微晶片科技 (MCHP) 2018 Q1 法說會逐字稿

Good day, everyone, and welcome to the Microchip Technology First Quarter and Fiscal Year 2018 Financial Results Conference Call.

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

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

Please go ahead, sir.

Good afternoon, everyone.

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

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

We refer you to our press 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 operations.

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 first quarter fiscal year 2018 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 want to remind you that we are including information in our press release and this conference call on various GAAP and non-GAAP measures.

We have posted a full GAAP to non-GAAP reconciliation on the Investor Relations page of our website at www.microchip.com, which we believe you will find useful when comparing GAAP and non-GAAP results.

I will now go through some of the operating results, including net sales, gross margin and operating expenses.

I will be referring to these results on a non-GAAP basis prior to the effect of our acquisition activities and share-based compensation.

Net sales in the June quarter were a record $972.1 million, above the high end of our June 5, 2017, upwardly revised guidance and up 7.7% sequentially from net sales of $902.7 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 60.4% in the June quarter and above the high end of our guidance, which was 60%.

Non-GAAP operating expenses were 22.9% of sales, below the low end of our guidance range of 23%, and non-GAAP operating income was a record 37.5%, well above the high end of our guidance range of 37%.

Non-GAAP net income was a record $319.1 million, resulting in record earnings per diluted share of $1.31, which was $0.07 higher than the midpoint of our guidance of $1.24, up 12.9% on a sequential basis and up 56% as compared to the same quarter last year.

On a GAAP basis, gross margins, including share-based compensation and acquisition-related expenses, were 60.1% in the June quarter.

GAAP gross margins include the impact of the $3.4 million of share-based compensation and $0.7 million benefit from the recovery of material that was previously written off due to a vendor material issue.

Total operating expenses were $362.8 million and include acquisition intangible amortization of $120.8 million, share-based compensation of $19 million, $2.9 million of acquisition-related and other costs and special income of $2.8 million consisting primarily of the gain on the sale of the Micrel San José wafer fab in the June quarter.

After these adjustments, GAAP net income was a record $170.6 million or $0.70 per diluted share.

The non-GAAP tax rate was 8.7% in the June quarter.

The GAAP tax rate was negative 2.6% in the quarter.

We expect our longer-term, forward-looking non-GAAP effective tax rate to be between 8.25% and 9.25%.

The large difference between our non-GAAP and GAAP tax rate relates to the differences in 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 June 30, 2017, was $426.8 million.

Microchip had 100 days of inventory at June 30, down 3 days from the end of the March quarter.

Inventory days are at a 7-year low, and we don't expect inventory days to grow in the current quarter, as our capacity increases are hardly keeping pace with the increases in demand we are seeing in the business.

Inventory at our distributors was at 31 days, and that was down two days from the March quarter levels.

The cash flow from operating activities was a record $345 million in the June quarter.

As of June 30, the consolidated cash and total investment position was $1.65 billion, of which about $546 million is domestic cash.

We continue to make good progress on our leverage with our net debt to EBITDA ending the June quarter at 1.58.

This was down for 1.94 at the end of the March quarter.

Our EBITDA in the June quarter was a record $395.6 million.

We expect our net debt to EBITDA to be under 1.3 by the end of September.

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.

Our net debt to EBITDA is in excellent condition and declining rapidly, so we are not going to continue to share this metric in our earnings calls in future periods unless there is a material change.

During the June quarter, we received about $40 million of capital at our facilities.

Capital spending for the quarter was only $22.1 million due to the timing of the receipt of the equipment and when it was paid for.

We expect about $70 million in capital spending in the September quarter and overall capital expenditures for fiscal year 2018 to be about $180 million.

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

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

Depreciation expense in the June quarter was $29 million.

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

Ganesh?

Thank you, Eric, and good afternoon, everyone.

We're very pleased with how all our product lines performed in the June quarter and how the combined assets of Microchip and former Atmel, working in harmony, continue to produce differential growth results.

These are our first results since we unveiled Microchip 2.0 to our investors about 2 months ago.

We look forward to sharing many more updates of our transformation to Microchip 2.0 as we continue to enable our clients with the very best, smart, connected and secure embedded applications.

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

Our microcontroller business performed very strongly in the June quarter with revenue being up 9.5% sequentially as compared to the March quarter, setting a new record in the process.

On a year-over-year basis, the June quarter microcontroller revenue was up a whopping 18.1%.

The June quarter of this year and the year-ago June quarter are completely comparable as they both represent a full quarter of combined Microchip and Atmel business.

We continue to see clients using microcontrollers that originated from Atmel heritage express confidence in Microchip's stewardship of these product families.

As a result, we are seeing more designs that are in the pipeline going to production and ramping in volume.

We're also seeing continued growth in our design-in funnel, which we expect will drive future growth as these designs progress into production over time.

Microcontrollers had over $2.5 billion in annualized revenue, represented 65.4% of Microchip's overall revenue in the June quarter.

Additionally, we shipped out 20 billionth cumulative microcontroller in the June quarter.

In the June quarter, we also started sampling the PIC32C product line.

