微晶片科技 (MCHP) 2017 Q4 法說會逐字稿

Good day, everyone, and welcome to the Microchip Technology's Fourth Quarter and Fiscal Year 2017 Financial Results Conference Call.

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

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

Please go ahead, sir

Good afternoon, everyone.

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

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

We refer you to our press 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 fourth quarter and full fiscal year 2017 financial performance, and Steve and Ganesh will then give their comments on the results 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 wanted to remind you that we're including information in our press release 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 we 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 share-based compensation and our acquisition activity.

Non-GAAP net sales in the March quarter were a record $902.7 million, near the high end of our guidance and up 2.4% sequentially from net sales of $881.2 million in the immediately preceding quarter.

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

On a non-GAAP basis, gross margins were 59.24% in the March quarter and significantly above the midpoint of our guidance, which was 58.2%.

Non-GAAP operating expenses were 23.66% of sales, significantly below the midpoint of our guidance range of 24.5%.

And non-GAAP operating income was an outstanding 35.6%, well above the midpoint of our guidance of 33.7% and very close to reaching our prior long-term operating model goal of 36%, which we had just established this past quarter.

Non-GAAP net income was a record $276.9 million, resulting in record earnings per diluted share of $1.16, which was $0.10 higher than the midpoint of our guidance of $1.06, up 12.6% on a sequential basis and up 64.7% as compared to the same quarter last year.

For fiscal 2017, on a non-GAAP basis, net sales were a record $3.502 billion and up 58.2% year-over-year.

Gross margins were 57.6%, operating expenses were 25.9% of sales, and operating income was 31.6% of sales.

Net income was $937.1 million and non-GAAP EPS was a record $3.99 per diluted share.

On a GAAP basis, net sales on the March 2017 quarter for $902.7 million, GAAP gross margins, including share-based compensation and acquisition-related expenses, were 59% in the March quarter.

GAAP gross margins including the impact of $3.2 million of share-based compensation and a benefit of $1.4 million from a settlement with the vendor associated with the fab excursion in the previous year.

Total operating expenses were $378.7 million and includes acquisition and tangible amortization of $94.3 million, share based compensation of $18.8 million, $6 million of acquisition-related and other costs and special charges of $46.1 million consisting primarily of charges associated with the acquisition integration activities, including a $33 million charge associated with the lease facility in San Jose, which we inherited in the Atmel acquisition.

We have vacated the San Jose lease building and are finding the environment for subleasing with the facility to be quite challenging.

With all the purchase accounting adjustments, the Atmel acquisition-related charges and their related tax impact, GAAP net income from continuing operations was $136.9 million, or $0.57 per diluted share.

For fiscal year 2017, GAAP net sales were a record $3.408 billion, gross margins were 51.6%, operating expenses were 43.5% of sales and operating income was 8.1% of sales.

Net income from continuing operations was $170.6 million, or $0.73 per diluted share.

The non-GAAP tax rate was 8.4% in the March quarter and 8.5% for fiscal year 2017.

The GAAP tax rate was a negative 91% in the March quarter and negative 90% for fiscal year 2017.

We expect our longer-term forward-looking non-GAAP effective tax rate to be between 8% and 9%, and the large difference between our non-GAAP and GAAP tax rates relates to the differences and the special -- and the specific tax rates that apply to the charges that are excluded from our non-GAAP results.

Moving on to the balance sheet.

Our inventory balance at March 31, 2017, was $417.2 million.

Microchip had 103 days of inventory at the end of the quarter, down 1 day from that of the end of the December quarter.

Inventory at our distributor was 33 days and up 2 days from the December quarter.

The cash flow from operating activities was a record $322.6 million in the March quarter.

As of March 31, the consolidated cash and total investment position was $1.41 billion, of which about $500 million is domestic cash.

Due to our February 2017 refinancing activities, we had no borrowings under our revolving line of credit at the end of March.

As part of the refinancing activities, we exchanged some of the 2.125% 2037 bonds issued in 2007 for newly issued 2 1/4% 2037 bonds.

There are still $143.75 million of the 2.125 % bonds outstanding, for which there is a call date in December 2017.

Our current intention is to call any of these bonds that remain outstanding at the call date, and we have classified these bonds as short-term on our balance sheet.

We continue to make good progress on our leverage with our net debt-to-EBITDA ending the March quarter at 1.94.

This is down from 2.47 at the end of the December quarter.

I'll remind you that last year, when we announced the acquisition of Atmel, we have projected our net debt-to-EBITDA to be about 3 at the end of March 2017 quarter.

So we have made tremendous improvements in our business over the past year to get where we are today.

We expect our net debt-to-EBITDA to be about 1.65 by the end of June.

Our net debt-to-EBITDA does not include our 2037 convertible debt as it is excluded from our banking covenants because it is more equity-like in nature due to its 20-year maturity date.

Capital spending was approximately $23 million in the March quarter.

For fiscal year 2017, capital expenditures were $75.3 million and well below our last communicated guidance of $90 million.

