Microchip Technology Inc (MCHP) — Q3 2016 Earnings Call Transcript

Thank you, and good afternoon everyone, and welcome to our fiscal third quarter 2016 earnings conference call. I would like to begin by saying how proud and pleased I am to be promoting Ganesh Moorthy to President and Chief Operating Officer. I am not going anywhere, and I will remain as Chairman and Chief Executive Officer. I will say more about it later in my comments, and let me now pass this call to Eric Bjornholt who will walk you through our financial results. Eric?

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 Chairman and CEO, and Ganesh Moorthy, Microchip's President and COO. I will comment on our third 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, provide an update on the integration activities associated with the Micrel acquisition, and provide some additional commentary on our announced acquisition of Atmel. We will then be available to respond to specific investor and analyst questions. I want to remind you that we are including information in our press release and this conference call on various GAAP and non-GAAP measures. We have posted a full GAAP to non-GAAP reconciliation on the Investor Relations page of our website at www.microchip.com, which we believe you will find useful when comparing GAAP and non-GAAP results. I will now go through some of the operating results, including net sales, gross margin, and operating expenses. I will be referring to these results on a non-GAAP basis prior to the effects of our acquisition activities and share-based compensation. Non-GAAP net sales in the December quarter were above the midpoint of our guidance at $552 million, and were down 1.3% sequentially from net sales of $559.4 million in the immediately preceding quarter. Non-GAAP net sales were $11.7 million higher than GAAP net sales, as we are reporting non-GAAP net sales on a full sell-through revenue recognition basis while GAAP does not recognize revenue on the sell-through of products sitting in the distribution channel on the date an acquisition occurs and when distributor contracts are changed to the standard Microchip format compared to the sell and revenue recognition contracts that Micrel previously had for certain of those distribution partners. We 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 57.9% in the December quarter and at the high end of our guidance. Non-GAAP operating expenses were 28.5% of sales, below the bottom end of our guidance range, and non-GAAP operating income was 29.5% of sales, which was above the high end of our guidance. Non-GAAP net income was $138.4 million resulting in earnings per diluted share of $0.64 which was higher than our pre-announced results from January 19. On a GAAP basis, net sales were $540.3 million, and gross margins, including share-based compensation and acquisitions and related expenses were 54.2% in the December quarter. GAAP gross margins include the impact of $2.3 million of share-based compensation, $6.9 million of gross margin impacts from the distributor revenue adjustment I mentioned earlier, and $17.8 million in acquired inventory evaluation cost and acquisition related restructuring cost. Total operating expenses were $216.6 million or 40.1% of sales and include acquisition intangible amortization of $48.3 million, share-based compensation of $14.7 million, $1.5 million of acquisition related expenses, and special income of $5 million. GAAP net income was $61.2 million or $0.28 per diluted share. In the December quarter, the non-GAAP tax rate was 10% and the GAAP tax benefit rate was 22%. The non-GAAP tax rate reflects the benefit in the December quarter for the R&D tax credit reinstatement but we are including the benefit from R&D tax credit from previous quarters that were reinstated only in the GAAP results to make future periods more comparable. We expect our longer term forward-looking non-GAAP effective tax rate to be between 10% and 11%. Moving on to the balance sheet, consolidated inventory at December 31, 2015 was $319.5 million and includes $11 million of fair value markup on Micrel's inventory required by GAAP purchase accounting. Excluding purchase accounting adjustments, Microchip had 120 days of inventory at December 31, 2015, which is up by five days from the levels at the end of the September quarter. Excluding purchase accounting adjustments, inventory at our distributors was at 34 days, which is down one day from the September quarter levels. I want to remind you that historically Microchip's distribution revenue throughout the world has been recognized on a sell-through basis. Micrel has some distributors that historically recognize revenue on a sell-in basis. Microchip changed substantially all of the contractual relationships with these distributors during the December quarter which has resulted in sell-through revenue recognition in the future. Our non-GAAP revenue guidance provided in our release today is based on sell-through revenue recognition for the Micrel distributors for the entire March quarter in order to continue to provide investors with a view of the true end-market demand for our products. There will be a difference in GAAP revenue recognition as the inventory in the distribution channel at the date of the conversion to sell-through accounting will not be recognized as revenue for GAAP accounting purposes. The cash generation in the December quarter excluding our acquisition activities, our dividend payment, and changes in borrowing levels under our revolving line of credit was $172 million. As of December 31, the consolidated cash and total investment position was $2.398 billion, our borrowings under our revolving line of credit at December 31 were $1.008 billion, $288 million lower than it was on September 30 as we paid down a portion of the revolving line of credit. Excluding dividend payments, changes in borrowing levels and our acquisition activities, we expect our total cash and investment position to grow by approximately $140 million to $160 million in the March quarter. Capital spending was approximately $17.9 million in the December quarter. We expect about $28 million in capital spending in the March quarter and overall capital expenditures for fiscal year 2016 to be about $110 million, well below our previous guidance to the street of $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 December quarter was $26.7 million. Over the past several years, Microchip's dividends paid to its shareholders has been treated as return of capital as Microchip did not have earnings and profits in the United States. As indicated in last quarter's earnings call, due to the integration of Micrel into Microchip global tax structure, Microchip will have earnings and profits in the United States in fiscal year 2016. For this transaction Microchip brought back about $250 million of offshore cash to the U.S. and we don't anticipate paying in the U.S. cash taxes on the amount as we will use net operating losses to offset the income. As a result, a portion of Microchip's calendar year 2015 dividends are taxable to shareholders versus the return of capital treatment from the last few years. We have posted a copy of the IRS Form 8937 on the Investor Relations page of our website which indicates the split between taxable dividends and return of capital for each dividend payment made during calendar year 2015. I will now ask Ganesh to give his comments on the performance of the business in the December quarter. Ganesh?

