James Bjornholt - VP & CFO Ganesh Moorthy - President & COO Stephen Sanghi - CEO & Chairman.

Vivek Arya - Bank of America Merrill Lynch John Pitzer - Crédit Suisse Aegean Craig Ellis - B. Riley & Co. William Stein - SunTrust Robinson Humphrey Christopher Caso - Raymond James & Associates Christopher Danely - Citigroup Harlan Sur - JPMorgan Chase & Co.

Kevin Cassidy - Stifel, Nicolaus & Company Christopher Rolland - Susquehanna Financial Group Gilbert Alexandre - Darphil Associates Mark Delaney - Goldman Sachs Group Craig Hettenbach - Morgan Stanley Rajvindra Gill - Needham & Company.

Good day, everyone, and welcome to this Microchip Technology Second Quarter and Fiscal Year 2018 financial Results Conference Call. As a reminder, today's call is being recorded. At this time, I would like to turn the call over to Microchip's Chief Financial Officer, Mr. Eric Bjornholt. Please go ahead, sir..

Thank you, and good afternoon, everyone. During the course of this conference call, we will be making projections and other forward-looking statements regarding future events or the future financial performance of the company. We wish to caution you that such statements are predictions and that actual events or results may differ materially.

We refer you to our press releases of today as well as our recent filings with the SEC that identify important risk factors that may impact Microchip's business and results of operations. In attendance with me today are Steve Sanghi, Microchip's Chairman and CEO; and Ganesh Moorthy, Microchip's President and COO.

I will comment on our second quarter fiscal year 2018 financial performance, and Steve and Ganesh will then give their comments on the results and discuss the current business environment as well as our guidance. We will then be available to respond to specific investor and analyst questions.

I want to remind you that we are including information in our press release on this conference call on various GAAP and non-GAAP measures. We have posted a full GAAP to non-GAAP reconciliation on the Investor Relations page of our website at www.microchip.com, which we believe you will find useful when comparing GAAP and non-GAAP results.

I will now go through some of the operating results, including net sales, gross margin and operating expenses. I will be referring to these results on a non-GAAP basis prior to the effects of our acquisition activities and share-based compensation.

Net sales in the September quarter were a record $1.012 billion, well above our guidance and up 4.1% sequentially from net sales of $972.1 million in the immediately preceding quarter. This was Microchip's first quarter with more than a $1 billion in sales.

We have posted a summary of our revenue by product line and geography on our website for your reference. On a non-GAAP basis, gross margins were 61.04% in the September quarter and above the high end of our guidance, which was 60.75%. Non-GAAP operating expenses were 22.46% of sales, well just below the low end of our guidance of 22.5%.

And non-GAAP operating income was a record 38.6%, well above the high end of our guidance of 38.25%. Non-GAAP net income was a record $344.1 million and was up 7.9% on a sequential basis and up 56.7% as compared to the same quarter last year.

Non-GAAP earnings per diluted share was $1.41, which was $0.06 higher than the midpoint of our guidance of $1.35. On a GAAP basis, gross margins, including share-based compensation and acquisition-related expenses, were 60.7% in the September quarter. GAAP gross margins include the impact of $3.7 million of share-based compensation.

Total operating expenses were $388.7 million and include acquisition intangible amortization of $120.9 million, share based compensation of $19.9 million, $0.7 million of acquisition-related and other costs and special charges of $19.9 million, consisting primarily of a $19.5 million charge for fees associated with transitioning from the public utility provider in Oregon to a lower-cost direct access provider.

This change is expected to provide significant expense and cash flow savings in the future. After these adjustments, GAAP net income was a record $189.2 million or $0.77 per diluted share. The non-GAAP tax rate was 9.1% in the September quarter, and the GAAP tax rate was a negative 1.6% for the quarter. Moving on to the balance sheet.

Our inventory balance at September 30, 2017, was $456.9 million. Microchip had 105 days of inventory at September 30, 2017, up 5 days from the end of the June quarter.

