Microchip Technology Inc (MCHP) — Q1 2016 Earnings Call Transcript

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 refer you to our press releases of today as well as our recent filings with the SEC that identify important risk factors that may impact Microchip's business and results of operations. In attendance with me today are Steve Sanghi, Microchip's President and CEO, and Ganesh Moorthy, Microchip's COO. I will comment on our first quarter fiscal 2016 financial performance, and Steve and Ganesh will then give their comments on the results, discuss the current business environment as well as our guidance and provide an update on the acquisition of Micrel, which was completed today. We will then be available to respond to specific investor and analyst questions. I want to remind you that we are including information in our press release and this conference call on various GAAP and non-GAAP measures. We have posted a full GAAP to non-GAAP reconciliation on the Investor Relations page of our Web site 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 our 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 acquisition activities and share-based compensation. Net sales in the June quarter were $534 million, below the midpoint of our guidance which was $555.5 million and we’re up 0.5% from non-GAAP net sales of $531.3 million in the June 2014 quarter. Revenue by product line in the June quarter was $348.2 million for microcontrollers, $127.1 million for analog, $31.8 million for memory, $23.3 million for licensing and $3.7 million of other. Revenue by geography was $104.5 million in the Americas, $114.7 million in Europe and $314.7 million in Asia. I remind you that we recognize revenue based on where we ship our products to, which tends to skew some of the revenue towards Asia where a lot of contract manufacturing takes place. On a non-GAAP basis, gross margins were at 58.3%. Non-GAAP operating expenses were 25.6% of sales, below the bottom end of our guidance range. Non-GAAP operating income was 32.6% of sales and net income was $148.9 million. This resulted in $0.69 per diluted share, which was at the low end of our guidance, was nonetheless a new record. On a GAAP basis, gross margins including share-based compensation and acquisition-related expenses were 57.9% in the June quarter. GAAP gross margins included the impact of $1.7 million of share-based compensation and $0.5 million in manufacturing shutdown costs associated with the Supertex wafer fab in San Jose. Total operating expenses were $187.7 million or 35.2% of sales and include acquisition intangible amortization of $34.6 million, share-based compensation of $2.2 million of acquisition-related expenses and special charges of $1.6 million. GAAP other expense includes a $13.8 million gain on the sale of the reminder of an investment that Microchip acquired as part of the SST acquisition back in 2010. And a $2.2 million gain on the sale of another investment. GAAP net income was $130.7 million or $0.60 per diluted share. GAAP net income includes nonrecurring favorable tax events of $18.7 million, which was primarily driven by the release of deferred tax liability due to some IP ownership restructuring that occurred in that quarter related to our prior acquisition of ISSC. In the June quarter, the non-GAAP tax rate was 11.4% and the GAAP tax benefit rate was 9.1%. The GAAP tax rate was favorably impacted by the $18.7 million of nonrecurring tax events that I mentioned before. Our tax rate is impacted by the mix of geographical profits, withholding taxes associated with our licensing business and the tax effect of various nonrecurring items. Excluding any nonrecurring events, we expect our longer-term forward-looking non-GAAP effective tax rate to be about 11% to 12%. To summarize the after-tax impact that the non-GAAP adjustments had on Microchip's earnings per share in the June quarter, acquisition-related items were about $0.163, share-based compensation was about $0.049, nonrecurring favorable tax events were about $0.086, a favorable difference on the sale of two investments during the quarter was about $0.074 and the difference in the GAAP and non-GAAP non-controlling interest in ISSC was a favorable of about $0.02 and non-cash interest expense was about $0.035. The dividend declared today of $0.358 per share will be paid on September 25, 2015, to shareholders of record on September 11, 2015. The cash payment associated with this dividend is expected to be about $75.4 million. This quarter's dividend will be our 52nd consecutive quarter of making a dividend payment. We have never made reductions in our dividend. In fact, this quarter's increase marks the 46th occasion we have increased the dividend payment and our cumulative dividends paid amounts to almost $2.6 billion. This program continues to be an important component of how we return value to our shareholders. During the time period that Microchip has paid dividends, we have also purchased back $1.4 billion of our stock. Our combined cash return to shareholders since the inception of our dividend program is almost $4 billion. Moving on to the balance sheet, consolidated inventory at June 30, 2015, was $303.7 million or 123 days, up by 12 days to the levels at the end of the March quarter. Inventory at our distributors was at 37 days and was flat to the March quarter levels. I want to remind you that our distribution revenue throughout the world is recognized on a sell-through basis. We have taken actions to moderate our production activities and our foundry wafer purchases in the current quarter to moderate any inventory build. The cash generation in the June quarter, excluding the purchase of the remaining shares of ISSC that were outstanding, our dividend payment, the changes in borrowing levels under revolving line of credit was $143.8 million. As of June 30, the consolidated cash in total investment position was $2.43 billion, and our borrowings under our revolving line of credit were $497 million. Excluding dividend payments and our acquisition activities, we expect total cash and investment position to grow by approximately $100 million to $120 million in the September quarter. Capital spending was approximately $33.6 million in the June quarter. We expect about $35 million in capital spending in the September quarter and overall capital expenditures for fiscal year 2016 have been reduced from our previously guided $160 million to a $125 million. We are selectively adding capital to support the growth of our production capabilities for our fast-growing new products and technologies and to bring in-house more of the assembly and test operations that are currently outsourced. Depreciation expense in the June quarter was $24.7 million. I will now ask Ganesh to give his comments on the performance of the business in the June quarter. Ganesh?

