Steve Sanghi - President, Chief Executive Officer and Chairman
J. Eric Bjornholt - Vice President and Chief Financial Officer
Microchip Technology Incorporated (MCHP) Citi Global Technology Conference September 4, 2013 2:20 PM ET
Thank you. Before I begin today I wish to remind you that during this presentation I’ll be making some projections and other forward-looking statements regarding the future financial performance of Microchip. These statements involve predictions and the actual results may vary materially. So I refer you to Microchip's filings with the SEC regarding any important risk factors.
So in the agenda today I’ll talk a little bit about some charts, how our growth has been very consistent, perennial market share gainer, very high margin business model, our track record of very accretive acquisitions, how we’re shareholder friendly with constantly increasing dividend and free cash flow. I’ll talk briefly about the current business conditions and opportunity for significant accretion as the margins expand towards the long term business model.
So this has been the annual net sales growth of Microchip since we went public. The very last bar on this chart is cited as the last quarter times four on a run rate basis. So despite the dramatic slowdown in the semiconductor industry that we have all seen with many other companies, Microchip through various factors, significant organic growth, market share gains growth, and some element of acquisitions we have been able to essentially map that slowdown and we continue to produce very, very outstanding year-over-year growth.
This is a 16-bit revenue growth. The green line-over-green line shows you year-over-year growth and the blue line-over-blue line is just first quarter-over-first quarter. Similar thing you can see on the 32-bit microcontroller. And here is the analog, again the yellow-over-yellow is just the first quarter-over-first quarter but going through very, very substantial growth.
Market share gain, if I combine all different bit widths of microcontrollers together, Microchip has about 10% market share, has been a consistent share gainer over the year -- over the long term and looks like a straight line. But while in the middle of the various quarters, various cycles, there are some ups and downs which are clearly visible depending on whether the markets we’re serving are doing better or not.
For example, a year ago, you couldn’t go wrong with smartphone. If you’re investing in a company that sells smartphones all those current stock was sky high. Today that doesn’t look as good. Most of the companies are selling to smartphones this year, haven’t done well. What’s working today is housing, industrial, automotive where Microchip has a very large exposure, and we have been gaining share and doing very, very well.
So this is the share gain chart in a way on the 8-bit microcontrollers. We started way back, back in early 90s, at the bottom of the pack, and you can see by that red line how Microchip's share has grown every year, rising to number one spot by 2006.
Then a number of Japanese companies, Hitachi, Mitsubishi and NEC merged together to form Renesas, and in 2010 they became number one by that combination. And in 2012 actually, we closed the gap to number one by half and we actually doubled the gap to number three which was Atmel. And I think at the rate we are gaining share we should really regain that number one position.
If you look at this chart, which is a chart produced by UBM, which is the parent company of EE Times as they asked their readers which of the following 8-bit chip families would you consider for your next embedded project, Microchip was in the number one spot by a very wide margin. So if you go to the 16-bit market you can see our share gains in the 16-bit market as the red line is moving up, so we came in the top ten in the last two or three years, we’re number seven last year and we feel confident that this year we’ll continue to rise into the top five and then we will gets a little bigger.
And the same survey by UBM regarding what are customers thinking of using for their next design using a 16-bit, Microchip again was in the number one spot.
A very high margin business model; this is the non-GAAP gross margin of Microchip, for majority of the decade it has been around 60%, has been in good times slightly higher than that. A couple of notable downticks, one was after 2008 when the worldwide global crises hit, we came down to about 50, worked all the way back up to about 61, 61.5.
And during the most recent business downturn that happened last year our margin was back down to about 56% and it's slowly inching back up, it's about 58% last quarter, current quarter midpoint of the guidance is about 58.4.
There is also an impact of fairly large acquisition last year, SMSC acquisition, whose gross margin profile was lower so averaging with that there is a slight effect of that. Without that our gross margin probably would be fairly close to where we were historically.
