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Atmel (NASDAQ:ATML)

Q3 2012 Earnings Call

November 01, 2012 5:00 pm ET

Executives

Peter Schuman

Stephen Cumming - Chief Financial Officer and Vice President of Finance

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

Analysts

Steven Eliscu - UBS Investment Bank, Research Division

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

Christopher Caso - Susquehanna Financial Group, LLLP, Research Division

James Schneider - Goldman Sachs Group Inc., Research Division

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

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

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

John Vinh - Collins Stewart plc, Research Division

Sidney Ho - Nomura Securities Co. Ltd., Research Division

Jaeson Schmidt - Craig-Hallum Capital Group LLC, Research Division

Operator

Good afternoon. My name is Christy, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Third Quarter 2012 Earnings Conference Call. [Operator Instructions] Mr. Peter Schuman, Director of Investor Relations, you may begin your conference.

Peter Schuman

Thank you, Christy. Good afternoon and thank you for joining us for Atmel's Third Quarter 2012 Earnings Conference Call. A copy of the press release issued today is available on our Investor Relations website. A replay of this conference call will be available after 5:00 p.m. Pacific today, and will be archived for 48 hours. The webcast will be archived on the company's website for one 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 Stephen Cumming, Vice President of Finance and Chief Financial Officer. Stephen will begin the call with a review of our third quarter financial results, and Steve will then provide additional information on the business. At the conclusion of Steve's remarks, Stephen will discuss our financial guidance for the fourth quarter of 2012, 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, litigation matters and the anticipated course of patent litigation, revenue, target gross and operating margins, product introductions and cost savings for 2012 and beyond. Our forward-looking statements and all other statements that are not historical facts reflect our expectations and beliefs as of today, and are therefore 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. The non-GAAP financial 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 Stephen Cumming for a discussion of our third quarter financial results. Stephen?

Stephen Cumming

Thank you, Peter. The third quarter revenue of $361 million decreased $7 million or 2%, and was within our guidance range of between $357 million to $379 million. The lower sequential revenue was primarily due to weakness in all business segments other than our microcontroller business, which grew sequentially for the second consecutive quarter.

Subsequent to the end of the third quarter, Atmel completed the sales of its serial flash memory business, which had approximately $50 million in annual revenues.

The results of the third quarter includes serial flash revenue at approximately $12 million. Third quarter 2012 gross margin was 43.1%, which was at the lower end of our guidance of between 43% to 44%. The non-GAAP gross margin was 43.7%.

The majority of the sequential decrease in gross margin was due to lower revenue, particularly in the ASIC segment and the adverse impact of the take-or-pay agreements with our European foundry partners.

These take-or-pay agreements are set to conclude at the end of the second quarter 2013.

During the quarter, we managed our operating expenses extremely tightly. Operating expenses came in at $128 million, and was significantly lower than our guidance of $133 million plus or minus $2 million. This compares to operating expenses of $137 million in Q2 of 2012, and $133 million in the third quarter of 2011. Non-GAAP operating expenses were $112 million.

The sequential decrease in OpEx is primarily the result of strict controls on discretionary spending, the restructuring actions we took last quarter and higher seasonal vacations from our European sites.

With the recently announced sale of the serial flash memory business, we expect to save approximately $1 million per quarter in operating costs starting in Q4 2012. We continue to maintain strong discipline managing our operating expenses during the past quarter, and we will persist with our efforts to take additional steps to improve operating margin leverage in the future.

R&D expense of $60 million in the third quarter was approximately $6 million lower compared to the prior quarter's $66 million, and compared to $64 million in the same period last year.

SG&A expense was $68 million for the third quarter of 2012, compared with $71 million in the prior quarter, and $68 million in the same period last year.

Stock compensation for Q3 was $18 million, allocated as follows: $2 million to manufacturing; $5 million to R&D; and $11 million to SG&A. Stock compensation was flat compared to the second quarter of 2012.

Income from operations was $27 million in the third quarter of 2012. This compares with income from operations of $8 million in the second quarter 2012, which included $14.4 million of charges related to restructuring activities.

Income from operations of $140.2 million in the prior-year third quarter included a gain of $33.4 million related to the sale of our corporate headquarters.

Non-GAAP operating income for the third quarter 2012 was $46 million or 12.7% of revenue and excludes acquisition-related charges, restructuring and stock-based compensation. This compares to second quarter 2012 non-GAAP operating income of $43 million or 11.7% of revenue, and non-GAAP income from operations of $124 million in the same period last year.

GAAP income tax provisions totaled $5.9 million in the third quarter of 2012, which is lower than our guidance of approximately $11 million to $12 million.

The third quarter 2012 GAAP tax provisions compares to $3.9 million in the prior quarter, and $23.2 million in the third quarter of 2011.

During the third quarter of 2012, our non-GAAP income tax provision was approximately $2.9 million, which compared to $1.8 million in the prior quarter. We expect to have non-GAAP or a cash tax effective rate in the mid-to-upper single-digit percentages for the remainder of 2012 and beyond.

GAAP net income for the third quarter 2012 was $21.6 million or $0.05 per diluted share. This compares to second quarter of 2012 of $754,000 or breakeven per diluted share and GAAP net income of $116.7 million or $0.25 per diluted share in the same period last year.

On a non-GAAP basis, for the third quarter 2012, we had net income of $43 million or $0.10 per diluted share. This compares with non-GAAP net income of $37.4 million or $0.08 per diluted share in the second quarter of 2012, a non-GAAP net income of $124 million or $0.26 per diluted share in the third quarter of 2011.

