Atmel's (ATML) CEO Steven Laub on Q2 2014 Results - Earnings Call Transcript

| About: Atmel Corporation (ATML)

Atmel (NASDAQ:ATML)

Q2 2014 Earnings Call

August 06, 2014 5:00 pm ET

Executives

Peter Schuman - Director of Investor Relations

Stephen A. Skaggs - Chief Financial Officer and Senior Vice President

Steven A. Laub - Chief Executive Officer, President and Executive Director

Analysts

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

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

Vivek Arya - BofA Merrill Lynch, Research Division

Craig Hettenbach - Morgan Stanley, Research Division

Gabriela Borges - Goldman Sachs Group Inc., Research Division

Christopher Hemmelgarn - Barclays Capital, Research Division

Christopher Caso - Susquehanna Financial Group, LLLP, Research Division

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

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

John Vinh - Pacific Crest Securities, Inc., Research Division

Charles L. Anderson - Dougherty & Company LLC, Research Division

Craig Berger - FBR Capital Markets & Co., Research Division

Operator

Good afternoon. My name is Chanel, and I will be your conference operator today. At this time, I would like to welcome everyone to the Second Quarter 2014 Earnings Conference Call. [Operator Instructions] Mr. Peter Schuman, Senior Director of Investor Relations, you may begin your conference.

Peter Schuman

Thank you, Chanel. Good afternoon, and thank you for joining us for Atmel's Second 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 5:00 p.m. Pacific today and will be archived for 48 hours. The webcast will be archived in 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 second 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 third 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 described in the Safe Harbor discussion found in today's press release. During the call, we will also discuss non-GAAP financial measures. Non-GAAP measures are 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 a discussion of our second quarter financial results. Steve?

Stephen A. Skaggs

Thanks, Peter. Second quarter revenue of $356 million increased $18 million or 5% from the prior quarter as a result of stronger microcontroller and memory revenue and was at the midpoint of our guidance range. On a year-over-year basis, revenue increased by 2%. Second quarter 2014 non-GAAP gross margin was 45.3%, slightly above the midpoint of our guidance range, and 130 basis points higher on a sequential basis. On a year-over-year basis, non-GAAP gross margin improved by 270 basis points. The increase -- this increase reflects continued progress on our previously articulated gross margin improvement plan. We're pleased to have increased gross margin for the fifth consecutive quarter and to also report our highest non-GAAP gross margin percentage since the fourth quarter of 2011. We expect significant further gross margin expansion next quarter and for the remainder of 2014 as we remain on track to meet our previously committed gross margin target. On a GAAP basis, second quarter gross margin was 45.4%, up 390 basis points on a sequential basis. Second quarter GAAP gross margin included a gain of $2.1 million related to the reversal of the previously reported loss from a legacy foundry arrangement. Non-GAAP operating expenses came in at approximately $120 million below the midpoint of our guidance range and increased approximately $2 million on a sequential basis. Stock compensation for Q2 was approximately $15 million, allocated approximately $2 million to cost of sales, $4 million to R&D and $9 million to SG&A. Non-GAAP operating income for the second quarter of 2014 was $40.7 million, or 11.5% of revenue, and excludes stock-based compensation gain related to foundry arrangements, restructuring credits and certain other charges described in further detail in our earnings release. Our second quarter 2014 non-GAAP operating income compares to the first quarter 2014 non-GAAP operating income of $30.1 million or 8.9% of revenue and to the non-GAAP operating income of $27.6 million or 7.9% reported in the same period last year. Second quarter 2014 non-GAAP income tax provision was approximately $1.2 million compared to the prior quarters' $1.0 million. As a reminder, our non-GAAP income tax provision approximated to our cash taxes incurred. On a non-GAAP basis for the second quarter 2014, we had net income of $38.3 million or $0.09 per diluted share. This result compares with first quarter 2014 non-GAAP net income of $29.1 million or $0.07, and non-GAAP net income of $25.3 million or $0.06 in the second quarter of 2013. GAAP net income totaled $19.2 million or $0.05 per diluted share for the second quarter of 2014. This compares to $2.2 million or $0.01 for the first quarter of 2014, and $13.0 million or $0.03 for the second quarter of 2013.

Turning to the balance sheet. We continue to improve the strength of our balance sheet while also increasing operating cash flow to $52.5 million for the quarter. Inventories dropped by over $2 million sequentially to $245 million. This represents our lowest absolute inventory levels since the third quarter of 2010. Days of inventory increased slightly and stands at 115 days below our target model of 120 to 130 days. Accounts receivables totaled $199 million at the end of the second quarter, an increase of approximately $4 million on a sequential basis. Days sales outstanding were approximately 51 days, a decrease of about 2 days from the prior quarter and within our normal range. Capital expenditures were approximately $9 million in the second quarter, down from $17 million in the first quarter. Depreciation and amortization in the second quarter of 2014 was approximately $14 million, up $1 million compared to the $13 million in the first quarter of 2014, and down from the $19 million in the second quarter a year ago. Combined cash balances, including cash equivalents and short-term investments, totaled $264 million for the second quarter, representing a sequential increase of approximately $8 million. This increase was after the return of $28.5 million to shareholders through stock repurchases last quarter. During the second quarter, we repurchased 3.6 million shares of common stock in the open market at an average price of $8 per share. Since the inception of our buyback program in the second half of 2010, we have now repurchased approximately $744 million of our stock at an average price of $8.67.

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

Steven A. Laub

Thank you, Steve. Prior to a discussion of our second quarter results, I am pleased to report that Atmel completed the acquisition of Newport Media, a leading provider of high-performance low-power Wi-Fi and Bluetooth solutions. This strategic acquisition adds 802.11n Wi-Fi and Bluetooth to our already broad portfolio of connectivity technologies, combined with our leading microcontroller solutions, positions Atmel extremely well for substantial growth in the Internet of Things marketplace.