Non-GAAP operating margin, so the red line is the dollar and last quarter was a record operating margin. The blue line are the percentages. So here for majority of the decade our operating margins were in the 35% operating margin range non-GAAP, a big downtick during the financial crises, big recovery coming out of there went back to the record.
And then again same situation like you saw on the gross margin chart. Some impact of acquisition, some impact of recent downturn last year where we had to take our factories down a little bit. We are working back up. Last quarter was 30.5%, current quarter guidance is I think about 31.5. So we are working back up here.
Track record of accretive acquisitions, we have, basically we are one company that has come to grips with the fact that the overall semiconductor growth has really slowed down from being a double digit 15% kind of growth many, many years ago if you go back in the last five years or even the last decades semiconductor growth has been in the mid-single digit range. And despite gaining significant share in our served market we have basically -- understand that we cannot meet our internal goals based on what growth we would like for the company year-after-year.
So we have decided very consciously to supplement that growth with a series of small and occasionally large acquisitions to build a long term growth rate which you saw on the very first chart where right from 1993 to 2013 over 20 years, looks like nearly straight line on revenue growth over a very long period of time.
So these are various acquisitions we have done, going back to October of ’08. I won’t comment on all of them. You could certainly ask questions later on about any one of them. And here is a second slide leading up to our very last acquisition which was SMSC which we completed in August last year. So it’s been exactly one year and that acquisition brought us a number of new technologies and revenue and the acquisition has worked out significantly better than what we had even guided to. We guided to significant accretion after acquisition and we have done even much better than that.
If you look at the accretion from SMSC in our fiscal third quarter last year which was the first full quarter after the acquisition was completed it was $0.065 accretive. Last December quarter was $0.085. March quarter of this year was $0.10 and the most recent, that was the most recent June quarter $0.10 over the quarter now.
And in the fiscal year ’14 we are in the fiscal second quarter of fiscal ’14 we expect about $0.40 to $0.45 accretion which is significantly better than what we had originally guided. So certainly have built a track record of very accretive acquisition.
If you look at some of our served available market areas, SAM, these are various areas that we are adding significant features and functionality and helping our customer get ahead in the state-of-the-art of their technology. The three I highlighted in green are the ones that came to us through SMSC acquisition; infotainment in cars, wireless audio and computing, embedded controllers. Rest of the other Microchip has historically been participating in and adding to it.
Just to give you one area today automotive how well we are doing in automotive, so if you go by S-Class Mercedes car today they are buying 26 micro controllers from Microchip, six analog parts and six memory and from SMSC the same car has 11 more chips on SMSC, six in the MOST entertainment biz and five in the KLEER audio so that’s a very, very substantial content.
If your years have gone buying Mercedes like Myna and you like the more recent models like the Tesla Model S then we’ve got substantial content in that too. If you don’t own one you buy one it's the best car you will ever own.
Microchip is also very shareholder friendly, with consistently increasing dividends and free cash flow, tremendous cash and investment, balanced growth considering 1993 when we went public, we had no cash to $2 billion in the bank, to $2 billion of dividend paid out already cumulative and one of the highest dividends in the industry. And consistently and slowly growing dividend constantly, never lowered our dividend.
Current business conditions so the freshest news more than even this slide is that this morning we narrowed our guidance. Our guidance was 2% to 6% growth with a mid-point of 4%. We narrowed it to 3% to 5% by keeping the mid-point the same, same thing basically on the earnings. But going back to June quarter we beat the high end of our upwardly revised guidance for sales gross margin, operating profit and EPS. Inventory is very much within our target range at 119 days, distribution inventory is low.
We also recognized revenue through distribution only at sell-through. And we are continuing to experience very, very strong bookings activity, pretty much worldwide both July and August had been very good booking activity, backlog looks quite strong. And just yesterday in fact I posted another CEO letter on our website.
I am sending it to our customers telling them that lead times are staying long and continue to actually go longer and if they haven’t placed the order for what they need for the balance of the year through December they better do so this month otherwise it will be difficult to supply them parts in less than 12 weeks of lead time as they go past September. And you may look at that letter on the website.
