accountable.

As of now, approximately 90% of the employees of Atmel are on a common bonus program with Microchip employees.

Number 5, poor team work: Atmel did not have a culture of team work, bonus and equity grants were very large at the top at Atmel and less than 30% of the employees had bonus and equity.

At Microchip, 100% of our non-Atmel employees are on a bonus program and nearly 100% of our non-Thailand production labor employees are on equity program.

With Microchip managers teaching them role modeling of our culture and with 90% of Atmel employees on common bonus program with Microchip employees, we are now all pulling the ship together and in the same direction.

Number 6, Atmel made no investment in training and development of employees.

In a short 10 months, nearly 100% of Atmel employees have gone through at least some training class at Microchip.

We are continuing to put Atmel sales and field application engineers through a two-week extensive training that we call boot camp, in which we train the employees on Microchip's client engagement process, our values, culture, and align them with our goals and award system.

Rapid changes are taking place and employees are bonding to the superior system at Microchip and the results are improving rapidly.

So with that, now let me continue with the deciphering of financial results of Microchip from the fiscal third quarter.

While we will refrain from providing a line by line breakdown of our results between core Microchip and Atmel, we will provide some useful nuggets of information on Atmel as well as Microchip.

Here are those nuggets.

We achieved an all time high operating margin percentage in our core Microchip business.

On Atmel, the gross margin improved by another 50 basis points sequentially.

Regarding Atmel's operating expenses, I mentioned earlier, that Atmel's operating expenses are now in range of the Microchip model and has been corrected.

With the combined effect of better than expected net sales, higher gross margin percentage and lower OpEx, the Atmel business achieved operating margins of over 26% of net sales, which is the highest operating profit percentage ever achieved in Atmel's history.

We achieved an accretion from Atmel of $0.21 per share versus our guidance of $0.13 to $0.17 per share.

Now despite the significant initial skepticism from investors and analysts about our ability to realize synergies, we had forecasted from Atmel, we were always confident in our assessment of synergies and our results have shown that we were actual extremely conservative in our initial projections.

By any measure our December results are stellar.

We're also proud to have crawled back up to 32.8% operating profit percentage for the combined Company and within a smidgen of our long-term model of 33% operating profit, which we initially guided to be three to four years away at the time of Atmel acquisition announcement.

I want to again thank the worldwide employees of Microchip, including acquired employees of all of our acquisitions, for delivering a stellar and a record calendar year 2016.

Before we go into March 2017 quarter guidance, I want to bring up one point.

Our integration of business systems for Atmel was originally scheduled for November 1, 2016.

However, due to extreme complexity of business systems in our largest acquisition ever, we had to push out the go-live of our business systems integration to January 1, 2017, a two-month delay.

As a result, several of our customers requested early shipment of their product that was originally requested to be delivered in the early part of January.

We believe the impact from these customer requests added approximately 1% to our December quarter revenue.

Ordinarily, we attempt to schedule these business system integrations in the middle of the quarter to minimize the impact on our quarterly revenue results.

As a result, investors should view the true end market demand for our products in the fiscal third quarter to be about 1% lower than our reported GAAP and non-GAAP net sales, and our fourth-quarter FY17 true end market demand to be about 2% higher than the midpoint of our GAAP and non-GAAP net sales guidance.

So now let's go into the non-GAAP guidance for the March quarter.

We expect total net sales to be between minus 1% to plus 3% sequentially.

Again, without the customer requested early shipments in the December quarter, the guidance for net sales would have been plus 1% to plus 5% sequentially.

But we will report and compare net sales against our true non-GAAP guidance of minus 1% to 3% sequentially.

We expect gross margin to be between 58% and 58.5% of sales.

We expect overall operating expenses to be between 24% and 25% of sales.

We expect operating profit percentage to be between 33% and 34.4% of sales.

We expect earnings per share to be between $1.01 and $1.11 per share with a midpoint of $1.06.