As to our stock repurchase program, during the third quarter, Atmel repurchased 3.8 million shares of common stock in the open market at an average price of $5.98 per share.

Now turning to the balance sheet. Combined cash balances, cash and cash equivalents plus short-term investments totaled $289 million for the third quarter, representing an increase of $43.5 million from the second quarter. The increase is primarily related to the higher net income of $21.6 million and $25 million received from the sales of serial flash business, offset by the repurchase of common stock, utilizing approximately $23 million in cash during the third quarter of 2012.

Cash flow from operations totaled approximately $54 million in the third quarter, up approximately $46 million from $8 million in the second quarter of 2012, due primarily to higher earnings.

Capital expenditures were $16 million in the third quarter, up from the second quarters $9 million, and just above the guidance range of $10 million to $15 million.

Depreciation and amortization in the third quarter of 2012 was approximately $19 million flat compared to the second quarter 2012 and the third quarter a year ago.

Accounts receivable total $248 million at the end of the third quarter, an increase of approximately $8 million from the second quarter. Our days sales outstanding for the third quarter stood at approximately 63 days, up 4 days from the prior quarter.

Given the new product ramps, including Windows 8 devices, linearity shipments were back-end loaded than the prior quarter, which caused DSOs to increase more than expected. Both the inventory dollars and inventory days decreased during the third quarter. Our third quarter inventory decreased by $13 million to $336 million compared to the prior quarter's $349 million. The drop in inventory is primarily due to the sales of serial flash business, our days of inventory decreased by 5 days and stood at 149 days compared to the second quarters 154 days.

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

Steven A. Laub

Thank you, Stephen. Despite the challenging global economic environment, our third quarter results showed progress in a number of important areas. I'm pleased to report our microcontroller business grew for the second consecutive quarter and represented almost 63% of our overall business. This was offset by incremental weakness in other product lines, especially aerospace, as we communicated last quarter. We undershipped consumption in the distribution channel as we brought down distribution inventories. If we had shipped in line with distribution sell-through, revenue would've been up sequentially during the third quarter.

Our largest -- from an end market perspective, our largest end market, industrial, weakened during the third quarter after a solid second quarter. Tablets, e-readers and Ultrabooks were strong toward the end of the quarter with the start of the ramp of Windows 8 devices. Communications and networking had a second consecutive quarter of growth, the consumer markets improved slightly in Q3. And as expected, automotive was down as was military and aerospace.

Moving to a discussion of our business segments. For our Microcontroller business unit, Microcontroller revenue of $226 million increased 3% sequentially and was down 25% as compared to the third quarter of 2011.

For the second quarter in a row, both our core microcontroller revenue and maXTouch revenue grew sequentially.

By product family, during the second quarter, our 8-bit micros were down 7% sequentially, and were down 35% year-over-year. While 32-bit microcontrollers increased 33% sequentially and increased 11% year-over-year.

As you know, microcontrollers are at the heart of our business. As the world's third largest microcontroller provider, our solutions are empowering the most innovative new products across a broad spectrum of markets, from industrial controllers to consumer devices, and many new emerging applications. As to new products, in ARM-based microcontrollers, Atmel is now sampling the SAM4L family of devices, which set record low power and efficiency standards ARM Cortex-M4 processor-based microcontrollers. The SAM4L family incorporates Atmel's proprietary ultra low pico power technology using hundreds of millions of Atmel AVR MCUs in the market today. The SAM4L allows for fast wake-up and innovative power-saving features. The SAM4L family consumes just 1/3 the power of current solutions in the marketplace and offers the lowest active power in an ARM-M4-based products available today. The SAM4L family is ideal for battery-powered consumer, industrial and portable health care products. Production quantities will be available this quarter.

When combined with the introduction of the SAM4S family in the second quarter, along with the SAM4L introduced in Q3, Atmel now offers both the highest density embedded flash devices and the lowest power products in the ARM Cortex-M4 processor marketplace.

In the world's most important trade shows running smart metering in Europe this October, Atmel introduced the world's first single chip power line communications-based solution. Also using an ARM Cortex-M4 processor-based microcontroller. Targeting the rapidly growing prime smart metering market. The new system-on-a-chip integrates Atmel's POC technology with the high-performance Cortex M4 MCU with 2 megabits of program memory on a dual bank configuration. The new solution also leverages the powerful peripherals of the MCU required for smart metering applications. Smart meter rollouts are instrumental to future smart grid developments and European governments are actively endorsing their implementation. For example, we recently signed a memorandum of understanding with one of the largest utility companies in Portugal, Labelec SA, a subsidiary of Electricidade de Portugal. This MOU is the industry's first agreement between a distribution system operator and technology provider for developing technology solutions using the product standard.

Moving to our sensor hub technology. We first introduced the concept of a sensor hub product at our Analyst Day in June of last year. As a reminder, a sensor hub product is a processor with embedded firmware that interfaces and manages the ever-increasing number of sensors such as accelerometers, magnetometers and gyroscopes found in electronic devices such as smartphones and tablets. Combining the management of sensors into a dedicated sensor hub processor eliminates the need to wake up the applications processor to perform these functions. Allowing for significant reductions in power consumption and improved battery life, while also reducing latency and improving responsiveness.

For Atmel, we have optimized our 32-bit AVR architecture to provide the highest performing and lowest power standalone sensor hub solution in the market. Atmel began shipping our first sensor hub product during the second quarter of this year and has recently begun shipping in high-profile smartphones and tablets, including the Samsung Galaxy Note II and the recently launched Microsoft Surface tablet.