Our first PIC32 microcontroller, which happened to have an ARM core.

So we now have PIC32 microcontrollers with MIPS and ARM cores within them, both of which are supported by the Microchip development tools ecosystem.

This is consistent with what we have always said, which is that the core inside the microcontroller is not as important as the brand on the outside along with the attendant brand promise for what clients expect from PIC microcontrollers.

Our microcontroller business gained further market share in the second quarter of calendar 2017 as evidenced by our June quarter results.

In fact, the results show that all our microcontroller product lines are firing on all cylinders and driving differential growth and market share gains.

We believe we have a new product momentum and customer engagement to continue to gain even more share as we advance the Microchip 2.0 transformation and build the best-performing microcontroller franchise in the industry.

Moving now to our analog business.

Our analog product revenue was up 3.7% sequentially in the June quarter as compared to the March quarter and also set a new record in the process.

Our analog results were negatively impacted by capacity constraints on products with Atmel heritage, without which the growth would have been higher.

On a year-over-year basis, the June quarter analog revenue was up 11.2%, well ahead of the market growth rate for analog.

At over $950 million in annualized revenue, our analog products represented 24.6% of Microchip's overall revenue in the June quarter.

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

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

We continue to develop and introduce a wide range of innovative and proprietary new, linear, mixed-signal, power, interface, timing and security products to fuel the future growth of our analog products, as we march relentlessly towards making analog a greater than $1 billion annualized revenue business for Microchip sometime in fiscal year '18 and a much larger business in the coming years.

Moving now to our licensing business.

Our licensing business was up 8.5% sequentially in the June quarter and set a new record in the process, as annualized revenue broke through the $100 million mark for the first time ever.

For the last 3 to 4 years, we have licensed multiple foundries and independent devise makers on multiple process technology nodes, and have been working to enable getting these technologies qualified for production.

We expect the fruits of this work will soon begin to manifest in our licensing results as the license processes start generating royalty revenue for many, many years to come.

Moving to our memory business.

This business was sequentially up 8.8% in the June quarter as compared to the March quarter.

We have been very successful in our memory business, using the combined product lines of Microchip and Atmel and getting the best from each.

There are significant cost reductions underway using Atmel-originated silicon, which will be assembled and tested using Microchip's back-end factories to achieve the lowest overall cost.

We believe that this effort will make us even more competitive and improve gross margins further.

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

Finally, before I conclude, a couple of general items.

First, in case there are any lingering concerns about the automotive end-market in light of the results announced by some our competitors and the seasonally adjusted annualized rate of automobile shipments, also known as SAR, which some analysts track, we would like to categorically state that our automotive business performance was strong in the June quarter, with sequential growth pretty close to Microchip's overall performance.

Now this is understandable, as Microchip content tends to be in mid- to high-end cars, which are less sensitive to inventory and consumer cycles, and we continue to benefit from the growth in automobile electronics as well as our market share gains in the automotive market segment.

Therefore, Microchip's automotive business does not necessarily track with the SAR numbers.

And we expect our automotive business to perform well again in the September quarter.

For more information about our automotive business, we refer you to a presentation we made on June 6 at an automotive-focused investor conference, which is available in the Investors Relations section of our website.

Secondly, on the heels of our ranking in April by Semicast as one of the top 10 largest automobile semiconductor companies, IHS in June ranked Microchip as one of the top 10 largest industrial semiconductor companies and among the top 3 largest microcomponent suppliers to the industrial market.

microcomponents in the IHS report refer to microcontrollers and microprocessors.

Automotive and industrial are important end markets for our growth and consistent performance, and as we shared with you in May, they together represent about 60% of our 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.

Well, how do you like the results from Microchip 2.0?

Today, I would like to first reflect on the results of the fiscal first quarter of 2018.

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

I will also provide update on capacity enhancement activities, as well as Microchip 2.0 that we introduced to the investors during the last quarter.

Our June quarter financial results were extremely strong.

Our net sales were a huge new record and well above the high end of our device guidance.

Our non-GAAP net sales for this quarter were up 15.2% from the June quarter of a year ago, and this revenue comparison is not impacted by any acquisition since Atmel's full quarter revenue was in the June 2016 quarter.

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

Our non-GAAP gross margin crossed the important 60% milestone, non-GAAP operating profit exceeded 37% for the first time and non-GAAP earnings per share crossed an important run rate of well over $5 per share annualized.

Non-GAAP earnings per share were up 56% from the June quarter of the 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 worldwide for delivering a record quarter in every respect.

This was also our 107th consecutive profitable quarter.

There are three other points I would like to make on our sales growth.

First, every one of our major product lines, 8-bit MCU, 16-bit MCU, 32-bit MCU, analog, wireless, licensing, memory and others were up significantly in the June 2017 quarter over the year-ago quarter.

Number two, every major geography, North America, Europe and Asia, were up significantly in the June 2017 quarter over the year-ago quarter.

And number three, sales in all end markets were up in the June 2017 quarter over the year-ago quarter.