The earnings per share guidance include an accretion from Atmel of between $0.18 and $0.22 per share.

Now last quarter, we increased the accretion target from Atmel from $0.40 to $0.50 for FY17.

With $0.44 of accretion already achieved in three quarters, the $0.50 target is a gimme.

With this quarter's midpoint, we are revising that FY17 accretion targets from $0.50 to $0.64 per share.

In the last quarter, we also increased our accretion target for FY18 and FY19.

Those increased targets were $0.70 for FY18 and $0.90 for FY19.

All these targets are without stock buy-back.

We are again revising the accretion targets upwards for FY18 and FY19.

We are revising FY18 accretion target from $0.70 to $0.90 and we are revising accretion target for FY19 from $0.90 to $1.

Mind you, that the businesses of Microchip and Atmel are now completely intertwined after January 1, 2017, and increasingly difficult to break down.

Last quarter, we told you that we will achieve our long-term financial model by the end of FY18 versus three to four years that was embedded in our forecast when we announced the Atmel deal.

With the success we have seen so far with Atmel and Microchip, and with great results from the core Microchip business as well as Atmel, we just about achieved our long-term model on the operating margin of 33% last quarter, a full year ahead of our last update.

We also expect to achieve our 59% gross margin model in the next six months as some of the benefits of Micrel fab shutdown are ahead and we have barely begun on moving some of the Atmel's products to Microchip's assembly and test technology.

We are already ahead of our operating expense model.

Therefore, today, we are revising our long-term financial model upwards.

We're setting up a new long-term financial model.

That new long-term non-GAAP financial model is 60% gross margin, 24% operating expense, and 36% operating profit.

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 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)

Craig Hettenbach, Morgan Stanley.

Steve, even if you exclude the 1% contribution from Atmel that got pulled forward, December quarter was a bit above seasonal.

Can you talk about the environment you're seeing out there?

How much of it is just some slight improvement versus Microchip-specific?

Well, I think we have been telling you all along that we see the environment to be pretty good and many other concerns that Street has shown on the environment or in China, in the past year or so, we have been continuously arguing that we were not seeing those.

Our results were very good.

They were good by month and for the whole quarter.

So, true, if you take that 1% away, our results would still have been about flat to the September quarter.

We have never had a flat December quarter, always down a few percentage points.

Got it.

Then as my follow-up, any thoughts on the dividend in terms of just potential growth there?

I ask that just because free cash flow is starting to inflect higher.

Certainly, on the other hand, you guys have been very effective in M&A and creating value that way.

So, just how do you think about dry powder for M&A versus some potential for increased dividend growth?

Well we are basically using up all of our free cash flow created in US for paying the dividend.

I mean we're barely breaking even on the US cash flow, sometimes we have to borrow a little bit from the credit line and all the excess cash [submission] is all overseas.

So there is really no change in the dividend strategy.

We'll continue to do what we're doing, increase it by a smidgen every quarter and majority of the cash flow will continue to really grow overseas and none of this has any kind of repatriation dialed in.

We don't know what the rule will be and what the new administration will or will not be able to do.

Okay.

Thank you.

John Pitzer, Credit Suisse.

Steve, congratulations on the strong results.

Just going back to the updated accretion numbers for Atmel.

I just wanted to make sure that I'm clear.

Is that assuming incremental cost synergies and your ability to do things like having better price discipline at Atmel and does it include any potential revenue synergies?

If that's the case, can you give us the 300-day update on what revenue synergies we should expect over time between core Atmel and core Microchip?

So it basically includes all of that, it includes cost reductions, it includes gross margin improvement, it includes reduction in the product cost using some of Microchip's technologies and others.

It includes revenue synergy, basically if we didn't have Atmel, what the results would have been and what are the results total the difference is the accretion, so it is all included.

I guess that's helpful.

Then a little bit more detail, maybe from Ganesh, on kind of the internal manufacturing capabilities that you're building up this year on the CapEx.

