Good day, everyone, and welcome to the Microchip Technology Third 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 President, Microchip's Chief Financial Officer, Eric Bjornholt. Please go ahead.
Good afternoon, everyone. During the course of this conference call, we'll be making projections and other forward looking statements regarding future events or the future financial performance of the company We wish to caution you that such statements are predictions and that actual events or results may differ materially. We refer you to our press 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 Sangey, Microchip's Chairman and CEO and Ganesh Moorthy, Microchip's President and COO. I will comment on our third quarter fiscal year 2018 financial performance, and Steve Ganesh will then give their comments on the results and discuss the current business environment as well as our guidance.
I want to remind you that we are including information in our press release and this conference call on various GAAP and non GAAP measures. We have posted a full GAAP to non GAAP reconciliation on the Investor Relations page of our website at www.microchip.com, which we believe you will find useful when comparing GAAP and non GAAP results. I will now go through some of the operating results, including net sales, gross margin and operating expenses, I will be referring to these results on a non GAAP basis prior to the effects of our acquisition activities and share based compensation. Net sales in the December quarter were $994,200,000, modestly higher than the midpoint of our guidance and down 1.8% sequentially, from net sales of $1,012,000,000 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 at the high end of our guidance range of 61.4% in the December quarter. Non GAAP operating expenses were at 22% of sales, which was a record low and below the low end of our guidance range, which was 22.2%. Non GAAP operating income was a record $391,700,000, up 39.4% above the high end of our guidance of 39.2%. Non GAAP net income was $341,200,000 and was up 38.4% as compared to the same quarter last year. Non GAAP earnings per diluted share was $1.36, which was above the midpoint of our guidance.
On a GAAP basis, Gross margins, including share based compensation and acquisition related expenses, were a record 61.1% in the December quarter. GAAP gross margins include the impact of 3.5 were $361,800,000 and include acquisition intangible amortization of $121,000,000, share based compensation of $20,500,000, $1,200,000 of acquisition related and other costs and special charges of $200,000. GAAP net income was impacted by a $439,800,000 discrete tax event in the quarter, primarily associated with the Tax Cuts and Jobs Act, and we also incurred a loss of $2,100,000 on the retirement of our 2037, 2.8% convertible bonds. After these adjustments, the GAAP net loss was $251,100,000 or $1.07 per diluted share. The non GAAP tax rate was 8.5 percent in the December quarter, and we expect the rate to be about the same in the March quarter.
Due to the Tax Cuts and Jobs Act, we expect about $300,000,000 of taxes to be paid over the next 8 years related to the tax incurred on foreign earnings or permanently invested offshore referred to as the transition tax. We estimate the tax payments to be approximately $25,000,000 in years 1 through 5, $45,000,000 in year 6, $60,000,000 in year 7, and $75,000,000 in year 8. We will continue to evaluate the impact from the Tax Cuts and Jobs Act and these estimates may change as we complete our analysis. We are working through the impact of recent U. S.
Tax reform on Microchip's longer term effective tax rate. There is no impact on the fiscal year 2018 rate, as you can see from our March quarter guidance provided in today's earnings release. Excluding the transition tax from the Tax Cuts And Jobs Act, we expect our ongoing long term cash tax rate to be below 9%, is what we are providing to investors and analysts for cash flow and operating model forecasting purposes. We will continue to refine this over the coming months prior to providing guidance for December 31, 2017 was $487,100,000. Microchip had 115 days of inventory at the end of the December quarter, Our targeted inventory levels are between 115 1 120 days.
Inventory at our distributors in the December quarter were at 34 days and up 3 days from the prior quarter and in the normal historical range for distribution inventory. The cash flow from operating activities was a record $365,000,000 in the December quarter. As of December 31, the consolidated cash and total investment position was $1,985,000,000, of which about $550,000,000 is domestic cash. Due to the Tax Cuts and Jobs Act, The majority of our offshore cash could be brought back to the U. S.
Without incurring any material additional tax costs. We bought back the remaining amount of our 20.37 and 8% convertible bond in the December quarter $66,400,000 in the December 2017 quarter. We expect about $50,000,000 to $60,000,000 in capital spending in the March quarter and overall capital expenditures for fiscal year 2018 to be about $200,000,000 to $210,000,000. Which is lower is at the lower end of the guidance that we provided last quarter. We are aggressively adding capital to support the growth of our production capabilities for our fast growing new products and technologies and to bring in house more of the assembly and test operations that are currently outsourced.
These capital investments will bring significant gross margin improvements to our business, particularly for the out mill manufacturing activities that we are bringing into our own factories. As mentioned last quarter, our capital spending in fiscal 2018 also reflects 3 new building projects we are constructing in Arizona, India, and Germany, which will give us meaningful lease cost reductions and avoidance in the future, as well as allow us cost effectively scale our future growth. Depreciation expense in the December quarter was $32,000,000. We also want to provide an update on the tax treatment of our dividends. In fiscal year 2017, our dividends paid to shareholders were treated as return of capital and we were expecting similar treatment in fiscal year 2018.
The Tax Cuts and Jobs Act, which passed in December 2017, has changed this outlook. Due to the U. S. Taxation in fiscal year 2018 of our foreign earnings, which were historically permanently invested offshore, Microchip is taxable in the U. S.
In fiscal year 2018. And as a result, dividends in the June, September December 2017 quarters are fully taxable to our shareholders and We believe the impact of US tax reform on Microchip's US taxable income in future periods will result in dividends being fully taxable to share holders in fiscal year 2019 and beyond. We will continue to provide updates to shareholders on this topic in the future if facts and circumstances change. I will now ask Ganesh to give his comments on the performance of the business in the December quarter. Ganesh?