Regarding the reason for the large sequential and year-over-year growth, I will refer you back to Microchip 2.0.

We are experiencing an enormous customer preference to design with our microcontroller solutions in all 8-bit, 16-bit and 32-bit customer applications.

This is also demonstrated in the recent EE Times survey.

The EE Times survey also indicates that customers believe that Microchip has the best ecosystem in the industry.

On the top of that, our various acquisitions have now built a powerful diversified product line through which we are able to provide a total system solutions to our customers.

Our sales channels have been trained and are welcoming the opportunity to sell multiple products to our customers in the same board.

As a result, our customers are responding by giving us incremental design-ins with multiple products in the same board.

We have an enormous design-in funnel, and we feel very optimistic that in Microchip 2.0 we will continue to see the acceleration in the organic growth of Microchip.

Now before I go into the guidance for September quarter, I will say that we are continuing to see a very strong business environment for our products worldwide and have a number of company-specific demand drivers.

Our bookings rate in the June quarter was extremely strong.

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

Both inventories at Microchip as well as distributors declined further sequentially in the June quarter.

While our manufacturing operations produced a lot more units in the June quarter, we shipped them all for growth and did not progress towards improving our inventory position.

However, through the growth of capacity and producing a lot more units, our lead times have stabilized.

While lead times are still longer than what we would like them to be, they're not getting any longer, and we appear to have created a soft landing so far without triggering any double ordering or panic from our customer base.

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

We will continue to add additional capacity in all of our fabs, assembly test plants, foundries and subcontractors.

In the back end, there are too many product-tester handler combinations.

We are catching up on some of those combinations as we convert Atmel products to Microchip's more efficient assembly test platforms.

However, we don't expect to fully catch up on all product-tester handler combinations until the middle of calendar year 2018.

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

We expect total net sales to be up approximately 3% sequentially, which represents approximately 14.6% on a year-over-year basis.

I want to remind investors that in the last 5 years, we had 3 acquisitions that closed in the September quarter.

SMSC closed in August of fiscal year '13, ISSC closed in July of fiscal year '15, and Micrel closed in August of fiscal year '16.

Therefore, mathematically taking the average of the last 5 years of sequential growth will give you a number of 6.7%, and that number would be totally wrong.

Excluding these acquisitions, the average sequential growth in the September quarter over the past 5 years has been just under 0.5% and ranged between minus 2.6% and plus 6.5%.

Our current sequential revenue guidance of 3% growth and year-over-year guidance of 14.6% growth is showing substantial organic growth, consistent with the Microchip 2.0 that we have presented to investors.

As a result, in September quarter, we expect to see our first $1 billion quarter.

Regarding gross margins, we see a steady improvement in overall gross margin of the company.

We expect gross margin for the September quarter to be between 60.5% to 60.75% of sales.

We expect overall operating expenses to be between 22.5% and 23% of sales.

We expect operating profit percentage to be between 37.5% and 38.25% of sales, and we expect earnings per share to be between $1.33 and $1.37 per share.

Now last quarter we revised up our long-term financial model to a long-term non-GAAP gross margin of 62.5%, operating expense of 22.5% and operating profit of 40%.

And as you have seen, we are relentlessly marching towards this model.

This quarter, we would like to share with investors our longer-term annual growth expectations of high single-digit growth.

This higher growth expectation comes from our transformation to Microchip 2.0 and an environment which we expect through industry consolidation will continue to improve from a pricing discipline standpoint.

Given all the complications of accounting for the acquisitions, including amortization of intangibles, restructuring charges and inventory write up on acquisitions, Microchip will continue to provide guidance and track its results on a non-GAAP basis.

We believe that non-GAAP results provide more meaningful comparison to prior quarters, and we request that the analysts continue to report their non-GAAP estimates to first call.

With this operator, will you please poll for questions?

(Operator Instructions) And we'll take our first question from Vivek Arya with Bank of America Merrill Lynch.

Steve, you mentioned the pricing discipline as being an important factor.

When I look at the 2 other microcontroller companies that are bigger than Microchip, Renesas and NXP, do you see this pricing discipline pervasive in the industry?

Or I assume you really mostly talk about Microchip, but what about your competitors?

Do you see this pervasive through the industry?

The pricing discipline is improving, and to a different extent with various manufacturers.

I can't mention it, the names of the competitors and specifically what they're doing, but we have seen some discipline on others also, some more than the others.

Microchip has kind of led this charge in the last 5 years.

And especially after the acquisition of Atmel, whose pricing was really below acceptable pricing, we have quite substantially corrected those pricing, and we have seen others who were relatively undisciplined also make some correct moves in that direction.

I see.

And for my follow-up, you have mentioned a few times the concept of attaching more analog products.

Is there a way to quantify what that attach rate is, how it's trended and whether it's even useful to analyze this trend?

Well it's not something we can completely externally share, but we have a large number of internal indicators which are really driven by number of Microchip products per customer board.

So if you think about years ago, we just sold microcontrollers, and you would usually have 1 device per customer board.

We have well in excess of 1 device per customer board, and the larger and larger that number becomes means you're being able to attach more and more devices, and rather than the attach, we're going to use the words these days total system solutions.