Thank you, Eric, and good afternoon, everyone. Before I start my prepared remarks, I'd like to take a moment to thank Steve, our Board of Directors, the Microchip Executive Team, and the over 10,000 employees of Microchip worldwide for the high honor and the distinct privilege they have bestowed on me to be the next President of Microchip. It has been the journey of a lifetime to have witnessed and contributed to the growth and success of Microchip, and I look forward to continuing that journey with the Microchip team as we scale new heights and achieve new business milestones in the years to come. Now let's take a closer look at the performance of each of our products lines starting with Microcontrollers. Our microcontroller revenue was down 3.5% in the December quarter as compared to the September quarter as we experienced the same broad-based weakness that the industry experienced. In calendar year 2015, our microcontroller business was down 1.4% as compared to calendar year 2014, and while we're not happy about the decline, we are confident that we're gaining market share in every microcontroller segment that we compete in during what was a difficult year for the overall industry. The official microcontroller rankings, we expect will be available in time for our next earnings conference call. We are continuing to deliver innovative new 8-bit, 16-bit, and 32-bit microcontrollers, as well as software and development tool solutions to complement them which we believe will enable us to grow faster than the market and gain further market share. As we mentioned at our January 19 conference call, the addition of Atmel's 8-bit AVR microcontroller family and 32-bit ARM microcontroller family we expect will enhance Microchip's industry leading 8-bit, 16-bit and 32-bit microcontroller offerings. Microcontrollers represented 58.5% of Microchip's overall revenue in the December quarter. Moving to Analog, our Analog business which includes Micrel results was up 4.1% in the December quarter as compared to the September quarter, and was up 3.6% compared to the year ago quarter. In calendar year 2015, our analog business was up 22.4% as compared to calendar year 2014. The strong growth and increase in market share in 2015 was the result of our organic growth efforts, as well as the Micrel acquisition. Our analog business represented 31.2% of Microchip's overall revenue in the December quarter, the highest percentage of our total revenue it has ever been. To put the size of our analog business in perspective, in the December quarter Microchip's analog business alone was almost the same size as all of Microchip was in the March quarter of 2009, and at an almost $700 million annual revenue run rate it is emerging as one of the larger analog franchises serving the embedded control market. We continue to develop and introduce a wide range of innovative and proprietary new products to fuel the future growth of our analog business, complemented by the products added to our portfolio through acquisitions. Now moving to the Memory business, our memory business which is comprised of our Serial E-Squared memory products, as well as our SuperFlash memory products was down 8.3% in the December quarter, as compared to the September quarter. We continue to run our memory business in a disciplined fashion that maintains consistently high profitability, enables our licensing business, and serves our microcontroller customers to complete their solutions. Our memory business represented 5% of Microchip's overall revenue in the December quarter. Now let me pass it to Steve for some general comments about our business, as well as our guidance going forward. Steve?

