Atmel Management Discusses Q1 2014 Results - Earnings Call Transcript

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 |  About: Atmel Corporation (ATML)
by: SA Transcripts

Operator

Good afternoon, my name is Jennifer, and I will be your conference operator today. At this time, I would like to welcome everyone to the first quarter 2014 earnings conference call. [Operator Instructions] Mr. Peter Schuman, Senior Director of Investor Relations, you may begin your conference.

Peter Schuman

Thank you, Jennifer. Good afternoon, and thank you for joining us for Atmel's First Quarter 2014 Earnings Conference Call. A copy of the press release issued today is available on our Investor Relations website. A replay of this call will be available after 5 p.m. Pacific today and will be archived for 48 hours. The webcast will be archived on the company's website for 1 year. Access information is provided in today's press release.

Joining us for the call today are Steve Laub, Atmel's President and CEO; and Steve Skaggs, Senior Vice President and Chief Financial Officer. Steve Skaggs will begin the call with a review of our first quarter financial results and Steve Laub will then provide additional information on the business. At the conclusion of Steve Laub's remarks, Steve Skaggs will discuss our financial guidance for the second quarter of 2014 and then open the call for questions.

During the course of this conference call, we may make forward-looking statements about Atmel's business outlook, including statements regarding our expectations for market growth, revenue, target gross and operating margins, product introductions and cost savings for 2014 and beyond. Our forward-looking statements and all other statements that are not historical facts reflect our expectations and beliefs as of today, and therefore are subject to risks and uncertainties as discussed in the Safe Harbor discussion found in today's press release.

During the call, we will also discuss non-GAAP financial measures. The non-GAAP measures are not prepared in accordance with Generally Accepted Accounting Principles. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures can be found in today's press release.

I would now like to turn the call over to Steve Skaggs for discussion of our first quarter financial results. Steve?

Stephen A. Skaggs

Thanks, Peter. Over the past several years, Atmel has undergone a strategic transformation and our revenue mix has shifted to faster growing and higher margin microcontroller products. While the organizational structure of the company has evolved over time to accommodate our business strategy, our external operating segment reporting structure hasn't changed in over a decade. The time is right to update our segment reporting in order to present our business in a clearer and more consistent manner that better reflects how we manage the company. As a result, this quarter, we will continue to have 4 reporting segments: Microcontroller, nonvolatile memory, automotive and multi-market and other.

The microcontroller segment will continue to include core microcontroller products, touch controller products and will add custom microcontroller products formerly reported in the ASIC segment. Nonvolatile memory will continue to include serial memory products and will add secure CryptoMemory products formerly reported in the ASIC segment.

The automotive segment, previously named RF and Automotive, continues to include high-voltage connectivity and mixed signals products for automotive applications as well as legacy RF identification products. The new multi-market and other segment replaces the ASIC segment and consists of aerospace products, ASIC programmable logic devices, XM sensors and foundry business.

For the ease of transition to our new segment reporting, we have provided an Excel spreadsheet disclosing 2 years of historical segment revenue under the new reporting structure. This spreadsheet is located under the Events and Webcast section of our Investor Relations website under today's event. Once our first quarter 10-Q is filed, we will update this spreadsheet with the historical operating profit by segments.

Moving now to the first quarter financial results. First quarter revenue was $337 million and decreased $16 million, or 4%, from the prior quarter as a result of the impact from the unplanned shutdown of our Colorado fab but was well above the high end of our guidance range due to better than anticipated demand and a faster-than-expected recovery from our supply disruption. On a year-over-year basis, revenue increased by 2.5%. First quarter 2014 non-GAAP gross margin was 44.0% at the midpoint of our guidance range and 30 basis points higher on a sequential basis.

On a year-over-year basis, non-GAAP gross margin improved by 350 basis points. This increase reflects continued progress on our previously articulated gross margin improvement plan. We are pleased to have increased gross margin for the fourth consecutive quarter while also driving another sizable reduction in our inventory balances. We expect further gross margin expansion next quarter and for the remainder of 2014 as we continue to execute on our improvement plans.

On a GAAP basis, first quarter gross margin was 41.5%, down 120 basis points on a sequential basis. First quarter GAAP gross margin was adversely impacted by a $7.1 million loss related to the manufacturing facility damage, unplanned shutdown at our Colorado Springs wafer fab, which occurred at the end of the fourth quarter and extended through the first half of January.

Moving to operating expenses. Non-GAAP operating expenses came in at approximately $118 million, below the midpoint of our original guidance range. First quarter non-GAAP operating expenses were up around $7 million on a sequential basis. This sequential increase was primarily the result of higher payroll taxes, the timing of government grants and tax credits and less employee vacation. Stock compensation for Q1 was approximately $16 million, allocated approximately $1 million to cost of sales, $5 million to R&D and $10 million to SG&A.

Non-GAAP operating income for the first quarter of 2014 was $30.1 million or 8.9% of revenue, and excludes the previously mentioned loss from manufacturing facility damage and shut down. Other excluded items include stock-based compensation, gain related to our foundry arrangements, restructuring credits, and certain other charges described in further detail in our earnings release.

Our first quarter 2014 non-GAAP operating income compares to fourth quarter 2013 non-GAAP operating income of $43.6 million or 12.4% of revenue to the non-GAAP operating income of $14.2 million, or 4.3%, reported in the same period last year. First quarter 2014 non-GAAP income tax provision was approximately $1.0 million compared to the prior quarter's $0.9 million. As a reminder, our non-GAAP income tax provision approximates our cash taxes incurred. GAAP income tax was $2.7 million in the first quarter of 2014.

On a non-GAAP basis, for the first quarter of 2014, we had net income of $29.1 million or $0.07 per diluted share. This result compares with fourth quarter 2013 non-GAAP net income of $43.6 million or $0.10. And non-GAAP net income of $13.6 million or $0.03 per share in the first quarter of 2013.

GAAP net income totaled $2.2 million or $0.01 per diluted share for the first quarter of 2014. This compares to $7.2 million or $0.02 per share for the fourth quarter of 2013, and a loss of $47.7 million or $0.11 per share for the first quarter of 2013.