Inventory days are still well below our targeted levels but are starting to improve from our significant capacity expansion efforts as well as selective and opportunistic buy-aheads of constrained materials. Inventory at our distributors in the September quarter continued to be low at 31 days and were flat to the June quarter levels.

The cash flow from operating activities was a record $350.1 million in the September quarter. As of September 30, the consolidated cash and total investment position was $1.844 billion, of which about $550 million is domestic cash.

We bought back 15.1 million of our 2,037 convertible bonds in the December quarter where the bondholders had elected to convert. We expect the remaining principal amount of $17.3 million of the 2,037 2 1/8% convertible bonds to either be converted by the bondholders or called by Microchip during the December 2017 quarter.

The call date for these bonds is December 15, 2017. Capital expenditures were $59.9 million in the September 2017 quarter.

We expect about $70 million in capital spending in the December quarter and overall capital expenditures for the fiscal year 2018 to be about $200 million to $220 million, up from our prior guidance of $180 million as we capitalize on growth and cost reduction opportunities.

We are aggressively adding capital to support the growth of our production capabilities for our fast-growing new products and technologies and to bring in-house more of the assembly and test operations that are currently outsourced.

These capital investments will bring significant gross margin improvements to our business, particularly for the Atmel manufacturing activities that we are bringing into our own factories.

Our capital spending also reflects 3 new buildings we are constructing in Arizona, India and Germany, which will give us meaningful lease cost reductions and avoidance in the future as well as allow us to cost-effectively scale for our future growth. Depreciation expense in the September quarter was $29.9 million.

I will now ask Ganesh to give us comments on the performance of the business in the September quarter.

Ganesh?.

Thank you, Eric, and good afternoon, everyone. We're very pleased with how our product lines performed in the September quarter with overall sequential revenue growth of 4.1% and year-over-year growth of 15.8%, all organic growth as there was no contribution from acquisitions in the last 4 quarters.

The Microchip 2.0 transformation continues to make strong progress, especially in terms of new design opportunities as we enable our clients' innovation with the very best smart, connected and secure solutions. Taking a closer look at microcontrollers.

Our microcontroller business has performed strongly in the September quarter, with revenue being up 4.7% sequentially as compared to the June quarter, setting a new record in the process. On a year-over-year basis, the September quarter microcontroller revenue was up a very strong 20%.

All microcontroller product lines, 8-bit, 16-bit and 32-bit, set new revenue records. Our microcontroller portfolio and roadmap has never been stronger, and we are seeing continued growth in our design end funnel, which we expect will drive future growth as these designs progress into production over time.

Microcontrollers at almost $2.7 billion in annualized revenue, represented 65.7% of Microchip's overall revenue in the September quarter. To put our recent performance into perspective, in the last 5 quarters, we have grown our annualized microcontroller revenue by over $0.5 billion.

All our microcontroller product lines are firing on all cylinders and driving differential growth and market share gains.

We believe we have the new product momentum and customer engagement to continue to gain even more share as we advance the Microchip 2.0 transformation and further strengthen the best-performing microcontroller franchise in the industry Now moving to our analog business.

Our analog revenue was sequentially flat in the September quarter as compared to the June quarter, and up 6.3% on a year-over-year basis and also set a new record by a whisker in the process.

Our analog results over the last two quarters were negatively impacted by two factors, first, the back-end capacity constraints on products with Atmel heritage, which we discussed at the last earnings call, have taken more time to resolve as the lead time for new back-end equipment has been longer-than-expected, reflecting the strong industry conditions that our suppliers are also seeing; and second, we have been adding microcontroller cores to several of our more complex analog products, especially those that provide our clients with smart connectivity solutions.

This enables us to subsume competitive microcontrollers which were sitting next to our analog products as well, as include the connectivity firmware in our products so that they form total system solutions and are, therefore, much stickier design wins. These smart connectivity products are ramping nicely.