Thank you, Eric and good afternoon everyone. Let’s take a closer look at the performance of each of our product lines, starting with microcontrollers. Our microcontroller revenue was up 1.3% in the June quarter as compared to the year ago quarter. We experienced the same broad-based weakness that has been reported by many of our peer group companies. In aggregate, over the last four rolling quarters, our microcontroller business was up 8% over the prior four rolling quarters. We are continuing to deliver innovative new 8-bit, 16-bit, and 32-bit microcontrollers that we believe will enable us to grow faster than the market and gain market share. Microcontrollers represented 65.2% of Microchip’s overall revenue in the June quarter. Moving to our analog business, our analog business was down 0.6% in the June quarter as compared to the year-ago quarter. In this business too we experienced a broad-based weakness that has been reported by many of our peers. In aggregate over the last four rolling quarters, our analog business was up 11% over the prior four rolling quarters. Our analog business represented 23.8% of Microchip’s overall revenue in the June quarter. We continue to develop and introduce a wide range of innovative and proprietary new products to fuel the future growth of our analog business. Our memory business, which is comprised of our Serial E-squared memory products as well as our SuperFlash Memory products, was down 4.8% in the June quarter as compared to the year-ago quarter. We continue to run our memory business in a disciplined fashion that maintains consistently high profitability, enables our licensing business, and serves to complete their solutions. Our memory business represented 5.95% of Microchip’s overall revenue in the June quarter. Now a short update about Micrel and where we are in the integration process. Since the announcement of the acquisition on May 7th, we have spent considerable time understanding Micrel’s businesses, organization, and assistance. We have developed detailed integration plans that we have begun to execute today after the transaction closed. As we described in our May 7th conference call, Micrel has three product line business units and a small foundry services business. Micrel’s linear and power solutions business is a classic highly fragmented analog business. This business, together with Microchip’s standard analog business, forms a combined portfolio that will serve a broad base of applications and customers and enable a number of cross-selling opportunities. Micrel’s LAN solutions business consists of a range of Ethernet products including controllers, switches and physical layers for different speeds. This business will strengthen Microchip’s overall Ethernet offering and also enable us to serve a broader set of applications and customers. Micrel’s timing solutions business consists of a comprehensive clock and timing portfolio including frequency control products, clock generation products and clock distribution products. It also includes MEMs technology capability that enables much smaller timing components. This is a brand new field of play for Microchip that we’re excited about and see sales synergies with our existing product lines. It also gives us visibility into a range of applications and customers that are new to Microchip who could be customers for our microcontroller, analog, and memory products. In regards to sales and field applications, we are planning to keep Micrel’s sales and applications engineers and we’ll cross-train them as well as our existing sales force so that we can find revenue synergies through cross-selling opportunities. We also plan to combine the distribution networks of the two companies. Some of the distributors for the two companies are the same while others are different. Our goal is to achieve expanded distribution capabilities for the products of both companies. In regards to manufacturing, Steve will comment in more detail in his section along with how we expect to see the accretion results rolling out over time. With that, let me now pass it to Steve for some general comments about our business, the Micrel acquisition, as well as the guidance going forward.