Thank you, Ganesh. Today, I want to first discuss our fiscal third quarter results for 2016 and then provide guidance for the fiscal fourth quarter of 2016, including insights on the integration progress of Micrel. I will also comment on the feedback we've received since our conference call regarding the acquisition of Atmel. Our results for the December quarter were strong despite a challenging macroeconomic environment and semiconductor industry conditions. Our non-GAAP revenue, gross margin percentage, operating expense percentage, and operating profit percentage were all above the midpoint of our guidance. Additionally, our non-GAAP diluted earnings per share were $0.64, surpassing the revised guidance of $0.62 to $0.63 that we announced on January 19, 2016. Now, for the March 2016 quarter guidance. We believe our business has stabilized, and most of the inventory correction is behind us. The March quarter will see some negative impact from the Chinese New Year holidays in Asia, but it’s also Microchip's strongest quarter in Europe. Based on our analysis of the economic and semiconductor industry conditions, along with our business indicators, we are guiding March quarter non-GAAP net sales to range from flat to up 3% sequentially. We expect a non-GAAP gross margin between 57.9% and 58.1% of sales, non-GAAP operating expenses between 27.3% and 27.9% of sales, and non-GAAP operating profit between 30% and 30.8% of sales. Our expected non-GAAP earnings per share are projected to be between $0.65 and $0.69. Regarding the integration of Micrel, it is progressing as planned. We had defined seven main elements for integration, five of which are complete: financial and business systems consolidation, consolidation of Micrel's wafer fab starts planning, integration of the salesforce and distribution network, integration of product lines and R&D activities, and integration of human resources systems. The remaining two areas, with progress made but not yet complete, are the closure of the Micrel San Jose fab, scheduled for August 2016, and the integration of backend operational systems, also set for August 2016. Now, on to the guidance for accretion from the Micrel acquisition. Micrel contributed approximately $0.07 of accretion in the September quarter and $0.038 in the December quarter to non-GAAP EPS. We now expect this accretion to rise to a run rate of $0.30 by the end of fiscal year 2017, an increase from the previous target of $0.25. This projection is dependent on the speed of integration and overall economic conditions. Regarding Atmel, I visited Atmel's headquarters in San Jose and their fab in Colorado Springs, holding employee meetings and one-on-one discussions with the executive team. Ganesh and I will be traveling to Europe in mid-February to visit Atmel's locations in France, Germany, Norway, and the UK. We recently completed the U.S. antitrust filing and have filings scheduled for Germany and Korea next week, with a target to file with the Securities & Exchange Commission soon. We expect to finalize this transaction in the second calendar quarter of 2016. Feedback from investors and analysts since the Atmel announcement has largely been positive, affirming that the deal makes sense. However, we acknowledge there are areas where we need to provide further clarification. Many investors have expressed a preference for self-help stories that can generate growth in a slow growth environment. We’ve shared that Microchip’s organic growth rate has been 8.3% per year over the last six years, with total compounded growth, including acquisitions, at 17.3% per year. There is confidence in our management’s ability to turn around Atmel and drive its success. We have heard concerns related to leverage, particularly regarding how the Atmel acquisition will affect Microchip's debt-to-EBITDA leverage and the cash quotient, which might pose a risk to our dividend. Following our stock buyback, we expect our senior debt-to-EBITDA leverage ratio to be 2.7, with total leverage at 4.5. It’s important to note these figures are before synergies. Once synergies are factored in, we estimate our debt-to-EBITDA leverage will decrease significantly over the first three years post-acquisition. The second concern relates to multiple architectures. Investors have questioned Microchip's past stance on ARM architecture and what has changed. In the past, our comments against ARM were in relation to investor inquiries about replacing our MIPS-based PIC32 architecture. We maintain that ARM has commoditized this market, and our PIC32-based solutions remain superior and differentiated. Microchip will continue to provide both ARM and PIC32 solutions, ensuring we meet customer demands. The third concern raised is about revenue dis-synergies, where investors worry some of Atmel's products may not meet our margin criteria, potentially leading to exits from certain segments. While previous attempts to acquire Atmel in 2008 involved plans to divest lower-margin businesses, today’s Microchip can afford to keep Atmel’s entire product lineup, as Atmel has already divested much of its low-margin business. The fourth concern involves perceived dis-synergy through multi-sourcing, suggesting that Microchip and Atmel microcontrollers would conflict in their applications. We clarify that different microcontroller architectures mean they are not designed into the same circuits. The combined portfolio will provide distributors with a substantial and sought-after offering, allowing for greater opportunities. Lastly, regarding our targets of $0.33 accretion in fiscal year '17, $0.67 in fiscal year '18, and $0.90 in fiscal year '19, these figures are rooted in three main growth factors: operating expense reductions, gross margin improvements, and revenue growth. The path to achieving these numbers involves continuous efforts to optimize expenses and enhance manufacturing efficiency. We anticipate Atmel's revenue will recover in the early part of 2016 and provide opportunities for cross-selling products. In conclusion, the December quarter marks the bottom of our recent correction, and we expect slow single-digit growth in the March quarter. The following two quarters historically show stronger performance, which will also reflect incoming accretion from the Micrel and Atmel transactions. This combination is expected to drive a 23% non-GAAP EPS growth from fiscal year 2016 to 2017. Operator, please open the call for questions.