We expect about $60 million in capital spending in the June quarter and overall capital expenditures for fiscal year 2018 to be about $170 million.

The capital expenditures in the June quarter were high due to rollover of some capital from fiscal 2017 that wasn't received until after year-end due to equipment lead time stretching out.

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

These capital investments will bring significant gross margins improvements to the business, particularly for the Atmel manufacturing activities that we are bringing into our own factories.

Depreciation expense in the March quarter was $32.6 million.

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

Ganesh?

Thank you, Eric, and good afternoon, everyone.

We are very pleased with how our strategic product lines performed in the March quarter and how the combined assets of Microchip and former Atmel working in harmony continue to produce differential growth results.

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

Our microcontroller products performed strongly in the March quarter, with revenue being up 4.4% sequentially as compared to the December quarter, setting a new record in the process.

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

Microcontrollers had over $2.3 billion in annualized revenue, represented 64.3% of Microchip's overall revenue in the March quarter.

We remain pleased with the performance and competitiveness of our overall 8-bit, 16-bit and 32-bit microcontroller portfolio in the broad-based market.

Clients using microcontrollers that originated from Atmel heritage continue to gain confidence in Microchip's commitment to these products.

As a result, we are seeing more designs that were in the pipeline, which are going into production and ramping in volume as well as continued growth in our designing funnel, which we expect will drive future growth as these designs progress into production over time.

Last month, Gartner Dataquest released their microcontroller market share report for calendar 2016.

We are pleased to report that Microchip retained the #1 position for 8-bit microcontrollers and, once again, gained market share in calendar 2016.

In the 16-bit microcontroller market, we continue to gain market share as we were the fastest-growing franchise among the top players, and we remained in the #5 position.

In the 32-bit microcontroller market, we gained significant market share again and climbed from the 11th to the sixth position.

For microcontrollers overall, we climbed from the fourth position to the third position and continued our relentless march towards #1 spot.

As the Gartner results demonstrate, we gained significant market share in calendar 2016, and we continue to gain market share in the first quarter of calendar 2017 as evidenced by our March quarter results.

And I believe we have the product momentum and customer engagement to continue to gain even more share as we further build the best performing microcontroller franchise in the industry.

Now moving to our analog products.

Our analog product revenue was up 1% sequentially in the March quarter as compared to the December quarter and also set a new record in the process, and close to $925 million in annualized revenue, our analog products represented 25.5% of Microchip's overall revenue in the March quarter.

We are successfully finding more opportunities to attach Microchip's vast portfolio of analog products to Atmel microcontrollers and microprocessors at multiple customers and application.

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

We, in the meanwhile, continue to develop and introduce a wide range of innovative and proprietary new linear mixed signals, power, interface, timing and security products to fuel the future growth of our analog products as we march relentlessly here, too, towards making analog a $1 billion revenue business for Microchip.

Moving to memory products.

Our memory product revenue was sequentially down 2.3% in the March quarter as compared to the December quarter.

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

One last note as we consider our 2016 performance -- calendar year 2016 performance, last month, Semicast ranked Microchip as the eighth largest automotive semiconductor company, a significant move up from the mid-teens ranking we were at in 2015.

Automotive and industrial are important end-markets for our growth and consistent performance.

And as you will hear in Steve's remarks, these end-markets have grown as a share of our overall revenue.

Let me now pass it to Steve for some general comments about our business and our guidance going forward.

Steve?

Thank you, Ganesh, and good afternoon, everyone.

Today, I would like to first comment on the results of the fiscal fourth quarter of 2017 and total fiscal year 2017.

I will then provide guidance for the fiscal first quarter of 2018.

Our March quarter financial results were very strong.

Our non-GAAP net sales were a record and near the high end of our revised guidance.

Our non-GAAP gross margin percentage, operating profit percentage and earnings per share each exceeded well beyond the high end of our guidance.

In non-GAAP earnings per share, we blew the top off with a record earnings per share and up $0.10 above the midpoint of our guidance.

Non-GAAP earnings per share was up 64.7% from the March quarter of a year ago due to improving sales, gross margin percentage, operating expense leverage and the successful execution of our core business as well as accretion from our acquisition.

I want to thank all the employees of Microchip, including acquired employees from various acquisitions worldwide, for delivering a record quarter in every respect.

This was also our 106th consecutive profitable quarter.

As I reflect on fiscal year 2017, we had outstanding financial results in every quarter and closing out the fiscal year with record sales in earnings per share was a befitting tribute to the fiscal year in which we repeatedly hit the ball out of the ballpark.

Now let me decide for the financial results of Microchip from the fiscal fourth quarter.

We achieved a new all-time high gross margin and operating margin percentage in our core Microchip business, excluding Atmel, substantially exceeding any prior records.

On Atmel, the gross margin improved by another 235 basis points sequentially, and Atmel's operating margin achieved another all-time record, exceeding 30% for the very first time.

We achieved an accretion from Atmel in the March quarter of $0.25 per share versus our guidance of $0.18 to $0.22 per share.

