Good day everyone and welcome to this Microchip Technology Second 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.
Thank you, and good afternoon, everyone. During the course of this conference call, we will be making projections and other forward looking statements regarding future events 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'll 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 In attendance with me today are Steve Sangey, Microchip's Chairman and CEO and Ganesh Morethe, Microchip's President and COO I will comment on our second quarter fiscal year 2018 financial performance and Stephen 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 effect of our acquisition activities and share based compensation. Net sales in the September quarter were a record $1,012,000,000, well above our guidance and up 4.1% sequentially from net sales of 972,100,000 in the immediately preceding quarter. This was Microchip's 1st quarter with more than $1,000,000,000 in sales. 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 61.04 percent in the September quarter and above the high end of our guidance, which was 60.75%. Non GAAP operating expenses were 22.46 percent of sales, well below the low end of our guidance of excuse me, just below the low end of our guidance of 22.5% and non GAAP operating income was a record 38.6%. Well
above the
high end of our guidance of 38.25 percent. Non GAAP net income was a record 344,100,000 and was up 7.9% on a sequential basis and up 56.7% as compared to the same quarter last year. Non GAAP earnings per diluted share was $1.41, which was $0.06 higher than the midpoint of our guidance of $1.35. On a GAAP basis, gross margins, including share based compensation and acquisition related expenses, were 60.7% in the September quarter. GAAP gross margins include the impact of $3,700,000 of and include acquisition intangible amortization of $120,900,000, share based compensation of $19,900,000 $700,000 of acquisition related and other costs and special charges of $19,900,000, consisting primarily of a $19,500,000 charge for fees associated with transitioning from the public utility provider in Oregon to a lower cost direct access provider.
This change is expected to provide significant expense and cash flow savings in the future. After these adjustments GAAP net income was a record $89,200,000 or $0.77 per diluted share. The non GAAP tax rate was 9.1% in the September quarter, and the GAAP tax September 30, 2017 was $456,900,000. Microchip had 105 days of inventory at September 30, 2017. Up 5 days from the end of the June quarter.
Inventory days are still well below our targeted levels, but are starting to improve from our significant capacity expansion efforts as well as selective and opportunistic buy aheads of constrained materials. Inventory at our distributors in the September quarter continued to be low at 31 days and were flat to the June quarter levels. The cash flow from operating activities was a record $350,100,000 in the September quarter As of September 30, the consolidated cash and total investment position was $1,844,000,000 of which about $550,000,000 is domestic cash. We bought back $15,100,000 of our 20.37 convertible bonds in the December quarter, where the bond holders had elected to convert. We expect the remaining principal amount of $17,300,000 of the 20.37 2.8% convertible bonds to either be converted by the bondholders or called by Microchip during the December 2017 quarter.
The call date for these bonds is December 15, 2017. Capital expenditures September 2017 quarter, we expect about $70,000,000 in capital spending in the December quarter and overall capital expenditures for the fiscal year 2018 to be about $200,000,000 to $220,000,000, up from our prior guidance of $180,000,000 as we capitalize on growth and cost reduction opportunities. We are aggressively adding capital to support 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 Atmel Manufacturing activities that we are bringing into our own factories. Our capital spending also reflects 3 new buildings 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 to cost effectively scale for our future growth. Depreciation expense in the September quarter was $29,900,000 I will now ask Ganesh to give his comments on the performance of the business in the September quarter. Ganesh?
Thank you, Eric, and good afternoon, everyone. We're very pleased with how our product lines performed in the September quarter with overall sequential revenue growth of 4.1% and year over year growth of 15.8 percent, all organic growth as there was no contribution from acquisitions in the last four quarters. The Microchip 2.0 transformation continues to make strong 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 businesses performed strongly in the September quarter with revenue being up 4.7% sequentially as compared to the June quarter setting a new record in the process. On a year over year basis, the September quarter microcontroller revenue was up a very strong 20%.
All microcontroller product lines, 8 bit, 16 bit, and 32 bit set new revenue records. Our microcontroller portfolio and roadmap has never been stronger 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 at almost 2,700,000,000 in annualized revenue represented 65.7 percent of Microchip's overall revenue in the September quarter. To put our recent performance into perspective, in the last five quarters, we have grown our annualized microcontroller revenue by over $500,000,000. All our microcontroller product lines are firing on all cylinders and driving differential growth and market share gains.
We believe we have and further strengthen the best performing microcontroller franchise in the industry. Now moving to our analog business. Our analog revenue was sequentially flat the September quarter as compared to the June quarter and up 6.3% on a year over year basis and also set a new record by a whisker in the process. Our analog results over the last two quarters were negatively impacted by 2 factors. First, the back end capacity constraints on products with Atmel Heritage, which we discussed at the last earnings call, have taken more time to resolve as a lead time for new back end equipment has been longer than expected, reflecting the strong industry conditions that our suppliers are also seeing.