Turning to the balance sheet. We continue to improve the strength of our balance sheet while also generating considerable cash. Cash receivable totaled $195 million at the end of the first quarter, a decrease of approximately $12 million on a sequential basis. Day sales outstanding were approximately 53 days, a slight decrease from the prior quarter and within our normal range.

Inventory dropped by almost $28 million sequentially to $247 million primarily as a result of the impact of the fab disruption and the higher than anticipated revenue. This represents our lowest absolute inventory level since the third quarter of 2009. Days of inventory decreased by 10 days from the fourth quarter and now stands at 114 days, which is below our target model of 120 to 130 days. We had another strong quarter of cash flow as operating cash flow totaled approximately $46 million in the first quarter. We expect to continue to generate significant cash from operations.

Capital expenditures are approximately $17 million in the first quarter, up from $9 million in the fourth quarter. Depreciation and amortization in the first quarter of 2014 was approximately $13 million, down compared to $18 million in the fourth quarter of 2013 and down from $20 million in the first quarter a year ago. Combined cash balances including cash equivalents and short-term investments totaled $255 million for the first quarter, representing a sequential decrease of approximately $24 million. This decrease was after the return of $55 million to shareholders through stock repurchases. During the first quarter we repurchased 6.9 million shares of common stock in the open market at an average price of $7.97 per share. Since the inception of our buyback program in the second half of 2010, we have now repurchased approximately $716 million of our stock.

Now let me turn the call over to Steve Laub for a commentary on our business. Steve?

Steven A. Laub

Thank you, Steve. First, I want to express my appreciation to our employees with the tremendous job they did in helping the company recover from the impact of the unplanned fab shutdown, which began this past December 23. Although we lost nearly 4 weeks of output, our operations, customer service and sales teams worked extraordinarily hard to make sure we protected our customers from any short-term supply disruptions through this difficult period. I'm pleased to report that the fab is running smoothly, and we have increased our fab's activity to the highest level since the third quarter of 2011.

Moving to the discussion of Q1 results. We have better than seasonal revenue, which exceeded our expectations due to stronger-than-expected demand and more rapid supply recovery with the unplanned fab shutdown. We are pleased that our non-GAAP gross margin continued to improve despite the lower sequential revenue, unplanned fab shutdown and reduction in inventory.

From an end market perspective, industrial, our largest end market, grew sequentially for the fifth conservative quarter and increased mid to upper teen’s year-over-year. While consumer, our second largest market, was down sequentially in a seasonally weaker first quarter but improved significantly year-over-year. Automotive was up sequentially and up double digits on a year-over-year basis. While communications and networking was down both sequentially and year-over-year.

Revenue from the mobile market was up sequentially due to sales into tablets growing for a third consecutive quarter while down year-over-year as a result of lower Sensor Hub business from a large smartphone customer.

Looking at our results by business segment, our microcontroller business generated revenue of $235 million, down 2% sequentially and up 3% year-over-year. Our microcontroller business performed better than seasonal and would have grown sequentially had it not been adversely impacted by the fab shutdown. By product family, during the first quarter, our 32-bit microcontrollers increased 1% sequentially and were down 1% year-over-year. Our 8-bit microcontrollers were down 3% sequentially and up 6% year-over-year.

Taking a look at our core microcontroller business, core microcontrollers declined slightly sequentially due to unplanned fab shutdown while increasing at a double-digit percent year-over-year. We continue to deliver a significant number of new 32-bit and 8-bit products during the first quarter with nearly 40 new core 32-bit microcontroller products released, at faster pace than last year when we introduced a record number of new 32-bit products. To put this into context, during 2013, we released to production 128 new 32-bit core microcontroller devices, as compared to 97 in 2012 and 52 in 2011. These new devices, as we have noted before, led to record high levels of customer design activity last year, which has continued into the first quarter of this year.

During the first quarter, among the new products released to production was a new ARM Cortex-M0+ family of ultra-low-power microcontroller products called SAM D21, which offers expand connectivity and communications functionality to enable design scalability for Internet of Things applications, targeted for industrial, consumer and medical applications.

Turning to connectivity and the Internet of Things, significant new product launch occurred at the Embedded World conference in late February, when Atmel introduced a revolutionary new family of breakthrough products for the IoT marketplace. The new family is called SmartConnect and combines Atmel's ultra-low power microcontrollers with wireless connectivity solutions in an easy-to-use turnkey solution.

The SmartConnect family offers both ultra-low power Wi-Fi module, which integrates company's ARM Cortex-M0+ microcontrollers with Wi-Fi Internet connectivity for IoT end points in a single package. We also announced a ZigBee-based solution with a robust set of peripherals and a high-performance RF transceiver combined with Atmel's MD 20 Cortex-M0+ microcontroller in a single package.

The SmartConnect solutions reduce the development time for cost effective, battery-operated applications in the industrial market such as machine-to-machine, home and building automation, LED lighting, smart energy and consumer markets such as wearables and home appliances. Atmel has one of the industry's most extensive portfolios of technologies for IoT applications, including ultra-low power microcontrollers, wireless connectivity, Sensor Hub and security IP.

When combined with our easy-to-use software development tools and worldwide application service and support network, Atmel is uniquely positioned to deliver these technologies to our global customer base. Mentor Graphics recently announced a collaboration with Atmel to accelerate the development of next generation IoT devices from medical, industrial, smart energy and consumer applications.

Atmel's ARM Cortex-M4 and M3 products will be combined with a Mentor-embedded real-time operating system and tools for applications that require a high performance connectivity, power efficiency and high memory densities for today's advanced connected devices. Embedded developers will have a complete embedded environment to develop their system designs leveraging Atmel's microcontrollers with advanced efficiency and productivity.

After new IoT design wins, Roku's Streaming Stick, a video streaming dongle that users can just discretely plug in to their HDTVs to access online video services such as just Netflix, HBO GO and Pandora, was recently introduced featuring our Wi-Fi solutions, are now have a reference design for gaming devices. We continue to see broad adoption for our Wi-Fi and ZigBee solutions in human interface device applications.

In a market for our smart energy products, Atmel recently announced a new product in smart metering for the Power Line Communications market that implements the physical layer of power line intelligent metering known as PRIME. PRIME is a worldwide standard for advanced metering, grid control and asset monitoring applications. Atmel's ATPL 238 solution includes enhanced features in addition to the current requirements of the PRIME specification such as additional robust modes and a frequency band extension. It has been developed to be bundled with an external Atmel microcontroller or microprocessor.