The total accretion from Atmel for fiscal year '17 was $0.69.

This was compared to $0.25 accretion as our first estimate after we announced the acquisition and without any stock buyback.

By any measure, our March quarter and fiscal year '17 results are stellar.

We're also proud to have achieved 35.6% operating margin for the combined company, which is a stone's throw away from our long-term operating margin target of 36% that we just revised upward last quarter.

I want to again thank the worldwide employees of Microchip, including acquired employees of all of our acquisitions, for delivering stellar and a record fiscal year 2017.

Now investors and analysts have frequently asked us about our revenue breakdown by end markets.

We have not broken those numbers out in more than a decade as we do not manage our business by end markets.

Our standard products sell in multiple vertical markets and have broad appeal across these various markets.

We occasionally see end-market breakdown mentioned in some analyst reports.

Our end market breakdown, though, has changed substantially in the last decade from various acquisitions as well as organic growth in several markets, especially industrial and automotive.

Therefore, we have done a comprehensive analysis to prepare and updated end market revenue breakdown of our business for our investors and analysts.

Based on fiscal year 2017 results, our largest market is industrial, with 35% of our business in this market; the second largest market is automotive, with 25% of our business; then comes consumer with 24% of our business; computing with 9%; communication with 5%; and finally, defense and aerospace with 2% of our business.

Over the last several years, our fastest-growing markets have been industrial and automotive which, together, account for 60% of our business now.

Additionally, our consumer exposure of 24% is not made up of mobile phone.

It is made up of home appliances, security systems, thermostats, televisions, remote controls, power tools, drones, joysticks, headphones, furniture, consumer toys, et cetera.

With a broad product line and large customer base, compiling our end market breakdown is quite time-consuming.

We are providing the color for investors to better understand the current complexion of our business by end markets.

We do not expect to provide this breakdown regularly, but we'll do so when there's a meaningful change to share.

Now before I go into the guidance for June quarter, let me say a few words about the environment.

We are seeing a very strong business environment for our products worldwide.

Our bookings rate is extremely strong.

As you know, we have not broken out our book-to-bill ratio in a long time since it is largely misunderstood.

However, to make you aware of the strength of our bookings, we are providing this indicator for one time.

Our book-to-bill ratio for March quarter was approximately 1.10.

Again, I caution you that bookings are aged out so a 1.1 book-to-bill ratio does not mean 10% sequential revenue growth.

We also take revenue base on sales out from distributors, and book-to-bill ratio only measures booking for sale into distributors.

Therefore, the book-to-bill ratio does not represent or help you predict the growth in this quarter but does give you a sense for the strength of the business environment for our products that we're managing through.

Our inventories at Microchip as well as at our distributors are towards the low end of the normal range.

Therefore, we are starting to see some lengthening all of our lead times.

We're starting to see challenges in fab, foundry, probe, assembly and test capacity.

We have increased wafer starts in our 3 internal fabs, and we're adding capacity in our 3 back-end facilities.

Despite all this, we are seeing significant business that we're not able to support by the customer-requested dates.

These challenges are more acute with our Atmel-originated products due to the inadequate capacity plan that we inherited.

We are adding capacity to alleviate these challenges as quickly as practical.

We also posted a letter on our website on April 4, 2017, informing our customers regarding many of these points.

Some of you have questioned our motives posting these letters in the past, suggesting that somehow we were trying to pull ahead backlog.

Our bookings were very strong before we posted the letter, and the rate of bookings has not changed after we posted the letter.

We believe that our 115,000-plus customers have the right to know about the challenges we face in the current business environment and to prepare for it accordingly.

Posting it on the web is the best way to disseminate this information.

Now let us go into the non-GAAP guidance for the June quarter.

We expect total net sales to be up between 2% and 7% sequentially.

I want to remind investors that in the past 5 years, we had 2 acquisitions that closed in the first week of April.

Supertex closed on April 1, 2014, and Atmel closed on April 4, 2016.

Therefore, mathematically taking average of last 5 years of sequential growth for the June quarter would give you a large error.

Without acquisitions, our average of last 5 years of sequential growth in the fiscal first quarter was 3%.

Therefore, our revenue guidance is substantially above seasonal.

We are also not seeing any issues with our automotive business as some others in the industry have commented.

We believe that the comments about subsidies in China on electric cars and other automotive comments were more company-specific.

Our automotive business has very strong backlog and continues to grow well.

Regarding gross margin.

As more and more savings from our fab consolidation and cost improvement efforts show up and Atmel gross margins continue to improve due to pricing as well as cost reductions, we see a steady improvement in overall gross margin of the company.

We expect gross margin for the June quarter to be between 59.5% and 60% of sales.

We expect all our overall operating expenses to be between 23% and 23.5% of sales, and we expect operating profit percentage to be between 36% and 37% of sales.

And we expect earnings per share to be between $1.17 and $1.27 per share.

I would like to remind investors that last quarter, we conservatively revised our long-term financial model upwards to our long-term non-GAAP gross margin of 60%, operating expense of 24%, and operating profit of 36%.