Thank you, Ganesh and good afternoon everyone. Today, I would like to first comment on the results of the fiscal first quarter of 2016 and then provide guidance for the fiscal second quarter of 2016 including comments on the integration plan for Micrel. Our June quarter results were shy of our guidance, but were consistent with what other semiconductor companies have reported. The quarter started out well but the negative effects of the very weak economy in China and challenges in Europe caused us to finish the quarter below our guidance in revenue. We were able to keep the non-GAAP gross margin percentage and earnings per share within the guidance albeit on the low end of it. Gross margin of 58.3%, operating expenses of 25.6% and operating profit of 32.6% were all very respectable achievements. The June quarter was also our 99th consecutive profitable quarter. I want to thank all the employees of Microchip for their contribution in this remarkable achievement of 99 consecutive profitable quarters. I look forward to the current quarter being our 100th consecutive profitable quarter, an achievement unmatched in our industry. I will now provide guidance for the September quarter including Micrel revenue. Our guidance is based on the assumption that Europe will continue to be in the doldrums and is made worse by the summer holidays, and China, which has been the engine of growth in the past, remaining slow. In preparing our guidance, we have done a bottoms-up analysis region-by-region, distributor-by-distributor and by major customers. We have also included Micrel revenue from today August 3rd to the end of the quarter as we understand it. We expect our net sales in the September quarter to be between $532 million to $569 million, which includes revenue from the sales of Micrel products from today till the end of the quarter. Without counting Micrel, we expect our net sales to be between flat to down 7% sequentially. I want to remind you that the guidance we are providing is for non-GAAP revenue which will include sell-through from the distributors of Micrel. The GAAP revenue will be much lower since GAAP does not account for products sold to distributors that were shipped prior to the acquisition effective date. We expect non-GAAP gross margin to be between 57.6% to 57.8% for the combined company negatively impacted by the lower gross margin of Micrel and sequentially flat without Micrel. We expect non-GAAP operating expenses to be about 27.7% to 28.9% of sales for the combined company and we expect the combined company non-GAAP operating profit to be between 28.7% to 30.1% of sales, again negatively impacted by higher expenses and lower operating profit of Micrel. We expect non-GAAP earnings per share to be between $0.58 to $0.66 per share. The non-GAAP earnings per share impacted by $0.015 dilution coming from the consolidation of Micrel. Now let me provide you more updates on the Micrel acquisition. We closed the acquisition today and we now begin the hard work of integration to drive shareholder value. The shareholders of Micrel overwhelmingly approved the merger with 98.95% of the Micrel's shares that voted in the favor of the merger. As part of the transaction, we will pay an aggregate of approximately $430 million in cash and issue an aggregate of 8,626,795 shares. Taking into consideration the equity awards assumed and the cash and investments on Micrel, the balance sheet at the closing date, the total enterprise value is in line with the $744 million that we shared with investors when we announced the signing of the definitive agreement back on May 7, 2015. Now Ganesh has already covered some of the elements of our integration planning, I will cover four areas. First, I will explain to you how the revenue of Micrel will be consolidated into Microchip's SEC revenue reporting. Second, I will explain our plans in the IT systems and manufacturing area. Third, I will give you guidance on the accretion we expect to get from this acquisition. And finally, I will provide guidance for the long-term financial model for Micrel. So let us begin with how the revenue of Micrel will be included in Microchip's revenue reporting. Micrel breaks down its revenue into three reported product lines, linear and power solutions, LAN solutions and TCG, which is timing and communication. 99% of Micrel revenue will be reported as analog revenue within Microchip. Approximately 1% of Micrel revenue is on products that are built on a microcontroller core. They are, in fact, special purpose microcontrollers and will be reported within our microcontroller revenue. Now I will give you update on our integration planning in the IT systems area and in the manufacturing area. In the last three months, we have studied the business systems of both companies. Micrel is a small company and its business systems are relatively old. We have laid out a plan that will transfer all of Micrel to Microchip's business systems. We estimate that this transition will be completed sometime in the calendar first quarter of 2016. Regarding manufacturing, Micrel operates a small 6-inch fab in San Jose, which is about 30% utilized at the current time. Micrel also uses outside foundries for some of its products, mostly for the LAN solutions group. These happen to be some of the same foundries that Microchip uses for some of our products that are outsourced. We will leave those products running in the outside fabs. Our focus will be to deal with the 6-inch San Jose fab that is severely underutilized. Microchip will transfer all of Micrel's products from its 6-inch fab to other facilities. A majority of these products will transfer to Microchip's two 8-inch fabs, one in Tempe, Arizona and the second in Gresham, Oregon; some products maybe transferred to other outside foundries, wherever there is a better process technology match. We believe that this transfer of all the products from Micrel's fab to either Microchip fab, or to some foundries will take about one to two years; after that, the San Jose 6-inch fab will be closed. Regarding backend manufacturing, Micrel's subcontracts 100% of its assembly and test. Many of the packages that Micrel uses are different than Microchip's but many are the same. Where appropriate, we will apply our extended purchasing power to lower our supply chain cost. As in the other acquisitions, we will also do a careful make versus buy analysis on each package and product type; over time some of the products and packages may be brought into our assembly and test facility while others will remain at the subcontractors. Microchip will, however, combine manufacturing systems like wafer ordering, assembly and test management, shipments, and warehouses. We expect that all Micrel products will be shipping from Microchip's manufacturing system by the end of the first calendar quarter of 2016. With this let me now provide guidance for accretion from the acquisition of Micrel. We currently expect the Micrel acquisition to be $0.015 dilutive to non-GAAP EPS for the partial September quarter. The acquisition just closed today, so we need more time to study and provide you further guidance. But with the rate at which we expect the integration to progress, our initial estimate will be that the Micrel acquisition will be breakeven to our December quarter non-GAAP EPS. For the long term, after we have closed the San Jose fab, which is about one to two years from now, we expect Micrel to add about $0.25 of accretion to Microchip's yearly non-GAAP EPS. These numbers are preliminary and depend upon the speed of integration efforts and the health of the underlying economy in general. Finally, let me provide guidance for the long-term financial model for Micrel. Our track record has shown that Microchip has been able to improve the business model of its acquisitions and our combined business model has remained virtually unchanged. If the San Jose fab is closed and the older 6-inch inventory has been depleted, we will improve the financial model of Micrel to be equivalent to that of Microchip. Given all the complications of accounting for the acquisitions including amortization of intangibles, restructuring charges and inventory write-up, Microchip will continue to provide guidance and track its results on a non-GAAP basis. We believe that non-GAAP results provide a more meaningful comparison to prior quarters, and we request that the analysts continue to report the non-GAAP estimates through this first call. With this operator, will you please call for questions?