So we track that internally, and it's moving in the positive direction.

It's not something we plan to share with The Street, as it's one other thing to track and hit us over the head with.

We also have some examples in some of the investor conference presentations, and if you go back to Steve's presentation from back in early June, you'll see some examples of what exactly total system solution means.

And those slides are still on the Internet.

You can check it on the Investor page.

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

The question was on the lead times.

I mean, if you could give us a bit more quantification of how extended lead times have gotten to and sort of differences between different types of products.

And if you could put it into context versus prior cycles.

So our lead times on most products today are between, I would say, 4 weeks and 20 weeks.

So lots and lots of products are kind normal on lead time.

It could be a version of the given silicon that is longer but other versions are shorter.

So the large bracket around it is about 4 weeks to 20 weeks.

But more important part is really they're not getting any longer.

They were getting longer in the prior quarters as we extended, and the normal lead times we will consider where 90% of our products can be brought in 4 to 8 weeks.

So that's kind of the brackets.

And with the capacity growth we have had, we have been able to stabilize the lead time.

But as I said in my remarks, we are essentially shipping all the excess production for growth and are not able to either lower the amount of delinquent product, unsupported product, nor are we able to really dramatically shorten the lead times.

On some products where tester-handler product combinations have caught up, yes, but in broad majority, lead times are stable but not coming in yet.

That's helpful.

And for a follow-up question, somewhat related to that.

In your prepared remarks, Steve, you commented that you think by stabilizing lead times you think you can engineer a soft landing.

You've always been very thoughtful on the cycle and the revenue growth.

Any more detail you have for the industry or Microchip specifically about what's baked into that assumption about a soft landing?

And how exactly you go from sort of mid-teens growth to what's assumed in a soft landing scenario?

Well, I don't have any comments on the industry.

I resigned from that job 2 years ago.

We're just simply -- I will comment on Microchip.

And what I'm saying is that by lead times really not going longer and taking almost a year to bring these lead times down, we're guiding to really by the middle of next year, we believe we already have engineered a soft landing.

I'm not creating any panic, not having a runaway book-to-bill ratio, strong backlog, fair amount of unsupported product, but still it's largely a good behavior on the part of customers and distributors.

Inventory is still very low all over the board.

The distributor inventories are low.

Our microchip inventories are lowest in 7 years.

This is essentially engineering a soft landing.

And we'll now take our next question from John Pitzer with Crédit Suisse.

Steve, I had a couple sort of clarifying questions around your longer-term growth rate of high single digits.

Is that your view on an organic basis?

Or will that continue to include sort of the successful M&A strategy you've employed in the past?

And if it's more the former than the latter, does that change your view on M&A?

In addition, you talked about better pricing.

I'd just be kind of curious from where we were to where you think we're going, how much pricing adds to that?

And then my last point would just be market share.

And I guess around that, specifically, the time when some of your peers are kind of consolidating their distribution partners and trying to take economics from them, you're taking sort of more of a switch-alone approach and kind of spreading the wealth a little bit.

Do you think that's having a positive effect just through the distribution channel and that enormous design funnel you were talking about?

There were a number of questions.

Let me see if I can remember all of them.

The first one was organic growth as our -- what you talked about (inaudible).

So the high single digits kind of growth I talked about is organic.

The acquisitions are unpredictable.

You do not know when they happen.

You cannot schedule them, so that growth rate is organic.

Now we believe over the last several years as the industry growth has been fairly slow, exception of this current year where the industry growth has been reasonable, it was -- there was always unit growth, but the entire unit growth was eaten up by the year-over-year price decreases and pricing pressures and bad practices in our industry constantly to give the price away.

As through consolidation and other reasons, as large companies have gotten pricing discipline, we believe that unit growth is not being eaten up by the price growth.

So some of that price discipline is built in into the longer-term organic growth guidance we're giving.

And the second part was?

The second question he asked was does the change in your view on organic growth change the M&A strategy?

Does it change the M&A strategy?

It does not change the M&A strategy.

If we find a right company that fits well, we can buy it at a reasonable price.

Is accretive going in and with all the other check all other boxes that we have, sort of a pretty proprietary scheme of how we essentially select an acquisition.

If we can do that, we will do it.

However, as you know, the herd is thinning.

There are fewer companies left, and the valuations are quite high as we speak.

But as we are able to find some things on reasonable valuations, it doesn't change our view.

And John, I think the last piece of your question was market share?

I'd like you to repeat that question to make sure we answer it specifically.

To the extent, how much of the high-single-digit, long-term growth is expected market share gains?

And specifically at a time when some of your peers are sort of consolidating their distribution partners and trying to take back some economics from their distribution partners, you seem to be taking more of the switch-alone approach and perhaps spreading the wealth a little bit more.

I'm just kind of curious as to what extent you think that's really helping that design funnel reference in your prepared comments?

Well, these distribution things go in cycles.

You may recall, 10 years ago we were taking some actions in distribution when we felt that certain distributors were not creating demand.