We are now already guiding the June quarter to be at/or above this long-term operating profit target.

Therefore, we are revising our long-term operating margin target upwards again.

First, let me give you some background.

We have seen an enormous gross margin, operating expense and operating profit leverage in our business.

We are ramping all of our 3 fabrication facilities.

The increasing utilization lowers our wafer cost.

We're also ramping all 3 of our back-end plans.

Atmel's test technology was about a decade behind that of Microchip's in terms of higher amount of parallel testing to achieve higher units per day out of the test system.

In many cases, Microchip's units per day per system is 5 to 10x higher than that of Atmel.

We are converting many of Atmel's high-volume products to Microchip's test technology that is substantially lowering the cost and improving the output.

This continues for the next 2 years or so.

The combined set of lower wafer costs, more efficient assembly and test technology and stable to increasing prices is that we expect our long-term business model to exceed any prior expectations.

Therefore, we are setting our new long-term gross margin target to be 62.5% of sales.

We are setting our new long-term operating expense target to be 22.5% of sales, and we're setting our renewed long-term operating profit target to be 40% of sales.

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 their non-GAAP estimates to First Call.

With this operator, will you please poll for questions?

(Operator Instructions) We'll take our first question from John Pitzer with Credit Suisse.

I guess, VP, can you help me understand a little bit relative to you, increasing CapEx, increasing wafer starts, what do you think you'll be able to catch up with the demand curve here in the near-term?

And I guess, you said in the press release that there's a considerable amount of demand that you can't meet right now.

Any way that you can help us quantify kind of what you're leaving on the table in the near-term?

So in terms of CapEx, the majority of CapEx that we are adding is in the back-end.

As I mentioned, Atmel's test technology was about a decade behind.

And we're converting many of Atmel's high-volume products to Microchip's assembly test technology.

The challenge with that is that the easiest way to add quickly incremental capacity is to buy off more of what they have, more of what we have at Atmel, same test systems, same capacity.

But that is very, very inefficient.

And if we buy more of that, we get stuck with it for 5 to 7 years in high cost structure.

So we are trying to buy more efficient capacity, Microchip type, which then requires writing the test programs, converting them to Microchip's test technology, correlating and doing all that, which takes a little longer.

So it's a very fine juggling exercise to reasonably able to satisfy the customers and not have lines down and yet keep a steady march towards converting those products or very low-cost technology, which is getting gross margin improvements and all that.

So driven by all that, there is significant constraints.

We are unable to dollarize the constraint for you today because it kind of changes every day.

We don't know where we'll end up at the end of the quarter.

We know the number, where we ended up last quarter, but I think we're less comfortable in sharing it.

I did want to say one other thing, John.

After our last earnings call, I saw in your report where you said, we see Microchip entering unchartered levels of operational efficiencies and leverage, which should support long-term operating margin of 40%.

You are right on.

I get lucky every once in a while.

You were, well, either good or lucky.

Probably good.

It seems that you were right on.

You saw something that we saw, too, but we were not ready to commit yet and not ready to guide to a 40% operating margin target yet.

And we are now, and we have guided as such.

We'll see.

Maybe that's related to my second question.

Clearly, the scale you've amassed is giving you leverage on the operating method.

I'm kind of curious as to what benefits you might be able to see on the top line from your scale, just given that the markets you have played have been pretty diversed.

I guess, are we seeing a trend where customers want to do with fewer suppliers so you can do more?

And do you think is that, that's our long-term sort of advantage for you to perhaps gain share at a faster clip that you historically have?

So I think I would say, in our commentary, we have been very careful to not describe the market environment to be anything other than for our product.

If you really listen to what I said, I said it twice, the market environment for our products.

We didn't really make any commentary on general market environment.

You could talk to everybody else.

That's kind of your job to figure out the general market environment.

We describe it for our products.

So baked in it, in that environment is also tremendous leverage that of are getting attaching vast portfolio of our analog products, memory products to WiFi products, Bluetooth and others, along with various microcontroller and other products we have.

We have sort of 19 different product lines within Microchip today, and we're getting enormous leverage in what you call sort of attach in the past.

And we have given a new term at Microchip.

We call it total system solution.

So if you look at the number of devices per board, that we had, let's say 5 years ago, it's dramatically increasing in terms of number of devices we have per customer board today.

I can't give you the number.

But that is accelerating and, therefore, somewhat we are creating our own environment.

There is a tremendous organic growth we have seen in our business in the last year.

And if you just recall a year ago, there were organic growth concerns.

And at the same time, we have added from acquisitions.

So if you just look out the March quarter, we beat the earnings by $0.10.

$0.05 came from higher Atmel accretion and the other $0.05 came from core Microchip.

So it's not one or the other.

We are really just accelerating on both fronts.

We'll go next to Craig Hettenbach with Morgan Stanley.

Steve, with John's successful run at 40%, I'll promise not to raise the bar to 45% up margins.