Thanks. Starting first with just that industry question, Steve, if I look at the current environment today, what’s your sense the biggest difference between today versus last fall, when there was also at that time, albeit a brief correction?

Craig, I was hoping this question could wait, but let's take it now. Throughout the earnings season, many investors and analysts have expressed their thoughts about the current semiconductor environment. Since our earnings warning last October, I haven't engaged in discussions with investors or analysts during the quiet period. However, I felt it was important to address this question here. It's painful to revisit that time, but we believe the first signs of a slowdown in China were evident then. We noticed this through numerous small customers facing economic challenges and not purchasing enough products, which was exacerbated by a tight credit environment in China. After our warning, December quarter results for most semiconductor firms were revised down by an average of about 5%. An exception was made for companies in the supply chain of one mobile customer. Then came the March quarter, which was usually weak due to Chinese New Year, and some attributed the weakness to Euro issues, a new factor. The June quarter, typically strong in China, saw broad misses driven by weakness in that market, and the guidance for the September quarter was also bleak because of China. Now, semiconductor companies are acknowledging an inventory buildup in China that needs to be corrected. We learned from the companies we've interacted with, including those we didn't acquire, that there was significant inventory accumulation in distribution channels that the existing demand levels couldn't support. You can only sustain a selling strategy for so long, and this time it extended longer than usual. Consequently, forecasts have been significantly adjusted downward, with many companies now trading below their stock prices from October 9th, prior to my statement about an impending industry correction that would become more apparent in the near future. It appears this adjustment took about a quarter longer than historically observed, likely linked to the smartphone supply chain, with widespread exposure. In summary, to address the inquiries from investors and analysts, I see this as largely a continuation of the trends we observed last October.