We have one of the industry's broadest portfolios of smart energy products from the analog front end to the processor and communication stack. We are experiencing strong design activity for our new smart energy platform as it has been selected for next generation of smart metering rollouts by 7 of the top 10 OEMs.

In the automotive space for our core microcontrollers, our automotive microcontroller business continues to deliver strong growth, posting double-digit gains sequentially and year-over-year. During the quarter, we introduced 2 new automotive grid AVR microcontrollers, the XMEGA64D3, and tiny1634. Both new families offer LIN-connected capacitive button slider and wheel applications targeted for HMI connections within the passenger compartment.

Also in the automotive space, we are experiencing high customer interest for door handle sensors in Passive Entry Go access systems, utilizing our microcontrollers and touch libraries. In our software development tools and ecosystem, Atmel recently introduced a new version of its very successful and widely adopted Atmel Studio 6 integrated development platform for developing and debugging Atmel ARM Cortex-M and Atmel AVR microcontroller-based applications. The primary focus for the new Atmel Studio 6.2 has been the addition of advanced debugging features such as data trace and visualization. The production release of Atmel's Studio 6.2 also gives users an even more seamless, easy-to-use development environment.

In addition, we added 2 new development kits focused on enabling designers with low-cost, fast prototyping platforms across a wide breadth of customers. One of the new kits introduced features a low-cost mini-development board based on Atmel's 8-bit AVR technology. The second evaluation kit is based on Atmel's ARM Cortex-A5 microprocessor. The A5 board comes with a rich set of ready-to-use connectivity and storage peripherals. RD [indiscernible] compatible connectors and a Linux distribution and software package that enables rapid software development.

Turning the discussion to our touch products. Earlier this week, we announced the production release of 2 new maXTouch product lines with our T Series family, 1066T and 1068T, which extend our product leadership to the midrange tablet market. These products are specifically designed to support tablets in the range of 7 inch to 8.9 inch with features that include multi-finger glove support, improved moisture resistance, the support of thin cover lens, and for the 1068T, the support active stylus and hover.

These products also offers significant improved noise immunity with a voltage crippler, which eliminates the need for additional hardware to handle noisy aftermarket chargers. We expect increased activity in the market for some 9-inch tablets as Microsoft stated at their recent Build Conference that they will be providing the Windows 8.1 operating system for free on screen sizes less than 9 inches.

In the market for large-screen devices, at the end of the first quarter, Atmel was Win 8 and 8.1 certified in approximately 170 different tablets, notebooks and ultra-books, more than any other touch supplier. And is actively engaged in well over 280 different Windows 8 and Windows 8.1 programs. These totals are higher if we include our precision touchpad design wins. We have won multiple new designs between maXTouch in both Android and Windows 8 tablets, and that momentum should continue as a result of the superior performance of our new T Series products.

New products available today featuring maXTouch include Samsung's Galaxy Tab 4 10.1 inch, Galaxy Tab 12.2 inch, Galaxy Note 12.2 inch and HP's EliteBook [ph] 1000 G2. As the largest touch supplier for large-screen systems including both Android and Windows 8 and 8.1 systems, we remain well positioned to benefit from the continued growth of tablet, ultra-books and convertible systems as users accelerate their transition to touch-based technology from traditional PC-based systems.

In a market for smartphones, we are well-positioned to increase our share in the smartphone market with maXTouch. Some new OEM product introductions featuring maXTouch includes several new models from LG, a new tier 1 customer. These models include the G Pro 2, G2 mini, L Series III L90 and the Lucid 3 for Verizon.

In the Chinese market for smartphones, Xiaomi, one of the hottest smartphone companies in China, released their Red Rice 5.5-inch while Gionee's new product called the Elife S5.5 and ZTE announced the Grand S Lite featuring maXTouch. Expect to see more design wins from the second half of the year with our high performance maXTouch T Series products, as OEMs release new products, which featured touch gestures with hover support, ability to write with passive stylus, superior multi-finger performance when wearing gloves, improved moisture and touch performance for on cell designs.

In markets beyond smartphones and tablets featuring touch, we are extending our leadership position within the automotive market with the announcements of 2 new automotive qualified maXTouch controllers, adding to our already extensive automotive touch product portfolio. The 1188S is optimized for touch screens up to 12 inches while the 1664S is ideal for touchscreens up to 14 inches. Both touchscreen controllers are optimized for automotive center consoles, navigation systems, video interfaces and rear seat entertainment systems. We also offer robust glove support and improved moisture resistance, which are 2 key requirements for touchscreen-using vehicles. Atmel is a leader in touch solutions for automotive, consumer and industrial markets. It continues to bring innovative technologies to these markets. We continue to win substantial new programs with maXTouch for OEMs based in Europe, North America, China, Japan and Korea.

Turning our discussion to XSense. As to new tier 1 OEM products in production, HP began shipping its third system featuring XSense, HP's EliteBook [ph] 1000 G2. This product combines our XSense metal mesh sensor with maXTouch and also features our maXStylus and an AVR micro for the capacitive home key. Corning recently announced they're collaborating with Atmel to develop ultrathin capacitive touchscreens with superior multi-touch performance for next generation applications. This collaboration combines XSense flexible touch sensors with 0.4 millimeter damage-resistant Corning Gorilla Glass. Very thin cover glass has been a problem for ITO technology but it is not an issue for XSense. Together, Corning and Atmel are able to deliver outstanding capacitive touch performance within flat or curved covered glass.

Looking at the automotive business segment, revenue of $41 million in the first quarter of 2014 was down 7% sequentially and up 4% as compared to first quarter of 2013. The business was adversely impacted by a decline in legacy products, which are approaching end of life. Our auto RF business, which includes remote keyless entry and Passive Entry Go systems had the strongest quarter in over 5 years as we continue to grow this business and take share in the market. As to new products, we extend our automotive network and product leadership with the launch of our fourth generation low-power, local interconnect networking or LIN system, used for automotive comfort, sensor and actuator applications. Atmel is a leading automotive LIN provider with the largest LIN product portfolio worldwide for in-vehicle networking systems.