But if we can talk about just attach rate as a follow-up, particularly for wireless connectivity, kind of what you're seeing for MCU with wireless attached and the momentum in that market?

We have many, many embedded systems, adding connectivity to that.

Certainly, wireless is a big component of that, but we also have wired connectivity in many systems.

And our portfolio of connectivity is extremely rich at this point between success of acquisitions that have added to our portfolio.

So embedded systems in general are becoming more valuable when they're attached.

We're finding lots of opportunities for Ethernet, WiFi, Bluetooth, LoRa, a number of other proprietary standards to help these systems connect to whatever is appropriate in their environment.

And it is a part of the growth that we're experiencing.

Got it.

And then as my follow-up, can you talk about 32-bit?

And I know you guys have the midst as well, the Atmel, ARM Cor.

And I know it's more focused on the peripherals than the core.

But just wanted to get a sense now that you're a year into Atmel, just some of the design win and product momentum that you're seeing in the marketplace for 32-bit ARM.

So we don't think of it the 32-bit ARM alone.

We look at overall at 32-bit business.

32-bit product line has been growing faster than Microchip average growth that we've had.

We have fully incorporated the products that came to us from Atmel, what we call the SAM time products, and the products historically from Microchip.

I think 32 into our integrated roadmaps as we presented out into our customer base when we pursue new designs.

And they're doing very well.

And we see strengths in the portfolio that we inherited from Atmel that have taken us to new areas.

Not only in microcontrollers.

We've also got microprocessors that were part of the portfolio.

And then we have some strengths from classic Microchip that continue on their effort.

And the forward-going portfolio has a single roadmap.

We've brought that altogether.

And we're very, very confident in the 32-bit product line and its growth under the Microchip clock.

We'll take our next question from Mark Delaney with Goldman Sachs.

I was thinking if you could talk a little bit of how you're thinking about capital allocation going forward, especially now that you've done better than you've anticipated on the leverage levels coming down.

As we're thinking about the company's interest in engaging in additional M&A?

And what are your thoughts around doing share repurchases?

So I think it's quite simple.

There are 3 uses of capital that can be 3 different uses: using it in our own business, in making investments; giving it as a dividend; or using it as M&A, and you can call it may be for stock buyback.

We're getting extreme leverage on the operating expense side in our business, and it does not seem like we will have a need to go outside of our P&L model to make really a lot OpEx or any kind of investments.

In terms of CapEx, even the number we guided for the year is really a small portion of the overall yearly revenue.

You will know that Q1 is higher with front-end loaded largely because of slip of capital from last quarter.

In terms of dividend, our dividend strategy does not change.

The Board is committed to pinching you with the dividend we have and a very, very small miniscule increase every quarter.

There is no desire to really do anything different.

And as far as stock buyback is concerned, we do not regularly buy back stock.

We only buy it -- bought it at extreme occasions.

Last time we bought stock was when we had to issue some stock in the Micrel acquisition, and we wanted it to be a cash transaction so we bought the stock back.

So that really leaves M&A.

Atmel acquisition now was about a year ago.

It's largely consolidated.

But as I mentioned, a lot of the back-end and other challenges still remain.

We're still trying to convert their test technology, some of their technology to ours, which will take some time.

So if a reasonable acquisition falls in our plate, we're willing to execute it.

But the valuations are fairly high right now, and there is really nothing imminent that we have on our plate.

And that's helpful.

A then a follow-up question.

I was hoping you could help us understand what steps we should think about in terms of bridging from company's margin level today toward the targets?

You talk a lot about the changes to Atmel's back-end operations and potential additional leverage as you go forward.

Are those the 2 things that got the company to its target, margin ranges?

Or are there other things we should have in mind that the company would execute on to get to those levels?

It's a little broader than that.

We are seeing tremendous gains in reduction in wafer cost essentially, both by increasing loadings in all of our 3 fabs, as well as being able to cross-pollinate and use our software of Atmel technology for each of those products, whichever the best solution may be.

They were good in certain things.

We were good in certain things.

Certain products will be cheaper here.

Certain products will be cheaper there.

So we're getting a significant leverage on our fabs.

And then as you mentioned, we're getting significant leverage out of assembly and test technology.

And overall, we're getting a lot of operating expense leverage, a lot of other manufacturing leverage also out of the same footprint and our facilities and all that, just pumping tremendous amount of output.

Recall that Atmel did no assembly themselves.

It was 0% assembly, and they only did 10% of the test themselves.

Microchip, on the other hand, did nearly 90% of our test ourself, and we did about 70% of our assembly ourselves.

So 2 companies combine together now, both assembly and test percentages done in-house have dramatically gone down because of Atmel.

And as we bring those things from subcontractors to inside and, in the process, also increased utilization and increase the output by 5x to 10x per system per day, the results are tremendous.

They're just beyond what we could have expected and beyond the leverage that we could reasonably describe.

And I must say that this detail level of due diligence was not available to us.

Very poor due diligence was shared just because we were ahead on competitors and all that.

So a lot of this area we have really done it on our own clock, identified the areas where we could bring significant cost reduction.