Just a quick follow-up to that before I have an additional question. Just the comment on China remained slow, how would you kind of frame just the environment in China? Do you think we’re through most of the inventory correction and it will attract demand or any additional quotes in China for Q3?

We’re not through all the inventory corrections, no. There will again be differences in sell-in versus sell-through also, all of our revenue is sell-through. But we bought Micrel today, which had a mixture of sell-in and sell-through with most of China being sell-in which will be converting to sell-through only recognizing sell-through, so there are a number of moving parts in our business. But the industry still has a lot of inventory in China.

And then just a follow-up on Micrel, appreciate the thoughts in terms of how you expect to transform the business, particularly in manufacturing. On the product side given that you had a little bit of time in talking to customers, any anecdotes of feedback in terms of their product portfolio and how you see that kind of best fit within Microchip?

We have decided to take Micrel's linear and power solutions business, which was the largest division inside of Micrel, and completely fold that within Microchip, which is happening starting today. So essentially we have taken our analog business and internally in Microchip split it into two portions, one is called the analog power and interface division and the second is called the mixed signal and linear division, both about equal size and then the entire Micrel linear and power business is folding into one of those divisions, which is the analog power management business. So, we will apply our principles, our metrics of R&D and all that. When I look at R&D as a percentage of sales for analog, Microchip is one of the most efficient in the industry, we don’t break it out into visual R&D, but the amount of R&D we spend to get the margins and revenue and all there and Micrel is one of the worst when you look at the numbers. So we have to move this from worst to best. And we have done that with others, we’ve done that with SSC and SMSC and Supertex and over and over and over, we have the team there, that’s what we have to do here. Then there is LAN business here which is about $50 million to $60 million and that also we’re going to completely fold into Microchip’s USB and Networking Division where our LAN business resides. That again will really benefit from our methodologies, our metrics, our management and everything else. And the third business here is the timing business, which is a new business for us and we will keep that as a business unit but if you’re reporting to one of our seasoned general managers so he can also get the mentorship and really move towards our model.

Steve based on the tenure of what now you’re describing as a three or four quarter downturn. And the order of linearity that you are seeing maybe in the calendar second quarter and into July and now August, I am wondering if you can provide any view as to when you think demand normalizes?

I think, I resigned from the forecasting business last year, you might recall that in November. I am not going to make that comment looking forward for the industry. If we just look at ourselves, we think we gave you September quarter guidance already, December is seasonally a weak quarter for Microchip and really also for the industry. Considering this correction happening in June and September, what would manifest for December, it's kind of hard to see right now. But as we go through the quarter, one could make a guess that December quarter should not seasonally be weak because ordinarily December quarter is followed by a very strong June and September. This time it is not. But I am not making that prediction today. I got to see the quarter. I got to see the bookings, the backlog, everything else and talk about it later maybe as we go on the road. The biggest leverage here short-term is really improving Micrel's business and I think there is a fair amount of opportunity for us to do that, and the largest leverage comes from the fab. There is 30% utilization in the fab and we dramatically lower its cost by transferring products and the first five products will be running out of Microchip's fab in about six weeks.

That's great. Steve, I appreciate that. Maybe I can use that as sort of the next question. So after completing this deal and understanding that all the synergies and all the work is still in front of you, I am wondering if you can characterize the current appetite for future M&A? It certainly helps dull the pain from the current demand environment a little bit. And I am wondering how much appetite there is for more of that though? Thank you.

Well, we have a substantial line in place, which we did that earlier in February. And we have constantly a good number of companies in our funnel that we are constantly talking to, dating with, analyzing and there's no guarantee, these things are not schedulable at any given point in time, and sometimes it takes longer for a deal to materialize, other times it's shorter. But yes, we still have appetite for the next acquisition, no question about it.