And as they replace older products in new designs, our revenue classification for these new products has shifted from the analog product line to a microcontroller product line.

Transitioning to more sticky and higher-margin smart connectivity revenue is the right Microchip answer, but does impact some of the product line reporting that analysts are interested in as some of the revenue growth shifts into our microcontroller product line.

As our back-end capacity constraints continue to get relieved and the revenue from analog attach design wins start to ramp, we fully expect that the analog product line revenue will grow at or above Microchip's overall growth rate.

At over $950 million in annualized revenue, our analog products represent a 23.6% of Microchip's overall revenue in the September quarter. We continue to successfully find more opportunities to attach Microchip's vast portfolio of analog products to Atmel microcontrollers and microprocessors at multiple customers and applications.

This effort should pay dividends over time as these new design wins go to production.

And we are developing and introducing a wide range of new innovative and proprietary products in the linear, mixed signal, power, interface, timing and security products lines to fuel the future growth of our analog products as we march relentlessly towards making analog a greater than $1 billion annualized revenue business for Microchip soon and a much larger business in the coming years.

Moving next to our licensing business. This business is up 3% sequentially in the September quarter and up 8.9% on a year-over-year basis, also setting a new record in the process.

We are seeing the fruits of having licensed several foundries and independent device makers for several years on multiple process technology nodes manifest in our results as the licensed processes generate royalty revenue for many years to come.

Last but not least, our memory business was sequentially up 5.3% in the September quarter as compared to the June quarter. There are significant cost reductions underway for this business using the combined strength of Microchip and Atmel. We believe that this effort will make us even more competitive and further improve our gross margins.

Let me now pass it to Steve for some general comments about our business and our guidance going forward.

Steve?.

Thank you, Ganesh, and good afternoon, everyone. Today, I would like to first reflect on the results of the fiscal second quarter of 2018. I will then provide guidance for the fiscal third quarter of 2018. I will also provide update on capacity enhancement activities, lead times as well as Microchip 2.0.

Our September quarter financial results were extremely strong. Our net sales were a new record and above our guidance, first time ever our net sales crossed a very important milestone of being above $1 billion for the quarter.

Our net sales for this quarter were up 15.8% from the September quarter of a year ago, and this revenue comparison is not impacted by any acquisition since Atmel's full quarter revenue was in the September 2016 quarter results.

Our non-GAAP gross margin percentage, operating profit percentage and earnings per share each exceeded the high end of our guidance.

Non-GAAP earnings per share were up 50% from the September quarter of a year ago due to improving sales, gross margin percentage, operating expense leverage and successful execution of our core business as well as accretion from our acquisitions.

I want to thank all the employees of Microchip worldwide for delivering a record quarter in every respect. This was also our 108th consecutive profitable quarter.

There are 3 other points I would like to make on our sales growth, first, every one of our major product lines, 8-bit MCU, 16-bit MCU, 32-bit MCU, analog, wireless, licensing, memory and others, were up significantly in the September 2017 quarter over the year-ago quarter; number two, every major geography, North America, Europe and Asia, were up significantly in the September 2017 quarter over the year-ago quarter; and number three, sales in all end-markets were up in September 2017 quarter over the year-ago quarter.

Now I will provide you with an update on Microchip 2.0. We are continuing to experience an enormous customer preference to design with our microcontrollers solutions in all 8-bit, 16-bit, and 32-bit customer applications.

On top of that, our various acquisitions have now built a powerful diversified product line through which we're able to provide total system solutions to our customers. We are winning incremental design wins with multiple products in the same boards of our customers.

We have a robust design win funnel, and we feel very optimistic that Microchip 2.0 is working and increasing the organic growth of Microchip. A year ago, in September 2016 quarter, our microcontroller market share in 8-, 16- and 32-bit combined was 14.46% as per the SIA numbers.