To further enhance our sensor hub solutions, we have successfully integrated the sensor hub functionality into our maXTouch touchscreen controllers for tablets and Ultrabooks. Extending human interface solutions to include not only touch but real-world sensor management in a single chip solution to deliver performance and power efficiency gains.

The integrated solutions, which this Monday, we formally announced as our MAXFUSION Technology are available with our 1664S maXTouch controllers for up to 14-inch displays. And with our 1188S maXTouch controllers for up to 11.6-inch displays.

Besides enhancing all motion-related applications including a gaming, navigation and virtual reality, our MAXFUSION technology offers up to 50% lower power consumption than competing solutions, with even greater savings when compared to architectures where sensor management is implemented on the application's processor.

In the developer ecosystem, Atmel continues our support of Arduino, an open-source electronics platform which features both Atmel's AVR and ARM microcontrollers. Atmel was nominated for a 2012 Markey Award for its commitment to the fast-growing Arduino community at the World Maker Faire in New York, and won an Editor's Choice Award. Arduino boards featuring Atmel's AVR and ARM cortex-M processor-based microcontrollers are powering well in excess of 700,000 different development units on the Windows, Macintosh OS X and Linux operating systems in a simple to use programming environment.

Moving to our touch products, in the marketplace for tablets and other large-screen devices, October 26 marked the widely anticipated launch of Microsoft's Windows 8 operating system. As a leading engineering partner with Microsoft for touch on Windows 8, Microsoft selected Atmel for its recently introduced Surface tablet, which includes Atmel 1386E touchscreen controller for the tablet touchscreen. The maXTouch 112E for the touch-based keyboard and our discrete sensor hub solution.

Windows 8-based products contributed meaningfully to our maXTouch revenue through the third quarter, and we expect this trend to continue into the fourth quarter of 2012 and beyond.

Atmel is currently Win 8 certified for 20 different tablets and Ultrabooks and is actively engaged in over 30 different Windows 8 programs. Our Microsoft Win 8 partners with certified products featuring maXTouch include Acer, ASUS, Dell, HP, Fujitsu, Lenovo, LG, Samsung, Sony, Toshiba, and of course, Microsoft.

According to IDC, continued robust consumer demand and strong expectations for the fourth quarter has led them to increase their 2012 forecast for a worldwide tablet market to 117 million units, up from its previous forecast of 107.4 million for this year.

IDC also revised upward its 2013 forecast number from 142.8 million units to 165.9 million units, and 2016 worldwide shipments should reach 261.4 million units.

In September at the Intel Developer Forum, Intel updated a number of Windows 8 models that we're seeing for adoption this holiday season from OEMs to over 140, with over 40 expected to be touch-enabled.

They also stated when consumers are given a choice, touch was chosen approximately 80% of the time over keyboards, mouse and track pads. Clearly, we're excited about the market opportunity that large screens offer for maXTouch, and we continue to be the leading supplier and innovator in this space.

During the third quarter, we received Windows 8 certification for our 3432S maXTouch controller designed for Windows 8 touchscreens up to 17.3 inches. This is the highest capacity of node count product commercially available.

In the Android community for large screens, Atmel continues our leadership in the market for Android-based tablets. MaXTouch is now powering the touch in the new 7-inch Amazon Kindle Fire HD tablet.

According to Amazon, its 7-inch Kindle Fire HD tablet, which went on sale in September, has outsold all other products on the company's website since then. This is Atmel's first product introduction in media tablets, which are an increasingly significant portion of the Android tablets available today.

Another significant win in Android tablets for Atmel during the third quarter was the Samsung Galaxy Note 10.1. Samsung selected Atmel's maXTouch to power the touchscreen on the Android Ice Cream Sandwich-based tablet, which features support for proximity-sensing and active stylus. We also won the ZTE V96A tablet and Parrot's ASTEROID in-car entertainment system.

In the market for handsets, Atmel continues to deliver best-in-breed solutions for our customers. For those customers desiring to offer a differentiated product with superior noise immunity and performance, our maXTouch X Series core to the design and is featured in the new Samsung Galaxy S3 Mini the 4-inch companion in the Galaxy S3 portfolio and the Samsung Galaxy Express. Other recent major smartphones released in the market using maXTouch include the Motorola Razr M, Photon Q 4G LTE, and Razr VXT885, and numerous handset wins from Kyocera, Sharp, and Chinese handset wins from ZTE, Gionee Communication, and Xiaomi.

In the automotive touch marketplace, expanding the Atmel portfolio of automotive qualified maXTouch devices, our new 143E and 224E touch controllers for in-car control systems are designed for small automotive touchscreens and touchpads up to 7 inches in diameter for center-stack displays, navigation systems, radio-human machine interfaces, rear seat entertainment systems. These products have the auto industry's most advanced touchscreen solutions and compliment the previously qualified 540E and 768E automotive products for screen sizes up to 12 inches.

With these new automotive qualified maXTouch devices, Atmel's strengthen its position as the market-leading touch supplier for automotive.

For capacitive touch and button sliders and wheels, our QTouch family of home appliance products of capacitive touch controllers was the first to receive the Class C UL product certification. Major appliance makers for washers, dryers, stovetops, refrigerators, HVAC controllers, and other consumer-related devices, commonly use this standard in the Americas and throughout Europe as they market product quality and safety. This is just another way that Atmel continues to be the touch leader in the home appliance markets.