Turning to a discussion of Q2 results. We delivered a solid quarter led by strong performance on our microcontroller business, while the other businesses performed as expected. We are pleased that our non-GAAP gross margin continued to improve for the fifth consecutive quarter and expect that trend to continue for the remainder of the year. Viewing our business by end market, industrial, our largest end market, grew sequentially and increased double digits year-over-year, followed by consumer, our second largest market, which also increased sequentially and year-over-year. The automotive end market, which has emerged as our third largest end market, was up strong sequentially and on a year-over-year basis. Revenue from the mobile market decreased sequentially due to weaker sales into the tablet market, and was down year-over-year as a result of lower Sensor Hub business from a large smartphone customer. Reviewing our results by business segment. Our microcontroller business generated strong results, achieving the highest quarterly revenue since the third quarter of 2011, with both our core microcontroller and touch businesses showing significant growth. Revenue climbed to $255 million, up 8% sequentially and 3% year-over-year. By product family, during the second quarter, our 32-bit market controller revenue increased 2% sequentially and was down 12% year-over-year as a result of lower Sensor Hub revenue as previously communicated. Excluding Sensor Hub revenue, our 32-bit microcontroller business grew over 20% year-over-year. Our 8-bit microcontrollers gained significant market share as revenue increased 12% sequentially and 15% year-over-year. Looking at our core microcontroller business. Core microcontrollers grew sequentially and year-over-year due to broad strength in the industrial, consumer, automotive and communications end markets. We continue to deliver a significant number of new 32-bit products during the second quarter with 34 new core 32-bit microcontroller products released, a faster pace than last year when we introduced a record number of new 32-bit products. More importantly, these new product introductions continue to generate record high levels of 32-bit customer design activity. We normally don't provide much color on our core 8-bit microcontroller business, but I'm going to make an exception this time because the results are exceptional and don't always get the attention they deserve. Not only did our core 8-bit microcontroller revenue achieve the highest quarterly level in 3 years, the cumulative revenue in the last 4 quarters was up 14.8% over the cumulative revenue in the prior 4 quarters. Based on other MCU supplier reports, we believe this is the highest growth rate of any major 8-bit microcontroller supplier. This demonstrates the strength of Atmel's 8-bit AVR product portfolio and a continued growth of the 8-bit market.

Turning to connectivity and the Internet of Things. During the past quarter, we launched the Atmel's smart line of 32-bit ARM-based microcontrollers. Atmel's smart microcontrollers combine powerful 32-bit ARM cores with industry-leading low-power technology and intelligent peripherals. Importantly, during Q2, we expanded our smart portfolio with the addition of the new SmartConnect SAM W23 modules, enabling Wi-Fi connectivity and the best of high-performance and low-power technology for Internet of Things applications. The W23 module is based on Atmel's industry-leading ultra low-power Wi-Fi system-on-a-chip combined with Atmel's ARM Cortex-M0+-based microcontroller technology and offers the ideal solution for designers seeking to integrate Wi-Fi connectivity with our turnkey system. Our platform provides an integrated software solution with application and security protocols such as TLS, integrated network services and a standard real-time operating system, which are all available through a simple serial host interface within Atmel Studio 6's integrated development platform.

As I mentioned at the onset of the call, last week we completed the acquisition of Newport Media, a leading provider of high-performance low-power Wi-Fi and Bluetooth products. This acquisition will add NMI's 802.11n Wi-Fi and Bluetooth certified products to Atmel's already broad smart connect wireless portfolio. NMI's products combined with our existing ultra low-power Wi-Fi and ZigBee solutions and our industry-leading microcontroller portfolio provide Atmel the industry's most complete wireless portfolio of SmartConnect devices for the Internet of Things. The integration of NMI is moving quickly. The organization alignment, sales distribution network, salesforce and applications training and cross-selling, payroll, IT systems and financial system integration are expected to be completed during the third quarter. NMI's operations, including planning, foundry operations, assembly and test and quality processes are on track to be integrated into Atmel business systems by the end of the year. The product roadmap realignment has been completed, which includes the accelerated introduction of Bluetooth low-energy products. As is our practice, we will make specific announcements when products are released to the market.

With regards to expanding the Internet of Things ecosystem, Atmel has joined forces with Samsung, Intel, Broadcomm and Dell to establish a new industry consortium focused on improving interoperability and defining the connectivity requirements for the billions of devices that will make up the Internet of Things. The Open Interconnect Consortium is focused on defining a common communications framework based on industry-standard technologies to wirelessly connect and intelligently manage the flow of information among personal computing and emerging IoT devices regardless of form factor, operating system or service provider. Member companies will contribute software and engineering resources to the development of a protocol specification, open-source implementation and a certification program, all with a view of accelerating the adoption of the Internet of Things. The Open Internet Connect Consortium specification encompass a range of connectivity solutions, utilizing existing and emerging wireless standards and will be designed to be compatible to a variety of operating systems.

In our software development tools and ecosystem, Arduino, the leading open source hardware platform and a maker in the education community, and Atmel, developed a next-generation IoT development board called the Arduino Zero. The Zero board is powered by Atmel SAM D21 microcontroller which features a 32-bit ARM Cortex-M0+ core and provides creative individuals the capability to create truly innovative solutions for IoT devices, wearables, high-tech automation, robotics and other applications not yet imagined. While the board is targeted for the maker community, an increasing number of commercial customers are using Arduino board to do rapid prototyping of new projects.