The total inventory, as you can see is pretty much where we want to be. The distribution inventory in blue is on the lower end and the red shows the Microchip inventory. We basically consider -- we’re not trying to take it higher, we’re not trying to take it lower, basically inventory is well balanced. And finally opportunity for very significant accretion as margins expand towards our business model.
So first column is the June quarter actual. The second column is our revised guidance as of this morning, which is 3% to 5% growth and earnings, non-GAAP earnings of, these didn't get revised…
J. Eric Bjornholt
Okay. $0.58 to $0.62
$0.58 to $0.62 with the midpoint staying same as of $0.60. If you look at the long term model, our long term model is 60% plus minus half; gross margin 27.5 plus or minus half in terms of operating expenses and 32.5% plus minus half in the operating profits. And from where we are, there is substantial revenue growth, gross margin growth and operating profit growth, which leads into significant accretion on the earnings per share.
Summarizing it today, Microchip is again a very consistent revenue grower, a perennial market share gainer, has consistently maintained a very high margin business model and we have shown a consistent track record of very accretive acquisitions. We’re very shareholder friendly with consistently increasing dividend and very healthy free cash flow. Current business conditions are showing strength and strong bookings. And investors have an opportunity for significant accretion as the model head towards the long term business model.
Thank you very much. I’ll sit down and take your questions.
Great. Thanks Steve. We’re asking a couple of questions to all of the analog companies…
The first is, as they think about heading into year-end it sounds like the comments you made about bookings trend in support of positive backlog for 4Q. Do you have the view now whether 4Q could actually be seasonal, flat or seasonal?
Well, if you look at Microchip’s revenue in December quarter, first of all, it’s our weakest quarter of the year.
And leaving the last year I will tell you why, the prior two years were down about 3.5% sequentially, both years, so in the calendar year December ‘11 and December ‘10, down about 3.5% sequentially. December ‘12 was up 2% sequentially but it was impacted by the acquisition of SMSC where the December month had three months of SMSC, the prior quarter had two months of SMSC, so it doesn’t quite fit. But basically what it says is December quarter is usually the weakest quarter of the year.
This time we -- still be the weakest quarter of the year, though we expect it to be much better than in the past based on the backlog we see, based on the environment we see, we see improving Europe, certainly improving U.S., China, Asia doing very well.
Three months ago, investors were really concerned about China, we were not, and we were saying so. But people were really concerned about China and we were correct. We were seeing strength in Europe in design wins, Germany picking up, people were really concerned, we were correct. Europe did better. And the U.S. economy overall has done better than what people said three months ago, GDP was revised.
So I think our view of from our vantage point of broad base of customers, broad base of applications, participating in every single market, I think we called all three geographies essentially correct. And with where we see December quarter we see it shaping better than seasonal but I’m not going to put any numbers on it right now.
Okay, fair enough. Now kind of extrapolating for the first half ‘14. What are either the applications or regions that you see accelerating and do you conversely see any deceleration in the business as well?
Well, when you look at the first half ‘14 you’re going to go through some regional seasonal factors. So when you go to the March quarter, China usually sequentially down because Chinese New Year there is nothing you can do there. They are out for two weeks and we can’t make up in the rest of the quarter. So China is usually down in the March quarter but on the other hand Europe is way up.
March quarter is very strong in Europe because there are no holidays. You don’t have the Christmas holidays, you don’t have the summer holidays, you don’t have the Easter holidays. Everywhere Europe is frozen and all they do is work and that's the only quarter they really work.
So, what we see every year is Europe is way up and China is down and U.S. is normal sort of like whatever normal would be in any given year. Combination of all that usually is March quarter is sequentially up.
Okay, terrific. And that this is another question that we were asking, that’s a little bit longer term. And it actually you kind of mentioned earlier the benefit of not playing into the mobile space, this is a double question. I am asking as an observer of the industry not a participant but what’s your expectation for microprocessor supplies into the mobile supply chain over time. What do you think will be the result of sort of the shift in growth in smartphones from developed markets emerging markets, if you could care to comment on that?