Thank you, Eric, and good afternoon, everyone. We performed better than we expected in the seasonally slow December quarter, with a sequential revenue decline of 1.8% and year over year growth of 12.8%. All organic growth as there was no contribution from acquisitions in the last four quarters. The Microchip 2.0 transformation continues to make good progress especially in terms of new design opportunities as we enable our client's innovation with the very best smart, connected and secure solutions. Taking a closer look at microcontrollers, our microcontroller business performed well in the December quarter, with revenue down sequentially only 0.6% as compared to the September quarter.
On a year over year basis, the December quarter microcontroller revenue was up a very strong 18.9%. 8 bit microcontroller revenue actually set a new record again edging out the September quarter performance, while 16 bit 32 bit revenue continue to have strong year over year performances. And we are seeing continued growth in our design and funnel, which we expect will drive future growth as these designs progress into production over time. Microcontrollers represented 66.5 percent of Microchip's overall revenue in the December quarter. Now moving to our Analog business, our Analog revenue was sequentially down 3.2% in the December quarter as compared to the September quarter, and up 1.5% on a year over year basis.
As we highlighted at our last conference call, our publicly reported analog results continue to see some revenue classification headwinds resulting from a deliberate shift in strategy we made several quarters ago. The change in product line strategy as we reported last quarter is that we have, for some time, been adding microcontroller cores to several of our more complex analog products, especially those that provide our clients with smart connectivity solutions. The addition of microcontroller cores to these analog products enables us to sell a higher value and more defensible total system solution. These smart connectivity products are growing nicely. And as they replace older products in new designs, our revenue classification for these new products has shifted from the analog product line to our microcontroller product line.
Transitioning to more sticky and higher margin smart connectivity revenue is the right Microchip answer, but does impact some of the product line reporting that analysts are interested in as some of the revenue growth shifts into our microcontroller product line. In the longer term, as the revenue from analog attach design wins continues to ramp. We fully expect that the analog product line revenue will grow nicely. Our analog products, represented 23.3 percent of Microchip's overall revenue in the December quarter. Moving next to our licensing business, This business was up 6.8% sequentially in the December quarter and up 15.5% on a year over year basis, setting a new record in the process.
We are seeing the fruits of having licensed several foundries and independent device makers for several years on multiple process technology nodes as they manifest in our results as the licensed processes ramp volume and generate royalty revenue for many years to come. Finally, our memory business was sequentially down 7.6% in the December quarter, as compared to the September quarter and up 3.4% on a year over year basis. 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 reflect on the results of the fiscal third quarter of 2018. I will then provide guidance for the fiscal fourth quarter of 2018. Our December quarter financial results were good. Our net sales were slightly above the midpoint of our guidance which itself were slightly better than 5 years of seasonality.
Our non GAAP gross margin of 61.4 percent of sales was at the high end of our guidance. Operating profit of 39.4 percent of sales made a new all time record and earnings per share of $1.36 exceeded the midpoint of our guidance by $0.01 per share. I want to thank all On non GAAP basis, this was also our 109th consecutive profitable quarter. Now I will provide you with an update on Microchip 2.0. We are continuing to experience an enormous customer preference to design with our microcontroller solutions in all eight bits, 16 bit, and 32 bit customer applications.
On top of that, through which we are able to provide total system solutions to our customers. We are winning incremental design wins with multiple products in and we feel very optimistic that Microchip 2.0 is working and increasing the organic growth of Microchip. Based on SIA numbers, our microcontroller market share in calendar 2017 was at a record 15.7 percent, up 2 20 bps from calendar 2016. To be fair, calendar year 2016 only had 3 quarters of Atmel, while 2017 had all four quarters of Aetna. So I calculated market share for 3 quarters of 2016, to 3 quarters of 2017, which will be April 1 to December 31, of both years.
Based on that 9 month comparison, our market share gain was 91 bps higher than 2016. Also, our microcontroller market share grew in each of 8 bit, 16 bit and 32 bit product lines. Now let us go into the guidance for March quarter. Our inventories at Microchip at the end of December 2017 were 115 days, which is right at our target. We were able to get to this target a quarter or so ahead of what we were thinking This is due to enormous progress we made on the manufacturing side and bringing capacity online and decreasing lead times.
Our book to bill ratio has also continued to moderate from 1.11 in both March 2017 in June 2017 quarters. And then the book to bill ratio was 1.05 in September 2017 quarter, and 1.0 in December 2017 quarter. This moderation of book to bill reflects the improvements in lead times that we have seen that we have been able to achieve over the last several quarters. As we have indicated before, our seasonality for any given quarter will change as we integrate acquisitions and end up with a new blended seasonality. The seasonality of the Atmel business is driven by a larger percentage of consumer oriented business has a sharper decline in the March quarter.
In fact, the historic atmel seasonality in the March quarter over the 5 years prior to the acquisition was a 7.8% sequential decline, when they were an independent company. Meanwhile, Microchip's historic seasonality in the March quarter in the 5 years prior to acquiring Atmel was a 2.75 percent sequential growth. The blended average March seasonality results in a minus 1% sequential results or 1% sequential decline. You can also, you can also see the contribution from Atmel's consumer business in the stronger than seasonal blended results, Microchip experience in the June, September, December quarters of 2017. We will compare our March quarter guidance to this combined seasonality of quarter.