Moving to our non-volatile memory business segment. Total revenue was $36 million in the first quarter of 2014, down 8% sequentially and up 1% as compared to first quarter of last year. The memory business is seasonally down in Q1 and was also impacted by the supply constraints due to the unplanned fab shutdown. We continue to see the need and to deliver higher density memory products going into the industrial and medical markets.

Looking at the multi-market and other business segment. First quarter revenue of $26 million was down 19% sequentially and down 2% as compared to first quarter of 2013. This is primarily due to softness in our Aerospace business in what is typically a seasonally weaker quarter.

Turning to the first quarter revenue by geography. Our largest ship to location was Asia, representing 53% of revenue, EMEA was 30% of revenue, while the Americas were 17% of revenue. Asia decreased sequentially during the first quarter while EMEA strengthened significantly and the Americas improved modestly.

In summary, our market opportunities continue to expand as our competitive position strengthens. Our core microcontroller business is benefiting from the substantial investments in new products, targeted at growth opportunities in IoT and connectivity, smart energy, sensor management and automotive. We have laid the foundation for solid growth in our touch business and are increasingly confident of share gains in the smartphone market while extending our leading position in large-screen automotive and other new touch markets.

Equally as important is our anticipated revenue growth this year, our improving cost structure should enable us to meet the margin expansion goals we have previously stated. We have delivered 4 consecutive quarters of non-GAAP gross margin expansion and expect this trend to continue for the remainder of 2014.

With the take-or-pay supply agreements and a short-term supply disruption behind us, our pace of gross margin expansion should increase due to higher revenue and improved utilization of our manufacturing assets, transition to lower cost geometries for our new products and the impact of operational initiatives we have already put in place. Our substantial stock buyback during the first quarter demonstrates our commitment to continue returning capital to stockholders and our confidence in Atmel's improving operating performance.

Now let me turn the call back to Steve Skaggs for our Q2 financial guidance. Steve?

Stephen A. Skaggs

Thank you, Steve. For the second quarter, we expect continued positive general demand trends and expect revenue to be between $348 million and $364 million or about $356 million at the midpoint of our outlook.

Second quarter non-GAAP gross margin is expected to increase by 125 basis points to 45.25% plus or minus 100 basis points. Non-GAAP operating expenses are expected to be approximately $121 million with a range of $119 million to $123 million. We expect spending to flatten in the second half of the year.

For the second quarter, total stock compensation is expected to be approximately $16 million. We expect depreciation and amortization of approximately $14 million, and the capital expenditures of approximately $10 million to $15 million. Other expenses are expected to be approximately $1 million and acquisition-related charges are expected to be less than $2 million for the quarter. We expect our non-GAAP tax provision to be approximately $1 million to $2 million. And finally, for modeling purposes, assume a non-GAAP share count of around 432 million shares.

This concludes our prepared remarks. Now we'll open the call up for your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Suji De Silva with Topeka.

Sujeeva De Silva - Topeka Capital Markets Inc., Research Division

First of all, in terms of the gross margin, could you just go through the elements that allowed you to expand the gross margin even though the revenues were down in the first quarter?

Stephen A. Skaggs

Sure. I guess I would take this opportunity to reaffirm our target of 49% for our non-GAAP gross margin by the end of 2014. At a quarterly level of at least $350 million. We're on track to that plan, and we are reiterating that target at this time. I think, additionally, as many of you are aware, we have also aligned our executive performance-based stock compensation plan to be consistent with that target. Our gross margin drivers are quite consistent with the plan that we articulated about 1 year ago now to get to that target at the end of 2014. And we remain on track to achieving that. During the current quarter, we continue to get the contributions from that plan. But let me just remind everybody what that plan entailed in moving gross margin from 40.5% to 49% in that timeframe. So we expected 200 to 300 basis points from the elimination of high-priced legacy take-or-pay contracts, which are being realized now that those contracts are completed and we've taken final inventory and we're selling through associated inventory from those contracts, now replenishing inventory at lower costs at foundry prices. We did continue to see benefit from that last quarter and expect benefit to accrue this quarter that's been embodied in our guidance. Additionally, we expected 500 to 600 basis points, again, as measured from Q1 of last year of improvement, from a substantial list of identified resource and timeframe-phased operational initiatives that are being implemented and driven within the companies at all levels. And again, many people are aligned around achieving those goals. So we benefited from that last quarter as well. And then finally, we expected about 500 basis points of improved utilization measured from $329 million of revenue, up to $450 million in quarterly revenue over that time. And the realization of that is dependent upon kind of our revenue level. So I would say, circling back to your question, we saw a benefit from the operational initiatives, from the take-or-pay contracts last quarter. As expected, we expect further benefits through the year as we drive towards our target. We did have some slight product mix headwinds last quarter but we were pleased to achieve our guidance despite that and being able to raise guidance or raise the target for next quarter, for non-GAAP gross margin.

Sujeeva De Silva - Topeka Capital Markets Inc., Research Division

Another question is around the 4 new segments you've broken out, what do you think the longer-term growth opportunity for each one is and are there any headwinds or legacy elements buried in any of the 4 that we should be aware of?

Steven A. Laub

With respect to the different segments, our sense is that certainly within MCU business, MCU business segment, which encompasses both the core micros as well as the touch controllers, in that we've added to is sort of our custom microcontroller business as well, our expectation is that should generate very nice growth for the company going forward, both the core microcontroller business, it's a business that we believe grows faster than a general semiconductor does. We expect to grow, certainly to gain share each year within that business and so that provides a kind of opportunity. Just to remind you, last year, we grew high double-digit, our core microcontroller business. With respect to the touch business -- we've talked about the fact that with a relatively weaker 2013, our expectation is that this year, we would see regain significant growth in that business. We talked about a number of new products, new customers products that have now been released to production.