Well, so again thanks for saying that. You know Microchip growth is not dependent on the mobile segment. Clearly have some peripheral content in battery chargers or here there as some things you may add to it. But not really, we are very low exposed to the overall cellphone market.
So if you go back to the last year when smartphones were big it would seem like Microchip wasn’t doing well enough but you look at this year when mobile phones are down and housing industry and automotive was up, we're doing very well.
So now answering your question what do I see over time, basically all the features and functionality of the smartphones are becoming commodity and today you can find that in [Calon] phones and there's some second, third tier suppliers in China becoming everyday function.
In fact the copyright phone, including Intel cellphone and non-copyright phone, and I see some of them in China like if you couldn’t tell if you put the wrong logo on it. So what does it really mean for the semiconductor content and what does it mean for margins what does it mean for that supply chain. I think that there is some concern over the longer term.
I would be concerned about, you’ve already seen significant compression of the revenues and margins as compared to when it was last year as the growth has matured. Now if there is another company that comes in which is lot of second-third tier suppliers from China using local Chinese parts and other stuff then what does it do to the overall market.
I think the people who have the core like the main processor and all that and they probably would be fine. The people who have all the memory and other stuffs and sensors and you know the tinker toys on the phone those probably are more -- likely to be compress because that’s where the completion will come from that’s my guess.
Okay, very much appreciate that. The other question that we are asking all of our companies is how visibility this year has changed versus prior year. You touched on this with the comments you made about the open weather. If you could just help elaborate and help us to understand if you are seeing a shift in either return of prices because of the firm demand that you are seeing.
J. Eric Bjornholt
We are seeing a substantially increased visibility all this year than we were seeing last year. We started to talk about that really November, December last year when we had the conference call in November last year we gave a up guidance for the March quarter which really wasn’t originally believed by the Street because they felt very negative on it and we were the only ones talking about positive March quarter.
And turned out we beat up in March quarter, guidance was 2.5 we beat it to 3.4. So we’ve been seeing this trend developing since then more and more visibility lead time lengthening and perming prices along with that and so sort of I think that trend has continued and lead time and visibility they are longer than what they were even three months ago.
Okay, terrific. Now Steve given that you are seeing pretty firm demand conditions does this affect your appetite at all for M&A or is that something completely independent?
Our M&A appetite is not dependent on current demand conditions. We’ve done acquisitions at very bad times, we’ve done acquisitions at very good times. As I mentioned we understand that the long-term semiconductor growth rate has dramatically slowed. And even if we had a perennial market share gain we won’t get there internally where we would like to do, year-after-year over the long-term.
So we are trying to add the element of acquisition growth and acquisition comes when it comes. We’re constantly engaged talking to companies, we are very disciplined, we do one deal for every 20 deals that we look at and you can’t schedule those, you can’t say well I am going to do one next quarter. If that’s what you want to do if you are time driven then you’re going to do bad deal.
If you are going to do very good deals then you have to let them come to you. And you have to be disciplined. So therefore our appetite is not dependent on what the market is doing, what the economy is doing. We have substantial cash assets, we have $2 billion working capital lines and we’ll do acquisition and we’ll find a good acquisition .
Steve one of the slides you showed Renesas claiming number one because of the merger with NEC. You made the comment that you believe that you will regain the number one spot. Any timeline to that thinking and also how is the Japanese competitor performing based on sort of the changes we’ve seen in the market in Japan?
Well, if you allow me to sell a dollar bill for $0.90 I can move that timeline up quite substantially.
Right, we are not going to do that.
If you want me to do it with our kind of gross margins and our kind of well over 30% operating profit then we are systematically doing it. We kept the gap to half last year, based on how we have done this year might get it half again and so I haven’t done that math on when that happens and we’re really not driven by a timeline in achieving these things. We are more driven by the disciplined opportunities to constantly gaining shares, doing better than the others, doing better than the market, maintaining profitability, high gross margins, that’s more important than having achieved that part of something.