We expect total net sales in the March quarter to be down 3% to up 1% sequentially giving us a midpoint of the guidance at minus 1%, which is right at seasonality that I explained above. In September quarter last year, our net sales were up 15.8% from a year ago quarter, In December quarter, our net sales were 12.8 percent from a year ago quarter. In March 2018 quarter, we are guiding the net sales to be up 9% from a year ago quarter, clearly demonstrating the soft landing scenario that we have been talking to the investors Our fiscal year 2018 sales, total fiscal year 2018 sales ending March 31, 2018, with midpoint of the guidance is expected to be up 13.2% from fiscal year 2017 sales beating most of our competitors for the margin of the company based on microchip 2.0 margin drivers. We expect gross margin for the March quarter to be between 61.3% 61.7% of sales. We expect overall operating expenses to be between 22% and 22.4 percent of sales, and we expect earnings per share to be between $1.30 $1.39 per share.
Want to remind investors that our long term financial model is a non GAAP operating profit of 40% and you have seen that we are relentlessly marching towards this model. 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 expect that the analysts 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?
You. We'll take our first question from Craig Hettenbeck with Morgan Stanley.
Yes, thank you. Steve, thanks for the color in terms of book to bill and lead times. When you think through the March quarter seasonality with Atmel Microchip combined. Can you help us as you go toward June in terms of what you typically see for the June quarter?
Well, the June September were stronger quarters for atmel as well as for Microchip. And you have seen pretty strong June September quarters for the last couple of years since we have had Atmel in both quarters. And you've seen the December quarter slightly stronger than our historic seasonality as we just reported. And what that results is, significant difference in the March quarter seasonality where Microchip was historically up 2.5to2.75 percent and Atmel was down, evolving 7.8%. And that's really when you combine it together, That's what results into a minus 1 percent seasonality.
Got it. And then maybe just a follow-up for Eric, as you approach the target model. And then given the margin expense you've seen, can you talk about just some of the initiatives this year and maybe on the intermediate term? For both gross margins and op margins?
No, I mean, on the gross margin front, it's more of the same of what we've been talking about over the past in terms of investing in the assembly and test and bringing more of that in house and we're making progress on that front. We've deployed a lot of capital over the last couple of quarters. We had more coming in this quarter as we talked about in my prepared remarks on the $50,000,000 to $60,000,000 of capital coming in. So that will continue to add to the gross margin improvement over time. We've got good utilization in our wafer fabs and all those things are making our cost structure very favorable.
At a midpoint of guidance here of about 61.5% gross margin, we've got about a 1% improvement go to get to the target model and we're confident that we're going to get there with all these initiatives that we have.
Got it. Thanks.
And same thing on the operating margin, we just reported 39.4% and our long term model is 40%. And we're fairly confident that most of that gross margin will fall through and we're going to be in that range.
Got it.
We'll go next to William Stein with SunTrust.
Great. Thanks for taking my question. I'm wondering if the inventory build is something that you had expected at the start of the quarter or if that occurred more as a result of perhaps orders not coming in with turn rates as fast as you might have expected when the quarter started?
So the inventory was pretty much right on target what we had guided to and what we achieved. The turns rate in December quarter was not soft. We beat the December quarter from the midpoint of our guidance. So I don't think there was any issue in terms of our bookings in December quarter, which will have changed the inventory.
Yes. And you can see from the guidance that we had on our release, we think we're going to continue to be within our inventory target range of 115 to 120 days and quarter that we're in right now. So I think inventory is well managed.
That helps. One follow-up if I can. You might have mentioned this, and I apologize if I missed it, but you've been talking about supply constraints on the Atmel portfolio in particular back end tests. And I think you've noted that you expected to be supply constrained there for one time you said for the next year, maybe now we're at either 6 or 9 months more. Any update on that relative to the capacity you've been adding?
And I see the book to bill coming down and lead times coming down are, is that specifically related to the Atmel backend test? And any update there would be helpful. Thank you.
So, atmel had many business units. It was just not one business. There was microcontrollers and memory and sense in aerospace and RF and automotive and wireless and other businesses. We had broad based challenges on the Atmel business. And every quarter, certain products, certain business units get healthy on that.
And we have been guiding from the very beginning that we expect this to take till about June of this year for it to all business units to get healthy. And that really hasn't changed. So as we speak right now, there's largely, I would say, 1a half business units that are still having significant challenges. Most of the others are in the very tail end where large amount of problems have been resolved. And this last 1.5 business unit largely chose the testing platforms to be the one that you cannot acquire anymore of.
These were very old testers of 1970, 1980 vintage that should have been up saluted prior to the year 2000. And 20 years later, they are still running, but they're not running. They're not running well. And the past due on them is going down, not up because every quarter, you got to take one of it down to use for spare parts because you can't buy anymore. Therefore, the capacity is decreasing, not increasing.
So we are bringing the testing up on those products on a more modern testers or Microchip platforms, but that process is painful and then qualification of customers Many of those are automotive customers. So that is the process we've been going through for the last year and a half. And I think during which we have grown the business, results been great. Lead times have been slowly coming down, but some of the remaining challenges remain. And we think we need another 5 months to get it all behind.
We'll go next to Harsh Kumar with Piper Jaffray.
Yeah, hey, guys. First of all, congratulations on solid quarter, 9% growth is pretty impressive, Steve. I wanted to ask about your outlook for March in those markets your broad end market solid industrial consumer, which one do you think is going to outperform in your opinion the most?