Help me understand at the end of this CapEx spend, what percentage of your test and packaging will you be doing in-house versus external?

What's the financial implication as you bring more in-house?

So we have a multi-quarter plan that looks at different package combinations being brought in for assembly and test.

If you go back and look at the last several acquisitions that we've done, they all had little to no internal capability.

And so the percentage of assembly we were doing in-house has come down and the percentage of tests we've done in-house has come down.

Now, we will only bring things back in-house when we find that the cost improvement is significant and the pay back on any CapEx we have is within our guidelines, and we have plenty of opportunity within those guidelines, and so we are systematically going ahead with CapEx increases, specifically to build up our assembly capacity in-house as well as our test capability in-house.

We have some more advanced test technology that we have deployed on many of our Microchip products that we can bring to bear an the Atmel and Micrel product lines as well.

So it will be a sustained investment over many, many quarters as we bring more in-house capability for assembly and test and bring the cost down in every one of those cases within the return of investment guidelines we have for any CapEx investments.

Ganesh, are those efforts already fully reflected in your long-term operating margin targets?

There is a big chunk of it which will be -- there will be additional improvements that we will make over time but by and large it is hard to separate out a single element of just assembly or test.

We have overall improvements that we're trying to make that are reflected in the long-term goals.

Perfect.

Thanks, guys.

Congratulations.

Thank you.

Mark Delaney, Goldman-Sachs.

Yes, congratulations on the good results.

The question's on the manufacturing side and just where your lead times are with the strength that you're seeing in the cycle and some of the changes you're making to your operational footprint, are any of your lead times for products starting to extend?

Our lead times are all generally normal.

There's always pockets here and there, but there's no significant lead time changes.

Got it.

That's helpful.

Then just in terms of the time line to get to the new target model of 60% gross margin, when you get Atmel fully integrated does that get you to that 60% gross margin or are there other things that need to occur to close the remainder of that GAAP?

We usually do not provide the revenue level or the time line at which we achieved that model.

It is a long-term model, usually, it is a little bit out.

You saw in the last couple of times, we achieved that rapidly while the initial guidance was two or three years away, but we don't really provide granularity on that.

Right.

We don't.

Maybe what I'll add to that is, we've said on this call that in six months we'll be at 59% or above gross margin.

That leaves us 1 percentage point away from a gross margin side.

The midpoint of our guidance for operating expenses this quarter is 24.5%.

We're going to make pretty rapid improvement to get there but we don't want to tie it to a specific date or revenue target.

Understood.

Thanks very much.

Harlan Sur, JPMorgan.

Congratulations on the solid quarterly performance and outlook.

On the analog side, you guys are within striking distance of $1 billion in annualized sales.

Steve, you have shown previously your MCUs and attach rates to Supertex's products for example, post that acquisition.

I'm wondering if you have any attach rate metrics you can share with us as it relates to Microchip's analog attach rates to Atmel's MCUs?

We probably have some data on it.

It is early.

Not enough time has lapsed.

But nothing that I can give it to you verbally on this call.

We'll see if we can include a slide or so in some future conference presentation.

Okay.

Great.

Then given the business systems switch-over that happened earlier in January, it looks like that got executed or is getting executed pretty well here.

Are there any OpEx synergies realized post-Atmel?

I believe also that there is a potential for some site consolidation here in Silicon Valley as well.

Has a decision been made to implement that and if so timing and impact to the cost structure?

So there are cost synergies post go-live.

So essentially -- starting this quarter, essentially most of the Atmel SAP system goes into the read-only mode only, it is not being used.

So lot of the cost related to that come out, some of them do not come out for the entire quarter because until we close the quarter, announce the earning, file the Q and all that, we have to keep accessing it.

Some of the costs go out for about half the quarter, some of the costs go out for about all the quarter and then the next quarter they would be even for longer time.

So, that is the first part of your question.

The second part of your question is regarding the site consolidation.

So, we are getting out of the Atmel building, it is an extremely expensive, eight-story building right near the airport.