And a decade later now, some other people feel the same way.

So these things kind of go in cycles.

But what we are experiencing is currently as the number of our competitors have de-franchised, either distributed completely or they have narrowed their margins and not giving any demand creation margins, we have seen these distributors put a tremendous attention and focus on Microchip.

And especially with a broadened product line, sort of under the Microchip 2.0 initiative that we have, we are finding that distributors are finding that the new Microchip 2.0 product portfolio to be so much more desirable and essentially being able to replace the number of other comparative companies, where they have lost a franchise on, including microcontroller, analog, wireless, USB, Ethernet, wired products, USB, Ethernet and wireless.

Just really timing is just perfect for the distribution to grab onto our broad portfolio and do a great job for us.

So I think we are taking advantage of it right now.

And them Steve, if I could sneak one more in.

Clearly, your initial intent around the Atmel acquisition was to buy back stock and you ended up not doing that.

The stock's had a good absolute run since then, but if you kind of look at the relative valuation of Microchip to the S&P, I think by our math, this is one of the lowest levels we've seen in almost 15 years.

And so can you talk a little bit about the appetite to do some buybacks here, and whether or not given where you are on your net leverage and your ability to generate cash flow, the debt might become a more systematic way of returning cash to shareholders?

Well, the net leverage isn't a problem now.

We're down to 1.58, and we'll be lower again by the end of September.

That's not the issue.

I think the issue is since the majority of the cash is still overseas, and we've got about $0.5 billion or so here domestically, and we're still looking for the next acquisition.

So it really wouldn't make sense to buy a bunch of stock back and then either have to issue stock in the next acquisition or really then borrow large amounts of money.

So I don't think buying back stock really fits right now.

And we'll now take our next question from William Stein with SunTrust.

Steve, I know you're out of the sort of broader semi-cycle discussion, but as it relates to your business, you've got very good year-over-year growth that you just posted.

The guidance suggests it moderates slightly sequentially.

Let's say you beat that a little bit, you're still growing very solid double digits year-over-year.

What do you anticipate with your new, high-single-digits, long-term growth view?

How do you anticipate sort of the back part of this cycle to look like?

At what pace do you expect that growth that's very strong right now to moderate?

I don't really have a whole lot to say on that, in terms of cycle.

I think we have -- we are seeing a very, very strong demand for our products.

I think it's largely driven by a lot of company-specific drivers in analog, in attach and being able to take the Atmel portfolio that was being marketed in a substandard way, costs were higher, other things were not right and we're correcting a lot of those things in being able to attach analog, wireless and other products to that portfolio.

So a lot of it is really company-specific drivers, and so I think really this growth momentum continues.

We didn't want it to get over frothy and get into the double ordering and holding and all that.

I believe we're successfully avoiding that by engineering a soft landing.

So somewhere over the next year, I think it goes from the current growth rate to the long-term growth rate almost in a soft landing fashion.

That's helpful.

One other question, it's actually a product question.

I normally don't spend a lot of time in this area, especially in the press releases, but you highlighted in the first bullet regarding highlights from the quarter a new product with a 2D GPU integrated.

I wonder, is that representative of any new trend as it relates to AI inference on the edge perhaps?

Are you seeing more demand for that sort of processing capability?

And if you could talk about the market for that sort of product, it would be very helpful.

So I'll have Ganesh comment on that.

But let me read the bullet for all the investors.

It says, Microchip announced the industry's first microcontroller with integrated 2D GPU and integrated DDR2 memory.

Our PIC32MZ DA family provides groundbreaking capabilities for an MCU.

Ganesh?

Yes, this is not really related to artificial intelligence.

This is -- in embedded applications, there is a set of applications where people want the richness of the human interface to include graphics that have more capability.

Those have historically been done with separate processors that did the microcontroller or microprocessor and the graphics on a separate chip.

We are now putting those together, creating more complete solutions where the microcontroller, the graphics and the DRAM that's required are all on the same chip and in the same package.

So it's an extension of continuing to have high-performance microcontrollers opening up new and better control spaces.

(Operator Instructions) And we'll now take our next question from Chris Caso with Raymond James.

I guess the first question, just a follow-on, on the steps you're taking with regard to the soft landing.

I think we understand what you're saying there.

Perhaps you could talk about what's different in the steps that you're taking now as compared to some price cycles when your lead time's extended.

Is it now that you've moved more quickly to expand some capacity and prevent the lead times from getting higher?

Maybe if you could just expand upon that.

I think the main difference is your memory is probably of the event 2 or 3 years ago.

Was it 2014, I think?

There was basically abrupt contraction in the Chinese business at that time, which we mentioned in our call, and that's really what led to the quarterly miss and then cycle unraveling, and it was seen by the entire industry subsequently within 3, 4 months of that.

Even though a lot of the investors and analysts original did not see it, we saw it first.

I can't predict the world events.

There's a war somewhere, something else happens and some sort of event terminates it or changes it.

So I think that was the main difference.

If your outlook is that some sort of strong event takes place somewhere, then all bets change, that I cannot forecast.

Right, okay.