Well, if the question is just for the March quarter, the consumer obviously is a weak Automotive should do very well. Industrial should do very well. In some markets, you have kind of brand new budgets coming in in the new year. The only market is soft, which is driving a minus 1% guidance is because of the atmel seasonality is usually down almost 8%. And that is driven by some of the consumer markets.
Everything else should be good.
Basis. This will be a strong quarter for Europe at all it is, just many more shipping days in the quarter without the holidays. Asia is the most challenged because of the, the Chinese New Year and, and America should, should, should do pretty well.
Steve, as my follow-up, you guys always run the company for the long term and historically in lean times, even you've grown inventories your target level of inventory is 115 to 120 days. You just hit 115 days now, but all metrics end markets are still pretty good. Does it actually make sense for you to, can you make the case that you should actually be growing your inventory levels even further and beyond the 115 days? So why stop here?
Well, if our inventories get below 100, then we don't have usually all the right product in the right place and, all the permutations and combinations and SKUs and flavors available. And then you go and support it and you're expediting and you're kind of having a lot of manufacturing challenges. When you are in the 150, 20 days of inventory, then I think we can manage our business reasonably well. I mean, I wouldn't distinguish between 11510020 or a few days, less than a few days, even more than that on the outer side. But we don't want to have keep going, like set to have 135, 140, 150 days of inventory because then you're not really making the right use of their inventory.
We don't need that much 30. And what you have the opposite risk of, obsolescence where certain products customer changes the flavor they want to use or want to use a different package and we packaged it in. And we want to keep most the inventory and the die inventory. And when you do that, then its dollar value doesn't grow as much versus if you put it in the finished goods. So I think, I think that's well tried over the years.
That's really the right kind of number. And when we are lower than that, we to grow inventory, even be higher than that. We're trying to decrease inventory and that's kind of still the right number.
Understood. Thanks guys and
congrats. Thank you.
We'll go next to Chris Caso with Raymond James.
Yes, thank you. Good evening. I just to start, if you could talk a little bit about where lead times are in general now, you talked about them coming down. Would you through them at normal levels now. And just following on from that, Steve, you had talked about the soft landing that you were trying to achieve.
You've got lead times down now. You have to book to bill at 1. I mean, would you consider that with what you're seeing now, that soft landing is sort of what we're seeing now or are there more steps that need to be taken as you go into next year in order to achieve that?
So let me have Ganesh answer the lead time, then I'll pick up on yourself landing question.
So lead times are running. If I look at the December quarter, in the 4 week to about 14 week window. So if you remember, we had it at the peak of this, we were between 4 20 weeks. And we have started as the capacity has come on board as we're able to get our manufacturing to respond. We've been bringing that down.
And we fully expect that it gets a little bit farther down in the March quarter, maybe closer to about 10, 11 weeks at the top end and then gets down to between 4 8 weeks, which is what we would consider to be normal on about 90% of our standard line items by the June quarter right about on the same timeline we established about a couple of quarters ago.
So picking up on the soft lending scenario, I think I would say we pretty much demonstrated it. We're on the tail end of it. So March quarter is rise at season combining Atmel and Microchip together. And if, June quarter grows from here, June, September are stronger quarters, then we kind of just went through soft lending and getting back to kind of seasonality. And March quarter is up 9% year over year.
And right on the upper end of that range that we had given you. And over time, it gets into the middle, maybe something around that. I mean, we're not minus 10. We're not correcting like some of the people thought we will.
Okay. Thank you. Just as a follow-up on the Analog business and some of your comments on that, And I think I understand what you're saying, that, this growth in analog within the microcontroller market which is affecting what gets classified in the Analog segment. But what does that mean going well, I guess two questions. One is, why are we seeing that now, in that, are there particular product cycle, transitions happening, which cause that to show up in the numbers now.
And then what does that mean for the analog business going forward? Should we expect some flattening of the growth on the analog over the next several quarters as that trend plays out?
So the transition we're going through is, some of our analog business was, connectivity business, when it either got originally created or if it came to us through an acquisition, was largely all analog in its functionality and therefore classify it as analog. As time went on, if you look at our customer system, we then begin to see what are the other functions that are on that customer system. And often, there are microcontrollers that are there to be able to take advantage of that analog. What we did, some time back was create a new set of products, which effectively combined the microcontroller and the analog into a single product. And as we go win new designs and by the way, sometimes that microcontroller was ours, in other cases, the microcontroller was somebody else's.
But when you take a complete solution, which is a single chip, which has the microcontroller and the analog, particularly in some of these smart connectivity solutions, and as a fair amount of software that we provide, the combined solution is a far more defensible, far higher margin and far more sticky business that we have. So it creates the right answer, and we don't think ahead of time should we create products that fall into analog or fall into controller, we're doing what we think we need to do to be able to grow, protect and have high profitability on the products we have. So that's one part of the headwind you're seeing, so to speak, by classifying it as microcontroller versus analog. But the other side of the tailwind that is coming, and I think we will see it progress along as the analog, the standard analog products that we've had as they get attached around our microcontroller on new designs as we have talked about the total system solution and the whole Microchip 2.0 approach of going to market. The remaining analog products will over time get back some of that tailwind and have that growth.
And there's a bit of crosscurrents between some of the analog that is moving to microcontroller for the right reasons and the new analog designs that will come in and give us growth. But, in the long run, we fully expect that analog will be a part of the growth story for Microchip.
By the way, if a pure analog company adds a microcontroller code to one other complex product to improve performance for programmability or for any other reason, they will still call it an analog product. If exact same product existed in maxim or linear or intrasil, or they'll call it an analog product. But same product, if it has a microcontroller core, we put it in microcontroller. So it's a classification difference. It doesn't change the value proposition.