And second, We have been adding microcontroller cores to several of our more complex analog products, especially those that provide our clients with smart connectivity solutions. This enables us to subsume competitive microcontrollers, which we're sitting next to our analog products, as well as include the connectivity firmware in our products so that they form total system solutions and are therefore much stickier design wins. These smart connectivity products are ramping 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 a 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 from our microcontroller into our microcontroller product line.
As our backend capacity constraints continue to get relieved, and the revenue from analog attached design wins, Doctor. Ramp, we fully expect that the analog product line revenue will grow at or above Microchip's overall growth rate. At over $950,000,000 in annualized revenue, our analog products represented 23.6% of Microchip's overall revenue in the September quarter. We continue to successfully find more opportunities to attach Microchip'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 wins go to production.
And we are developing and introducing a wide range of new innovative and proprietary products in the linear, mixed signal, power, interface, timing and security product lines to fuel the future growth of our analog products. As we march relentlessly towards making analog a greater than $1,000,000,000 annualized revenue business for Microchip soon, and a much larger business in the coming years. Moving next to our licensing business. This business was up 3% sequentially in the September quarter. And up 8.9% on a year over year basis, also 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 manifest in our results as the licensed processes generate royalty revenue for many years to come. Last but not least, our memory business was sequentially up 5.3% in the September quarter as compared to the June quarter. There are significant cost reductions underway for this business using the combined strength of Microchip and Atmel. We believe that this effort will make us even more competitive and further improve our gross margins. 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 1st reflect on the results of the fiscal second quarter of 2018, I will then provide guidance for the fiscal third quarter of 2018. I will also provide update on capacity enhancement activities lead times as well as microchip 2.0. Our September quarter financial results were extremely strong, Our net sales were a new record and above our guidance. First time ever, our net sales crossed a very important milestone of being above $1,000,000,000 for the quarter.
Our net sales for this quarter were up 15.8% from the September quarter of a year ago, and this revenue comparison is not impacted by any acquisition since Atmel's full quarter revenue was in the September 2016 quarter results. Our non GAAP gross margin percentage, operating profit percentage and earnings per share each exceeded the high end of our guidance. Non GAAP earnings per share were up 50% from the tember quarter of a year ago due to improving sales, gross margin percentage, operating expense leverage, and successful execution of our all the employees of Microchip Worldwide This was also our 108th 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 September 2017 quarter over the year ago.
Quarter. Number 2, every major geography, North America, Europe and Asia were up significantly in the September 2017 quarter over the year ago quarter. And number 3, sales in all end markets were up in September 2017 quarter over the year ago 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 8 bit, 16 bit and 32 bit customer applications.
On top of that, our various acquisitions have now built a powerful diversified product line through which we're able to provide total system solutions to our customers. We are winning incremental design wins with multiple products in the same boards of our customers. We have a robust design win funnel and we feel very optimistic that Microchip 2.0 is working and increasing the organic growth of Microchip. A year ago, in September 2016 quarter, our microcontroller market share in 816 and 32 bit combined was 14.46% as per the FIA numbers. In September 2017 quarter, Our market share is up to Now, before business environment for our products worldwide and have a number of company specific demand drivers.
Our inventories at Microchip as well as our distributors are towards the low end of our normal range. We are continuing to slowly add incremental capacity the at various bottlenecks. With that, our lead times have stabilized. With stable lead times, we're engineering a soft landing so far without triggering any double ordering or panic from our customer base. Our book to bill ratio has moderated from 1.11 in both March June quarters to 1.05 in September quarter as the lead time stabilize.
We expect the book to bill ratio to come down further as lead times continue to moderate, hence engineering and soft landing. At the rate we are adding capacity, we believe that it will still take us through June 2018 when our lead times return to fully normal. Now let us go into the non GAAP guidance for the December quarter. Flat to down 4%, which at the midpoint represents a growth of approximately 12.6% on a year over September quarter. SMS closed in August of fiscal year 13.
ISS closed in July of fiscal year 2015, and Microwell Close in August of fiscal year 2016. All these three acquisitions had a partial quarter revenue in September quarter, and a full quarter revenue in the December quarter. Therefore, mathematically taking the average of the last 5 years of sequential growth would give you a false number. Excluding acquisitions, the average sequential decline in the December quarter over the past 5 years has been 2.5% and ranged between plus 0.8% and minus 4.9%. Investors should compare our guidance for December quarter of flat to down 4% with an average 5 year seasonal performance of minus 2.5% in net sales and against the backdrop of a 1% beat of our FQ2 revenue guidance.