And we are basically in the process of implementing the first high-volume products on microcontrollers and memory, and a few other products are already throwing out of manufacturing facility.

So this is not a pipe dream.

We have delivered the front-end of that already.

I would add pricing discipline as the other element that we have brought over the last year to help improve the overall gross margins.

Maybe one other thing to add is that there's still benefits from the shutdown of the micro fab that aren't being recognized in the P&L yet today.

So a lot of things we're working on together.

The things that Steve is talking about it in Atmel, that's a couple-of-years project.

So we've got a lot of headroom and things to work on over the coming quarters.

(Operator Instructions) We'll take our next question from Chris Danely with Citi.

First question is just on the lead time extensions.

I know you have several different products with different lead times.

But if you could, is there any way to quantify the amount of the lead time extensions?

And then Steve, when was the last time you saw this type of lead-time extensions?

And then do you think you'll be able to catch up to demand over the summer?

Do you think they could get worse?

It's not to -- not getting worse.

Unlike what some of the people on The Street think, the letter has not accelerated the bookings in any way.

It didn't accelerate the bookings last time.

It didn't accelerate the bookings this time.

The letter was supposed to run April 4, and we've received these tremendous bookings in the March quarter with a book-to-bill of 1.1, and it did not change afterwards.

Our customers are fairly trained on, they expect that -- with this letter it's about 10x probably in the last 20 years-or-so.

It's -- the results were less than optimal onetime a couple of years ago which, soon after that, the China market fell apart and, as a result, we had a miss.

And many times, Street just remembers what happened last time.

So these letters have been very effective in informing our large 115,000-plus customers regarding what is happening, and then working with them to understand the requirements, being able to build a product in a better mix to understand people's drop-dead requirements so people don't go lines down.

So I can't give you one number across the range of our products, 100,000-plus SKUs.

People kind of like to look at one number, what the lead time is, and there's no such number.

On any given product, lead time could be 8 weeks today and you get one large order and the lead time goes to 12 weeks because the products which were after the 8 weeks are now booked.

On the other hand, there are plenty of products available on the shelf so the lead time can be anywhere from in stock to 16 weeks, I would say, all over the place.

Okay.

We are working hard to try to get the delinquencies all down by the September quarter time frame, right?

It all depends on what happens in terms of the bookings on a continuing basis.

But that's what all the firepower and the company is aimed towards.

Okay, great.

You mean, Steve, you're not just going to sit in the office and call 115,000 customers and tell them that the lead times are extending?

That's what we're waiting for.

So my next question is just some clarifications on the margins.

In terms of the new targets, is that like half from Atmel and half from the legacy Microchip?

And then just in terms of the oldest accretion and upside you've seen on Atmel's operating margins, can you break out how much is sort of COGS versus your operating expenditures?

Well, I mean, Atmel's road to growth and operating margins still remain well behind Microchip's.

And as I mentioned, Atmel's operating margin, we've got it over 30%, and gross margin was up by another 235 points.

Despite those numbers, they are still substantially behind Microchip.

And we always said based on large amount of mix they have taken before, we never expect that to make 40% operating margin, which really means core goes above and Atmel's is below and we break and average to about 40%.

So the improvement will really come from both.

As we are ramping our fabs, it's lowering wafer cost and helping both gross margin.

As we are bringing Atmel's assembly test technology to Microchip's level, the help of the transition to our technology is helping Atmel gross margin, but it's bringing much more output into our factories from outside, which then is also lowering core gross margin -- or increasing core gross margin.

Spreading that overhead over a larger base.

Spreading the overhead over a larger base, allowing us to buy more volume of lead frames to packages to molding compounds to everything else in a larger supply with better economics and all that.

We'll go next to William Stein with SunTrust.

I'll add my congrats as well.

I'd like to ask about maybe characterization of the cycle as -- Steve, as you've done in the past.

Clearly, we're heading into a time of a bit of tightness, a bit of this imbalance between supply and demand.

How much of what you're seeing is more related to lack of capacity in the Atmel product versus accelerating demand?

And do you anticipate we'll continue to see improving year-over-year growth beyond the June time frame, which is, I think, the sort of consensus view at least among the sell-side analysts?

Again, I will refrain from making any general remarks about the industry and largely focusing on how I see the business environment for our products.

Its significant impact of what we are seeing is really driven by the success of our own products in the market and the total (inaudible) situation that I already have talked about.

There was a -- number one, there was a significant reluctance on the part of the customers during the year that Atmel was up for sale regarding what would happen to those products, what would be supported and what not to be supported.

And if you, as a customer, have a concern, then you kind of always have a back-up plan in case those products are not to be available.

When it became clear that Microchip will buy Atmel, customers were more even disheartened originally, thinking that Microchip, being a strong competitor, may discontinue AVR and ARM-based products and others.

What we did was -- is the opposite.

And as Ganesh mentioned in his commentary, the result of all that has been a tremendous amount of customer confidence that we have gained in our strategy, in what we're getting unfair share of the design wins and customers here, and then analog and WiFi and memory and other attached to boot.