Thank you for taking my question and congratulations on the good execution. Steve you mentioned March as seasonal, and I think you said China down and I believe Europe and perhaps U.S. up. Given that you have exposure to such a large range of customers, what are you hearing from your customers just in terms of your specific demand environment? Do you think it appears normal or do you think there are ways versus what you would have thought entering this year? Thank you.

The demand environment in the U.S. and Europe is about normal. The demand environment in China has been weaker than normal but we were the first ones to call the weakness in China which the industry has been experiencing for some time now. And we have modeled that weakness of China and especially also because of the Chinese New Year into our guidance that we have provided today.

Got it. And the fact that probably squeezing just a quick follow-up on just microcontroller segment growth in calendar '15, I think you mentioned you gained share and assume that there were likely tailwinds from IoT and autos and other areas. But then how do we explain the sales actually being down somewhat year-on-year? Was it an inventory issue? Was it a geographic issue? Like one should have expected your sales to grow if you were gaining share and you had tailwinds from a number of these new secular trends? Thank you.

Well, that depends on what the total numbers were for microcontrollers. As we have monitored the numbers and earnings report coming out from various other companies, the microcontrollers have been down significantly. So I think once the Dataquest numbers come out, Gartner data come out, you can see what has happened to the market share. We have tracked our performance against the SIA which come out more routinely and we have shown it to you at certain conferences and the graphs have looked up into the right where we have been gaining share. Now gaining share doesn't necessarily mean that the numbers are up year-over-year; you could gain share with flat or 1% down business if the business shrunk more than that.

Thank you.

Good afternoon, thanks for taking my question and Ganesh, congratulations on the promotion. On the $0.05 more of accretion you're targeting on an annualized basis exiting fiscal year '17, just wondering is that better synergies on the COG side or OpEx side or a combination of both?

It's due to a combination of three factors: improved operational efficiencies in operating expenses, enhanced gross margin synergies as we approach the fab's closure, and significant revenue synergies from expanding our product line to both our distribution channels and direct customers. We are also forecasting additional revenue synergies. While $0.05 may seem minor, it translates to an annualized $11 million to $12 million, which reflects a notable improvement for Micrel compared to just a quarter ago.