At the end, we have a better total solution for the customer, more sticky sake, higher ASP, higher margins and overall growing the revenue.
Sure. But just to be clear then with that trend and the microcontroller growth on a year on year basis already up, as we model your analog business going forward, that trend should persist until, I guess, you said, you see that rate from the analog components start to rise. Is that correct interpretation?
It's certainly, as Ganesh described, it has some headwind because of that. It would be because of that classification, it puts a little tailwind on the microcontroller, a little headwind on the analog. How it will manifest itself longer term, longer term, next quarter to quarter after and all that. We don't really yet know. It's a new new phenomena.
Mean, we manage the company during the overall growth and we don't really care where you put it.
All right. That's fair. Thank you.
We'll go next to Mark Delaney with Goldman Sachs.
Yes, good afternoon. Thanks for taking the questions. First question relates to atmel, company did a fantastic job of improving the margin structure of at And I had thought that maybe some of that margin improvement was adjusting which end markets are being targeted with the the historical Atmos products maybe more towards automotive and industrial. Can you just talk about to what extent that was a factor? And or is consumer still a pretty big part of the mix?
And I asked you just to better understand that the comment around that malo seasonality March versus the historical rates?
Well, I mean, we've had Atmel for seven quarters. That's usually the six, six quarters plus is the lead time to get a new product in production. So if you thought a lot of this improvement has come from because we largely changed the flavor of which market suppliers were sold. I think you miscalculated there. What we had said was, Atmel had a focus on what terminology we used, Homeland, right?
Yes, swinging for the fences.
Yes, swinging for the fences. We had a focus on large account and consumer segments, swinging for the fences and some you win and some you lose and gross margins are lowers and all that. So we very largely changed the focus on where the future attention is. And true, it's automotive, it's industrial, you know, in other areas and less on the consumer accounts. But it didn't change, the existing flavor of those parts in the last several quarters till those designs go obsolete and the new designs we are focused on come to fruition.
So a large majority of the margin structure change has come from improvement of pricing, discipline pricing, dramatic cost reduction in the fab assembly test, bringing a lot of those parts inside. Reducing large portion of the expenses, just doing the whole job overall better and rationalizing R and D, rationalizing manufacturing. But you cannot change the flavor of the business regarding what segments the business is in seven quarters. We barely touch it in seven quarters.
Got it. That's helpful. And for follow-up on capital allocation, I know the company had talked in previous quarters about potentially engaging in M And A now that the balance sheet has been improved. I'm curious for an update on how Microchip is thinking about that at this point, especially with the increased flexibility in your cash post the U. S.
Tax reform?
We are really not thinking any differently, post U. S. Tax reform. The cash becomes easily movable, you know, from from offshore that really was not easily movable before because it was permanently invested offshore. But our priorities have not changed.
We, continue to believe our priorities are investing in the M and A first, dividend second and stock buyback only opportunistically. So those have not changed. Thank
you.
We'll go next to Christopher Dowling with Citigroup.
Thanks, Steve. Just to talk about the, I guess, the soft landing that we're all trying to engineer here. Can you give us a little more color on like specifically what would be the combined typical June seasonality for a microchip plus atmel? And then could we be above or below that? I mean, I guess, how can we be sure that we've, I guess, landed yet in terms of the soft landing?
So I don't have the number for June quarter, it's a good question. We should have thought about it. I don't have it off the cuff, but you have seen strong June quarters for the last 2 years. Seen strong September quarters for the last 2 years, and you have seen stronger than historical December quarters, March quarter is right at seasonality. So it's really that's what I'm saying where it has landed.
If the June quarter is below seasonal. If that's your concern, we think the June quarter should be pretty good. June quarter should be strong.
Got it. And then how would you compare this, slowdown or return to normal or soft landing or whatever though we want to call it? Versus like prior slowdowns that you've seen. How's maybe talk a little bit about the linearity of bookings, how your customers feel, how the distis feel inventory?
Well, I think when I look at cycles, not 2 cycles are really different. You know, 1, many of the prior cycles have crash landed. And, this one, SMB, is not crash lending, we engineered the soft landing here. The other factor was in some of the prior cycles, some sort of second catalyst happened. In 2014, it was a dramatic slowdown in China.
That we saw it 1st and 4 months later, everybody saw it and struck saw a significant sell off. In some prior cycles that were driven by, you know, other factors that are tech bust in 2000 or whatever, then we're going way back. I I don't I don't see any of the second catalysts this time. It's just, you know, driven by getting our capacity in line, bringing the lead times down, going from a high book to bill ratio to a very moderating, one book to bill ratio, mean, at one book to bill ratio, you can grow the business forever. Just take incremental time every quarter and the business can grow.
And for, I think, 90% of our business lives, the book to bill is around 1, right?
Yeah. That's right.
And that's where it should be. That means the lead times are short. People can get their product. We still have some challenges on the ethanol side in about 1.5 business units like I talked about. And those are built in our analysis and that part of it was still need to soft land.
But it's largely there. I think, you know, I think Lane is right over the runway. Okay, thanks.
If you'd like to ask a follow-up, please re queue. We'll go next to Craig Ellis with B. Riley FBR.