Regarding gross margin, we see a steady improvement in overall gross margin of the company based on Microchip 2.0 margin drivers that we have discussed with the investors, we expect gross margin for the December quarter to be between 61 and 61.4% of sales, we expect overall operating expenses to be between 22.22.6% of sales and we expect operating profit percentage to be between 38.4% 39.2% of sales. And we expect earnings per share to be between $1.30 $1.40 per share non GAAP. I want to remind investors that our long term financial model is a non GAAP gross margin of 62.5 percent operating expense of 22.5 percent and operating profit of 40%. And as you have seen, we are relentlessly marching towards this model. And we expect our longer term annual revenue growth to be high single digits.
We believe we can grow above the industry, driven by 4 factors We can achieve We can achieve an additional 1% to 2% growth due to higher attach rate from our total system solution approach we can achieve 1% to 2% higher growth from much less ASP erosion or stable ASPs and we can achieve 1% to 2% higher growth from our distributor partnership approach versus competitors pulling back. And we have judged it down due to confounding effects to yield a 7% to 9% growth going forward. 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 prior quarters, and With this operator, will you please poll for questions?
Due to time constraints on today's call, please limit yourself to one question and one follow-up question only. And we'll now take our first question from Vivek Arya with Bank of America Merrill Lynch.
Thanks for taking my question and congratulations on the strong results and on execution. Steve, if you look over the last year, growth has been very strong for you guys. Can you give us a sense of how much of that has been sort of company specific how much of that has been the macro? Because I think what most investors are trying to get a sense for is how much of this growth is actually sustainable as we look out into the near to intermediate term?
Well, it's it's very, very difficult. Customers don't have a good answer for that you're giving me this design or winning this design. Is it because industry is doing well or we are winning more than that. So that is very, very hard to decipher. If you look at our last quarter, our year over year growth was 15.8%.
We're not guiding to that. We're not expecting that. We're expecting a growth going forward of 7% to 9% with the December quarter guided at about 12.6% over the prior December. So Growth will moderate from these high numbers and some of that excess is driven by the industry conditions.
Got it. And as a follow-up, in the last few days, there's been a lot of M and A excitement in semis. And I'm wondering how you are thinking about M and A given that your leverage is at a very, very comfortable level. And at what point would you decide that it is better to resume buybacks instead of maybe going after assets that might be marked up with all the excitement in the industry?
Well, our capital allocation strategy and our thoughts have not changed. Since we discussed with you all of you many times, our first preference is to utilize our cash for our operations. R and D and other activities, but those are very well funded into the P and L. And we do not need to really reach out into the balance sheet to spend excess cash The second priority is to utilize our cash towards M And A. Our 3rd priority is actually the second priority is to maintain the dividends, keep growing its small amount incrementally like we are, but not really have a very large incremental dividend program, then our next priority is to utilize a cash for M and As.
And our last priority is really to buy stock back, which we only do opportunistically.
And we'll now take our next question from John Pitzer with Credit Suisse.
Yes, good afternoon guys. Steve, congratulations on the strong results. Guess I just want to go back to the increase in the CapEx budget. Eric, you did in your prepared comments, gave us sort of a good rundown of what's driving that. You did say that there would be some cost savings because of that.
I'm just kind of curious, does that put you sort of towards your target margin or above the target margin. And if you can help me understand what percent of the increase in CapEx is going because you just feel better about the overall demand environment. Versus bringing more stuff in house?
Well, we've been talking about for the last several quarters that, there are a lot of margin improvement that we can get by bringing a lot of the outsourced atmel activity in house and the percentages of our internal production versus where they've been historically are out of line with where we'd like them to be. So we're making these incremental investments and there are significant gross margins to come. We think that by making these investments, we can get to our 40% operating margins and the 6 2.5% gross margin goal. And it's gradual. These things come in on over a steady period of time.
There's only so much our manufacturing and operations teams can do any given quarter. But we've laid out a pretty aggressive plan for us to increase the production capabilities in house and the gross margin will improve from there.
That's helpful. And then, Steve, maybe as my follow-up, just to follow on to Vivek's question about M and A, you've always been very disciplined about price you're willing to pay for an asset. I think in the past, you've said for every deal you've done, you've probably vetted and walked away from 3 or 4 deals. I'm just kind of curious with Microchip 2.0 and your confidence level increasing that you can grow revenue faster than the industry, does that change the parameters around asset value you're willing to pay on the M and A front? And just given where the SOX index is now, any comment around asset values or your perception thereof would be helpful?
There is really no change. We have, We have strong filters in place in our M and A analysis, which are multi dimensional in terms of multiples in revenue and gross margin. Operating profit growth rates and others. I can't give you all those filters, but it's a fairly complex metrics that we have to check off. And really, from at various times, the assets available outside could be on the lower end of that metrics.