Great views and all that, but just extremely unaffordable and expensive compared to any of the Microchip properties anywhere in the world.

And we're consolidating all of the remaining Atmel employees into two other campuses we have in San Jose.

One is the Micrel campus and the other one is the campus where all of our other acquisitions are, SST, SMSC, ZeroG, Roving Networks and all the other acquisitions which is on Holger Street off Zanker in San Jose, if you're familiar with it.

About half of Atmel employees have already moved to our campuses and the remaining half will move pretty much by the end of February, early March.

That building total had, I think, a $10 million cost per year.

What portion of it was already behind?

About half of it.

Because half of the floors have already been vacant --

So, half of it is already behind and in our Q3 numbers, the other half will be no longer in our numbers.

Probably 0.75 for this quarter and 100% for the following quarter.

Great.

If I could just squeeze one more in or Eric, at your long-term financial target of 33%, I can see your runway for free cash flow margins to approach 28% to 30%.

Is that the way we have to think about it?

Yes, so that is not a metric that we have provided to The Street, but you're definitely in the ballpark there.

If you look at the free cash generation last quarter just taking the operating income less the CapEx, it's at those levels.

Great.

Thank you.

(Operator Instructions)

Craig Ellis, B Riley Financial.

Congratulations on the execution, guys.

Steve, I wanted to start off just by getting your feedback on what appears to be when I listen to the prepared comments and some of the Q&A, an unusually large number of Company-specific growth drivers for this year.

It seems like the list would include better Atmel customer reception for products based on improvements you've made to that business, the competitors' distribution actions which have facilitated Company-specific share gain for Microchip.

The pricing action that was taken on Atmel's portfolio last year, which would have meaningful year-on-year benefits.

Then your ability to attach your analog products to Atmel's microcontrollers and drive growth from that initiative.

So is that fair?

And as you look at the business are there any thing -- is there anything that you see that would be a material driver to Company-specific growth beyond that list?

I think you got most of them.

I think we are gaining share in our microcontroller, analog, Wi-Fi, licensing business, and other businesses are improving their gross margin, cutting the OpEx, gaining the synergies, having a good attach success with all sorts of analog Wi-Fi products and on the microcontroller and [WhiteSource], so I think you got most of them.

Okay.

Then looking at the Company's intermediate term evolution you made no secret in the past that you want to continue to execute an organic and inorganic growth strategy.

As you look at the financial readiness, you're certainly getting to debt coverage earlier than expected three months ago, operational readiness, working through the systems integration.

Where are we in your mind with respect to being ready to look for incremental opportunities for inorganic growth?

We have been extremely inward focussed lately to make sure all this integration goes flawlessly and while we're doing all that and basically running two companies, the Microchip core performance does not slip, and you have seen that we have performed miraculously in both hands.

So there is currently not a company in our funnel.

We have to complete the Atmel integration and we have to restart the work of really re-energizing the funnel and look at what is available and start today to try to find some things.

For right now, we can't give you any update on the next M&A.

Got it.

Thank you.

Chris Danely, Citigroup.

Great job.

Just a question on market share out there.

Now that Freescale is being taken over by NXP and Renaissance is undergoing a big restructuring in Japan, how has that been for you guys market share wise, are you seeing any opportunities there?

Is there any impact from the microcontroller market from those two actions?

There's nothing I can point to in the near term that results in to market share changes from what you just described.

Obviously, as the combination for NXP and Qualcomm complete, they will be restructuring actions that will be announced, some of that will create opportunity for us.

We've seen that in prior combinations as others have gone through, and we expect to gain our fair share on that.

Renaissance is a more of a mystery in that a lot of their business is really transacted in Japan.

Japan is not always the easiest of markets for a non-Japanese manufacturer to be able to break through.

But we have seen Renaissance opportunities outside of Japan and that is not something recent.