Great, thanks for the insight there, Steve. In the automotive sector, was there a notable improvement in the December quarter? I believe we observed a significant recovery. You mentioned last quarter that it was a relatively bright spot in your business. How do you anticipate the broader automotive end markets performing in the March quarter?

Ganesh?

Automotive was strong as you noted in the December quarter and continues to be a stronger segment than some of the other ones. It's consistent with what you've seen in the other reports about automotive. It remains one of the more resilient market segments even in the broad-based weakness.

Thank you.

Yes, good afternoon guys, thanks for letting me ask the question. Ganesh, congratulations as well. You did a good job in the December quarter taking inventory down. In the press release you talked about growing inventory in the March quarter, and Steve, I'm wondering if you could just help me understand is that kind of normal seasonal or is that sort of a habit of your expectations for demand as you look beyond March. Give me the explanation behind the inventory going back up in the March quarter?

John, this is Eric. So we had some extended shutdowns in the December quarter in our wafer fab that aren't going to repeat in the March quarter and that's the biggest change that's happened quarter-on-quarter.

That's helpful. Maybe I could sneak another one in. I guess Steve, the farm what you assumed Micrel did in the December quarter is going to do in the March quarter. It does look if you back that out as if the year-over-year growth for the core business is down, anywhere from 6% to 8% in December and down again 6% to 8% year-over-year at March which does seem to be lagging the peers. Now I know in your prepared remarks you said you feel confident that you're gaining share, I'm just hoping maybe you can help elaborate on that. And I think you also put the qualifier in there, in the markets that you address. And so help me understand, do you think that your served addressable market is growing slower than the overall addressable market for microcontrollers and that's one of the reasons for the disconnect?

I think in trying to calculate those percentages you are probably off on the Micrel revenue. Our numbers are in front of me where we could follow up offline. I don't believe your calculations are correct.

Okay. Could you just talk to in general why you're so confident that you're not losing share, that you're actually gaining share Steve?

When we compare our 8-bit, 16-bit, and 32-bit numbers against the SIA figures, we're confident that we have gained market share in all three categories as well as in analog, which has seen significant growth. We have experienced some decline in the memory business and in other miscellaneous areas. The companies we've acquired, such as Supertex, already had some foundry business, particularly with their six-inch fabs, which were underutilized and engaged in small foundry tasks for other clients over the years, as transferring such work is often avoided due to the limited volume. When a fab closes, that segment of the business suffers because there's little motivation to shift it to another facility. Atmel, Supertex, and Micrel all had similar foundry operations. We classify these activities under other. Overall, our core businesses have performed well. You can compare our core business performance to Atmel, Renaissance, and others, and when Gartner releases their numbers, we will share them with you.

Helpful, thanks guys.

I believe it's important to note that we have separated the organic and inorganic numbers as you requested, but I don't think that has been beneficial for us. Investors and analysts need to understand that these acquisitions require significant effort; they demand a lot of attention from Microchip executives and our team to turn around what were underperforming businesses. For instance, when we acquired Micrel, their operating profit was only 6.7%, and now it's approaching 20%, with the expectation of reaching 30% or more eventually. The work we've invested would have gone into our existing business. Specifically, in the case of Micrel, we discontinued one of our products, Gigabit Ethernet, and chose to promote Micrel's version instead, as it was more advanced in development. Looking ahead, when you assess our performance over the next few years and differentiate between organic and inorganic growth, you're effectively excluding all the earnings and revenue we've generated from these acquisitions, which were initially not profitable, and have since contributed significantly to our operating profit of over 30%. By doing this, it seems to imply that our core business isn't performing well, which is not the case.

Thank you, Steve. I have a question about Atmel. You mentioned that you will be visiting and meeting with some executives in Colorado. I just started these meetings and would appreciate any insights you could share regarding what you are learning about the business and how it relates to the deal.