It could be on the high end of the metrics, but there are always companies that fit the metrics. And if they go on the higher end of the matrix and even beyond that, and they're too expensive when we won't do it. But there are always companies available, which are still following the matrix.
Perfect. Thank you.
And we'll now take our next question from Craig Hettenbach with Morgan Stanley. Me.
Yes, thanks. Just a question on just the microcontroller share. And as you kick through kind of some of the things that should allow you to grow above the industry and high single digit growth. Any particular end markets or product segments that you'd call out in terms of where you're seeing the best market share positioning?
We don't go to market with a end market view in order to be able to grow. We have a very broad, approach to markets, applications and a broad product line to go after them. Clearly as the end markets strengthen in one area and other, we get participation incrementally from there. We've shown you how our automotive and industrial market share when we presented it about 6 months ago was at 60% of the overall revenue for us. And of course, those industries have been helping as they've had some strength.
But we don't have a particular end market that is driving us in one direction or another.
Got it. And then just a follow-up question for Steve. Appreciate all the color on some of the cyclical barometers around lead times and book to bill. Anything as you try to kind of navigate to a soft landing, is there anything different in terms of this cycle versus prior cycles, whether it's communication with distributors and customers, inventory you're holding to kind of help navigate through that?
Well, I think, the lead times did not get as long this time as, probably they have gotten some other times. The customer behavior and the distributor behavior has been much more normal this time than we have seen in the other time. So I think everybody has behaved. We wrote a letter back in April informing our customers, that industry conditions were strengthening and the lead times were going out. In the March quarter, our lead time was, I'm sorry, our book to bill ratio was 1.11.
And we wrote the letter on April 4th after we had seen this very strong bookings. And in the June quarter, our book to bill was again 1.11, which means really There was no panic created, no customers rushed to place large orders. They kept doing what they were doing before the ladder, and conform to our lead time and place the orders to conform to the longer lead times. And then in December quarter book to bill ratio came down to 1.05 as some of the products where the lead times are moderated and the lead times right now are anywhere from 4 weeks to 20 weeks, but the products are all over the place. But the products where the lead times have become shorter the bookings on them have moderated because people have the orders in place.
So I think it's a much more behaved environment. This time than kind of we have seen before. I do not know what's happening at the competitors and the rest of the industry. There are scattered cases where the customer isn't willing to take one of our product because he cannot complete the kit. There's a product coming from one of the competitors or other analog or other companies where he needs to build his entire product.
And if that one is not available, they don't want hours either. But same can be said by by those competitors that one of our product wasn't available. So their product didn't sell. But those are scattered cases. It's not all over the place.
I think environment is kind of pretty reasonable and reasonably well behaved.
Got it. Again, appreciate the
color. Welcome.
And we'll now take our next question from William Stein with SunTrust.
Great. Thanks for taking my question. You spoke in the prepared remarks about, subsuming competitive microcontrollers when they're next to your analog products. It sounds almost like the cross selling opportunity is being driven from analog to the digital MCU. I would have thought that the cross selling opportunity was much more in the other direction.
Can you elaborate on this? Help us understand that dynamic a little bit.
It happens in both directions. So, in many cases where we have the analog sorry, the microcontroller at the center of the design, we see the breadth of what else surrounds that microcontroller early and are able to attach products There are some specific cases where it's very complex analog. And especially when it's smart connectivity, where in addition to the analog and the connectivity function, it needs a microcontroller. And we, in many cases, entered those businesses through some of the acquired entities. We didn't have our microcontrollers there to begin with, but once we now see where we are on the analog from a smart connectivity standpoint, we can begin to see what else can be subsumed.
And that's where it goes in the opposite direction where the strength that came from analog gives us the ability to attach microcontroller. And in many cases, do an integrated product that gives us more complete, total system solutions in that application.
That's helpful. I can squeeze in one follow-up. I just want to make sure it's really a clarification point of the last question, that someone else asked. It sounds like perhaps the shortages on the passive side have been sort of clipping overall demand. I think you mentioned a moment ago about if a customer can't get a complete kit because he short say a capacitor he doesn't want your product, at least not yet until he can do a full kit.
Did I understand that as sort of the dynamic that might have contributed to a sort of soft landing where things didn't get out as out of hand because, let's say, passives or some other product clipped peak demand rate?
So I don't know if the others are seeing a massive a number of cases where they're not able to ship the product because some passive product is not available. I think, I'm kind of just seeing it sporadically where it's not large enough that that becomes an excuse why numbers are one way or the other. I think it's a noise level, but certainly effective. It's possible that for some other people, it's a much larger factor.
Thank you very much.