Turning the discussion to our touch products. Our MaXTouch T Series family for smartphones, large screens and other applications is ramping volume production across many different OEMs, with screen sizes from 4-inch to above 15.6 inches. Our market traction for the high-performance maXTouch T series is very positive as OEMs release new products which feature touch gestures, including our always on feature, hover, passive and active stylus, superior multi-finger performance from wearing gloves, improved moisture and touch performance for on-cell designs. The market for smartphones, maXTouch revenue grew double-digit sequentially and several OEMs introduced new products featuring maXTouch, including LG G Vista and Volt LS740, Kyocera's Hydro Icon 4.5-inch and Hydro Vibe 4.5-inch and Tecno Mobile's Phantom Z. In the Chinese market, Xiaomi released the Mi4, which features our maXTouch T Series, building on the success of Xiaomi's Red Rice 5.5-inch. In the market for large screen devices. At the end of the second quarter, Atmel was Win 8 and 8.1 certified in approximately 208 different tablets, notebooks and Ultrabooks, more than any other touch supplier. The total is higher if we include our precision touch pad design wins. We have won multiple new designs featuring maXTouch in both Android and Windows 8 tablets and notebook. That momentum should continue to build as a result of the superior performance of our new T series products. New products available today featuring maXTouch include ASUS' MeMO Pad, ME 581CL and Transformer Pad TF103, HP's EliteBook 725 G2 and 755 G2, Lenovo's ThinkPad 11e, Yoga 2 11.6-inch and N20p Chromebook. Xiaomi's Mi Pad, LG's E7 and E8 and E10 G Pad and Motorola Solutions TC55 Touch Computer.

The Markets beyond smartphones and tablets. This past quarter, we had the largest percentage of maXTouch revenue coming from outside of the smartphone tablet and notebook markets in the company's history. Touch technology continues to proliferate into diverse end markets such as consumer, industrial and automotive. And new applications, including microwave ovens, point-of-sale terminals, gaming, thermostats and factory automation equipment. We continue to expand maXTouch into the automotive market with new car models on the road, including Mazda's new J03 [ph] Demio and are expanding our presence with customers such as Jaguar, Land Rover, General Motors, Hyundai, Kia, as well as adding new customers such as Subaru and RuLing [ph], a Chinese automotive manufacturer.

As a leader for touch solutions in the automotive consumer and industrial market, Atmel continues to bring innovative technologies to the marketplace. Turning our discussion to XSense. Our XSense revenue grew significantly on both the sequential and year-over-year basis. XSense technology was selected by EDN China as a top 10 most influential technologies for the future an award ceremony at the end of June in Shanghai. The prestigious EDN China innovation awards are handed out annually. Customer interest for our XSense products remain high, and we continue to win new designs. In the automotive business segment, revenue was achieved of $36 million during the second quarter of 2014, down 12% sequentially and decreased 1% as compared to second quarter of 2013. The business was adversely impacted by a decline in legacy end of life products, which are mainly sold to nonautomotive customers. Our auto RF business, which includes remote keyless entry and passive entry go systems, had another strong quarter as we continue to grow this business and take share in the market. For our nonvolatile memory business segment. Total revenue was $40 million in the second quarter of 2014, up 13% sequentially and up 11% as compared to the second quarter last year. The memory business was up significantly in Q2 driven by our Serial EEPROM products sold into the PC and server markets. We are also experiencing significant adoption of our CryptoMemory products for security applications, as OEMs are increasingly concerned about brand protection, theft of IP and loss of accessories sales due to clone products. Our latest security solutions are cost effective and offer easy-to-use software, allowing users to rapidly implement the security function in their end products.

Turning to the multi-market and other business segment. Second quarter revenue of $25 million was down 4% sequentially and decreased 13% as compared to the second quarter of 2013, primarily due to softness in our aerospace business, which has been impacted by export restrictions due to geopolitical events. In viewing our second quarter revenue by geography, our largest ship to location was Asia, representing 59% of revenue, EMEA was 25% of revenue, while the Americas were 16% percent. Asia increased significantly on a sequential basis during the second quarter, while EMEA weakened and the Americas declined slightly. In summary, we are pleased that our businesses are well-positioned in growth markets, and we have largely completed the transformation of our supply chain. The substantial investments in new products have led to record high levels of customer design activity for 32-bit products and our recently completed acquisition of Newport Media has considerably enhanced our already strong position in the microcontroller market. Our business is enjoying sustained growth in our largest end market, industrial, with noteworthy strength this past quarter in the medical, security and smart energy markets. The automotive end market, driven primarily by our microcontrollers, has grown for 6 consecutive quarters and has become our third-largest end market. For our microcontroller business, we have product and technology leadership in several growth areas and are particularly excited with the leading portfolio of solutions we can now offer to the Internet of Things marketplace. IoT dwarfs all other opportunities for the semiconductor industry as virtually every device or system equipped with electronics of any kind will be connected to the Internet in some way. With the investments we have made in connectivity, combined with the industry-leading ultra low-power microcontrollers and software, Atmel is well-positioned for substantial growth in this market. As anticipated, our maXTouch business grew double-digit sequentially as our business rebounded in smartphones, enjoyed rapid expansion in other new touch markets. Our new T product family is getting significant design wins that should lead to substantial revenue growth, particularly in 2015. Additionally, our CryptoMemory products are experiencing significant customer adoption as security applications have become paramount across a wide range of end markets. We expect these advanced products will be the primary driver of growth for our memory segment in the future. From an operating perspective, we delivered 5 consecutive quarters of non-GAAP gross margin expansion and expect gross margin to accelerate through the remainder of the year.

Now let me turn the call back to Steve Skaggs for our Q3 financial guidance. Steve?