Well, we're not learning much about the business at this point in time. Atmel is essentially not shedding anything about the business. We still see that Antitrust hasn't cleared and we still see the businesses as competitive. We're largely getting through the people, we tour the facility, we're learning where people are located, we're starting to formulate some initial thoughts about how we will go about the integration. We have done enough of these that we know what burdens we have to push and what we have to do so we can get there quite quickly. But in the two weeks that have passed, they are not letting us into the business yet.

Understood. Just other follow-up in terms of kind of being at the bottom here and then you guys have seen some of this first and then been out in front of it. That said are there still any kind of variations by different geographies or end markets or from a bookings perspective at this point is that kind of stable and seasonal?

I don't have any end market commentary but from a geography standpoint it is clearly a distinction, I mean the world knows at this point in time that China is weaker than normal and we're finding that U.S. and Europe to be normal.

Okay, thank you.

Thanks guys. Steve, just a question on the China weakness, you said you're baking it into the guidance this quarter. When you talk about the 23% EPS growth in fiscal '17 do you think the China weakness lasts beyond this quarter? And then if you could just share your insights as to why or why not, that would be great. Thanks.

Chris, I'm not going to comment what the industry would do beyond this quarter but whatever our assessment is of that is baked into when they are talking about 23% EPS growth.

Got it, okay. Ganesh, you mentioned the automotive end market. Can you provide your thoughts on the other main end markets, such as industrial and consumer, and how they have been performing this quarter?

It is challenging to forecast the performance of specific segments for the quarter. We can clearly identify areas of strength, but we have also noticed some softness, particularly in areas related to China, which has consumer content associated with it. The PC segment is performing reasonably well, despite the broader macro challenges in the PC market, as we operate in value-added areas such as office computing, server side, and PC peripherals. Nothing in particular stands out, although the automotive sector appears to be performing relatively strong compared to others.

Got it. Thanks a lot guys.

Great, thanks for taking my question. First, I'm hoping Steve you can talk a little bit about when you highlight the very strong accretion you expect from Atmel, can you talk a bit about how much you expect to come from revenue synergies and perhaps highlight how front end or back end loaded you anticipate that to be?

Well, we did not break the synergies into OpEx, gross margin, and revenue growth, and we're not going to. Some of the work has been done by our knowledge and assessment and experience and applying cycles of learning or the previous acquisitions. As I said earlier, Atmel management hasn't let us into the business to really do a bottoms up on product line by product line, cost by cost, wafer by wafer, ASP by ASP. So the analysis is not done at that level, it's done at a more higher level but our experience shows just look at Micrel, I mean this is the second or third time we have increased the accretion guidance on Micrel, we did the same thing with SMSC. So, we think the numbers we have given you are good but we are not going to break it down further by the three pieces.

Understood. Maybe one for Eric, I think you mentioned there was a special income of $5 million in the quarter, did I hear that right? And can you elaborate as to what that is and whether it repeats?

Yes, so it does not repeat so we had a couple of things happen in the quarter. On the legal front we had settlements that brought some income into Microchip and there were a couple of settlements that went out, and the net of those were essentially the $5 million.

Great, thank you.

Then not in the non-GAAP. Are they in the non-GAAP?

Yes, they are not in the non-GAAP.

Understood, thank you.

Thank you. Regarding Atmel and your comments about the volume of business you aim to retain, you mentioned that around 95% of the business meets your margin criteria. Should we interpret this to mean that you plan to maintain those 95% of business lines moving forward, with the objective of aligning them with Microchip's margin targets? Is that correct?

Well, look at the history of what we have done. The same kind of concerns were raised with SMSC. Did we sell a product line from SMSC? Did we discontinue the PC business? Did we discontinue the other parts of the business? This question is raised every time. When we go in, we assess the situation, we look at all the product lines, we see how it maps to our product line, what the margins are, we put higher focus on the product lines which we can grow faster at higher margin, we put less focus on the product lines that have lower margin and we change the model mix, we change the factory strategy, we shut down factories, we move things around. In every acquisition we have gotten those results. Two weeks after announcing the acquisition and the one in which basically we got very little insight into the company because of competitive factors compared to any of our acquisitions. Why do you guys always assume that the gross margin improvement has to happen only from discontinuing the product lines, those pieces have been there before and they will always run? We didn't do that in the prior acquisition and yes, we got them into last quarter, the December quarter. Supertex gross margin was 17%, actual data.