And we'll now take our next question from Chris Caso with Raymond James.
Yes, thank you. Good evening.
I just want to talk
a little bit about the efforts to build inventory and the timing of that. With demand slowing a bit seasonally in the December quarter, does that give you the ability to catch up on inventory somewhat, or does that have to wait until more capacity is in place a couple of quarters from now. And then with that, is there a, I'd have to imagine there's some gross margin benefit as you run the fabs a little harder to build the inventory you quantify that benefit and talk about how that, works its way into 2018?
So the way I will answer is, it's a continuous phenomena. It is not digital where inventory doesn't grow this quarter and a couple of years from now it all grows to the right level. Our inventory grew by 5 days last quarter. Inventory will grow by somedays this quarter, you grow some again in March. And by June, we expect to try to get to the model.
So it's a continuous phenomena in the stronger quarters like we have had in the last 2 or 3 quarters, inventory was harder to grow because even though we added capacity produce more units, we largely shipped them into the growth. Current quarter is seasonally weak quarter is seasonally the weakest quarter of the year. So this quarter, the incremental capacity we're adding gives us a chance to add a little bit to the inventory because we can produce more than the a demand. But it's a continuous phenomenon. It's really not waiting for something to happen two quarters from now.
The other thing to keep in mind is our distribution inventory is at the low end of their range as well. So, us having a little extra inventory helps as we go into
And I'm sorry, the margin impact as the inventory is building?
So So margin impact is essentially doesn't care about whether inventory is building or not. It cares about overall production. If you produce more in wafers assembly test, then it has better absorption and it has an accretive effect. So, we have been producing more units every quarter, and you have seen the margin going up every quarter. So that's also a continuous phenomenon.
Okay. As a follow-up, you had talked in your prepared remarks about a number of factors for why you think you grow faster than the inventory growing forward, and what the impact would be. Can you talk about that looking backwards over the last year. And I know some factors are more difficult to measure than others, but perhaps give us a walk through, perhaps some of these factors. And I think market share, you talked about a little bit pricing, how that may have affected your revenue growth over the last years compared to the industry and what we'd say microchip 1.0, I guess?
Well, it very difficult to numerically assign to the history and take our 15.8% growth last quarter over the previous 1 year and figure out what portion happened with price increase, what portion happened with gaining market share, what portion happened with what, because it's impossible to do, 115,000 plus customers and 100,000 SKUs we are shipping. But the 4 elements that drove it in the last year and will continue to drive it going forward is really the traditional market share gains, a better ASP management either stable ASPs or increasing ASPs or lesser erosion. Depends on various product lines. And then achieving higher growth from our distributor partnerships where a number of competitors are pulling back in their distribution programs. And distributions are focusing attention on us.
And the total systems approach where Denish talked about what's happening both ways. We're able to win the microcontroller where we had a lot of analog parts by giving heritors analog because we have our microin'. So from both of those factors. So when you combine it together, if you take 1% to 2% growth for those 4 factors, it kind of becomes 4% to 8% incremental, Len, we can have judged it down overall to come up with a 7% to 9% growth, counting the growth of the industry, whatever your assumptions are plus a little bit more that we can do.
Got
it. Okay. Thank you.
You're welcome.
And we'll now take our next question from Chris Stanley with Citi.
Thanks guys. Steve, you said that as the lead times are coming in the book, the bill is dropping a little bit. Is it possible that if the lead times drop fairly suddenly in this quarter that book to bill could be below 1 for for the March quarter and you could potentially see some below normal seasonality?
Well, we are not seeing it and we're not expecting is because there's not big capacity increments coming in because the lead time for equipment is large. Many of the test equipment, fab and other equipment, there's a lot of semiconductors going to them. So our equipment suppliers are unable to produce the product and deadly turns along because they can't acquire all the semiconductors they need. So there is not big bulk of capacity coming in. Capacity is coming incrementally.
And that's why I said, I think it's capacity is coming incrementally and lead times are moderating slowly and that kind of all leads to a soft lending rather than a contraction.
Okay, great.
And then for my follow-up,
can you talk about 7% to 9% long term growth? And like you said, analog slowdown to like, I think it was 6% year over year growth. So would you expect the microcontroller business to grow faster than analog going forward? Or would you see And what would be driving like a reacceleration in the analog revenue growth?
I think what drives the reacceleration in analog is Atmel acquisition was a little over a year ago. And usually, you have year, year and a half design cycles. So, with Atmel, we acquired a large amount of microcontroller business. I think it was about 6, 7 $700,000,000 of the $700,000,000 of the business was microcontroller, which, those sockets had 0 microchip analog around it. We were the enemies.