Yes, thanks for taking the question. And Steve for giving us the numbers that really show the 10 percentage point difference between Atmel's first quarter calendar seasonality and what was microchip to make sense of things. So what I wanted to do is shift over to margins and ask you about the target margin model because when I look at the business, I see that with gross margins were I think within 100 basis points of target with operating, I think we're within 60 basis points. The team has done a spectacular job improving margins over time. And you've raised the targets multiple times, I believe.
The question is, as you get this close to targets, is there anything that you would see that that says the business would have a ceiling at those targets, or is there an opportunity operate above those targets?
So I think, what we do not want to do is on any parameter when we are above the target on the case of operating expense will be below the target. Then we suck that in and make that as a new target and keep thinking that the other one has to go higher. And then the operating margin goes over 40. And then we say, well, how high is the target? The peak can't be the target.
The business will oscillate over good times and bad times and very strong environments and weaker environment. 40% is a long term target. Can it temporarily in a good times go over 40? The answer is yes, because it'll be equal times when businesses in the session, it's softer to be less than 40%. So if you're really doing a math like you did, you're saying, well, Gross margin is about 100 basis points away from target and operating expenses already at target wouldn't our operating margin go higher?
Well, the answer to that is yes, but that's not long term. That's temporary. It might go there. But, during huge growth we have had last year, fiscal year 2017 over 2018, We grew, 13.7 percent of some number like that. During that, sometime expenses do not keep up.
And you get on the lower end of the expenses. And when the business moderate sometime, then the expenses catch up a little bit, because otherwise, you're not able to hire people enough in a very, very strong time. So again, you got to give it a flex. And as managers, we're going to be in such a tight box, that every little slack, you suck it in. And then we're in such a small box, then we're just missing point 1 here and point 2 there.
So think of that way. On a pure math basis, can the operating margins go higher? Yes, temporarily. We're not willing to yet admit that longer term margins could be higher than 40%. And the second piece of that is still the M and A strategy.
I have never bought a business that makes 40% operating margin or 39.5% where we are. So whenever we buy a business, it's usually much lower. Then you have to understand the flavor of its business Can we improve its gross? Can we improve its operating expense? Where does it go?
And then a blended margin comes up and usually most acquisitions result into a blended margin to be slightly lower. For example, Microchip's operating margins are still several 100 bps above the atmel flavor of the business. So it's 39.5 total But Microchip is well above 40 in Atmel is much lower than 40, and we're still improving it. So And some of the atmel may never get where Microchip is, and we were quite honest from the beginning and say, we'll improve its substantially, we have gone from atmel breakeven to in the mid-30s, but it can't match mid-40s where microchip might be. And I'm just putting set brackets here.
I'm not giving you where the breakdown is. So I don't know whether that helps, but, don't keep making our box smaller and smaller, please. We need some room to operate.
It's also the balance of and profitability. So we got to make sure the investments for growth are there so that it's not just profitability, but without any growth.
Speaking of growth, Ganesh, I'm going to ask a question on a business. I don't think I've ever called out on the quarterly call before, but you did note the very strong sequential performance of the licensing business. And underneath that, you highlighted some of the recent agreements that have been made with foundry and the growth that's being driven off that. As we look at that, that strong sequential growth, what does that mean and what do the recent business signings mean for the performance of that business intermediate term and what kind of beneficial effect does that have on the company margin structure?
So I want to be clear that the improvement in the results are not from recent signings. Signings took place multiple years ago, after which you have to go install the technology, qualify the technology, allow the technology to ramp, and then have that ramp generate royalty revenue. And royalty is the larger substantially larger portion of the revenue that we get from the licensing business. And that continues to layer in as by either foundry or IDM that we license it to by node that it is licensed. And it can also change based on how a given process node succeeds, it doesn't succeed.
So the much like in our IC designs where you have to get those designs early and then work with the customer to realize the revenue it can take 24, 36 months. Licensing has a similar kind of thing where what you're seeing in today's benefit are things we did 1, 2, 3 years ago. And we continue to have new licenses that we are, getting signed off that will create future growth. And I think we expect licensing will contribute to the overall growth that Microchip has. And of course, at a much higher level of profitability.
I would say though that on the effect of licensing on the margin, licensing is a $100,000,000 business. So $100,000,000 business at a higher gross margin than Microchip's overall, but Microchip is at a $4,000,000,000 run rate roughly. It's just really a small needle mover. There are equal number of other various business units where certain products are much higher gross margin, certain other products are less gross margin. The mix moves forward.
And sometimes one has a stronger growth, the other has stronger growth. True, licensing business is accretive to the gross margin, but it $100,000,000 out of $400,000,000, it doesn't dominate.
Got it. Thanks guys.
We'll go next to Vivek Ayush from Bank of America Merrill Lynch.
Hi, yeah, this is Adam Gonzalez on for Vivek. Thanks for taking my question. Wondering how we should think about your CapEx moving into fiscal 2019 in the context of some of the views you've laid out in the demand environment and the relative supply demand balance? Thanks.
So, we haven't gone through our, annual operating plan process for fiscal 2019 yet. So we're not ready to give a number on that as it is. We have made significant investments since last year. We have goals to bring the assembly and test that we do higher, and that will require investment. But, I don't think we're ready to give a provide the street with a number yet for next year's CapEx.
Still going to be a small percentage of overall net sales.
Got it. And I guess just one quick follow-up. I know this is nitpicky on the seasonality issue. But in the March quarter, you guys, it's down 1% quarter on quarter. What's different this year versus last year?
You had had Atmel for a full quarter then and sales still grew 2% sequentially. So just what was better than seasonal in March versus this year?