I don't have a crystal ball for that either.

Just with the follow-on, on gross margins, perhaps you could talk about some of the specific benefits over the next few quarters.

I know that you're still working to consolidate some of the manufacturing, there's still some steps that will benefit gross margins aside from just better fixed cost absorption.

So we're ramping all 6 of our facilities, 3 are front-end wafer fabs and our 3 back-end facilities, investing significant capital.

And those investments increase the utilization of the facilities, make us more cost effective, make the cost per unit go lower, and so there's a lot of things happening across the board.

There's a lot happening in back-end manufacturing, which we've talked about more extensively where a lot of the capital dollars are going and as those come to fruition, the gross margin is going to improve.

This last quarter, we continued to see benefits from the Micrel shutdown.

Most of that is in the model at this point in time, but there's still a little bit of that to go, but the main things are really the capacity improvements.

Pricing, as Steve has talked about publicly, continues to be a driver of gross margin, and we think that's going to continue as better practices happen throughout the industry.

And we'll take our next question from Craig Ellis from B. Riley.

I'll just start on that point and go back to on 2 points that you made, Steve.

One, the target for high-single-digits, long-term growth and the view that, that's attainable.

And secondly, that with Microchip 2.0 organic sales should accelerate.

You've recently presented, I think, it's 7 points on revenue growth related to Microchip 2.0.

So with an eye towards monitoring the levers that are really going to drive that growth acceleration, what are the things that us investors should be focused on as we monitor Microchip's progress to drive accelerating growth under those 7 initiatives?

You have 7 initiatives from our conference call presentation?

That was from your presentation of Microchip 2.0, I believe.

I think you have 7 different revenue growth drivers there.

Just pulling it up.

I think your question is really sort of how can investors track it.

So a lot of it is related to being able to sell a large number of peripheral products around the main microcontroller, which you sometime call it attach, and we're calling it total system solution.

We are seeing it in our funnel.

We are seeing it in a number of design-ins of devices per board.

Going up from 1. Like, 1 would be no attach.

So a lot of these things we don't plan to share it externally.

I think -- so that's part of the challenge, but total system solution we will track it internally.

You can track customer preference for designs with our MCUs, and that analysts and investors can track.

There is an EE Times survey which is public.

It's on our website.

When asked the customers which microcontroller do you expect to use for your next embedded design, on 8-bit, 16-bit, 32-bit, 8 and 16 we were #1, and 32-bit, if you combine ours and Atmel and 2 or 3 different lines, we were #1, tied again over there too.

So that you can track.

We have multiple growth drivers as we quarter-after-quarter talk to you about growth of our microcontroller business, growth of licensing business, growth of analog business.

We don't break out our wireless business, wired and wired connectivity.

A lot of that is embedded into the analog business.

We have tremendous growth going on in our security business, as people in IoT are looking for security of transactions, security of being able to connect to the device.

We have a number of key assets in that area.

Automotive business is doing very well, in networking, in HMI, and access control, lighting, body electronics, you can see some of that through our press release, continuous flow of press release we're having with (inaudible) and other.

So I think it's complex tracking, but it's all there.

All right.

The follow-up question will be for Eric, and it's just related to inventory.

So 7-year lows, on hand the channel is lean.

Is that a level that Microchip can comfortably operate at if we think about the intermediate term?

Or should we expect in what would typically be a seasonally softer period, like the fiscal third quarter, that the company would look to replenish some inventory, whether it's in the channel, on hand or both?

So channel inventory, we can't really manage other than the fact of delivering the product that the distributors want.

So that's a little bit tougher.

But it is on the low end of what we've seen historically.

Our own inventory, we've been trying to build inventory on the balance sheet for the last 3 quarters, and just haven't been able to do so with the upsides in demand that we've experienced.

So this quarter, we expect to not build inventory again.

The lead time commentary that Steve talked about getting healthy by the middle of calendar '18, I think that's probably at the point when inventories might return to a more normalized level, but it's very hard to predict what the demand environment is going to be.

So you talked about seasonally softer December quarter in which we could build some inventories.

I think what's more likely is that we're able to catch up on some of the delinquencies and unsupported product, leading to better than seasonal December but not building inventories because you can't build inventory before you are given the product for the customer to meet their demand.

So it's more likely that we will reduce the unsupported amount of product than building inventory.

So that's what it looks like right now.

Okay, so your -- from what you can see now, the demand from your customers, as well as of the timing with which new capacity is coming online, both front-end and back-end, would lead you to believe that it's likely that there'll be some demand catch up and you can have an above seasonal December quarter, Steve?

We're not actually numerically guiding it, but directionally I expect it better than seasonal December.

And we'll now take our next question from Harlan Sur with JPMorgan.

On the strong quarter-on-quarter and year-on-year performance on MCUs, I'm just wondering if the Atmel products grew faster than the overall MCU segment, just post-closure you had higher confidence levels by Atmel's customers?

You've got the refresh 8-bit AVR product line and other enhancements?

It's only been more than a year post-Atmel.

You guys are probably still seeing some of that momentum.