So it was anybody's analog except ours. So that was a very, very large opportunity. We identified for you we are just in the front end of it going to production. So I think that's what accelerates the analog. Don't be fooled by just last couple of quarters of lower analog growth because in some cases, we were already producing the integrated product with analog, with microcontroller, and we were able to sell the package to the customer.
And therefore, the revenue shifted rather than putting into the analog bucket, we put it in the microcontroller bucket.
We still have that analog. It's just coming in We
still have that analog, but it's counted as part of the microcontroller revenue. 98%, 99% of our microcontroller has large amount of analog on it, but that revenue still counts as a microcontroller revenue.
Any product that we ship that has a microcontroller core, we classify as a microcontroller product.
That's not different for anybody. Our competitors do the same. All 32 bit micro, 16, 8 bit micro, they all have, you know, some power management converters, supervisors, LDOs, lots of analog is built into the microcontrollers.
Right.
So that's where you saw and there were some large designs where we captured that and it kind of depressed the analog sequential growth for a couple of quarters. I will not be fooled by it. There's a large amount of analog attach rate coming around Atmel's microcontrollers soon.
Okay. Thanks. Okay.
We'll now take our next question from Harland Sur with JP Morgan.
Good afternoon and solid job on the quarterly execution. You're at your you were at your target OpEx ratio on the September quarter. You'll be there as well in the December quarter, actually a bit better than that. So clearly, you guys are continuing to drive OpEx leverage. And I think on a go forward basis, I think the team is going to continue to drive revenue growth faster than OpEx growth.
So is there a new OpEx ratio target that we should be thinking about?
We we have not revised them and we're not thinking of revising them. We believe our long term target is 20 2.5 percent in good times. We happen to be slightly below that in a discretionary time in the future. We could be slightly higher than that by 25 bps or something. Basically, we're in the range.
We're not calling for substantial OpEx leverage going forward. And if the times continue to be very, very strong and the growth happens to be well above the mean, you could temporarily be in that situation. But longer term, we've got to make the investments to grow the business.
Okay. Thanks for the insights there. And the team is clearly executing on the microchip 2.0 initiatives, system level focus, more content per board. You guys have a lot of analytics platforms in house that tracks design wins, tracks content per board, seems like this is a contributor to the strong year over year growth. Can you guys quantify content increase per board on a year over year basis or any other metrics that you use to gauge success in terms of value capture per system?
Well, we have a proprietary indicator. We certainly don't want a competitor with anybody else to know So for the last several years, we have been tracking, average number of microchip parts, per customer design. And that is growing and growing significantly. So that is the measure of the success of the TSS effort We want to share that success with you qualitatively, not quantitatively. Local.
And we'll now take our next question from Kevin Cassidy with Stifel.
Thanks. Congratulations on a great quarter.
Thank
you. Just within your microcontroller business, can you say which products are growing the fastest, both on units and revenue?
I would think, 32 bit microcontrollers are growing the fastest. 16 bit microcontrollers next and 8 bit microcontroller next. Given that, all three are making record quarter after quarter.
Right. But so not so much on a like, the like basis your ASPs in general should be trending up because you're selling more 32 bit?
That could be true if you just look at the average microcontroller ASP, but then the average cards would be going up too. Because 32 bit parts cost more to make it than 8 or 16.
Right. Yes. I just, some investors are concerned about you outgrowing your end markets, but if your end markets are shifting to higher ASP devices, than it justifies why you would outgrow your end markets?
Yes. Okay. That's the question.
I'm just checking to see if you agree with that.
Yes, I agree with that.
Okay. Congratulations.
Thank you.
We'll now take our next question from Christopher Rolland with Susquehanna International Group.
Hey guys,
so your lead times have increased, but some others like some European MCU guys, their lead times have expanded well beyond yours. So overall, do you think you guys have net gained or loss share because of competitive lead times in the industry?
Well, you know, the numbers say we have gained share and I've given you the numbers, The year ago in the September quarter, our microcontroller revenue divided by SIA revenue was 14.46%. And in the September quarter that we're announcing today, our share was 15.84%. So that's an increase of 130 bps in 1 year. That's one of the significant increase in market share in 1 year. We used to gain that kind of share years ago.
And lately, the gains have been slower. So this was a very significant increase. But I don't think the reason for the share gains just because the competitive lead times have gone longer than ours. In microcontroller, you cannot gain the share like that. You have to have design done with your product, which is a year and a half, it takes to put your part in their design.
So These were the designs we won a year ago, 2 years ago. The lead times of competitors does not have effect on it. It may
have effect
forward because we're winning more designs now and some of the more designs we're winning today could be because customers that are unhappy with the competitors, that will lead to a higher share next year and the year after, but the share we gained last year had nothing over the late time.