That's kind of what threw everybody off. Last quarter was very noisy. The, not the last quarter, March quarter last year was very noisy. We had just gone go live on January 1. There were a bunch of orders that were pushed out into the quarter.
There were just there were a lot of moving parts. And there was a large amount of delinquency we had carried in the prior quarter of December. Some of it were able to meet. We were new to that business. It was the 1st March quarter we had had.
At malware had also left fair amount of pricing and all that on the table. We talked about it, and we were seeing a significant impact of price increases we had done, which masked some of the seasonality, there were just way too many moving parts.
That's the environment. It was stronger.
Yeah, I mean, not that the environment is weak now though, but certainly not as strong as a year ago. So I think, I think that's what threw everybody else off. Okay. Thanks very much. I think, this time, there's no such noise.
And this is a true seasonality with that, Mel.
Thanks. Got it.
We'll go next to Kevin Cassidy with Stifel.
Thanks and congratulations on the quarter. Going to the Microchip 2.0 strategy of platforms, how is that affecting your pressure on ASPs. You had mentioned before, Steve, that industry consolidation is seeing less pressure, but is this helping maybe even lift ASPs?
Well, I mean, the answer to that is yes. I mean, I don't know if the ASPs continuously go up, but, we are severely resisting the pressure to give year over year declines in Laws and Georgia's cases, we're succeeding and are able to hold our ASPs, plus as we add microcontroller intelligence to analog, as we attach analog around microcontroller, be more important to the customer, have a total solution, in general, you can bundle and it's more sticky and it helps ASV, all that is happening. But, I mean, semiconductor ASPs do not constantly go up. I think if you can have them not go down, that would be good enough.
It avoids commoditization of the individual products when you can take a complete solution and have them show the customer the value in doing that.
Right. And maybe even on the OpEx side is, are your platforms, the designs robust enough that you can win designs without Microchip employees or FAEs being involved?
Well, across 115,000 plus customers, vast majority of the customers, we don't have Microchip FAs involved. We just can't have them and employees covered there is a large amount of effort in us building reference designs, documenting, training on the web, training in person, We train 30,000 engineers around the world in various master's conferences, seminars and webinars and on-site customer training. So there is a Microchip is huge. Microchip is a very vast training organization, teaching our customers how to do it. And then there's a lot of self start help and all that where customer design product.
You know, vast majority of Microchip's customers, you do not have a Microchip Effie involved in helping them in their design. There's a Microchip Effie involved in overall general training with which they do the design. Otherwise, we wouldn't be able to have enough people.
Okay. Thank you.
Welcome.
We'll go next to Harlan Sur with JP Morgan.
Good afternoon and thank you for taking my question. From a geographical perspective on a year over year basis, you're driving growth in all of your geographies. So demand looks pretty broad based, but one of the geographies that kind of stands out is the Americas region. Growth was up 5% versus the rest of the fees that were up at least double that rate. Any reason for the slower growth in the Americas region?
Well, the problem is, we count the revenue on where the product is shipped, where the product is not where the product is designed. So manufacturing largely keeps moving out of the Americas and I don't know whether it will change in the coming years. So when you look at 5% America's growth, it artificially understates it when internally we look at the revenue in Americas, counting back the revenue, which was generated in America and shipped overseas and Americas growth was great. Was just as good as any of the geography. It wasn't weak.
Yes. Thanks for the insights.
What we report actually is where we shipped it.
Got it. Seems like the team is gaining quite a bit of traction with these analog products with the integrated MCU cores for these what you guys call smart connectivity solutions. Can you guys just give us some examples of where these type of connectivity solutions are used, applications or end markets And when you say connectivity, are you talking about both wired and wireless connectivity integrated with your MCUs?
Yes, it's both. So, let's take one example, which probably you have, which you're not familiar with. Your car has a USB hub in it. And depending on the vintage of your car, that is a hub that has progressed over time from, at one time, being largely an analog only solution, to today being a smart, connectivity solution where that hub has a way to recognize what is being attached to it as a way to either be a slave or a master. It has a way to control your display.
So, and, of course, power the device connected. So it's a far smarter hub today than it was several years ago. Several years ago, we would have called that a, an analog product. And as the new designs have gone into production, those we would call as a microcontroller product.
You could take a different market, take a thermostat, a large number of thermostats nationwide, you can access them now through your phone or pad. Know I can access the thermostat in my house and my phone remotely while traveling, turn the temperature off or down or up or if I'm be on business for longer and wasn't anticipated, I can keep the house turned off. Those are all connectivity solutions where you're doing it wirelessly. And it would have a micro
Wi Fi or a micro and a Bluetooth, for example, on the same chip. Rather than 2 chips.
I mean, large number of speakers in the home, you don't connect them anymore. You simply Bluetooth hit from your phone. Into the speaker and the sound is coming, you don't really access the phone, access the music, through a through a box or something anymore these days. I mean, you can still do that. Most times you access the music through the phone and just Bluetooth into any of the speakers in your home, that's connectivity, wirelessly.
You can take those same general examples and apply it to ethernet to can to various forms of wireless and so on and so forth.
We'll go next to Gay Alexander with their full investments.
When you look at your business, you still see revenues growing at 7 to 9%. Over the next few years?
Yes. As we are driving our business, we're modeling our business. And looking at the impact of 2.0, those are the targets we're driving towards.
And as you look at the business now, how strong do you find the Asian business and the European business?
The last year, all three businesses were very strong. If you look at just on a quarterly basis, March quarter has the Chinese New Year. So Asian business and the current quarter is always weak. European business in the March quarter, they are the strongest geography in the March quarter. And America is normal.