Turning to XSense. We have completed qualification of our XSense film-based touch sensor product on schedule and have started production. We have sampled multiple customers, including several Tier 1 OEMs, and made our first production shipments in October.

Customer interest has been enthusiastic, especially with our latest versions, which offers several performance advantages and enhanced optical quality, which is comparable to ITO. We expect to see first products with XSense in the market during the first half of next year, with major volumes expected to ramp in the second half of 2013.

Turning the discussion to our Non-Volatile Memory segment. Total revenue of the non-volatile memory segment was $44 million in the third quarter, down 7% sequentially and down 33% as compared to third quarter of last year. The decrease was primarily the result of a weaker pricing environment.

At the end of September, Atmel sold its serial flash memory families, which consisted of our DataFlash and Bios flash product lines. Atmel had $12 million of revenue in Q3 2012 from the serial flash devices and $19 million in the same period in calendar year 2011.

The Atmel employees that supported that business transferred to the new owners. We thank those employees for their contributions over the years. Atmel will continue to support the growth of our special memory products, which includes Serial EEPROM, Crypto and our digital temperature sensor product families.

Our ongoing strategy in the memory market is to leverage Atmel's market position in microcontrollers to provide more complete solutions with value-added memory, Crypto and analog products, which offer a higher margin profile for the company than our historical memory business.

In the RF and Automotive segment, revenue decreased to $43 million in the seasonally weaker third quarter of 2012, down 9% sequentially and down 17%, as compared to the third quarter of 2011. Most product areas were weaker given a slowdown with European automakers.

We announced the availability of a new family of low-power high-performance microcontroller-based RF transceivers designed specifically for the automotive market. These new devices offer high sensitivity and high output power, along with the industry's lowest power consumption.

These parts are ideal for automotive applications, including remote keyless entry, Passive Entry Go, remote start and tire pressure monitoring systems. The new RF family is also suitable for various smart RF applications, including remote control systems such as garage door openers. Low power is a critical requirement for both car access and industrial RF systems, especially for small battery-powered applications.

Moving to the ASIC business segment. Third quarter revenue of $48 million was down 11% sequentially, and decreased 21% as compared to third quarter 2011. As we've communicated during our second quarter call, the placements was down considerably due to being adversely impacted by government funding delays and changes concerning export controls for products shipped from Europe to Asia.

Looking at the third quarter revenue by geography. Our largest ship-to location was Asia, representing 62% of revenue, EMEA was 23% of revenue, while the Americas was 15% of revenue during the third quarter.

Now a brief update on operations. On Tuesday, we announced that Walt Lifsey, Atmel's Executive VP and Chief Operating Officer, had retired after nearly 6 years with the company. Walt has built a strong global operations team and played a critical role in several strategic transactions, which have provided substantial value to our shareholders. We thank Walter's years of service and wish him the best with his well-deserved retirement.

On Tuesday, we also announced that Shahin Sharifzadeh has joined Atmel as our new Senior Vice President of Worldwide Operations. Shahin was most recently at Cypress Semiconductor, he served as their Executive Vice President of Worldwide Manufacturing and Operations, and President of China Operations. We welcome Shahin and look forward to continued enhancements in our global operations.

In summary, we are pleased to have our second consecutive quarter of sequential growth for both our core microcontroller and touch businesses.

During the past 6 months, we have made great strides in the 32-bit microcontroller market with the release of multiple leadership products. In the ARM Cortex marketplace, we've introduced the highest density embedded flash devices and the lowest power products.

For the rapidly growing prime smart-viewing market, we introduced the world's first single-chip power line communications-based solution. And we are particularly enthusiastic regarding our new sensor hub solutions, which are focused on the high-growth smartphone and tablet markets, and which we have already begun high-volume production with Tier 1 customers.

Atmel continues to lead the market for capacitive touchscreen controllers. Atmel's maXTouch is in 2 of the hottest non-Apple tablet products in the market today, with Amazon's new 7-inch Kindle Fire HD and Microsoft's Surface tablet, and has been Win 8 certified in 20 different tablets and Ultrabooks. We expect our maXTouch momentum to continue into the fourth quarter 2012 and beyond.

During the quarter, we took actions to enhance the company's business portfolio with the sale of the Serial Flash business, and we have taken and will continue to take significant actions to reduce operating expenses and improve Atmel's operating performance. This is particularly important given the current economic environment.

To conclude, the investments we have made during the past 12 to 18 months in Atmel's core microcontroller and touch businesses have positioned us very well. And we expect to grow faster than the overall microcontroller market.

Now let me turn the call back to Stephen for our Q4 financial guidance.

Stephen Cumming

Thank you, Steve. The company's revenue for Q3 was $361 million. Excluding the sale of the Serial Flash business at the end of the third quarter, the adjusted revenue would have been $349 million. Using $349 million as our new base for the fourth quarter of 2012, the company expects revenue to be between $328 million to $352 million, which is down 6% to up 1% sequentially from the adjusted revenue as a result of the continued growth in our microcontroller business, offset by a slowdown in our other businesses and the sale of the Serial Flash business.

We expect GAAP gross margin to be between 41% to 43% in the fourth quarter of 2012, on a non-GAAP basis, modeled to 41.6% to 43.6% gross margin for the fourth quarter.

Fourth quarter GAAP operating expenses are expected to be $126 million, plus or minus $2 million. Non-GAAP operating and expenses are expected to be approximately $110 million, plus or minus $2 million.