I see. And then you guys had some interesting commentary, I thought, on the Direct Energy Access Provider in Oregon. I'm assuming it maybe direct hydroelectric or something. What's the nearly $20,000,000 upfront charge? And then what kind of benefit do we get maybe gross margin or something like that going forward from that?
So there's a transition fee that you have to pay when you make that change. And that, that fee essentially covers a 4 or 5 year period. And so, From a cash flow perspective, the cash flow savings come at a later date, but the P and L, just what the way the accounting works, the income statement benefit start getting that impact in our costs here over the next couple of quarters. And then it will get capitalized inventory and we'll get the benefit later. So there are incremental savings.
It's a good change for us. We think it's going to drive, better costs and better cash flow for us in the future. Essentially it's a transition fee that's were being paid and that's why we have the one time charge.
And can you quantify at all or is it just too small?
It's too small and the big picture of our overall gross margin.
Clearly, it was good enough. For us to be able to make a substantial investment and accrues for many, many years.
It'll be one out of our 3 fabs plus 40% of our business comes from foundries. I mean, it's one of the factor in gross margin, along with all the other drivers, which are more analog, higher yields, shrinks, taking ethanol products, bringing them in for assembly and tests and all these other margin drivers we have talked to you about, this is kind of just one of them, but not really on the top of the list.
Interesting approach. Thanks.
And we'll now take our next question from Gil Alexandre with Darphil Associates.
Congratulations. Thank you, Gavin.
In the past, you only used to go out 1 quarter on giving results. And now you talk 7% to 9% gain, which is great. And I'll have to go through what you said in your last commentary. But what gives you is it just the addition of products that you sell, which is giving you 7% to 9% gain? And how far does it how long does it continue like this?
So, Gil, in the last conference call commentary, I talked about high single digit. And somewhere along, on the investor circle, it got translated into 7% to 9%. But my exact words were high single digit. You can go back and listen to it. And, I didn't disagree with that.
High single digit sounds like about 7% to 9% or somewhere there. This in this conference call, I broke them into 4 different events. As I said earlier, which was traditional market share gains, TSS attach, distributor partnership approach, and I don't know which was the first one. You know, a stable ASPs or increasing ASPs. So When you say in the past, we only did not talk about that long term, we didn't have these 4 differentiated drivers.
We didn't have a portfolio rich enough to drive the total system solution. A few years ago, we were not driving ASPs to be as stable or higher. Some of the industry consolidation as well as our own efforts have created the environment where you can keep the ASP stable. So things have changed years ago, distributors Now, competitors were not pulling away from distribution today. They are, and we are approaching them and they're putting more focus on it So things have happened, which had given us the opportunity, and we're capitalizing on those opportunities.
So we're able to quantify and guide that we can grow higher. So the last part of your question was how long does it continue? I don't know. I really don't know.
I want to thank you very much and congratulations.
Thank you.
And we'll now take our next question from Mark Delaney with Goldman Sachs.
Yes, good afternoon. Thanks for taking the question and congratulations on crossing that $1,000,000,000 mark with revenue.
Thank you.
First question is actually on some of the proposed tax reform changes in the U. S. I guess a couple of parts related to that topic. I know it's early, but any sense at this point what it may mean for Microchip's consolidated effective tax rate. And given the proposed rate for repatriating foreign cash, how's Microchip thinking about managing overseas cash balance?
I think a general answer on that is, that we haven't fully evaluated it. And proposal is just a proposal. A lot of other proposals that have come out on on tax rates, health care and other, not much has happened in Washington. And there's really not much reason to burn calories on it. I don't really know if there is support in Senate with a number of senators against anything that they want to do.
So, I think it's kind of too early, but if something were to happen, tax law would be changed, would were to change, will be upfront and fully understanding it utilizing our foreign cash and thinking about all the possibilities that exist to the take advantage of it. And Eric may add some more.
Don't think that's exactly right. It's too early. Our tax group and advisors are looking at what's being proposed. We kinda see what actually comes to fruition here and we'll respond accordingly.
That's helpful. And just for a follow-up on IoT, I know that's been a part of the company's growth strategy in the past. And I realize Microchip has a more stringent criteria for what counts as IoT versus non IoT, but maybe you can just level set us at this point to how much revenue you think is tied to IoT and what your outlook is for that part of the business? Thank you.
We haven't broken out IoT as a revenue segment. We have done it a couple of times in the past, just to provide some more insight at that point. The strategy for the company that we've explained is around providing smart connected and secure solutions. And all of what IoT requires are those 3 big ingredients. And a large chunk of our product line today is feeding the requirements of what would be classified as IoT.
So it is a growth driver for us. We see a lot more applications that are building the connected and the secure capabilities. And we have the strong product line to be able to take advantage of that. But I don't, unfortunately, I don't have a good way to estimate the IoT specific revenue.