Just wondering if this is driving some enhanced growth in the product line.

So we're not commenting on any breakout of growth on Atmel products versus our growth.

Some cases, product can even be substituted.

And like we said from the very beginning, we manage it as one company and give the customers the best solution where we have product available or can meet its needs.

In some cases, switch from one to other if the product is not available in one category, make it available in the other category.

So I think individually commenting on where the growth is coming from is really not meaningful at this point in time.

Okay.

Then on the transformation to Microchip 2.0 and then the results of the EE Times survey, I mean, the team has already had a strong systems focus in place for a long period of time.

I think you guys have something like over 2,500 reference platforms, development boards, sample projects, et cetera.

So you guys already had a pretty strong program in place to help customers with their design solutions and drive attach rates.

So how does Microchip 2.0 build upon this to further drive the attach rates of analog connectivity, networking and memory and interface products?

So that's a good question, and let me take a shot at answering it.

Microchip 2.0 is not an event where I flipped the switch today.

Microchip 2.0 has been in formation for about 5 years, and which you yourself said.

When we acquired SMSC, we got USB technology, we got Ethernet technology, we got audio technology.

When we bought Micrel, we got a number of great analog asset.

When we bought Atmel, we got some Wi-Fi assets.

We got some security assets.

And Atmel's large microcontroller portfolio, as you go to the customers, there was largely 1 product per board.

Atmel sold the microcontroller.

There's no Microchip analog or anything else present around it, because we were the enemies.

So it will be anybody else's product but Microchip's.

And in the last year, on all the internal reference designs, development tools, sales brochures and sales training and all that, is now full with Microchip's analog and power management and Wi-Fi, Bluetooth, Ethernet, USB timing products and all that kind of stuff.

So this has been a thing in building, and we are really just packaging it for you now and saying, we are seeing it working.

And it took some time to train the apps engineers and sales force and get the distributions aligned with what some other companies have done with their distribution also gave us an opportunity.

So it's really culmination of all these initiatives coming together where we can tie a bow around and say hey, this looks like a new company to our distributors today and to our salespeople and others, and saying I can sell a very broad portfolio today.

Take any one company out of it, Atmel, it substantially reduces it.

Take Micrel out, reduces it further.

Take SMSC out, it reduces it further.

So it's a buildup on all these companies.

I don't know if that helps you.

And we'll now take our next question from Chris Danely with Citigroup.

Steve, I'll ask you to refrain from any industry predictions, but it sounds like the improvement in Microchip is mostly Microchip-specific, so between what you're seeing and what your distis are seeing, how do you think like the overall semi business, the overall semi industry did during the June quarter?

Do you think it was kind of held serve, or do you think there were some improvements sort of industry-wide that happened during the quarter?

Well, I was hoping that as I announced their June numbers, usually they always announce it on July 31.

This one time I needed it and they did not and I was going to use that comment on it.

I think they're going to announce later this week, and that would be a read on the industry.

I don't really have any comment on the industry.

Okay.

And then one quick clarification.

So on the lead time stretching out, when do you think you could take them back to normal?

Do you think it's like a year from now or maybe 6 months from now?

Or when do you think it can get back to normal?

Yes, I earlier said the lead times right time are between 4 weeks and 20 weeks and are stable, not going longer.

The normal we consider between 90% of our products to be within 4 to 8 weeks, and we believe it's going to take us at least until June next year to get there.

And we'll now take our next question from Gil Alexander with Darphil Associates.

On your normal inventory levels, you used to have 130 days or 120 days, do you use these numbers now or you've changed?

So the normal inventory for us would be 115 to 120 days.

We may have in the past also said 115 to 125 days when we felt we needed a larger band.

We haven't changed the targets.

We just cannot seem to get there.

With the strength of the demand -- the growth we had last quarter of 7.7%.

For last several years, there was 2 years of growth, that we did it in 1 quarter.

So we're basically -- it's taking everything we got in growing the capacity, building more units and then shipping it out the door for revenue.

And the inventories are very low.

Our inventory is 7-year low right now, and we don't see short term being able to build it.

And we'll now take our next question from Kevin Cassidy with Stifel.

As you're adding new capacity, do you have an idea what revenue level can the capacity you've added drive?

Well, our capacity is being added in smaller chunks all over the place.

You add a furnace here, a handler here, a tester here, a prober here, to resolve specific product constraints on specific package types and specific product lines.

It's not like we build another billion-dollar fab and it takes you from here to there.

The new equipment is arriving every week to 2 weeks, so it's really more incrementally slowly being added rather than in a very, very large chunks to get to some new number.

This is a better control or this is higher avoiding risk of your customers I guess putting in ...

Yes, there is no capacity.

There is no risk here if all this capacity then somehow sits idle, because as soon as the next tester and handler arrives, there's a rush to put it on the floor, qualify it, characterize it and put it in production.

Every diffusion tube, every handler, every stepper, everything is very quickly going to incrementally produce the product and help do either 3 things: help to either reduce the unsupported product, delinquent product to the customer, that's the first priority; number two, to then really build a little bit of the inventory so that the lead times will come down.