Yes. Good afternoon guys. Thanks for letting me ask a question. I guess Steve, Ganesh and Eric, I was wondering if I could get a little more detail about kind of the actions you are taking around utilization rates in your own fabs. I am kind of curious, do you think September will represent the trough, I guess Steve given your comments about uncertainty around December, but possibly a scenario where December is a little bit better than normal seasonal weak. Does that mean that most of the utilization action is behind you or how should I think about that? And Eric, remind me again how that flows through the gross margin?

Let me provide some insights on our utilization. The Gresham factory in Oregon is relatively new, and as such, we need to schedule a major shutdown for maintenance every five years, which is coming up this October for about seven to eight days. We've made preparations for this shutdown and plan to extend it slightly to reduce inventory, since the factory will be closed anyway. On the other hand, the Tempe facility is older and lacks the same redundancies. We also schedule a shutdown there during the holidays in December, and similar to Gresham, we plan to add additional days to that shutdown to address inventory levels. Consequently, you will see an increase in our internal inventory during the September quarter, but this will normalize due to the shutdowns in both factories throughout the December quarter. Typically, we account for the regular shutdown over four quarters, but the additional days will be recorded in the current quarter, affecting our gross margin in Q4. I'm not certain if Eric can quantify the financial impact at this moment, but it will be categorized as a one-time event, either GAAP or non-GAAP.

Yes, Steve, I believe you've addressed John's question, and at this time, we are not prepared to provide guidance for the gross margin in the December quarter. I will leave it at that.

That’s helpful guys. Maybe as my follow up for Steve and Ganesh. Steven and Ganesh, we tend to like to sometimes compare apples to oranges here on Wall Street. We look at your microcontroller business and often time compare that to sort of 8-bit part of the business and might be a relatively new entrant. And I guess I am trying to think about kind of your relative growth rate of microcontrollers versus your peers. Is the right way for us to think about this as given your breadth in 8-bit perhaps you are more cyclical in these parts of the cycle? And if that's the case, maybe Ganesh you can give us some metrics around 16 bits and 32 bits that make you guys comfortable that you are at least maintaining if not gaining share in those segments in the market?

So we don’t break out 16-bit and 32-bit as you may recall from about two to three quarters ago but we did present in April, where the market share results were and we had significant growth in market share in each of 8-bit, 16-bit and 32-bit. So we look at the market as a continuum of solutions that are needed in many cases where an 8-bit is good enough, in some cases it's a 16-bit and in other cases it's 32-bit. And we see growth opportunities in all three of them both in terms of the applications and the markets that they can go into. So our view is that there is growth that is taking place and there is growth yet to be had in all three segments we’re not looking at 8-bit to save us or 32-bit to save us or 16-bit to save us, all three of them we expect will grow.

The first question is about Micrel and the expected $0.25 of accretion over one or two years. Can you provide some insights on how much of that we might see sooner and how much will take longer? You mentioned that most of this, I believe the majority, is related to the fab closure, which I assume we will need to wait for. Is there any near-term accretion as we start to manage some of the operating expenses?

So there is near-term accretion, I don’t know if I have a breakdown considering we’re closing the acquisition just today before that all we had model and then we have quickly verified some stuff. But if you give us a little more time maybe as we get on the road and see you at some conferences or the next conference call we can have much more intelligent numbers for you. But there is accretion coming from expense reduction and other things that prior to that it's not all from fab.

I wanted to follow up on the market conditions and I've heard some different perspectives regarding the pace of bookings throughout the quarter and how things have started in July. Can you provide some clarity on that, including any insights on the linearity from the June quarter and whether the beginning of July has given you any additional optimism or pessimism as you look ahead?

I listened to some of the calls and it's amazing how the customers been placing bookings are kind of behaving almost the same for everybody and I could say the same team that, this quarter’s bookings look better than it was last quarter and there was some strength in the overall numbers. But that’s baked into the guidance and I think if you look at various people’s commentary last quarter, April was good and May was good and then June fell off. So I think people make these adjustments throughout the quarter and better a July doesn’t necessarily mean better end of September for us or anybody else because customers can correct that anytime in the quarter. Sometimes people place bookings earlier so whatever product they need for the quarter they have commitment from the supplier that they will get the product for their needs and then it's easy for them to cancel or slip it out, that they don’t need it in September, give it to me in October than to have a situation where they don’t place the order and the September quarter comes and someone’s lead time is more than four weeks and they can’t get it. So customers seem to have very little penalty for getting their queue in line, almost no penalty. Therefore, it's not unusual for the first quarter sometime to see stronger bookings only to get corrected later on. And I would not reach so much into it for anybody.