And so particularly, we expect to increase share in the smartphone for the marketplace while extending our position, transition to the other parts to marketplace. So we expect that, that part of the market will also generate very nice growth for us this year, as well. And the sort of the custom microcontroller business that's now being included in there, that's probably relatively steady, steady for such a relatively small amount of business. But what it does is it encompasses all the microcontroller products for the company in one particular business unit. The automotive business segment -- we expect that the automotive I think is what we have seen. We talk of the fact that, that grew for us as a business. All automotive sales by this company grew very nicely last quarter and very nicely also, year-over-year. This particular business segment does have a bit of a legacy product in it that doesn't grow quite as fast, but our expectation is that this year, it's probably going to be relatively flat to last year but after that, it becomes very much consistent with the automotive semiconductor marketplace. Nonvolatile memory now includes both serial memories and also includes what we call our secure CryptoMemories. We actually think that serial memories tends to grow pretty much with the semiconductor marketplace, maybe a little bit slower than the semiconductor marketplace. But the secure crypto, actually, we believe has significantly faster growth opportunities than the general semiconductor marketplace. So our expectation is that, you'll start seeing at the second half of this year and clearly into next year, that overall segment should grow faster than your general semiconductor marketplace, as well. The multimarket and other is actually sort of a mixture of different businesses. The aerospace business for us is a relatively flat business, towards which is probably the largest component today in that segment. The XSense businesses in there -- we think the XSense business has significant growth opportunities but it's relatively small today, and so that's going to be longer in coming in that regard. And then some of the other businesses, I would say the programmable logic and some of the legacy ASIC business is relatively flat to slightly down. So overall, putting aside XSense, I would say that business is probably flat overall, generally. Maybe even slightly down. The XSense business would be one area growth in that particular area.

Operator

And your next question comes from the line of Craig Hettenbach with Morgan Stanley.

Craig Hettenbach - Morgan Stanley, Research Division

Yes. Steve, thanks for the color on some of the new SmartConnect product family. Can you just talk about the trajectory of that business, kind of where you stand from a design perspective and customers' response to it?

Steven A. Laub

The customers' response is actually very high. There's a lot of action design activity. I would say overall, our connectivity business has actually been growing very nicely for us. I think year-over-year, from a quarterly -- if I had to compare Q1 of this year to Q1 of last year, I think the business actually doubled for us. So actually, they're still off a relatively small base. So this is going to be a high-growth area for us, and we think that by delivering these products to the marketplace, that will help accelerate already a high-growth area. But it's going to take some time, because it takes time for these products to actually be incorporated in the customer systems and to drive that. But we are one of the few companies that actually has that I would say a complete system that allows customers to begin to design a very sort of cost-effective low-power, fully incorporating both wireless technology and microcontroller technology along with the relative IP to implement really IoT applications for customers. So we have that now, Wi-Fi, we've also become co-designers with ZigBee, and again, I think it puts us in a very good position for Internet of Things growth as we move forward.

Craig Hettenbach - Morgan Stanley, Research Division

Got it. And then as my follow-up, how would you frame the opportunity in touch going forward when you look across automotive handsets and then kind of tablets/notebooks, where do you see the best relative opportunities?

Steven A. Laub

Well, as I look at all 3 of those areas, I'm expecting actually significant growth in all 3. From a standpoint, they all have different characteristics. Clearly, the smartphone market is probably the most dynamic, because the designs last for -- production volumes last for less than a year whereas the automotive market designs -- what's nice about those is once you've won those, they typically last for anywhere between 3 to 5 years in a customer system. So we actually find all 3 to be attractive. All 3, we expect to have very significant growth for us. But clearly, more and more long term, the more we can drive into these other markets being automotive, industrial and so forth, which have, I'd say, much longer product life cycles. I think that's very healthy for us as a company and for our business, overall. But as we have talked before, we are engaging much more deeply into the smartphone market this year, and we're actually seeing a lot of success already. And I think you guys will start seeing those numbers really reflected in the second half revenues.

Operator

And your next question is from the line of Vivek Arya with Bank of America Merrill Lynch.

Vivek Arya - BofA Merrill Lynch, Research Division

If my math is -- Q2 sales guidance has touched below the target you had set before, even though you beat Q1 and you're seeing the demand trends improving. So I'm curious why is the guidance below the targets you had set before?

Stephen A. Skaggs

And so the reason for that is as follows: if you go back Q1, as you can see, turned out about $12 million above our expectations. We had set the expectation at $325 million. This was due to the fact that $10 million of it are roughly was due to faster-than-expected recovery from the supply disruption. And we think roughly $2 million or so was due to higher demand than anticipated. Previously, we had put out for Q2, that revenue would be $361 million, we had anticipated out of that. Roughly $9 million will be based on supply recovery. We're now expecting $356 million. We're all showing, expecting supply recovery of roughly $2 million to $3 million this quarter because we did so well and actually recovering last quarter. So if you adjust the supply recovery, we've actually raised our guidance for Q2. And in fact, if you look at the first half of 2014, our initial guidance had been $325 million for Q1, $361 million for Q2, which is $686 million. We're now forecasting actually $693 million or up $7 million higher than what you anticipated before. So it really is adjusting for the supply recovery to how much better we had done on that in Q1 than we had anticipated.

Vivek Arya - BofA Merrill Lynch, Research Division

Got it. And then XSense, I know you had mentioned a lot of design wins. I'm wondering how much of a financial burden that is right now. Obviously, it's in the investment phase. And what milestones are you looking forward to as to whether you should stay or exit or look at other options for that business?

Steven A. Laub

With respect to the XSense business, we are obviously, in investment phase. That's something we have articulated. Clearly, the growth of the business with respect to revenues and certain margin, and milestones as well are things that we have internal. We don't share those externally. And I won't be sharing those now. But with respect to that, we do have certain milestones for us with that levels of investment, levels of return and so forth.

Operator

And your next question comes from the line of Rajvindra Gill with Needham & Company.

Rajvindra S. Gill - Needham & Company, LLC, Research Division

Just a follow-up on XSense. Can you talk about at least the design win traction that you're getting? I know you mentioned HP, but are there additional designs that you anticipate in the second half? And I think with respect to CapEx, the CapEx I think you had said it was $16 million for Q1 or $17 million for Q1 and so that was up significantly from Q4. That increase in CapEx, is that your to XSense and when do you think you'll be able to get a return on that?