That has happened ever since the combination of Hitachi, Mitsubishi and then subsequently NEC, all have taken place as people have had different challenges with Renaissance from a long-term perspective, some of it natural disaster based, many of it business based sometimes on how they've gone forward.

Got it.

For my follow-up, now that things are starting to settle down and you've really got your arms wrapped around Atmel.

How would you characterize your thoughts on the relative growth rate (inaudible) analog versus your microcontroller business going forward?

Chris, we really don't really look at it that way.

There are microcontroller business units and there are analog business units and they're all funded.

They're all looking for new products and opportunities and we don't have a model in mind that we have to drive microcontroller to a given percentage at the expense of the other.

So each finds its markets and growth and some are connected because of attach, and whenever the numbers fall the percentage of analog or percentage of microcontrollers is (inaudible).

It is the output, it is not the input.

Got it.

Okay, thanks, guys.

Steve, now that you fixed Atmel, can you come run for Governor of California and fix our state like you fixed Atmel please?

(laughter)

I should get my head examined (laughter).

Gill Alexander, with Darfil Associates.

Wonderful job.

Question, on your inventories, aren't they a bit light?

Or where would you like them to be at the end of the first quarter?

On inventories are definitely on the lighter side.

They are lower than they have been in the recent past.

But every quarter we have been beating the numbers and honestly not been able to build the inventory.

We set a target where the inventory would slightly grow, and then we ship it all, and then the inventory does not grow.

Last quarter, especially, we shipped all this product requested by the customers because of the -- because of the go-live slipping out, so that product got shipped, otherwise I would have it in the inventory.

So if the inventory builds a little bit in the coming quarters, we will not be disappointed but we haven't been able to build them.

Could you give us an insight on what your R&D expenditures will be for this year?

So no significant change.

I think if you look at the current model for this quarter of 24.5% non-GAAP, R&D is about, what--

13.5% to 14%.

In the 13% of the (inaudible).

So whatever model for the revenue you want to use for the year, about 13% of that would be pretty good approximation.

Thank you very much.

Appreciate it.

Thank you.

Chris Caso, CLSA.

Just a question as you move toward the long-term operating model, are there any discrete items in there, discrete things that you need to accomplish there, or is this more of just kind of the normal revenue growth and blocking and tackling going forward?

Well, lots of moving parts.

Mostly blocking and tackling, but the completion of the Atmel integration, which means all the duplicate expenses have to go-live going away, which will be really completely gone away next quarter, then you got all the cost savings from Micrel fab into the P&L.

Remember, we're shipping first in first out and we close the fab in the November time frame.

So you will see some this quarter, some next quarter, some may even filter into the following quarter.

Then as the business is rising the utilization in all of our factories is increasing.

In the last couple of months, we have increased wafers in essentially all three of our fabs, wafer starts to add the number of wafer starts continue to increase, with the revenue growing this year, this is a higher year transition accretive to gross margin.

Then Ganesh talked about applying our assembly test technology to some of Atmel's products and bringing them in, that would be beneficial.

Doing the same thing for Micrel.

That is continuing.

The utilization is also improving in our back-end factories.

We have three of them now.

Two in Thailand and one in Philippines, the Philippines ones came from Atmel.

So it's really all of those things.

The pricing increase on Atmel that we haven't situated.

Some is done, some is under way, some yet to be done.

Some customers had stage pricing increases and the last (inaudible) effective for a while.

The new customers were winning for Atmel products Microchip pricing rather than the old pricing and that is kind of a gift that keeps giving.

So it is just lots of different things.

I'd maybe add one more thing to that.

We've got an internal team looking at costs within the wafer fab, the joint factories working together to find the best costs to be able to bring to the table, and that's bringing in significant opportunity today and into the future of costs that are coming out of the system.

All right.

That's very helpful, thank you.

As a follow-up, you talked about I think you said you expected to be under 2.1 net debt to EBITDA by the end of March 2017.

What should we expect after that in terms of priority for use of cash going forward?

Are you interested in doing something else, are you looking to return that?

What's your view going forward for use of cash?