Going back to the Micrel fab and shutting that down, you gave data point that five products have moved. Can you say, what is the determination between getting it closed in one to two years? Is it customer qualifications or finding other fabs that can manufacture?

So that’s a good question. So we bought Supertex on April 1, 2014 and we closed the Supertex fab in April of 2015, it took us about 13 months and that fab was much smaller than Micrel fab is. Micrel fab is larger, it's a larger company than Supertex. But we learned a lot doing Supertex and we were able to do that in 13 months. So we’re mounting a much larger team and we’re going to transfer the products at more than twice the rate than actually we transferred the products from Supertex fab into. The basic difference between whether it's a year or two years is sub-types of customers, products from the new fab, products coming out of fab and working the first time and you have to reroute it, running into any kind of equipment issues. Equipment and fabs seem to be different, we believe we can emulate Micrel’s process on our equipment and we are successful in the first couple of processes we are attempting so far. But at any point in time you could run into a challenge and have to then convert a Micrel piece of equipment from 6 inch to 8 inch or buy a new one and have three, four, five months delay in getting that equipment. So there are a lot of unknowns, a lot of unknowns, that’s why we gave this band of a year to two years. My desire is 11 months, but I don’t get everything I desire, I think it's going to be somewhere between one to two years.

Okay, maybe just, maybe some unknown also but is there a chance that there would be some products you can't manufacture somewhere else and they would be discontinued and maybe not get the full revenue Micrel had?

We always have certain products, especially in analog, that require a fab run every two years. For these products, it doesn't make sense to have a mask set and incur the costs of transferring it. Typically, we build a strategic inventory for four years. If a product needs one run per year, we conduct four runs out of the Micrel fab before shutting it down, which means we have four years of customer demand to address. During that time, we can decide whether to integrate it into our fab or transfer it to a subcontractor. This process won't delay the fab. Since Micrel is a small percentage of Microchip, even though we will build strategic inventory on the products being transferred as well as those that are not, this inventory will not be significant relative to the overall size of the company and is strategically planned. We also need to give customers time to qualify 8-inch materials while they still have access to 6-inch materials, so you will see this strategic inventory reflected on our balance sheet, but it will be relatively small and remains strategic in nature.

Hi. Thank you. My question has been answered.

Thank you, Gil.

Hey. Thanks guys. I guess just one quick clarification on what you are seeing in terms of your guidance. So I think as the other Chris said some of the competitors are saying that business is getting better. So are you, implicate in your guidance, are you assuming that your business is going to get a little worse or just kind of remain at this level throughout the quarter?

I don’t know if I can decipher anymore, Chris. I mean our business in the September quarter based on guidance is worse than last quarter and so is everybody else's. So far the guidance I have seen, their guidance for September is worse than what they accomplished in June. So they have got a little bit of spurt in bookings, I saw the spurt in bookings, also in July, my customers trying to lock up their place in line for September, it is not any different by for us versus anybody else. So, I wouldn’t read anything more than that.

Okay. Great. For Micrel, can you quantify the benefits of shutting down their fab? What revenue should we expect from Micrel in the December quarter since I believe you will be including two months of it? Also, could you discuss your planned operational expense reductions for Micrel in December?

I think it’s supposed to give that considering the deal closed two hours ago, so probably just be a little more patient. I think I could even do a better job two weeks from now, but not today. We are cutting expenses. We are letting a number of people go as we are merging these divisions; there is some high-level senior leadership that we do not need. So we're making those changes and we got to dollarize it. We are unable to give you December quarter Micrel guidance, Micrel revenue has been falling for four years and recently has fallen a little harder. And we need to understand that. We need to meet with the distributors. We need to see what Microchip's sales force can do. So I don’t quite trust the guidance that I am hearing from them. So therefore I am not able to give December guidance on it yet.