Steven A. Laub

So regarding the sort of the design activity on XSense and so forth, we are working on several designs. So design activity is actually reasonably active. I think what we find is that the customers' decision point in reaching a conclusion, picking and going has taken longer than we anticipated. So we don't share the actual number designs. We do have several designs that are moving into that win phase, but it has been a slower process than we had anticipated and some designs haven't yet come to fruition. It isn't that the designs were lost. It's more on the lines of the customers deferred decisions on some of these projects longer than we had anticipated. So we're working with them on the designs, they just haven't yet gone into production. And that's when we declare it a design win would actually go into production. With respect to the capital, let me turn it over to Steve.

Stephen A. Skaggs

Sure. Capital expenditures were $17 million in the first quarter. Those were higher due primarily to the capital expended in Colorado to remediate the supply situation. In addition, some IT investments that were made at the first part of the year due for budgeting reasons. We expect that to moderate through the year and I think as I said on the prior call, the target for capital spending for this year is relatively consistent with last year.

Rajvindra S. Gill - Needham & Company, LLC, Research Division

Okay. And just a question on the competitive landscape and the smartphone capacitive touch market. You had mentioned that you're kind of regaining some share and LG was a big new customer for you. Can you talk about where you're seeing the share gains? Is it coming from more of the U.S.-based established competitors or are you gaining share from the Asian suppliers, the local Asian touch controller suppliers there?

Steven A. Laub

Actually, it's from both. Depending on the who the customer is and who has obviously been the incumbent supplier. But we are finding that we're gaining share or gaining designs replacing the incumbent, both American suppliers as well as Asian suppliers. So it really cuts across both.

Rajvindra S. Gill - Needham & Company, LLC, Research Division

And just as quickly on that, how would you describe the pricing environment in the touch business this year -- regards to your expectations this year versus, say, the last 2 years?

Steven A. Laub

I actually expect that this year, the pricing environment to be actually more moderate than I think what we've experienced the last 2 years. I think to some extent that's being driven by -- even though it's hard to appreciate for us because there's a number of different suppliers in the marketplace. There actually has been some consolidation and also some focus that people have in different parts of the marketplace. But our expectation is that the pricing is actually moderating a bit relative to the declines in the prior 2 years.

Operator

And your next question comes from the line of Anthony Stoss with Craig-Hallum.

Anthony J. Stoss - Craig-Hallum Capital Group LLC, Research Division

Steve, if you wouldn't mind for your June guidance, can you give us the up and down at each of the segments like you've done in the past? And then secondly, referring to your microcontrollers with Wi-Fi and MCUs with ZigBee, I'd love to hear kind of the design activity you're seeing in those versus a discrete microcontroller.

Steven A. Laub

Sure. With respect to the businesses, our expectation is that our overall microcontroller business will be up in the high-single digits. That includes obviously, our core business as well as our touch business. And just to give you some -- I should break that out for you. The core business, we expect will probably be closer to mid-single digits. The touch business will be up double digits, as our expectation. The automotive business, we actually think will be down mid-single digits. Memory, up double digits. Multimarket and other business will probably be down in the mid-single digits. With respect to design activity, with respect to sort of the Wi-Fi and the SmartConnect solutions that we have, again, we just announced these products in February. This 2 months later, so right now a lot of things have to -- it's really a lot of presentations, demonstrations and so forth, going on with customers. And I can tell you that the level of activity is -- this new customers' level of activity is actually quite high. I can't share with you who those particular customers are. It does cut across primarily sort of the industrial marketplace is actually a pretty active market for that. I'd say really home and building automation, a lot of products that go into -- what you'd find in a home, what you'd find in buildings sort of the climate-type of things or things controlling security, really peripheral type of products like that is were seeing a very substantial amount of interest for.

Anthony J. Stoss - Craig-Hallum Capital Group LLC, Research Division

And then lastly, on the Sensor Hub side, can you share with us the number of customers and what your expectations are for Sensor Hub for the remainder of the year?

Steven A. Laub

I can tell you there's actually -- the covered customers in our Sensor Hub business continue to expand. Sensor Hub has become a product or a business that I would say you can count on one hand the number of customers for that, if you go back 12 to 18 months. And what's happened is because I'd say that the 2 largest smartphone suppliers in the world have now added that to their products in a much more prolific way. As well as it's being used, for example, in a number of I'd say Window systems and now also being used, added to Android tablets as well, due to some of the requirements in the latest operating systems. We're actually seeing the number of Sensor Hub customers has become double-digit for us. So that's a very healthy thing for us because -- and most of those are mobility customers today. We're also seeing a desire for Sensor Hub in a lot of sort of IoT and wearable-type marketplace as well, where people are adding a lot of sensors and those kinds of products sell. This is a business that started off as a sort of a solution for smartphones and then tablets, and it's now expanding actually pretty significantly. We did have some softness. We will have softness in the first half of this year because of a particular customer of ours who will be less for us in the first half of this year than they were for us in the first half of last year. And so that is impact the Sensor Hub business in the first half. We do expect that business actually to actually grow nicely in the second half of this year based on the activity that we're seeing.

Operator

And your next question is from the line of Chris Caso with Susquehanna Financial.

Christopher Caso - Susquehanna Financial Group, LLLP, Research Division

Just with regard to the impact of the fab shutdown. Last quarter, you talked about 1/3 of the recovery happening in the third quarter, do you still expect that to happen right now or given the fact that the pace of recovery was faster than you thought, have we seen most of the recovery factored into the Q2 numbers by now?

Steven A. Laub

We do expect a little bit of recovery to continue to the third quarter, but because we were able to recover so significantly during the first quarter, we think it's been relatively small, and not significant enough to really break it out in a meaningful way.

Christopher Caso - Susquehanna Financial Group, LLLP, Research Division

Okay. Good. And just with regard to what you guys considered to be normal seasonality in the third quarter. Obviously, it's early, but just particularly with the new segmentation, could you provide some color on what generally we would expect?

Steven A. Laub

Just a moment. So usually, our third quarter is -- it's typically, I'd say, up low- to mid-single digits for us as a company. And my expectation is that this year should be pretty consistent with the way we've experienced it -- what we experienced in the past on that. If anything, I think maybe a little bit stronger this year than they were in all years because obviously, our seasonality takes a blend of both good years and soft years. This is probably a little bit better this year, what we're saying than is a typical year for the industry. For example, I think last year would be a softer year than this year, is what we're seeing so far. But the typical seasonality again is low- to mid-single digits.