As a result of the recent restructuring activity announced, going forward, we expect greater operating margin leverage. For the fourth quarter, depreciation and amortization is expected to be approximately $20 million and stock compensation to be approximately $90 million. We expect capital expenditures to be approximately $5 million to $10 million for the quarter.

Other income and expense is expected to be approximately $1 million to $2 million expense, and Quantum and ADD Semiconductor acquisition-related costs are expected to be approximately $2 million for the quarter.

We expect our Q4 GAAP tax expense to be approximately $10 million to $12 million. For those doing non-GAAP models, we expect our non-GAAP or cash tax rate to be in the upper single-digit percentages in Q4 and in the mid-to-upper single digits for next year. For modeling purposes, assume a GAAP fully diluted share count to be approximately flat at around 433 million, for the non-GAAP share count flat at around 444 million.

This concludes our prepared remarks. We'll now open the call to your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Steven Eliscu with BBS.

Steven Eliscu - UBS Investment Bank, Research Division

[indiscernible] around the -- let's just do a Touch question first.

Steven A. Laub

Steve, you broke up at the beginning. Could you repeat that?

Steven Eliscu - UBS Investment Bank, Research Division

Yes. The first question is regarding Touch for smartphones. Congratulations on the recent wins. I wanted to understand how as you look out over time, what percentage of your overall Touch do you expect revenue from smartphones to be given the growth in tablets and Ultrabooks?

Steven A. Laub

Steve, let me give some perspective on where we are. So with respect to the Touch business in Q3, we had a breakout of roughly smartphones, 40% to 45% of the total tablets eReaders; Ultrabooks, 50% to 55%; other areas, between 5% and 10%. My expectation for the year is to try to break out 50%, 55% smartphone; 35% to 40% tablet eReaders; and probably closer about 10% in other markets. Our expectation is long term, there's great growth in the tablet eReader, Ultrabook marketplace and in the smartphone marketplace. We think they're both very, very attractive. But with the adoption of Touch that we see going on in the Ultrabook, laptop, notebook tablets and so forth, we think that, that's going to provide greater opportunities over the long term, whereas the smartphone, what we see is the major growth that's occurring today vis-à-vis -- still got very good customer market but primarily in the low end of that market. For us, we will be investing in both but sticking out the leadership position, really, at the large screens.

Steven Eliscu - UBS Investment Bank, Research Division

Yes, I have a follow-up question. In terms of the sensor hub, it sounds like a useful function. The thing is it doesn't sound like a necessary function. And as the market matures, it just seems susceptible to be designed out. And can you give us a sense -- I understand with the fusion product, you now combine touch and the incremental price at or for a sensor hub is relatively small. But give us a sense as to what you see over time in terms of the percentage of smartphones to use a sensor hub and how you think you could gain some percentage of share but also hold that -- to be able to hold that share as the market matures.

Steven A. Laub

Well, in fact, I think one thing I can say is that what we're saying is adopted as -- it's adopted in both phones and tablets as we have disclosed that we have design wins in both the Galaxy Note II, as well as the Microsoft Surface tablet. With respect to the function, actually this is a function that's garnering even greater importance, not less importance over time. It is actually specified within the Win 8 spec to have a specific function for a sensor hub management. That is something that is new that is actually as close as part of the specification. Now whether that's a discrete implementation or integrated implementation, that really depends on how effective and efficient those implementations are and how people want to adopt that. Our expectation is if the sensor hub functionality is something that will be more increasingly adopted certainly over the next -- as we look at 2013, increasing over 2013. At the current time, it is probably more of a higher-end requirement versus lower-end because there is more sensors in higher-end applications and higher-end functions in those phones and tablets. But we expect, actually, increasing adoption, and the reason we've integrated that within the large screen touch controllers is that our expectation is that it will become much more standard in those kind of products.

Operator

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

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

If you look at the guidance on an apples-to-apples basis, taking out the Serial Flash, it assumes that 4Q will be down about 3% sequentially at the midpoint. And I'm wondering if you could maybe talk a little bit about the drivers in each segment. What do you see in each of the businesses and some of the end market dynamics into those businesses?

Stephen Cumming

Sure. So what we're experiencing or our expectation is that the MCU business will actually be up in the fourth quarter. We think it will be up probably in the sort of low to mid-single digits. Expectation is that the ASIC businesses and the RFA businesses and memory business, some combination of that, are probably down somewhere between 5% and 10%, depending on the dynamics of the business. So ASIC down probably -- I'd say, actually all of the businesses is probably 5% to 10% down, pretty consistent with what you are seeing from most other semiconductor suppliers of the difference that's happening for us is we're experiencing growth and expect growth in our Microcontroller business, which we think is are far better than what others are experiencing.

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

On the gross margins, the midpoint, 42.6%, continue to decline. Where do we see those margins -- when do we start to see the margins pick back up again? I know the take-or-pay scenario in the second quarter of '13. Will you start to see a benefit there? Will you start to see a benefit from mix shift, cost reductions? When should we expect margins to start to trough and bounce up again?

Stephen Cumming

This is Stephen. Yes, just to make sure clear on our GAAP margins, it was 42%. I assume you didn't [indiscernible] so it's a non-GAAP number but...

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

Non-GAAP.