Stephen A. Skaggs

Thank you, Steve. Our third quarter guidance includes approximately 2 months of revenue and expenses for our recently completed acquisition of NMI, and also the impact of certain purchase accounting adjustments. For the third quarter, we expect continued positive general demand trends and expect revenue to be between $364 million and $382 million. This includes approximately $7 million of revenue from NMI. Third quarter non-GAAP gross margin is expected to increase by 170 basis points to 47.0%, plus or minus 100 basis points. At this time, we also reaffirm our 49% non-GAAP gross margin outlook for the fourth calendar quarter, both of these gross margin outlook numbers include NMI. We expect spending to increase slightly as a result of our acquisition of NMI. Non-GAAP operating expenses for the third quarter expected to be approximately $123 million with the range of $121 million to $125 million. This outlook includes approximately $4 million of cost related to the addition of NMI. For the third quarter, total stock compensation expense is expected to be approximately $16 million. We expect depreciation and amortization of approximately $15 million and capital expenditures of approximately $10 million to $15 million. Other expense is expected to be approximately $1 million, and acquisition-related charges are expected to be $5 million to $7 million for the quarter. We expect our non-GAAP tax provision to be approximately $1 million to $2 million. And finally for modeling purposes, we assume a non-GAAP share count of around 430 million shares. This concludes our prepared remarks. We now like to open the call for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question is from Rajvindra Gill with Needham & Company.

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

Just on the business trends. So $364 million to $382 million, which includes $7 million of NMI. Can you talk a little bit about the business drivers by segment as you go into the third quarter?

Steven A. Laub

Yes, this is Steve. So overall, as you know, the benchmark for our outlook was approximately 5% with including the NMI revenues. Our expectation is that with cost value -- are you talking about business drivers like by segment but with applications -- business segment. So expectation is that our MCU business should experience growth, we would say, low to mid-single digits, driven by stronger growth actually in our core business, which we expect to be sort of closer to sort of mid-single digits toward the high-single digits. The touch business sequentially down, I'd say, low to mid-single digits. Our automotive business, we expect to be up low to mid-single digits. Memory business to be up double digits, and our multi-market and other business to be up in the sort of high single-digits.

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

And why is touch being down -- is going to be down -- you said touch is going to be down double digits or...

Steven A. Laub

No, no, no. Touch is going to be down, we said probably low single to mid single-digit, single digits.

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

Why?

Steven A. Laub

Well, it's a very strong quarter, the quarter we just completed. The expectation is that we're seeing a little bit of softness in sort of the tablet space, which is filtering through. There is some -- I'd say, some customer transitions that are occurring. I think there's some changes occurring, some of the customers that you guys are probably aware of in Asia, that's filtering through to some of the different providers and that's what's impacting us, to a lesser degree than others, but is impacting us as well.

Operator

Your next question is from Anthony Stoss with Craig-Hallum.

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

Steve, if you wouldn't mind expanding on the Crypto opportunity, you called it out a couple of times saying that customers are finding it extremely attractive. Can you talk about potentially how you see Crypto ramping? And also what gross margins might be like on Crypto, if they are accretive to corporate gross margins? And then also I'd love to hear your view on kind of strength in designs on the connectivity side.

Steven A. Laub

Sure. With respect to the Crypto opportunities, I think what we're seeing is a number of customers and these are large, very large, blue chip Tier 1 customers, who are looking at is really for one being brand protection using and also to connect accessories. And what do we mean by -- let me give you some background on brand protection. What it means is there's a number of typically accessories they sell with their products. There's also what happens is not uncommon as in Asia a lot of cloned products are made for those accessories. What this allows the OEM to do is to make sure that their product will only operate with their own product by using this Crypto part. It authenticates accessories through the host product. And that's very important for them. It keeps their brand protected, so there isn't cheap knockouts that are used that degrades their brand. It also protects their revenue associated with their investment in their accessories. And so but then also in addition to that, there's a number of applications where it protects IP from being -- the theft of IP when people are trying to grab data whether it be a -- typically from a wireless type of application but it can also be from a connected wired connected application as well. This forwards us an authentication before information will be shared. And so we're seeing, for these reasons, a very big uptick, customer desire this and we've now also been seeing the actual customer adoption of it. We're not going to forecast numbers for that. We call it out because it is something that's become -- it's more than just a passing fancy, and so we think it's something that's going to be more and more important over time. We do find that our business, along with that, we do expect will be accretive to the company's gross margins based on the opportunities that we're seeing today and the ones that were being adopted today. What was your second question?

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

On the connectivity side, just kind of design activity and your expected growth in the second half of the year?

Steven A. Laub

So the -- on the connectivity side, we are seeing lots of activity, actually across-the-board Wi-Fi and ZigBee products. And we're seeing -- with the announcement of the acquisition, we began to see more customers as well and that has continued as we close the deal, and we now actually are adjusting in last week to begin to actively market that with our customers. So there's a very high level of, I'd say, customer interest and actual filtering to customer designs. My expectation is you'll see we've been experiencing growth in our wireless business. We'll continue to see that growth. I expect that 2015 will be a very strong -- will be a strong year for growth in that business based on a lot of IoT type of applications.

Operator

Our next question is from Vivek Arya with Bank of America.

Vivek Arya - BofA Merrill Lynch, Research Division

Steve, I'm curious about how you think about the sustainable growth rate in your microcontroller business with and without touch. As I look at the last few quarters, growth has been in that low single-digit range and I understand there are some puts and takes related to the touch and smartphone and tablet products. But if we have to think about a longer-term growth model for Atmel, what is the right level of growth to bake in for your microcontroller business?