And do you see any incremental shift in competitive pricing aggression because of what’s going on with the exchange rate?
Not really because most of their business is in Japan and you see them outside firm but mostly they are in Japan and then it doesn’t matter these things it doesn’t matter.
Okay, fair enough. The next question I had is looking at longer term out three to five years what are some of the smaller growth drivers that you actually see developing material size and contribution to the business. You had a slide you showed a number of them. If we were to rank the top three or four that you are excited about what should we be thinking about. Also what’s the company is involved in, in Internet of things and how do you view that long term?
So in terms of what I am most excited about I think Microchip has always been very 70,000 plus customers, very broad big front, we are trying to defend and grow from power management, to lighting, to displays to motor control, to touch, to automotive to entrainment to wireless audio to there are just too many of them. And each one of them has a center of expertise in the company app engineer, design engineers people dedicated to understanding these markets and what those customers want and what futures and functionality would win.
So I am really excited in very many of them and really couldn’t rank them. So I am excited in lot of different things. And Microchip’s growth traditionally has always comes from using a baseball terminology hitting a lot of singles, once in a while doubles we are largely hitting singles.
We don’t win by a home run, we have no customer, no design win where we are going to win $50 million and $100 million design win next year and partially because we are not in those cellphone and other kind of markets. So lot of our business is if you look at the size of our business and take 70,000 customers you will find average customer from Microchip buys $25,000, $30,000 a year and that’s lots and lots of singles.
And so therefore in trying to do that we have to win in lot of different areas and focus again is really preserving the margin, doing it well, building sustainable things, sustainable differentiation and doing it year-after-year predictively and that where the focus is.
Now in answer to your question on Internet of things I am lot more excited about it today than I was just a few years ago and seeing significant revenue and design wins attached to that is also. If you had talked to me five years ago I would say Internet of things is kind of a buzz word. You know back in 2000 Internet days people used to talk about the refrigerators connected to the toasters and depending on how many times it opened and went into the toaster a new bread will show up on your door. Nobody wants to buy bread that way. That didn’t work and that was crazy and it didn’t not work.
And I thought it was another one of those trends starting. But this time it has been much more structured and has much more meat behind it. Now there is not a day that goes by that I don’t use that kind of connectivity myself. Every single day I use my smartphone to dial into my Tesla, open the sunroof, turn the air conditioner on ten minutes before I leave my office to go start my car and in the Phoenix heat it is 110 degree outside, my car is 140, inside when you begin. By the time I get there it’s much cooler.
I routinely dial into my DIRECTV to program something somebody tells me about. I can contact my thermostat to change the temperature. You can disable your security system, you can check your garage door opener. And these are becoming common phenomenon. You can go buy a garage door opener today from Chamberlain, Centex, Elite any of those lift master brands.
And you can buy a security systems, alarm systems, thermostats, air conditioners and you can really access these things by your smartphone and be able to interface with them in doing something constructively. And that’s real Internet connectivity and I am doing it personally every day. And therefore our company is in the center of it.
And we make Wi-Fi modules, Bluetooth module, RX modules, Wi-Fi modules together with a microcontroller, sometime in a single package sometime in two chip solution which are helping customers add that Wi-Fi connectivity or RF connectivity machine-to-machine.
So now it’s a very, very real trend and we have pages and pages and pages of engagements that we are working on.
Are you comfortable with the radio capabilities you have now or do you need to extend it either organically or through acquisition.
No we are very comfortable with it, there -- is it ever enough no. So in the Wi-Fi area we have 802.11 b and g and we don’t have n. We’ll get that internally but it could also come from acquisition, most like we will finish the development internally. In the RF area we have Zigbee, , we have MiWi. We have most of the others. We don’t have Bluetooth inside and the Bluetooth chip we are still buying from outside to really put in to the other with our microcontroller into a module and all that.