Christopher Caso - Susquehanna Financial Group, LLLP, Research Division

Okay, great. And just one final one, and you provided a good walk-through of how you got to the 49% gross margin target, just with regard to the operating cost reductions and the benefit from the take-or-pay, how much is left to go in each of those areas? In other words, how much incremental benefit do you still think you get in each of those areas as you get from here to the 49% target?

Stephen A. Skaggs

It's difficult to breakdown at a very fine level of precision. We tried to give everybody a roadmap and I think all would say we've been quite consistent with that roadmap and we haven't changed the value of each pocket. We do have some additional benefit from the take-or-pay that will accrue in the second quarter, which has been factored into our guidance. There may be a small amount after that. The remainder of the benefit above our guidance is due to operational initiatives including migration of some high volume products to smaller geometries and getting the benefit of a cheaper die, as well as any utilization benefit that would accrue as the revenue increases after the Q2 guidance we gave.

Operator

And your next question is from the line of Blayne Curtis with Barclays.

Christopher Hemmelgarn - Barclays Capital, Research Division

This is Chris Hemmelgarn on for Blayne. So I guess just generally, I was interested in your thoughts on the touch business this year, you mentioned that large screen touch, is a little slow in 2013. Kind of your expectations for the trajectory in the next couple of years, and I guess, more broadly, do you still see quite the opportunity you've seen before in laptops or do you see tablets, et cetera, as a greater opportunity going forward?

Steven A. Laub

We've anticipated both. We've actually seen -- more recently, we've seen actually the tablets provide a better opportunity than I would say than the laptops from that standpoint. So from a standpoint of looking from a more nearer term, we see the tablets provide that. If you think about the business generally, one thing that we do believe is that I think what you're hearing from the PC manufacturers, I would say so the market adoption of touch on laptops sort of that -- sort of the transition or flip over hasn't yet occurred. And we get our best information from our customers on their new designs and what projections they're putting out there, what they're building for that. And so far to date, they've been disappointed that they've not been able to achieve the kind of numbers they expected to achieve. From the standpoint of what percent of their PCs ship with touch, what percent ship without touch. However, one thing that they say to us and we also believe is that the cost of touch to add to, say, a laptop has been coming down dramatically over the last 18 months. And so it will -- it does provide a better user experience for the customer. So with the continued adoption of Windows 8 and 8.1, combined with the fact that the cost of adding touch is coming down, significantly, we do expect there will be a time when the customers will just flip over. And so it's one of those things where people often predict nice and steady transitions. But what often happens in reality, it's not a nice and steady transition. It is a slow transition and then it flips. It turns on. And our expectation is that's going to happen here, we just don't know exactly when that's going to happen. But we want to be positioned, so that when it does, we garner that a big benefit from that actually occurring.

Christopher Hemmelgarn - Barclays Capital, Research Division

And then just as a quick follow-up, your products, typically offer some more premium, I guess, capabilities than maybe in a lot of handsets sold into emerging markets, that's certainly been a hot area of growth lately. I was just interested in -- are you seeing a greater interest in your Sensor Hubs or in the premium features your touch products offer, particularly in Asian white-box manufacturers or is that still mainly price competitive market?

Steven A. Laub

We're certainly seeing that with respect to dominance, I'd say the smartphone carriers, the smartphone developers and system guys in Asia, we're actually seeing ourselves being quite successful and penetrating into a number of those this past few months than we had historically. So I think that they're appreciating the distinction of what we offer for that. With respect to the white-box manufacturers, we're still not seeing a big, I would say, a big change in their behavior on that. But we are still -- what we are saying is that the Asian manufacturers, for example, in the automobile area or the industrial -- or the automobile area particularly, that they are very much caring about what they choose. And so our penetration into Asia, whether it'd be China, Korea, Japan on automobile base, touch is actually going extremely well.

Operator

Your next question is from Jeff Schreiner with Feltl.

Jeffrey A. Schreiner - Feltl and Company, Inc., Research Division

Steve, could you talk maybe about how broad the industrial end market strength was really in March? And maybe what's implied in your June guidance, as it relates to industrial?

Steven A. Laub

So just to give you some background, so industrial for us grew for the March quarter. Say sequentially, it was kind of sort of in the -- it's sort of low- to mid-single digits growth projection, it was low single digits. But we've been faster or stronger but for our supply disruption, which impacted our ability to ship some of our products to that. So with the fifth quarter of sequential growth in industrial, our expectation is it will continue to grow. This quarter, as well, based on the feedback we get from our customers. And also, it also is based to some extent that this is a -- products that are sold to a number of people not just in North America and Asia but particularly strong in Europe, which is beginning to see -- and we're starting to see, I think others are seeing a recovery occurring. So our expectation with industrial will continue to be an important part of driving our business during this year.

Jeffrey A. Schreiner - Feltl and Company, Inc., Research Division

Okay. And then could you also then possibly talk about maybe the magnitude of snapback that we have been anticipating within the touch markets, be it smartphone and tablet, it seems that certainly you could go out and you could gain a little bit of share, and that would be great and would be an improvement on the business. But could you kind of help us in terms of the magnitude you're expecting touch to be as a component of your growth over the next 12 months?

Steven A. Laub

I don't want to give forecast regarding what we think the numbers are going to be 12 months from now. I think any time anyone has done that, they've always looked back and say, they wish they had not. We did give guidance regarding this quarter and we said we expected the touch business to be up double-digits this quarter. So I think that gives you a sense for -- that we are seeing a significant sort of growth in the business, which is different than, for example, the experience we had last year. And I can tell you that our expectations will continue to grow in Q3, as well. So I will share that with you. But I think in the touch business, any time it would go beyond 3 or 6 months, it just won't have the visibility as well, with respect to that because of the dynamic nature of that marketplace.

Operator

And your next question comes from the line of Hans Mosesmann with Raymond James.

Hans C. Mosesmann - Raymond James & Associates, Inc., Research Division

Most of my questions have been answered but just one clarification there. Can you give us some detail on the mix of your core microcontrollers coming from AVR versus ARM, and how should we view their growth profile over the next couple of years? [indiscernible] 32-bit?

Steven A. Laub

Hans, we don't give any break out -- on the 32-bit?

Hans C. Mosesmann - Raymond James & Associates, Inc., Research Division

Yes, that's right.