Steven A. Laub

Well, in respect to microcontroller business, the business actually -- we're actually very pleased with the growth specifically on the space sort of core micros on that, the growth has been impacted a little bit certainly on the year-over-year comparisons because we had a very strong Sensor Hub business that was particularly strong in Q2 of last year that has declined, and I think that to somewhat it has skewed the perception of the business in general. But overall, the business has grown very nicely, as I mentioned, excluding the Sensor Hub business, the 32-bit business was up well over 20% year-over-year. So I think what we're seeing is we're actually seeing a very nice growth. The business is positioned and is growing very nicely in such things, a lot of the industrial market places. We have most -- these are the largest marketplaces we're seeing automotive being an area for us, which historically had not been a strong area for us but has become one, certainly coming off from a very small base but has become actually meaningful for us. As I mentioned during the prepared remarks our third-largest end market and that's driven primarily by the microcontroller business. Smart energy in the industrial market places is an area that we're seeing significant growth. The wireless area is an area we're seeing significant growth. So I think when you put this together and think about how the products are positioned to a lot of these different segments, you actually feel very good about it, about where we're positioned, about what we've achieved there and about what we can expect going forward. The question was what growth rate we expect going forward be largely dependent on what happens to the marketplace itself going forward. But we think with the products that we have today, especially our investments in 32-bit and our investments also in connectivity, we will be disappointed if we weren't growing faster than the overall microcontroller market as we move forward. And I'll leave it up to you guys to predict what you think that market growth will be.

Vivek Arya - BofA Merrill Lynch, Research Division

Maybe as a follow-up, Steve, then if I look at -- see, I have no issues with your non-smartphone non-tablet business. Atmel is doing very well there. My concern is related to the mobile business. The tablet category seems to be saturating and slowing down. And in smartphones, the competition -- you have great products, but the competition is also very strong. So is there a point at which you can avoid the drag from the mobile business and start growing the microcontroller category overall? Or do you think that you -- that the smartphone and tablet business is extremely strategic and you have to stay there even though it's adding all the volatility to your sale?

Steven A. Laub

Oh, I see. I didn't fully appreciate your question initially. With respect to the mobility segments, the mobility, as you've seen, as you've commented, has declined and it has created some volatility I think to some extent on our business. I think that overtime that will continue to be less and less significant for us, and I think it has actually come down significantly already. Our expectation is there's parts of the mobility segment that are important to participate into. And despite the fact that there is, I think, some short-term softness with respect to the tablet marketplace, our solutions are actually very good there. One thing that we have been investing and I commented in the prepared remarks is we have a unique advantage of the other guys that are in this marketplace do not have, which is we have the varied product portfolio of not just products but customers that cut across the industrial markets, the automotive markets and so forth. And one thing that we had always anticipated was that eventually that touch would be adopted into these markets as well, and we are now seeing that happen in a much more rapid pace. And we thought it would take longer. It's taken a little bit longer perhaps than we had expected, but that actually is occurring now. And as earlier stated, we have this past quarter our highest percentage of revenues in our touch business in these other markets. So industrial markets, automotive markets are actually growing quite rapidly for us. They are much more stable. They're actually much more stable not just from a revenue standpoint, but obviously, from a sort of margin profile standpoint as well. And we continue to invest very heavily into that part of the marketplace. But I think over time, you'll see that part of it continue to grow. And I think you could expect that our business will be much more consistent and predictable because of that.

Vivek Arya - BofA Merrill Lynch, Research Division

Got it. Last one, if I may. Any clarification on how you plan to fund the NMI acquisition and if that has any impact on your stock repurchase activity.

Stephen A. Skaggs

Sure. This is Steve Skaggs. As I think most people know we do have a revolving credit line that has up to a $300 million facility. We have drawn $90 million from that line at a fairly attractive interest rate, it's the 1-month LIBOR plus 1.25%. So the effective interest rate is approximately 1.4%, and that's partial funding for the acquisition. The other funds have come out of cash on hand. So that's how the acquisition was funded. With respect to your question about stock buyback, we do still have sufficient cash balances and liquidity to continue to manage that program on an opportunistic basis, and we'll continue to look towards stock repurchases as the preferred redeployment of capital. As I pointed out in my prepared remarks, the company did generate significant cash flow the last quarter, and we expect that trend will continue this quarter as well.

Operator

Your next question is from Craig Hettenbach with Morgan Stanley.

Craig Hettenbach - Morgan Stanley, Research Division

I wanted to follow up on the strength in the 8-bit market and one of your peers has also recently talked about that. So Steve, can you talk about just the influence of maybe the macroenvironment and then also just from a market share perspective how sustainable you think the growth in 8-bit is.

Steven A. Laub

Sure. I think what's been driving it, as I mentioned, we've actually seen it growing very strong over the past year. I think to a great extent is that the 8-bit market is much more tied to the industrial marketplaces. It's our core microcontroller and what I spoke about specifically with our core 8-bit microcontroller business. So I think that also has been driving that business considerably, and I think we have great relationships and great penetration into that customer base and that we continue to drive that very nicely. And I think that may have -- and we saw this in industrial if you go back to a couple of years, impacted that business, but I think that that's recovered now and I think that should continue to be sort of a steady growth area for us. I think to the extent that the marketplace believes that the 8-bit market doesn't have attractive growth opportunities going forward, I think that that has been overblown by the marketplace. And I think that based on what we're seeing, based on what potentially others are seeing in that marketplace as well, I think that proves that. The other thing is I think to some of extent some of this penetration of 32-bit into other parts of the marketplace what we're seeing is that our penetration is much greater into 16-bit rather than 8-bit. And that's an area we don't actually compete in the 16-bit. We compete into those customers applications with our low end 32-bit products.

Craig Hettenbach - Morgan Stanley, Research Division

Got it. And sort of my follow-up, can you talk about just your view of inventory in the supply chain today? Any change in terms of customer order patterns and how they're viewing inventories for the quarter and into early Q3 here?

Steven A. Laub

Sure. With respect to inventories, so we measure obviously through our distributors, which is easiest to measure. And what we saw was that our recent inventories with our distributors is about 8.7 weeks down slightly from last quarter. And so we don't see any issues at all with inventories in our distribution channel. Lead times have gone out a little bit. I think that's indicative just to be relatively more sort of steady or a more robust business environment. But with respect to the overall inventories, I think things are actually pretty well, pretty steady. I do not see any type of major urgent issues with our end customers. So I don't see any customer hoarding. I don't see any customer building up excess inventories. I don't see any of those issues at all at this time.