Well, I think it was the same question asked earlier.

Basically, we are not changing (inaudible) the Board decision, the Board has discussed it, we're going to maintain our dividend policy that we have today, just increasing it by a very nominal amount every quarter like we have been doing and really reserve the majority of our cash for M&As which have been so successful.

We have added so much accretion and so much other revenue and profit and market share and all that has come from good number of acquisitions we have done over the years.

Great.

Okay.

Thank you.

Lena Zhang, Summit Redzone Partners.

Congratulations on solid results and the guidance.

So you, Steve, you mentioned that you're now back and facility television rates improving.

Would you mind giving us some numbers on that, on utilization rates?

No, really I can't.

We don't share the utilization that way.

I don't really have them on my fingertips.

I'd rather share it qualitatively.

We're improving utilization in all of our three fabs and seriously all of our three back in the manufacturing plant but really not in percentage terms.

The percentage is also always misunderstood.

You try to make a mathematical calculation of utilization going from one number to second number and try to derive that it doesn't tend to really correlate that well that way.

It is different complexity of processes, and you could be doing a high value added step outside and being a low value added step inside and utilization looks higher but the change may not be as much.

So we haven't seen the Street decode a utilization to gross margin as well, and I think it adds to confusion so we think to not share it.

I see.

Thank you.

That's all I have.

Thank you.

Rajvindra Gill, Needham & Company.

Congrats on phenomenal results.

Steve, I was wondered if you could perhaps characterize the demand environment that you're seeing across the different segments as well as maybe any color on the geography?

Any view on overall demand, that would be helpful.

Well, this is now strictly speaking about Microchip really nothing to say about the order of semiconductor industry.

We're finding that demand environment to be normal.

Really, I mean, you should look at the industry numbers for 2015 and 2016.

I believe 2015 industry was low single-digit negative, and from the numbers I've seen for 2016 was plus 1%, give or take some.

And the numbers for 2017 I am hearing numbers to be positive.

So after two years of really factored down industry, I'm hitting industry numbers to be positive but not giving any personal view on it.

When I look at the Microchip opportunities and we see our market US, Europe, Asia and Japan, I'm seeing market to be normal.

And a question on the IOT market, specifically on the industrial Iot, there seem to be a lot of momentum going on in that particular sub segment.

I was wondering if you could provide any thoughts on that market and how you're positioned with your portfolio of connectivity, microcontroller (inaudible) of your distribution channel.

I think we've always believed that the industrial market is where the true strength of IoT fits.

It's where there are very strong business models for the investments that acquired in the IoT infrastructure that is going to put in.

We have many, many designs that would fit within that category.

And we're optimistic of how that growth will be a part of our overall growth going forward.

Thank you.

Congrats, again.

Thank you.

Kevin Cassidy, Stifel.

Congratulations, also.

My question was too around the semiconductor industry and whether you've seen any change in behavior from your customers with the consolidation in the industry.

Are they giving you better visibility for orders?

Or Ganesh had said earlier that lead times have been stable and that just seems like we're -- it's a long cycle and do you think this is -- has a semiconductor industry changed in less cyclical?

I think from the consolidation, I don't think lead time behavior is any different.

The behavior that's different is on pricing.

There are customers who have recognized that the industry has consolidated, it has changed and how they were able to essentially molest their supplies before to constantly get lower prices, it is less possible today.

Suppliers are standing up to them.

Many customers have realized that many customers are painfully realizing it and not quite accepting it and fighting it, but losing.

Great.

Thank you.

Thank you.

With no additional questions in the queue, I'll turn the floor back over to Mr. Steve Sanghi, for any additional or closing remarks.

Thank you, everybody, for attending the conference call.

We are pleased to deliver an outstanding quarter.

We'll see some of you on the road as we attend various conferences this quarter.

So thank you.

Bye-bye.

Thank you.

Ladies and gentlemen, once again that does conclude today's conference.

Thank you all again for your participation.