So a large portion is really driven by that.

There are always small numbers that can really drive a significant change.

Beyond that, we're also seeing general strength in the economy, especially happened postelection in the U.S. The whole world seems to be positive.

You could talk to distributors, and they are seeing strong bookings and a strong environment.

Lead time for equipment is lengthening.

Lead time for packages, all sorts of things is lengthening.

So those are some of the signs of what's happening generally in the economy, but I think what we are seeing has really also a significant company-specific element on the top of that.

One follow-up if I can.

Eric, I think more of your area of expertise.

I think there's a FASB pronouncement that's going to require you to transition to a sale in rev-rec.

Can you talk about -- confirm that, that's correct.

And if so, the timing and anticipated impact on your reported financials?

Yes.

So that change will be effective for Microchip April 1 of 2018.

So the beginning of our next fiscal year.

We are going through the planning process associated with that.

I guess what should be important from an investor standpoint is we are not going to change, in any way, our go-to-market strategy with our distributors, the way that we price our product, the way that we interact with them.

But the reporting will would have to be on a sell-in where, essentially, you're making an estimation of what the net sales price of the product that you're shipping in is going to be.

So our accounting team is working through that and will be effective for us next year.

We'll take our next question from Harlan Sur with JPMorgan.

Congratulations on solid results execution, the outlook.

As you think about growth and as it relates to Atmel's design win pipeline, I know you guys recently refresh Atmel's AVR 8-bit product line.

I think you guys even embedded some of your own IP into this particular product line.

I know you guys do a good job of keeping track of design win rates.

So I'm wondering if you've seen a step-up in design wins or see that from customers for the new AVR 8-bit products?

I mean, it just depends on what timeframe you compare against.

So we have been at it for a year since we bought the company, and the funnel size is normal.

We're seeing substantial growth and total funnel size on Microchip across 8-bit, 16-bit, 32-bit, WiFi, our networking business and automotive business, and for -- most business, the funnel size across Microchip is just enormous.

There is -- I think we are incredibly and beautifully set up to really deliver what we are telling you.

And then on the analog side, you guys are basically, within striking distance of $1 billion in annualized sales.

I think the last I ask this question, about 50% of these products are tied to your MCU programs, and the other 50% is old kind of standalone on the -- on performance merits.

Is that kind of still the right mix?

Or are you getting more traction on a standalone basis?

And then maybe any updates on your analog attached rates to Atmel's MCUs?

Well, we don't really look at the analog business to be either attaching to our microcontrollers or standalone.

We want to succeed in both.

If we had a very high attach rate, we never won anything standalone that would be negative.

Because that really means we can only win when it is our microcontroller.

That's not the case.

Even if we don't win the microcontroller, it's a microcontroller from Freescale, and assets, NXP and anybody, or maybe the socket have a microcontroller, it is-driven off microprocessor or FPGA or some sort of SoC, we still want to be able to win the analog in those sockets rather -- it's for program management, converters or has some WiFi on it, or has some supervisory [options] or some other things.

So right now, I think as we look across, we have -- we train every area.

We are winning around microcontroller.

We're winning around Atmel microcontroller.

And we're winning around other people's microcontrollers, SoC, and PGA, processes et cetera.

And there's no specific focus to be one way or the other.

We actually have identified built-in large opportunity to attach to analog around Atmel's microcontrollers because those were the sockets we were purposely kept out.

Any of the reference designs that Atmel produced before, by design, they would put anybody else in it but Microchip.

In the last 1 year, all those reference designs, tools, development tools, et cetera, they're all been refurbished to replace anybody's analog and WiFi with Microchip.

So there you have incremental additive analog that we should be able to attach.

And we are.

Our next question will go to Rajvindra Gill with Needham & Company.

This is Robert Mertens on behalf of the vendor.

You broke out the revenue breakdown by end markets.

You had about 25% in the automotive end market, and you've mentioned that it was around the eighth largest semi suppliers.

Do you have any visibility towards what areas of automotive you're seeing your products go into, if there's strength in infotainment versus a [Dass] or power management?

Or any granularity there would be great.

We are in a broad range of applications but we have some specific ones we have a larger exposure to.

So you mentioned infotainment, but I've broadened that to networking inside the car as one area.

We are in many access control applications in the car.

We are in touch control for a range of both touch screen and touch buttons and things where many USB connectivity inside a car.

We're on all the garage door openers inside the car.

So it's a pretty broad set of applications and specific areas in which we have a much higher penetration than even normal.

I think we have 51 chips in a Mercedes S class car.

55 in a Hyundai Genesis.

It's everywhere up and down the car.

It's much more broader than anybody can describe.

Okay.

And then in terms of, I guess, products going from the high-end S class, I envision this going more mid-market.

Are you seeing that be a trend that's taking off now or still a quarter-or-so out?

Those trends don't happen in a quarter.

I mean, if you look at the keyless entry, where you don't need a mechanical key anymore to begin nearly 20 years ago from General Motor cars, I think we put the first keyless entry where you don't have to use a mechanical key to open the car.