We can never get to the second because largely -- and number three, to ship for growth.

So shipping for growth is number one, reducing delinquency is number two and building inventory is number three.

We're only able to do number one right now, ship for growth.

(Operator Instructions) And we'll now take our next question from Rajvindra Gill with Needham & Company.

And with no response, we'll take our next question from Craig Hettenbach with Morgan Stanley.

I just want to dig in a little bit more into Microchip 2.0.

And Steve has just said it's kind of formation over 5 years.

But just anything you're doing from a sales organization, from a distribution, whether it's incentivizing them or education to kind of really see the full benefits of 2.0?

So I happen to have VP of Sales and Applications, Mitch Little, in the room, and I'll give him the unique opportunity to answer that question.

Thank you, sir.

Our compensation system -- first of all, we have to recognize that our compensation system has never changed.

We are the only noncommission sales team in our industry.

So we've not changed any of that.

We've done basically the same things.

We've engaged with our distributors partnerships in just that mode, engaging with them to help them do more of what they're doing.

So we've not shifted anything other than shifting our thinking about total system solutions a litter more broadly.

We're pretty much what we've always been and been successful at.

Got it.

And then just as a follow-up, Steve, any commentary, and I know one of the focuses has been kind of Atmel attaching.

You touched on that in terms of opportunities.

But any other color you can add in terms of the design kind of funnel and what you're seeing on that front?

Well, like I said, the design-in funnel is very, very large, it's almost scary.

And you never know from a large design-in funnel what is a yield out of that, because customers can always tell you this design is 10 million units and turns into lower amount.

We have metrics on that from years of experience, what size of the funnel can yield to what kind of growth.

So what is the yield out of that funnel.

But as with the Microchip 2.0, as some of the input variables are changing, a lot of attach, a lot of ancillary designs around our micro, the whole integration of Atmel, attaching our products to Atmel's microcontroller, I think that the yield out of that funnel is a bit less predictable.

If the yield is the same as it was before, it's scarily large but it's possible that it is a little bit new and therefore, the yield could be slightly different.

But it's enough good to be very optimistic about what I'm telling you and it's based on data and information, it's not a pipe dream.

And we'll now take our next question from Chris Rolland with Susquehanna Financial.

Steve, I think you mentioned all those different MCU categories that were up year-on-year.

Perhaps you can highlight maybe a few that had upside surprises for you or perhaps some that had faster growth than others.

Ganesh, do you have anything to comment on that?

No, we don't break out the growth rate of specific microcontroller segments.

It works as a collective portfolio.

It's very, very strong with a combined portfolio of classic Microchip and Atmel combined, and I think it's winning designs because we've infused energy into the Atmel designs and our historical products have always had strong momentum behind them.

Outside of that, we don't have any additional color.

Switching gears then.

Steve, looking back on publishing that letter to customers in April, what were the effects that you saw immediately after you published that?

Did you guys actually see a marked surge or kind of uptick in orders immediately?

Or would you say that it was kind of just select customers coming in and a smaller percentage of customers that put fresh orders in?

How would you describe kind of order churns immediately after publish of that?

Was it a big deal or not?

It was not a big deal.

We published the letter on 4th of April.

For some strange reason, investors didn't catch onto it for 2 weeks.

We thought you guys get that in a nanosecond, but we published the letter on the web on 4th of April, so I commented on that in our May press releases -- in the May conference call.

We basically did not see any impact.

The bookings were extremely strong in the March quarter.

And after publishing the letter, the bookings did not really get any stronger.

The activity that usually takes place is all of our worldwide salesforce takes the letter to our customers and to our distributors, and distributors start working with customers to understand their longer-term needs, and saying lead times are going longer, so don't only tell me what you needed for this quarter, also tell me what you need for next quarter.

Start looking at major products and new designs that may have a substantial ramp coming up.

And that information then through distributors and our own people, customer by customer, start flowing in into building a demand forecast and is a more accurate reflection of what we should be building and what we should be planning.

And what it results is, and some of it comes into backlog, and what it results into is it increases our ability to build the product in a better mix.

Remember, large amount of product that we start wafers on, we start wafers on in forecast, not always having a backlog today.

We start on a forecast, and by the time the wafers go through fab assembly test, then the backlog will come in on that product to ship it.

So anytime you start on a forecast like that, you always have a level of art of mix situation, where we build a little too much of this, a little too little of that and a little too much then ships in the following quarter, but it results into some lost sales because you didn't have the right product.

The effect of the letter is really giving us a broader understanding of customers' needs in more exact mix, resulting into an outstanding execution in the correct mix, and its results you saw in the quarter with a very strong growth and continuing strong growth in the coming quarters.

And it appears there are no further questions in the queue at this time.

And Mr. Sanghi, I'd like to turn it back over to you for any additional or closing remarks.

Well, we want to thank all the investors and analysts for attending the call, and we'll see some of you during the quarter as we get back out on the investor circuit or conferences in September.

So thank you very much.

And ladies and gentlemen, that concludes today's conference call.

We thank you for your participation.