Steven A. Laub

Okay. So with respect to the vast majority of our 8-bit is our AVR product. Within the 32-bit space, I'm not going to give you specific percentages because we keep those confidential. But I can tell you that we are seeing a shift from the AVR 32 product, which we call it, toward the ARM product line. And so that is occurring, and that's something that we expect to increase as we go forward in the future. So in that respect, I will share with you and also share with you that the ARM product line today is larger for us than the AVR 32, and they will be growing faster for us moving forward.

Operator

And our final question comes from the line of Christopher Rolland with FBR Capital Investments.

Christopher Rolland - FBR Capital Markets & Co., Research Division

I'm sorry if this has already asked but because capacity came online faster, how much revenue was pulled into Q1 that was expected in Q2? Or I guess, asked sort of a different way here, how close is that Q2 number to being a real run rate?

Stephen A. Skaggs

So yes, I think this was asked earlier, and so that you potentially missed it but just to let you know, so Q1 came in at $12 million above our expectations, the midpoint of our expectations. Of that $12 million, approximately $10 million was due to faster-than-expected recovery from the supply disruption, which tells you that roughly approximately $2 million was higher demand than we had anticipated as part of our forecasted revenue. So Q2, we had said would be $361 million, in that $361 million, we've anticipated $9 million of it was supply recovery. We've now told you guys that the Q2, we now expect $356 million. But the supply recovery in Q2 is probably closer to just $2 million to $3 million. So when you adjust for supply recovery, our Q2 number is much -- is actually higher than it was before, when you adjust the supply recovery, and it therefore tells you it's probably within $2 million to $3 million dollars of our natural number as well. Put in perspective also, our first half 2014 revenue was previously forecasted at $686 million. Now it's actually being forecasted at $693 million, so it's actually up $7 million first half as compared to what our previous forecast was. So it's important to know that despite the fact that the number we've given you for Q2 is lower than before, it's actually higher on natural basis than it was before.

Christopher Rolland - FBR Capital Markets & Co., Research Division

Great. That was great detail. Also a quick one on lead times, did -- was your lead times, did they expand in the quarter? And then also one of your competitors was fairly vocal about their embedded segment and MCUs in particular, what's going on there? Is it sort of a rising tide situation in all boats here or is this potentially, are they doing something different than they haven't in the past and are there any market share implications?

Steven A. Laub

With respect to what's happening in the marketplace, it's interesting. We grew our core market controller business last year, high-double digits. And so we grew significant faster, we believe than the market actually grew last year. And so in that regards, I don't get into what my competitors may or may not be seeing or experiencing. But we actually feel very good about our business. We feel very good about our positioning with respect to that business. And as I mentioned, we're forecasting also for our core micros to be up in sort of the mid-single digits this quarter. Our total micros, they'll be up in the high-single digits, so I'd just give you a perspective.

Christopher Rolland - FBR Capital Markets & Co., Research Division

Sorry, lead times?

Steven A. Laub

With respect to lead times, lead times initially are pushed out because of the supply disruption, they're actually coming back down now because their supplies are getting a better balance.

Operator

And we do have one final question from the line of Betsy Van Hees with Wedbush Securities.

Betsy Van Hees - Wedbush Securities Inc., Research Division

I know you guys have talked on -- there's been several questions on XSense and if I recall correctly, on the last quarter guidance, you guys were talking about other ways to monetize XSense, and I was wondering where we were with that in terms of -- I believe XSense hasn't really materialized as quickly as you had anticipated. So I was wondering if we could kind of get an update as to how that's looking.

Steven A. Laub

Yes, I mean what we've stated in the XSense business, and I think particularly before, we weren't giving forecast. For this year, the ramp has been slower than we had earlier anticipated. It is as it says -- and we're forecasting for this quarter, for example, I think it will be up nicely this quarter but from a relatively small base. With respect to alternatives to monetizing, that's the kind of thing that you don't discuss really in an earnings call but it's something you do when you announce really after the fact. But we are looking at alternative ways to make sure we can maximize the return to our investors with respect to this particular business.

Betsy Van Hees - Wedbush Securities Inc., Research Division

Okay, Steve. I appreciate that. And then my follow-up question is and I apologize if this has been asked, is that when you're looking at maXTouch for this year, can you give us some percentages or just sort of ranges in terms of how much you think tablets will be or PCs or smartphones? In the past, you've done where you sort of helped us out. And if you already gave that, I apologize if I missed that. There's so much information.

Steven A. Laub

Well, I think one thing we shared is that we expect maXTouch to be up actually very nicely this year. And we expect all 3 of those areas to be up nicely for us this year. What we are seeing right now is -- and what we articulated is we expect, for example, maXTouch to be up this quarter double digits sequentially relative to last quarter. We are seeing -- we are regaining, increasing our share in smartphones, we believe. We're seeing growth, assuming growth in that area, which is what we articulated before that we expect to see that with our new T family. We also expect that we'll be growing at both tablets and PCs. I think one thing we've all learned in this particular business is that's very hard to predict beyond 3 to 6 months, because of the dynamic nature of the marketplace. And as I articulated earlier, I was asked a similar questions is while we expect growth in all 3, it's very hard to guess exactly how much will be in each of those 3 different areas. Particularly PC, which has been below people's expectation. It is the kind of market we do expect that when it does convert to touch, it will convert very strongly. So again, I think it's something that's very important that we'd be participating in because we do expect that it will grow very nice return for the players that are in that, and we are the I think the largest supplier into the PC space.

Operator

And that concludes our Q&A portion for today's call. And I would like to turn the conference back over to Peter Schuman.

Peter Schuman

Thank you, Jennifer. During the second quarter, Atmel will be presenting in the New York at the Wedbush Conference on May 13. We will be in Minneapolis at the Craig-Hallum Conference on May 28, and in San Francisco at the Bank of America Merrill Lynch conference on June 4. Webcast and other information for these events will be available on the company's Investor Relations website. In the meantime, you're always welcome to contact our Investor Relations Department at (408) 437-2026 with any questions that arise. Thank you for joining us and this concludes today's call.

Operator

Ladies and gentlemen, that concludes today's quarterly earnings call. Thank you for your participation. You may now log off.

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