And we'll now take our next question from John Pitzer with Credit Suisse.
Hey, guys. Thanks for letting me ask a follow-up question. Eric, just going back to the CapEx, if you look with the raise that you guys announced today, it puts your CapEx to rev over 5% for this fiscal year has historically run at sort of 4% to 4.5%. Should we expect CapEx to come back down to that range in fiscal year 2019? Or how do we think about the long term target for CapEx?
Thank you.
Yes. So you're right. The percentage is higher. We mentioned in our prepared remarks that we have 3 buildings in Chandler, India and Germany that were kind of I'll call them one time items to help with future lease costs or avoidance of lease costs. So that's one thing.
And the other piece is we've got all the ethanol products that were outsourced historically where we can get very fast return on those investments from a cash flow payback perspective that we're making that it's very much worthwhile from a gross margin to make those investments. And those are a bit out of the ordinary. So we don't expect long term to be at a 5% rate, but the investments that we're making today definitely are worthwhile and cost beneficial. So hopefully, that's the color that you're looking for.
And we'll now take our next question from Craig Ellis with B. Riley FBR.
Thanks for taking the question and congratulations on the sharp execution. Steve, I wanted to follow-up with the earlier comments regarding some of the company specific drivers to the high single digit growth. You mentioned lower ASP declines, distribution, analog attach and traditional share gain. My question is, as we look at those 4, company drivers for Microchip, is the company getting optimal benefit from each those right now? Or are there things that are more, formative or early innings that would give us more benefit next year?
And if so, what are they?
Yes, I think he's trying to figure out which ones are more fully baked in, which ones are coming time. I would say when you look at TSS, the gains from TSS are going to be accruing as we go into the coming 1, 2 years of time. Those are typically design driven. It takes a complete design cycle. From when we begin to engage, are able to attach and those attached designs go to production.
So I think that's one of the larger ones ahead. Clearly, some of the changes in distribution took place within the last year, that change in engagement again takes time. It's new designs that you're affecting things. So I think the best of what's to come is ahead of us. From some of the
And we'll now take our next question from Ravindra Gill with Needham And Company.
Yes, thanks. And I echo my congratulations. Steve, you had mentioned or Ganesh, sorry, you had mentioned your smart connectivity And obviously, you talked about attach rates for analog increasing as a drive for overall growth Can you talk about a little bit, if you can even quantify where we are in terms of the attach rates, maybe for the ethanol products and kind of where do you expect that to go in the future?
Qualitatively, it's still low because when we inherited the app melt product lines and those designs with our customers, they didn't have much microchip attached in them. Now our sales teams and our overall microchip teams have been working on new designs as they come up. Be able to showcase the rest of the Microchip product line and to increase that attach. Now we can see the leading indicators in how we see our own design in activity, some of the indicators Steve talked about, which is, as we measure, the rate of attacks that's taking place over time. And so in the revenue numbers themselves, they are still yet to come, especially on the ethanol part of the product line, and there may be small things that have taken place.
But as time goes on, all these designs, as they go through the 12 to 24 month incubation period, start to go into production. And that's when you begin to see the growth and the revenue that comes from that attach.
And just a follow-up. So is it fair to assume that that $600,000,000 of that metal microcontroller revenue that they generated that over that design period, whether it's 24 months or more, that a certain percentage of that will start to be attached with the microcontroller core. Is the, can you maybe talk about what the additive effect on the ASPs would be?
So in general, when you look at the dollars per board, were driving towards increasing the dollar content per board. So attached is taking place, as we mentioned earlier, in two ways. In one way, it is where We have the microcontroller hours are what came to us through the ethanol acquisition. In that case, the microcontroller is still the microcontroller of the microchip or AppMA had been shipping, but there's incremental dollar content on the board. In the other way is where if we have some of the richer analog product lines.
And then our always come from atmel only. They come from some of our older acquisitions as well. Where we are now providing a higher integration solution, a microcontroller with that analog, perhaps with security, something else on board, Now those products, the ASP will go up, because more often than not, we didn't own the microcontroller portion of that design. We had the analog portion and we're subsuming other people's silicon with our new products. And there's the ASP we do expect and we do see going up.
Great. Thank you and congrats.
And it appears there are no further questions in the queue at this time. And at this time, I would like to turn the conference back over to Chief Executive Officer, Steve Sangee for any additional or closing remarks.
We want to thank everyone for joining the call. I think the next conference we go to is CSF Week.
Credit Suites, yeah.
Yeah. In, which is in our backyard here in Scottsdale. So love to see you, all of you at the conference. Thank you very much.
And ladies and gentlemen, that concludes today's conference call. We thank you for your participation.