If you look at the December quarter, usually with all the holidays and all that, Europe and America businesses were weak and Asia business was okay. So each quarter, it's kind of slightly different. When you go to June quarter, Asia business rebounds strongly from Chinese New Year quarter of March to June. I'll make that help. Yes.
Thank you.
We'll go next to Rajvindra Gill with Needham And Company. Due to a response, we'll move on. We'll go next to John Pitzer with Credit Suisse.
Yes, guys. Thanks for squeezing me in. Steve, congratulations on the solid results, especially on the operating margin. Steve, one of the questions I had over the last several months have you talked about sort of the soft landing scenario. You kind of alluded to the potential that you could keep every quarter this calendar year in that sort of high single digit long term revenue growth target.
Is that still kind of the way you see this calendar year playing out? And I guess secondly, if it is, do you get there on just seasonal growth sequentially or will it take some above seasonal quarters?
John, I don't know. I think this this March quarter at atmel seasonality last year kind of threw everybody off, I would say, including us. And as we really dove into it and looked at our backlog and look at the business and then analyze the prior 5 years of Atmel business, and the behavior of these large swimming for the fences, accounts and design wins, the last year's performance kind of threw it off. And those accounts still had a problem last year. But it was kind of overcome by the general halo of price increases and a lot of under marketing of AVRs and all that that Atmel had done and where we improved the position, stronger distribution and things like that.
So the number of things last year kind of threw it off. And I guess, all of us together somehow didn't quite capture, the blended market seasonality. So that's what we are adjusting to. So give us a little time to get a feedback on the earth and really see what effect it has on rest of the quarter. I mean, economy is not bad.
Bookings are not bad. Our business is not bad. We're getting strong terms. Our inventory is right. We're not in a massive inventory correction mode of any kind.
There's really no problem in business. We're doing well. And when you do the calculation, like we have shared, we're right on target. But obviously go ahead.
Well, just anecdotally, for me, one of the things that's always important as we kind of orchestrate the soft landing as book to bill of lead times come in Are you seeing any sort of unusually high cancellation patterns or different order patterns from your customers or are they responding to your ability to meet demand in an orderly fashion?
Yes. So they're just responding to us, shipping it in a more orderly fashion. And if you recall, last March to last June, the bookings were not any stronger. The book to bill was exactly the same. Because we informed the customers of lead time, they responded with higher orders out in time to respond to that lead time, And as the lead times have come in, then customers that are adjusting to that lower lead time and don't have to place outer bookings, which is then lowering the predictable ratio and now it's at parity and it's moderating.
So customers are essentially giving us as many bookings as they need. And don't have to give a huge bookings out in time. This is almost perfect landing, I think, so far. The only difference, I think, you know, Street had higher expectations for March looking at, March seasonality last year, which was kind of typical microchip. And basically, there were lots of other factors in the business, pricing and others, which masks that seasonality.
And this year, December to March, we can't.
Perfect. That's very helpful. Thank you, Steve.
Obviously result is that some of the other quarters have to be stronger. And I think I think there will be and hopefully there will be. Certainly, last year there were, March, June, September, December, they were all stronger. And this year should be the same. Next couple of quarters should be stronger because of that March seasonality.
Perfect. Thank you very much.
Yeah. Welcome.
We'll go next to Hans Mosesman with Rosenblatt Securities.
Thanks for squeezing me in. Hey, Steve. Can you give us a rundown on the competitive dynamic in 8, 16, and 32 bit have things changed over the past several years and so on? Thanks.
The number of competitors has it continues to be a reasonably reasonable number of good strong competitors. We have continued to move up that ranking And so we have been gaining share in, all of these product lines, including the overall microcontrollers as well. Some of these competitors have had various challenges relative to, either their, capacity in some cases, they're, whether they're being acquired or not. So then those kind of things that are taking place there. But, microcontrollers remains a competitive product line, competitive market.
And, I think that a more rational actors today than they were perhaps 5 years ago, and they are responding in some cases, more so or in some cases less so, to the consolidation that's taking place. And that certainly helps, as well. So nothing dramatic to report that is different about competitive dynamics in my controllers.
I'm sorry. Our funds are doing business up by I think almost 19% last year. Was higher than Microchip's growth and higher than the industry growth in that segment. Based on FAE numbers, we gained share in all 3, 81632. And I shared with you the overall share gain by 90 bps almost.
So I think things are good.
Okay. Would it be safe to say that the average microcontroller after out there is not using price as a as a way to gain share. It's more a value proposition.
I don't really know if, just gaining share by price has ever worked in microcontroller. These are complex parts and Over time, we have shown surveys when you ask the customer, what do you consider for choosing a microcontroller? The most frequent answer is the ecosystem, the tools, the support, the quality, the reliability, the customer, the samples, development tools and everything else, price is one of the factors. So these are not commodity products. It takes 2 years for a customer to go to production.
After they have made the device selection. So price has never been really the way to gain share, but there were players in the market that were, irresponsible. They will drop the price too quickly and not stand up and fight to really maintain their price. And some of those have disappeared, but some of those have become better and more responsible. But overall, I don't think price has been a mechanism to gain share in the market ever.
Okay, good. Thank you very much.
And with no further questions in the queue, I'd like to turn the call back over to Steve Sangee for any additional or closing remarks.
Well, thank you everybody for joining our conference call and we'll see some of you on the road at various conferences we might go to. Thank you very much. Bye bye.
This does conclude today's conference. We thank you for your participation. You may now disconnect.