We did the first hotel room door-lock years ago before there used to be mechanical keys to even open the hotel room door-lock.

And as you've seen over the years, people don't even know there's a mechanical key there exist for hotel rooms or cars and stuff like that.

So these changes are a lot slower.

It happened over time.

These are not 1-quarter phenomenon.

There are 400 different car models that the has a home link on it, all exclusive product of Microchip.

There are many hundreds of models that have most bus.

There are large number of models that have our touch in it and so on and so forth.

They all start at the high level, and every year, in the following model year, the company will take it down to the middle range model.

And then a few years from now, it could get to the lower end model.

Feature by feature, they migrate down, but the trend doesn't as much quarter-to-quarter.

I think the way to think about it is we have a high presence in all cars segment.

It's not just at the high-end that we are present.

That was just an example to show you in a rich environment of electronics, we have a pretty high percentage.

But if you look at the lower-end cars, we have just as high percentage in many of those cars.

We'll go now Christopher Rolland with Susquehanna, Financial Group.

This is Liz Pate, in for Chris Rolland.

Most of my questions have been asked and answered, by just a quick one on the pricing environment.

Maybe you can talk about how that is currently industry-wide and specifically on the Atmel products.

Do you still have some ability to raise prices on those products?

We've been talking about it for multiple quarters.

It's taking us the time to implement the price changes across a broad range of customers.

Some of them have been phased in over time so that they don't all come together in one quarter.

But I would say at this point in time, a substantial portion of the price increase is that we have begun last June-or-so are in place.

And as we go in going forward, it's really no program increases in price.

What we have done is also put in a significant discipline on new designs because what we were doing with the price increases was correcting past issues where pricing was done poorly.

And those new designs are all being done using a more disciplined process to make sure that we don't have to come back and change the pricing other time.

But pricing for our market tends to be something that it happens at the point of a design.

And so that's when the competition for what the best performance, price, value, equation is.

And then that happened a year or 2 before, designs usually go into production.

And there isn't as much pricing discussion that takes place once the designs have completed and production is getting started.

I would add, though, that same what Ganesh said, that as all the new coat we are making, really, in the last year all substantially better-disciplined pricing than the average pricing we are having on Atmel parts today.

As these designs are going to production, it has been about a year now, so designs are starting to go to production on those things that we recorded on our clock.

There will be a steady stream of wind on the back where every quarter, the mix gets richer and richer with higher and higher percentage of pricing to be better-disciplined, pricing coming from Microchip, and smaller and smaller percentage of older devices on which we raise the price where we couldn't raise it although to where the new prices are.

So this would be a long-term tailwind that will continue to blow in the back.

We'll go now to Craig Ellis with B. Riley.

Congratulations on your execution.

The first question is gross margin question, maybe most appropriate for Eric.

I believe the company was expecting to see the benefit of the micro San Jose fab shutdown in the first part of the calendar quarter.

Is that, in fact, happening?

And if so, is it more in the calendar first quarter, calendar second quarter, more evenly distributed?

So I would say the benefits from the micro shutdown have been coming over time.

We still probably have a couple of quarters to go as we sail through all the order inventory and all the 8-inch inventory starts to be realized in the course of sales.

So -- and we have got benefits from that the last 2 quarters but expect that to continue on in the June and September quarters also.

And then the follow-up question is for Steve.

And Steve, it goes back to a comment that I made -- I think you made a few calls ago when you indicated that if industry were to grow, I think the number was high single-digits or 10%, I don't know specifically that, that would pay vertically integrated manufacturer.

So my question is this, with the demand strong, with the global economy showing signs of improvement and with what appears to have been a 5-year period of fairly disappointing analog CapEx, are you seeing signs in your business where the environment is favoring a vertically integrated manufacturer like Microchip?

And if not, do you think that will occur later this year?

Or is that something that would be further into the future?

Well, I think it is happening already.

You're seeing it in our results.

And you'll see it in our results in the coming quarters also.

If Atmel was a standalone company today, they wouldn't be able to take advantage of this tremendous improvements we're making on assembly test technology, inside capacity, being able to bring large volumes on our test technology, already running in our Thailand facility, producing 5x high ARPU persistent.

They just -- subcontractors have no incentive to give you their canal where they get paid by the hour and the persistence.

If you dramatically improve output and output goes up 5x, and now you only have to pay them for 20% of the hours, they're not happy.

So there, the incentives are not aligned properly.

You're seeing tremendous benefit of vertical manufacturing, both from fab to assembly and test already, and you'll continue to see it as we go forward.

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

At this time I'll turn the conference back to Mr. Steve Sanghi for any final remarks.

Well, thank you, everybody.

We are pleased to deliver an outstanding quarter and outstanding fiscal year.

And watch us grow.

Hopefully, we can deliver another one.

And we'll see some of you at the conferences we will go to later this quarter.

Thank you.

This does conclude today's conference.

Thank you for your participation.

You may now disconnect.