Chris, if you look at the January 19 presentation that we put up when we announced the transaction I think you will see what our thought process was relative to gross margin overtime and expenses overtime as we combined the two companies. And you will see that there is improvement in all areas that we're planning on.

Right, okay. Just addressing one of the other things you had brought up with Atmel as well, and the leverage. Maybe you could speak to how you have looked at this perhaps under different macro conditions and obviously neither you nor I can predict what the macro does over the next two or three years. But how have you looked at this through a bunch of different market conditions? I know in the past when we've hit downturns, you've been able to ramp back OpEx for Microchip in order to protect EPS. Do you feel the same confidence in the ability to do that on the Microchip with some leverage as you're in the process of paying down that leverage from the deal?

Yes, I believe the answer is yes. I discussed this in the last conference call. Do you think a cautious management like Microchip would pursue this acquisition and leverage without thoroughly analyzing the potential downsides, such as any risks to the dividend, impacts on cash flow, and changes to our capital? We have thoroughly analyzed these factors, and we found that in a downturn, our capital requirements decrease. We’ve previously shared that our capital needs are largely self-sustaining with a small portion for maintenance, while most of our capital is intended for growth in new technologies. In a declining market, with reduced capital needs, we actually see a significant increase in cash flow since we are not spending as much on capital expenses. Our downside analysis shows that our total leverage metric is 5, while the senior leverage threshold is 3, and we remain comfortably below those limits when considering all these factors.

Alright, thank you.

Steve, I wanted to ask you about analog, which you mentioned is a bonanza. Could you share your expectations for Atmel? Do you think you can achieve a similar attach rate with their products as you do with your own microcontrollers? Is there anything Atmel produces that you could utilize through your salesforce? Any insights would be appreciated.

Harsh, the answer to that is yes. Where it works is, a customer sits down to lay out the board and when they choose a microcontroller they start to write the code and the analog is fit in later. I need a supervisor, I need an LDO, I think I need an A to D converter, I think I need this and that. So those are things that you can attach to the microcontroller and many times those selections are made many months later. But when a microcontroller manufacturer like us has its own analog, so one of the advantages we have is we can sample all the things that customer needs in their application, right away. So when the customer is ready, it's handy already; it's available in front of his eyes. And the attach rate to the Atmel's microcontroller would be very similar; that's the first thing we would do to take all of their block diagrams worldwide that exist out to customers and really see whose analog is around.

Got it, very helpful Steve. And then as a follow-up if I can ask you, I've seen you acquire a bunch of companies here in the last seven/eight years, and most of them have been successful, some underway to that track. When you buy a company Steve, when you look at a new acquisition, what kind of up margin goals do you have for them? We have seen some of the older ones that are done well into the 30s but is there a number or hurdle rate that you can share with us or perhaps even arrange or qualitatively even?

I think Harsh I rather not because that becomes a model for the next acquisition regarding what I could pay.

Yes, thanks for taking my questions. Steve, I was wondering if you could talk a little bit about the IoT strategy going forward now that you've acquired Atmel's assets. And can you talk a little bit about what they bring to the table and what you have with your existing portfolio and how you think you would be able to generate a competitive advantage with respect to that market?

As mentioned in the last call, defining IoT can be quite challenging. Many people include all microcontrollers in the IoT category, which would place our business well over $1 billion. However, a stricter definition of IoT focuses specifically on applications that are wirelessly connected to the internet via Wi-Fi, Bluetooth, or similar technologies. Our IoT business is roughly twice the size of Atmel's, although definitions may vary. When we consider growth, we are seeing a 50% increase in this segment. We possess all the necessary functionalities, including Wi-Fi, Bluetooth, and BLE. From that perspective, while we are not introducing something entirely new, the larger scale—50% larger—allows us to compete more effectively. Additionally, when looking at individual specifications and products, arguments can be made about superiority in aspects such as power consumption and range, leading to varying advantages. Collectively, this larger scale will enable us to reach a broader market more effectively.