Operator

The next question is from Gabriela Borges with Goldman Sachs.

Gabriela Borges - Goldman Sachs Group Inc., Research Division

My question is on the gross margins not just in 4Q, but as we look out to 2015 as well. I think previously, you've talked about utilization being the biggest swing factor between $250 million and $450 million in revenue and that being maybe about 500 basis points. Maybe you could just talk about if that's the right range to be thinking about and if there's additional tailwind that we can expect from richer mix shift?

Steven A. Laub

So as we commented on the call, we are reiterating -- we're guiding margin up. We're reiterating our targets and kind of reaffirming that we're on track to meet our target of 49% on a non-GAAP basis in Q4. The path to get there has been both illumination of take or pay agreements, which is for the most part, behind us. There'll be some slight benefit to be had this quarter. And in addition, operational improvement as we move to kind of a fab-lite supply chain fully. In addition, there are utilization benefits, as you point out. We expect to exit the year at or above our target and to sustain margins at that level into 2015.

Gabriela Borges - Goldman Sachs Group Inc., Research Division

That's helpful. And then maybe just on 4Q. I understand it's early days. So maybe you could talk about what we should expect to see in terms of normal seasonality and even that could drive this year to be better or worse than that?

Steven A. Laub

Yes, with respect to the fourth quarter, it is early days. Our expectation right now is probably normal seasonality for the fourth quarter right now. And so I think that's what we're seeing. I think that's what others are seeing as well. I have no reason to differ from that at this point.

Operator

Your next question is from Blayne Curtis with Barclays.

Christopher Hemmelgarn - Barclays Capital, Research Division

This is Chris on for Blayne. First, I guess, seen a slight pause or pullback in touch in the Q3 from what you're saying. Could you just talk a little about your long-term expectations there? Earlier in the year, you talked about seeing share gain and really seeing significant progress in handsets. I mean, with the pullback, do you still think you're on track for the type of recovery you've been looking for in that business?

Steven A. Laub

With respect to what we're seeing from the standpoint, I'd say, of design activity and customer project wins, actually we're doing very, very well with respect to -- as compared to our expectation. I think the thing that's caused a little bit of, I'd say, a little bit of below I'd say our expectation was that the tablet space has actually slowed considerably. And so I think that has impacted the business in a way that I think it surprised not just ourselves, but I think if you look at the market generally, there's a number of people that indicated that market has a much slower growth this year than had been anticipated. But with respect to the business, I mean, what we had talked about or articulated was expecting that we'd have a rebound in the smartphones business, which we're seeing, which we saw very nicely in Q2. We expect to continue to see gains in that business for us in select areas where we are actively participating. We do also expect that as is often the case when you have a little bit of slowdown in one area, it's typically just a one, at most 2 quarter type of event, and so we do expect that the tablet market will come back, if not in Q4, certainly in Q1. And the other thing is our progress in the large growing area of PCs, notebooks and so forth continues to be very strong. The number of Windows 8 projects that we are winning and that have been released in the marketplace. We have the #1 supplier into that marketplace continue to be and continue to win lots of new design. So that combined with the progress we're making in the markets outside of smartphones and notebooks and tablets, we actually feel very good about the business. So progress we measured by our customer penetration design wins and so forth. And on that level, we're actually feeling very good about where we are on that business.

Christopher Hemmelgarn - Barclays Capital, Research Division

That's really helpful. Then just as a follow-up. Obviously, a prominent design loss in the Sensor Hub area. Could you talk a little bit about where you see that opportunity going forward and whether you think that can recover to '13 levels anytime soon?

Steven A. Laub

With respect to the Sensor Hub business what we're seeing is a couple of different things. We're seeing, one, that the Sensor Hub is being adopted in lots of new markets, lots of new customers and new markets. For example, lots of new customers in mobility are now using Sensor Hub that we're not using them a year ago. We're also seeing new markets such as the wearables where Sensor Hub technology is also being desired. So we're actually seeing the technologies expanding as you're seeing sensors expanding to new applications. From that standpoint, we feel very good. Also our penetration or design wins that were occurring today actually will help the business, I think you'll see some nice rebound in that business through the end of this year and into next year. So we actually feel good about the progress that we're making in the business today.

Operator

Your next question is from Chris Caso with Susquehanna Financial.

Christopher Caso - Susquehanna Financial Group, LLLP, Research Division

First question is on your production expectations. And I think you said in your prepared remarks the internal inventory was down 2 days. What's your expectation for the third quarter? And what's your plans for production as you go forward? Are you planning to ramp the fab some more?

Steven A. Laub

Our expectations for the third quarter is that our inventory will probably be up a little bit, which we've mentioned we're actually -- in our prepared remarks which are actually lower than we typically target. So we do expect to see some increases in our inventory. We have ramped our internal fab. It's running at a quite high utilization right now. We expect it will continue to run at that way through this quarter and probably through next quarter as well. And so overall, I would say you should expect inventories to be up slightly in Q3.

Christopher Caso - Susquehanna Financial Group, LLLP, Research Division

Great. And as a follow up. With respect to the gross margin guidance for the second half of the year, I guess, the first part would be with the ramp in production, I think you guys the gross margin change comes as a lag as that goes to the income statement, do I have that right? And then just finally with regard to revenue levels in the second half, I guess, based in your commentary, it sounds like getting to the 49% level by the end of the year, did not particularly depend on achieving a certain revenue level, can you talk about that?