So nobody has all of them but we got more pieces then most others. Somebody may just have Wi-Fi somebody may just have RF. We have RF, Bluetooth , Wi-Fi...
Okay, terrific may be switching gears a little bit to the financials, Eric can you remind us what the target model is, and what is the walk through is to get there and what sort of utilization levels we would need to achieve the target model?
J. Eric Bjornholt
Sure so, the gross margin long term model is 50% plus or minus 0.5% and operating margin is 32.5%, plus or minus 0.5%. So gross margin guidance for the current quarter at the midpoint is like 58.4%. So we made very good progress in getting there. And in the June quarter we had guided to 57.25% and actually came in at 58%. So we’re getting there rather rapidly.
So the two major things that we can do to improve that gross margin is one, better utilize our factory, that will come as revenue increases and we can increase wafer starts in the factory. And then we’ve also go activity related to SMSC, the acquisition we did about a year ago that Steve mentioned and pulling in some of their probe assembly and test activities and do low cost factories in Thailand.
So I don’t have a time frame in order to get there but we’re making really good progress in getting their pretty quickly.
And then on operating expenses, we’re essentially operating at the model today. Our operating expense model is 27.5%, plus or minus 0.5%. And our midpoint of our guidance this quarter is 27.25%.
Okay, great. We have about five minutes. So I want to make sure that we ask questions from the audience as well.
It seems that the business was pretty strong right now. You talked about others, you obviously talked about [inaudible] how these types are expanding. However, when I look at your revised guidance you did take down high end a little bit. But when I look at the previous cycles when you’re coming out of a downturn, there is a thirst in the business and the revenue growth really accelerates. So why did you take down the high end, what are you seeing in the business, customer push outs or cancellation, what just on the high end? I understand you reiterated the mid-point but happened to the high end?
Well, you see these customers push out, you don't lose the high end, you’ll lose the mid-point. So, usually we do bottoms up model coming from by region and by division, by major customers, by distribution and we build up the model every quarter. And that model has some upsides and downsides. And then that really drove the range.
Pretty much everything has to happen to make the high end but largely it’s built around the mid-point. So if you have all these customers push out, you don’t lose the high end, we usually love the mid-point. So I wouldn’t read anymore or any less than to release what the earning this morning says it basically says we’re very comfortable with the mid-point, we no longer believe it's as low as the low point which is 2%, it’s stronger than that. But if you only lose the low point, if you lose the high end [spend] and your average moves up.
So if you have to drop the low point because if I get no more orders today, I’ll make the low point, the older low point of 2. So, that’s how it need to be low. So, needed to move that up to three, and if I move it up to three, I got to take something from the top as well as the mid-point moves. So much more than solving a math problem than anything more than that.
Okay, great. One of the last questions I had, Steve was a lot of people think about U.S. having just simple microcontrollers but don’t appreciate really what has to go around that. We talked a little bit about the RF capabilities that you’ve been building into the business. What are some of the other capabilities that are ancillary to the core that are very important to maintain your competitive position?
Today, based on last quarter annualized we have $413 million on annual run rate analog business that is very complementary to our microcontroller business. And steadily over the last decade we’ve become one of the larger analog companies, a number of $50 million to $250 million analog company, reasonably well-known brand names which are substantially smaller than us today.
So, analog will be the largest piece that’s really around the microcontroller. But also lots of sensors, there's some memory devices like static RAM or instant memory or some FLASH, they are also some of the other interface kind of products, so talk about RF, and all those stuff.
And we’re really basically trying to build everything that would go in a microcontroller board so that's a Dynamic RAM.
J. Eric Bjornholt
I will just add that analog is very synergistic with microcontrollers. We don't introduce any microcontroller products today that doesn’t have significant analog embedded on it. So the sharing of IP between groups of the Microchip -- within Microchip that make us very cost effective in our development activity.
Okay, terrific. Well this has been very helpful. I really appreciate you attendance. This has been a great session. Thanks Steve, thanks Eric.
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