So can you tell us if it was in the June quarter, the revenues for Micrel?

Well, I think the June quarter really wasn’t announced because the acquisition closed and I am not sure I am in a position to say that.

Steve, could you elaborate on the weakness in China? Specifically, which segments or verticals are experiencing this weakness? Back in October, you mentioned the industrial sector; has this issue spread to other areas in China? Any additional insights would be appreciated.

I think China is weak across the board exactly what it was in October. I don’t remember Microchip has been having industrial and I said we believe that another industry correction has begun. This correction will be seen broadly across the industry in the near future and the verbiage led by China, so I’m not sure whether it could be more industrial, but not only industrial. It’s really not that much different than it was back then. China is weak across the Board.

And if you could talk about the competitive landscape in the microcontroller market, you have obviously a big pending merger that will be closing in Q4. That merger the combined entity will become one of the largest microcontroller suppliers in the world both from the 8-bit and 32-bit side and a huge player in the automotive market. So I want to get a sense from you how you’re viewing the competitive landscape going forward given these changes in the market share and M&A that’s occurring?

If you look at our 25-year history, we started from scratch, competing against some of the biggest microcontroller manufacturers in the U.S., Europe, Asia, and Japan. When we were a $100 million microcontroller business, we were up against companies with billions in revenue, like Freescale, NXP, and Renesas. Therefore, I don't believe that scale is always a definitive advantage. We have succeeded due to our disciplined approach to product development and our responsible management of profits, maintaining a high-margin business. Our marketing strategy is quite different from others; while many competitors aim for substantial contracts with large OEMs at low margins, we've built our success with a diverse base of around 100,000 customers, where no single customer accounts for more than 1.5% of our revenue. This means that our business isn't restricted to specific areas. Renesas hasn't been able to hinder us for years, neither has Freescale, despite them being significantly larger. The merger with NXP doesn't fundamentally alter our position in the IoT space. Even after the data deal closes, my approach to work won't change from how it was before.

And just last question on IoT. Wondering how you’re thinking about that market in terms of your competitive position and assembling the building blocks to address the market. And any color in terms of how the intensity of the activity of IoT at your customer base, is that really picking up or is it going to take some time to take off? Thanks.

Everybody says that and people don’t kind of wake up a numbers nor do we and everybody is putting different stuff into IoT, so it’s kind of very hard to compare; it’s wild west. But all make the claim that we have the strongest IoT franchise. You need intelligent microcontrollers, you need RF building blocks, you need Wi-Fi, Bluetooth, Bluetooth Light, RF, Zigbee. We have all of them. You need various ecosystems with software and stacks and middleware and all that. We have all that. And we have a significant number of cloud partners where you have to ping off to often connect with equipment or whatever. We have the strongest building blocks of anybody. We’re seeing companies that will take all of their microcontroller business combine it with sensors of something and petition that as an IoT business while you could do that. But if a PC is connected to a printer and then a microcontroller in that chain, it’s not really IoT. But it’s connected and you can call it IoT, and so I think we gave you a little summary last quarter remember.

I think we said our IoT business was about $275 million annualized growing at a 35% compounded annual growth rate and really to more narrowly define it to be where there is both smart and connected application.

So this is a microcontroller attached with some sort of connectivity to it, is that how you’re going to?

IoT refers to making a true RF connection by utilizing technologies like Wi-Fi, Bluetooth, or Zigbee.

Ethernet can be used if it’s wired, so we are talking about microcontrollers, analog components, memory, and connectivity. All these solutions come together with the software framework that Steve mentioned, which includes built-in security and an ecosystem of third parties enabling cloud connectivity. This is a significant market where we have historically had strong presence because all companies looking to connect need to have something intelligent. To create smart devices, microcontrollers and analog components are essential.

Well, thank you very much, we are going to a couple of conferences this year and the next conference would be?

We’ll be at the Jefferies 101 conference in Chicago in late August and then the Citi conference in New York in I think September 8th or 9th.

And by that time we may have more understanding of Micrel and may be able to tell you more. So I'd love to see you at one of those conferences. Thank you.