Stephen A. Skaggs

Sure. This is Steve Skaggs again. Yes, you're correct in your assumption that increases in utilization tend to flow through the P&L and about 1 quarter lag due to the fact that the inventories that's produced at the higher levels of utilization needs to be sold through before we can recognize the benefit in the P&L. So as I think most people know, we have increased utilization in our Colorado fab. As Steve just mentioned, it's running very high levels of utilization, and we expect to see the benefit of that in the gross margin in the third and fourth quarter. And that's one of the drivers for the margin increases that we've forecasted. And we expect to achieve those margin targets. Obviously, the Q3 target is tied to our revenue guidance and the Q4 target of 49%, we said in the past requires a minimum of $350 million in revenue. But at this point, I think we want to reiterate that number regardless of the revenue level in Q4.

Operator

Your next question is from Christopher Rolland with FBR Capital.

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

You guys talked about lead times going out a bit in the quarter. We had them out a bit in the quarter, also pretty consistently through the year, they've been in a pretty solid uptrend here. Some of that was the fab fire, but that you said pretty much subsided at the end of last quarter. So is this all demand driven? Is it related to shutting down the L foundry capacity last year or moving away from that take or pay? Is it involved in requalifying in the ongoing transfer to outside capacity? How should we think about those lead times? And how should we think about lead times going forward?

Steven A. Laub

This is Steve. So in fact, it's actually related to many of those different things. So first of all, lead times been pushed out initially because of the fab fire, and so that was the impact that we did see and that I think you guys also could pick up from the, for example, distribution. That has mostly subsided, but not completely subsided. So there's a little lingering effect that's still out there because of that but that's mostly down now. A big part also that happened is that you're seeing that our 8-bit business has been particularly strong, and that was something that caught us a little bit by surprise as well as I think it did other people. The 8-bit business is being manufactured at our fab in Colorado. And so we've had to load up to the fab level because of the strength of that business, and the lead times of that business have gone up because of that. We do expect that during this quarter, we're hopeful that we'll catch up with that. We expect that we don't expect extended lead times because of that, extending further out because of that at this point. Because also the L foundry shutting down at the end of last year, the transition to UMC there's been little bit of impact because of that, but that was something that we had planned for. But I think again just getting the mix consistent and so forth. Our lead times have gone out a little bit, but our lead times are certainly at a reasonable level for our customers. And so there's no adverse impact to our customers. There's no adverse impact to our competitiveness or to any types of new designs. Unlike perhaps some other people they're experiencing I think much more extended lead times than we are.

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

Okay, great. So maybe you can talk about the Colorado fab. I mean, are we very full there. We're talking 90% kind of numbers on utilization and then how quickly can you requalify outside capacity? Or are we really on the cusp of moving meaningful amounts across now? Or is this going to take a little bit of time? And then a quick housekeeping. All of that Newport $7 million is that going into the multi-market segment?

Steven A. Laub

Okay. So with respect to the fab in Colorado, it's actually running over 90% utilization today. We discussed qualifying -- we actually have a lot of those products qualified outside foundries as well, so that's not an issue. And in fact, part of what we're doing is, as I mentioned, we do not expect that the lead times associated with those products to extend out further. So right now, they've already gone out a little bit. We don't expect it to extend out further and they're well short of what other people I think in the microcontroller space are actually experiencing. Part of the reason we're also building is we have -- we do want to build some inventory as we've mentioned our inventory days are lighter than we'd like to do. So part of the reason we're running the fab at high utilization to get inventory levels back to the levels that we think are prudent for our business.

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

The Newport $7 million all going into multi-market.

Steven A. Laub

The Newport revenues will actually go into the microcontroller business because it is actually now part of that business. IoT connectivity is really integrated encompassed within our microcontroller products.

Operator

Our next question is from Jeff Schreiner with Feltl.

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

Steve, just the overall strategy in touch it seems that may be moving away from mobility a little bit. But I want to understand maybe some things that you might be trying to do in mobility that could enhance the touch products. In the late 2000, Atmel was a purveyor of fingerprint technology, and I believe still had some decent IPs there. That's certainly become an area of growth in mobility that is overtaking touch ICs. Are there plans to move into the fingerprint market or other interface type products to supplement your touch ICs?

Steven A. Laub

So just generally, we don't share in earnings calls what our plans are for that type of new products or areas that we're investing and that we've not yet generally introduced into the marketplace, so I won't be doing that on this call as well. Let me assure you this company is our first and foremost. Our product line we sell primarily into the industrial markets, the automotive markets, consumer markets. Mobility is a very relevant market for us, but it is not our first priority market for us. With respect to our touch business, as I mentioned earlier, we will continue to come up with very innovative products that will be supportive and useful for the mobility space. But what we're seeing plan or what we plan on doing is to drive all these products into the industrial marketplaces and automotive marketplaces. These customers are adopting it very readily today. And our competitors in the touch area don't really have access to these customers the way that we do. And so you could expect that, one, we will be adding a lot of IP and adding a lot of capability to these products. And you're right, we have had IP historically and, in fact, some relevant new IP as well in these areas that you mentioned. But at the same time, I won't be announcing that at this point.

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

Okay. Just as a follow-up. When we get to -- Steve Skaggs, when we get to 49% in Q4 if you're able to reach that target, it seems like there's some utilization pushing it, but certainly a lot of the prior cost-savings initiatives that the company has laid out now for some time is going to be a part of that as well. What I'd like to understand, are those cost-savings initiatives excluding the ones relating to targets above $425 million a quarter all but utilized when we reach fourth quarter '14? Or are there additional gross margin cost-savings that we may see in '15?

Stephen A. Skaggs

We'll obviously continue those initiatives and push through the end of the year, sort of an artificial timeline from kind of running the company, we have established a goal for external purposes. But the company's obviously going to continue to work on improving gross margins and driving initiatives. And there'll be some effect that carries on beyond the end of the year from those initiatives that we have underway. Now I would say that we do believe that the company is organized today with products and has a supply chain that's been transformed, and we feel comfortable about our sustainable gross margin should be at or above the level at which we exit the year at.

Operator

Your next question is from John Vinh, Pacific Crest Securities.