And if I can add to that, I think the other part of IoT which is growing is the security of the nodes themselves and Atmel does have an awesome good products line that address that. So you put the two together, it's a more powerful combination than what we had individually.

And as my follow-up, in terms of the consolidation that's occurring in the semiconductor industry, how do you look at your competitors are positioning now with the acquisition of Atmel, say vis-à-vis NXP/Freescale who are also going to have a large portfolio of 8-bit to 32-bit microcontroller assets? Thank you.

We believe that our acquisitions are not must-do decisions. We haven't pursued past acquisitions with the mindset that they were essential. We've made these choices when we identified opportunities that were available at reasonable prices or when we formed a business model that justified them. As you know, we have walked away from potential acquisitions, including CSL and many others that remained under the radar. In the past, we have competed with companies like Freescale, which had revenues in the billions while we were much smaller, starting with revenues of only $100 million, then $200 million, up to $1 billion. Despite our smaller size, we have continually managed to compete against larger firms like TI, Freescale, STMicro, and others. While scale is significant, achieving scale for its own sake is not enough without having strong product lines and effective execution; many larger companies falter because of poor business models. With Atmel, we have the capability to compete effectively with both NXP and Freescale, as we have done in separate scenarios. Our reasons for acquiring Atmel have been explained previously.

Thanks for that.

Thanks for taking my questions and congratulations Ganesh. What are the strengths that Microchip has had with your microcontrollers if you have a consistent development tool for 8-bit, 16-bit and 32-bit? Do you plan on bringing the Atmel products under that same development tool umbrella, is that possible or will you be running two separate tools?

It's early days, Atmel also has a very good development tool environment that they run for their products and as we move forward, we'll look at other ways for Atmel products to work under the Microchip development tools, other way is for Microchip products to work under the Atmel development tools. There is a lot more to be discovered and done and when we get to the stage where we can engage in more detail with them. Development tools to the engineers are a very touchy subject and it's one that it's important for them to feel comfortable designing with our entire portfolio, we thought they've gotten used to. And I think there are ways to slowly over time build the ability for each other's products to be fit underneath the development tools that are available. So, more to come on that but I think both companies have strong development tools, Microchip obviously has had them over the entire 8-bit, 16-bit, 32-bit portfolio and Atmel has one for the AVR products and one for the ARM products. And we'll look for ways to make it so that design engineers find it sticky using our development tools.

Alright. Okay, great.

Let me add a bit to that. I feel that Investor Analysts may be overestimating the situation. For years, we have used a common development tool because we could. All of our developments in the 8-bit and 16-bit range were created internally, and one of the reasons we chose MIPS was that we could work with them to bring everything into a unified development environment and extend our Microchip toolset to the MIPS architecture. However, no other company has achieved this. Freescale has various development environments for Power to PC, for ARM architecture, and for the 8-bit and 16-bit product lines. Other companies like Atmel have similar offerings, including AVR. Silica has 8051 for 8-bit and ARM for 32-bit, so again, no one else has this setup; those companies are still active. While acquiring a company with the same architecture would provide incremental benefits, the market seems to perceive it as if it's failed, thinking that the tool will break and it will be disastrous. These product lines are quite successful on their own. Other companies have thrived under multiple architectures, just as we can at Microchip. We currently have a development tool that markets products from SMSC and Rob Networks. We utilize other architectures, including 8051 and ARM, but primarily focus on our own architecture, which we agree is significant. In recent years, we have begun introducing ARM-based products from smaller acquisitions. If we had an ARM-based product that lacked momentum, it could present challenges for development, but that's not the case here; it’s a successful product line, as is the AVR 8-bit. I encourage you to view it from this perspective. Regarding ARM, for eight years you have criticized us for not having an ARM solution, which was a drawback. Now that we do have ARM, it somehow has become a disadvantage again. You can't have it both ways.

Well, I just wanted to say that thanks for attending the call today. And there are number of conferences we'll be going to in the month of February and early March and we'll see you on the road. Thank you very much.