Stephen Cumming

Yes, okay. We had initially expected our fab operations to operate at a higher level given the expectations that we see at the macro environment. We're anticipating to now operate our fabs in the sort of low to mid-70s. So that's creating a little bit of a headwind to us during Q4, and that's one of the main reasons that's pulling our gross margin down. Also, given the take-or-pay that you mentioned in our European foundries, we do expect them to complete by the end of Q2 of 2013. And so that has prevented us from being able to take advantage of lower foundry wafer pricing in the marketplace today and created a little bit more of negative gross margin impact. As we look out into next year, assuming that the macro environment improves, we expect to see gross margins come up a little bit. I think you should expect our gross margins, certainly in the first half as we work through the take-or-pay agreement, to be in the sort of mid to low 40% range as we work through these agreements.

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

And my last question.

Stephen Cumming

I think you should expect for the second half of 2013 for things to improve obviously pending the overall improvement in the macro environment and growth of the business.

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

And just last question for me. The maXTouch forecast for '13, any stab at what that would be given the fact that the maXTouch was down in '12? Any sense of what it could be in 2013?

Steven A. Laub

The touch marketplace is such a dynamic market that I've noted that everybody who forecasts this early tends to get it wrong because the design cycle is so short. The business itself is growing very well for us, very nicely in Q3 to actually grow very strong in Q4. But we're not going to put a stab in our forecast at this point. But that's a question I'll ask in the next quarter's call.

Operator

Your next question comes from the line of Chris Caso with Susquehanna Financial Group.

Christopher Caso - Susquehanna Financial Group, LLLP, Research Division

This is a follow-up to one of the earlier questions. With the regard to the 8-bit business as you look into the fourth quarter, are you expecting that to grow as well now that it's got a different customer profile there? Or is that more along the lines of some of the other businesses which are more exposed to the industrial markets?

Stephen Cumming

We don't tend to break out usually a forecast for 8-bit versus 32-bit. We do sometimes give a sense for what's happening, perspective between sort of our core Microcontroller business, which encompasses 8-bit and 32-bit, and then separately from the Touch businesses. Our expectation right now for Q4 is that the core Microcontroller business will probably be essentially flat, maybe up or down slightly. It's too early to say what the final number will be, whereas our Touch business, we actually expect that, that business will probably be up double digit in Q4.

Christopher Caso - Susquehanna Financial Group, LLLP, Research Division

Okay, that's great color. And just a follow-up to that. If I take Touch out of the equation for a moment, and I understand what's happening on year-over-year basis, your core business, it seems like you still think that you're shipping below consumption. Do you have a sense on a year-over-year basis or whatever kind of color you can provide of how far below consumption you're shipping right now? And obviously, we'd assume once the inventory adjustments are happening that we can get back to normal consumption levels?

Steven A. Laub

I don't tend to break that out specifically because it's very hard to do it with a specific product line. We did have some general numbers. For example, we can understand what's happening with respect to shipping below consumption and surely in distribution because we get POS information versus shipping information. So we do have that sense and we know that, for example, this past quarter, that the POS out of our customers as compared to the ship in to our Asian distribution because we recognize revenue on the shipping as compared to the POS that the ship out was significantly higher, which is a good thing from the standpoint of getting the inventories in balance. But right now, my sense is there is some of that. But it's very hard to go into specifically what's happening with some of the OEM customers right now. What's also really impacted the business, which I think is impacting everyone's business has been the softness in the industrial end market segment, which is the largest end market segment for those products.

Operator

Your next question comes from the line of James Schneider with Goldman Sachs.

James Schneider - Goldman Sachs Group Inc., Research Division

I was wondering if you could follow up on the last question and talk about where do you think the distributor inventory levels are right now. Do you think they're lean? Or do you think there's still more to be worked up? It sounds like you're still in work off mode. But do you think that we're less than a quarter are more than quarter away from that?

Stephen Cumming

This is Stephen. So our distribution channel inventory came actually down both in dollars and weeks. We roughly decreased it from Q2 to Q3 by about a week, so it came down to about 10 to 9 weeks. A lot of that reduction really came out of Asia. And as Steve said in his prepared remarks, we're shipping under consumption there. I think probably given the more muted or weaker macro environment, I think it's fair to say that inventory probably will continue to drain a little bit more in channel. It's tough to gauge by how much. But certainly, we're operating in our target ranges now, as we've said, between 8 and 10 weeks, but we should expect that to come down a little bit more in Q4.

Steven A. Laub

And Jim, this is additional color on that. Assuming that our distys are good at their forecasting, which we have found historically they are not, but we would expect that they're pretty good at understanding what their business is and the average time to take in that. I think after this quarter, we should expect to be pretty good in balance throughout our distribution network.

James Schneider - Goldman Sachs Group Inc., Research Division

That's helpful. And then as a follow-up, I think, Steve, last time you talked about in Q4, you're expecting an uptick in the Military and Aero driven by some European aerospace contracts coming back. It sounds like that's no longer the expectation. So can you give us some color on when you think that might come back now? And is that much longer way off? And to what level do you think you can return to?

Stephen Cumming

So actually, we do expect in Q4 a recovery in the Aerospace business. We were running at -- we probably dropped -- very substantially in Q3. We expect to actually have a reasonable, pretty good recovery in Q4, but it will not get back to the run rates of Q2. Overall for the ASIC business is that the other parts of ASIC business are where we're seeing the decline in Q4, consistent with what's happening generally in the semiconductor industry. And so that's why you're seeing the ASIC number come down, but that's where that's coming from. But actually, we're seeing a drop in our APG, or Advanced Product Group. We're seeing some drop when we called off our CASP [ph] product lines as well. So there's actually a group of product lines that are encompassed within the ASIC business. The one that's going to actually be growing is the Aerospace one, but we expect the other ones to be declining probably in the high single-digit space.