John Vinh - Pacific Crest Securities, Inc., Research Division

I wanted to follow-up on the CryptoMemory opportunity. I was wondering if you could help us quantify that opportunity a little bit more. Can you maybe talk about kind of the ASPs on the CryptoMemory chips and for kind of opportunities that you're talking going forward, is this a 1 or 2 chip solution? Do you need 1 in both the host or the slave device or do you only need 1 chip?

Steven A. Laub

With respect to ASPs, these products actually they're widely varying depending on the application in which memory configuration and so forth the customer is buying. But I would say that typically these products are going to be less than $1 and some of the very, very high-volume ones will be less than $0.50. And so just giving a sense for that. With respect to the products often times, you will have it both from a host side and a what I'd say the accessory side as well. So kind of a master slave type of thing, because it really would be a key connection. With respect to guidance opportunity, I could just tell you it's hundreds of millions of units. I won't get into is it 100, is it 900 million? It's hundreds of millions of units we expect this market place to grow over time.

John Vinh - Pacific Crest Securities, Inc., Research Division

And then my follow-up question I wanted to touch on the XSense business. You talked a little bit about earlier in the prepared remarks. Do we currently have a line of sight to break even at this point? Alternatively, I know you guys have talked about being open to monetizing the IP in other ways if this fell short of your expectations. If you could update us on your current thoughts on XSense, that'd be great.

Steven A. Laub

As we mentioned in the prepared remarks, the business actually grew very nicely in Q2. And we are winning new designs with respect to the business. We also -- we do look at it as if like any business, it is something invested in and you expect a return from. We aren't sharing specifically the timeframe for when the thing does begin to break even and contribute. But as we discussed earlier, we are looking at alternative ways to maximize return in this business, including optimizing the IP and so forth. And at this point it wouldn't be right to elaborate beyond that.

Operator

Our next question is from Charlie Anderson with Dougherty & Company.

Charles L. Anderson - Dougherty & Company LLC, Research Division

As it relates to IoT, I wonder if you can just talk and also numerically about connectivity portion of the business? Maybe at P&L level, what percentage is today and of expectations moving forward?

Steven A. Laub

With respect to what percentage of the company of business, I'm actually hesitant to share that. The number of people who've been asked that some have given answers, some haven't, other suppliers of our industry. I could tell you that our connectivity business has been growing for us very nicely, quite rapidly actually. And that's one of the ways that we measure that. Also we see that a lot of our micros are going into what we call IoT applications, but we may or may not be using our wireless connectivity as well. But some people are using, I'd say, very generous interpretations of what IoT applications are. We're very comfortable with respect to the amount of activity we're seeing, the designs that we're winning, our competitive position in that particularly after acquisition. And as this becomes, I'd say, easier to define and to measure, we'll provide some further, I'd say, clarification at that time, but right now, though, is not the right time to doing that.

Charles L. Anderson - Dougherty & Company LLC, Research Division

And then a follow-up for me. You guys set out the 49% target earlier in the year, I think, probably quite a bit has changed since you mentioned the weakness in tablets. So that business has shrunk a little bit. And you also acquired a company. So you had some maybe downward pressure potentially from that. How are you recovering to get to the 49% in other areas, what's stronger than you expected when you look at the end of the year?

Steven A. Laub

I think the thing that's occurred to us, we set out that target actually last year. So a lot of things have changed in the business which is the nature of semiconductor industry. What hasn't changed is our commitment to hitting the target. And as we've gotten much closer to it, I think we've affirmed that we are going to -- we expect to achieve that target. 47% this quarter, 49% next quarter. So lots of things have changed. One thing hasn't changed is that. So we continue to drive our execution in the company. And we take into account that we expect things to change. Nevertheless, you drive your business to achieve a certain level of profitability. Our expectation, I think it's very important to communicate. Once we've achieved this 49%, and as Steve mentioned earlier, we don't expect a stop at that point. Lots of activities to drive the gross margin further. And I think one of the things also that we feel is that the company should be at a sustainably higher gross margin going forward. This isn't as if we meant that during only peak business cycle, you achieve that, then you drop back down when things slow. Our expectation is that we've actually changed the operating model of the company with the activities that we've gone through for the past, I'd say, 6 to 8 quarters.

Operator

Our final question is from Craig Berger with [indiscernible].

Craig Berger - FBR Capital Markets & Co., Research Division

Can you just remind us what your sort of long-term margin model is on gross and operating at kind of what revenue levels, so you're talking about just longer-term transformation, but what are those levels?

Steven A. Laub

Craig, so what we'll share is our expectation of gross margin over 50%. We expect that our, I'd say, our OpEx and, I'd say, the best way to think about it would be in the sense the way we measure it now sort of on a non-GAAP basis, so excluding stock comp at our OpEx that will be roughly around 30%. And our -- therefore our op income should be 20% plus on a Non-GAAP basis.

Craig Berger - FBR Capital Markets & Co., Research Division

Yes, I mean, the follow-up was stats of the capacity, and that is how much foundry upside you have available to service continuing design wins, et cetera?

Steven A. Laub

Yes, foundry capacity has gotten actually a little bit tighter currently than it was, say, 6 to 9 months ago. But given that we are a very significant customers to our foundries, we are being given and provided efficient, I would say, wafer capacity and assembly and test capacity to grow our business consistent with whatever we need on that basis. So that's one thing when you're committed to you're committed to going outside as we are, unlike smaller companies who have a lot of internal operations. When you're committed to the foundry model, which we have moved toward certainly fab-lite model, we have very good relationships with our foundries, and we are getting what we need.

Peter Schuman

Thank you. Chanel, during the third quarter, Atmel will be presenting in Boston at the Oppenheimer conference in August 12 and in the Canaccord conference in August 13. 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 conference call. Thank you for joining. You may now log off.

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