Operator

Your next question comes from the line of Jeff Schreiner with Feltl and Company.

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

[indiscernible] deeper regarding the sensor hub product...

Steven A. Laub

Jeff, Sorry to cut you off again. It seems that we got a bit of a bad line again. Could you repeat the first part of your question?

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

Yes, sorry about that. Just trying to dig in a little bit deeper regarding this new sensor hub product and integrated in with the larger screen maXTouch. Trying to understand, are some of these initial large screen designs seeing multichip deployments? Or have you already started to move to single-chip solutions when you're looking at these larger touchscreen wins that Atmel would like to capture?

Steven A. Laub

So the first designs that we have are using a discrete sensor hub product. The integrated solution is something that we have been ensuring the customers had a very good reception on that. But there's been no product that's been released in the marketplace yet that is using the integrated solution. That's not because it isn't desired. It's more just the timing of when the product was introduced and the timing of getting designs done.

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

And just a follow-up on that. The sensor hub, I think, Steve, you referenced it as a more high-end product. How is this going to help in terms of your push into the Chinese smartphone market?

Steven A. Laub

So it is more of a sort of a high-end smartphone and tablet type of solution. It is not going to be a kind of product that I expect is going to be particularly required for sort of the Asian or Chinese smartphones. This is a different type of solution. As mentioned, it's already shipping today in the Samsung Galaxy Note II and the Microsoft Surface tablet.

Operator

Your next question comes from the line of Craig Berger with FBR.

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

Can you help us understand, once you do get out of the take-or-pay arrangement and can use more foundries, what does that do to your expected gross margins? And also, are you already including any of that savings in the pro forma numbers that you already put out?

Steven A. Laub

So Craig, in answer to your second part of your question, no numbers that we put out is incorporating any of those savings. Those agreements do not complete until the end of Q2 2013. So nothing is built into -- from an outside perspective, built into our Q4 guidance. Obviously, from the downside perspective, it's part of the headwind for us partly because we have managed to leverage our own manufacturing assets and those foundry agreements are probably not coming down as quickly as overall foundry way for pricing is overall. I think, Steve, did you want to take the second -- the first part of the question?

Stephen Cumming

We're trying to be also mindful of the information that obviously is confidential. But I think what we'll share with you guys is that the impact from a wafer pricing standpoint, and I don't want to disclose specifically what the gross margin impact is because I think it creates different set of questions, but the difference in wafer prices that were there in our P&L because of this is well over 20% for product that we have to buy from our European foundries as compared to buying it from a Asian foundry or building internally on the wafer price. Well over 20% to give you a sense for the impacts for us.

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

Okay. And then just following up, I know you've talked a little bit about the impact of Win 8 on touch. Can you help us understand what kind of content are you seeing per device? Are you using multichip solutions or single chip? And how do you expect that to progress into next year?

Steven A. Laub

So from a content standpoint, we're actually using both, depending on the product and the customer. With respect to the Ultrabook solutions, typically those are 13-inch and above or so forth, that's using a multichip solution. The tablets are using a single-chip solution. Generally, all those very high-end or very high-performing tablets want to use or prefer to use a multichip because you really get -- you will get a higher performance with a multichip solution. So it's really a mix today of that. What will happen over time as we come out with new products, we will migrate more and more to single chip at a given screen size. But then as people move to higher screen sizes, they will continue using multichip at that level. So you can expect over time, there will be a migration more and more towards single chip. From a standpoint of what percent of the business is multi versus single, I would say that today, probably -- it's hard to break that out from a $1 million standpoint because it is quite a difference on that standpoint. But I would say it's a lot more single chip than it was a year ago. Remember, when we had a lot of the Android tablets and they fundamentally almost all multiple chip, this one there is a much higher preponderance of single-chip solutions in the tablets today.

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

Steve, can you just help us understand, is Asian competition coming on intensely for the PC space as well? I mean, can we a replay of the phone market for PCs? And why or why not?

Steven A. Laub

There is some Asian competition as you'd expect, as you see in all of the markets. But I think for the things that we've seen is even on the smartphone side, it typically is on the lower end. What we're experiencing in the sort of PC, Windows 8 and so forth is that there's a lot more opportunity for innovation. An example of that is the sensor hub integrating that gives us a real distinction as vis-à-vis other people who don't have that and nobody else has in integrated touch solution with a sensor hub. There are other technologies that we have, for example, stylus, which also gives a distinction that other people, for example, there don't have. So we think -- we believe there's a lot more opportunity for innovation and differentiation in that area, which is one of the reasons also we put high investment there.

Operator

Your next question comes from the line of John Vinh with Pacific Crest Securities.

John Vinh - Collins Stewart plc, Research Division

I was wondering if you could give us a little bit more color on how much maXTouch grew in Q3? And then how are you tracking relative to your par expectations of down 10% to 15% for maXTouch for the year?

Steven A. Laub

So with respect to Q3, I can tell you that -- actually, give me a moment here. So the maXTouch business for Q3, I would say, is sort of mid to high single digits, is the best way to think about that. With respect to tracking to the 10% to 15% down relative to the over 375 that we have forecasted much earlier for this year, we're probably going to be closer about that 15% down based on what we have experienced through the first 3 quarters and what our outlook is for Q4.

John Vinh - Collins Stewart plc, Research Division

Great. And then my follow-up to another previous question on the multichip touch solutions, you talked about the mix being more single chip versus multichip. But as we go into 2013 and as you start to introduce more single-chip solutions for these larger screens, are we going to be looking at a similar headwind in terms of chip consolidation as we saw earlier this year in Q1?

Steven A. Laub

Our expectation is that you will not because -- for 2 reasons. One, there's already a lot -- a pretty high amount of single chip in the marketplace unlike a year ago when virtually everything was a multiple chip solution. And it was actually -- it was 4 multiple chips. Today, the majority of multiple chip is actually down to 3. The second reason, I don't expect that, is that what happened in the marketplace is that the market kind of came down substantially in the number of tablets that were being shipped. And so you had a combination of both the Android market actually declined, the Win 8 market hadn't yet started, and then you had also solutions being integrated in the single chip. So really kind of a perfect storm in a negative way. Our expectation is the market will continue to grow throughout 2013. There will be some movement to the single chip from the multiple chip, but the amount of integration, the percentage of designs that we'll integrate are substantially lower than existed before. So we don't expect that.

Operator

Your next question comes from the line of Sidney Ho with Nomura Securities.

Sidney Ho - Nomura Securities Co. Ltd., Research Division

So first, a clarification. I think when you sold the Serial Flash business, you guys talked about foundry and support service for up to 1 year. I wonder if that is included in the guidance. And what kind of EPS impact would that be?

Steven A. Laub

I'm not quite sure what you're referring to, actually.

Sidney Ho - Nomura Securities Co. Ltd., Research Division

When you sold the business, I think you put out a press release saying that there will up to 1 year of support service for the company who acquired that business. Is that...

Steven A. Laub

So I think it's primarily for the back end manufacturing services. It's an immaterial impact, I believe, for us. This is a very small business.

Sidney Ho - Nomura Securities Co. Ltd., Research Division

Okay, great. And then my real question is if you look at your Automotive business, can you remind us between microcontrollers, and I think you have the new touch controllers and maybe in the RFA segment, how much exposure to the automotive market do you have? And also, can you remind us your exposure by geography within that segment? And what are the trends that you're seeing? And the reason I asked is because things could be very different in North America versus Europe and versus Asia, and I think a lot of automotive suppliers have talked about weakness in Europe in the past few weeks. I just want to see if you are seeing the similar trends or if increasing content is providing an offset?

Steven A. Laub

So for us, the vast majority of our sales in Automotive do go to the European OEMs, either directly or to their suppliers. So we are quite -- we are much more dependent upon what happens in the European marketplace than I think the typical American automotive supplier or [indiscernible] supplier is. So yes, we are experiencing some weakness, and it is primarily coming from, obviously that customer base. Does that help?

Sidney Ho - Nomura Securities Co. Ltd., Research Division

Yes, that helps. Would you mind sharing with us your exposure, total exposure, for the whole, like the revenue going to the Automotive market?

Steven A. Laub

Well, I think we broke out the Automotive revenue. So I don't quite understand what the question is.

Sidney Ho - Nomura Securities Co. Ltd., Research Division

Okay. I was just curious because I thought some Microcontroller business also goes into Automotive as well, but maybe...

Steven A. Laub

Well, what we do is we do -- there are some sales from our general micros into automotive. It's relatively small. I mean, it's in single digits as a percentage of our total micros. We have a separate Automotive business, which are microcontroller-based products, but those roll up into the Automotive business, the RF&A numbers that we shared with you guys.

Operator

And we have time for one more caller. Your last question comes from the line of Jaeson Schmidt with Craig-Hallum and Company.

Jaeson Schmidt - Craig-Hallum Capital Group LLC, Research Division

[indiscernible] you guys are seeing anything out of the ordinary as far as the price environment goes? And do you expect that to continue in 2013?

Stephen Cumming

Jaeson, I'm sorry, you broke up right at the beginning. We apologize, we definitely had some technical problems today. If you can you repeat the first part of your question.

Sidney Ho - Nomura Securities Co. Ltd., Research Division

Yes, sorry about that. Just wondering what you guys are seeing from a pricing environment standpoint and kind of expectations for pricing next year.

Steven A. Laub

Is that overall as a company? Or do you want to get a...

Jaeson Schmidt - Craig-Hallum Capital Group LLC, Research Division

Specifically in the maXTouch business.

Steven A. Laub

One thing we noticed is that some other people that participate in that marketplace indicated that there were seeing, I think, ASP declining roughly sort of between 3% to 5% a quarter. And I would say that our experience is probably pretty similar.

Jaeson Schmidt - Craig-Hallum Capital Group LLC, Research Division

Okay. And then quickly, Stephen, looking at OpEx next year, we shouldn't expect a significant bump up any quarter, should we?

Stephen Cumming

The simple answer to that, no. I mean, you can see we've done some significant structural changes to our OpEx. We reduced it on a sequential basis by $9 million in Q3. I think if you look back in history, that's probably the lowest level seen for the last few years now. So I think going into Q4, it's going to come down a little bit more as we benefit from some of the restructuring activities we actually took in Q2. As we go into next year, our burn rate, certainly, can be a lower level. You should always expect some slight upticks with regards to PICA [ph] resets and bonuses, et cetera, as we go into the beginning of the year. But in essence, we're going to be at much lower burn rate throughout 2013.

Operator

That does conclude our question-and-answer session for today. I hand the program back over to Mr. Schuman for any further comments or closing remarks.

Steven A. Laub

Thank you, Christy. During the fourth quarter, Atmel will be presenting at the UBS Global Technology Conference on Wednesday, November 14, in New York, as well as meeting investors at the Consumer Electronics Show in Las Vegas on Wednesday, January 9. Webcast information for the UBS event 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.

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