In September 2017 quarter, our market share is up to 15.84%, an increase of 138 bps in 1 year. Now before I go into the guidance for the December quarter, I will say that we are continuing to see good business environment for our products worldwide and have a number of company-specific demand drivers.

Our inventories at Microchip as well as the distributors are towards the low end of our normal range. We are continuing to slowly add incremental capacity at various bottlenecks.

With that, our lead times have stabilized, with stable lead times we're engineering a soft landing so far without triggering any double ordering or panic from our customer base. Our book-to-bill ratio has moderated from 1.11 in both March and June quarters to 1.05 in September quarter as the lead times stabilize.

We expect the book-to-bill ratio to come down further as lead times continue to moderate, hence engineering and soft landing. At the rate we are adding capacity, we believe that it will still take us through June 2018 when our lead times return to fully normal. Now let us go into the non-GAAP guidance for the December quarter.

We expect total net sales in the December quarter to be about flat to down 4%, which, at the midpoint, represents a growth of approximately 12.6% on a year-over-year basis. I want to remind investors that in the last 5 years, we had 3 acquisitions that closed in the middle of September quarter. SMSC closed in August of fiscal year '13.

ISSC closed in July of fiscal year '15, and Micrel closed in August of fiscal year '16. All these 3 acquisitions had a partial quarter revenue in September quarter and a full quarter revenue in the December quarter. Therefore, mathematically taking the average of the last 5 years of sequential growth would give you a false number.

Excluding acquisitions, the average sequential decline in the December quarter over the past 5 years has been 2.5%, and ranged between plus 0.8% and minus 4.9%.

Investors should compare our guidance for December quarter of flat to down 4% with an average 5-year seasonal performance of minus 2.5% in net sales and against the backdrop of a 1% beat of our FQ2 revenue guidance.

Regarding gross margins, we see a steady improvement in overall gross margin of the company based on Microchip 2.0 margin drivers that we have discussed with the investors. We expect gross margin for the December quarter to be between 61% and 61.4% of sales.

We expect overall operating expenses to be between 22.2% and 22.6% of sales, and we expect operating profit percentage to be between 38.4% and 39.2% of sales. And we expect earnings per share to be between $1.30 and $1.40 per share non-GAAP.

I want to remind investors that our long-term financial model is a non-GAAP gross margin of 62.5%, operating expense of 22.5% and operating profit of 40%. And as you have seen, we are relentlessly marching towards this model. And we expect our longer-term annual revenue growth to be high single-digits.

We believe we can grow above the industry driven by four factors, we can achieve about 1% to 2% extra growth due to our traditional market share growth continuing; we can achieve an additional 1% to 2% growth due to higher attach rate from our total system solution approach; we can achieve 1% to 2% higher growth from much less ASP erosion or stable ASPs, and we can achieve 1% to 2% higher growth from our distributor partnership approach versus competitors pulling back.

And we have judged it down due to confounding effects to yield a 7% to 9% growth going forward. Given all the complications of accounting for the acquisitions, including amortization of intangibles, restructuring charges and inventory write-up on acquisitions, Microchip will continue to provide guidance and track its results on a non-GAAP basis.

We believe that non-GAAP results provide more meaningful comparison to prior quarters, and we expect that the analysts continue to report the non-GAAP estimates to First Call.

With this, operator, will you please pool for questions?.

[Operator Instructions]. And we'll now take our first question from Vivek Arya with Bank of America Merrill Lynch..

Steve, if you look over the last year, growth has been very strong for you guys.

Can you give us a sense of how much of that has been sort of company-specific? How much of that has been the macro? Because I think what most investors are trying to get a sense for is how much of this growth is actually sustainable as we look out into the near-to-intermediate term..

Well, it's very, very difficult. Customers don't have a good answer for -- that you're giving me this design. I'm winning this design. Is it because industry is doing well, or we are winning more than that? So that is a very, very hard to decipher. If you look at our last quarter, our year-over-year growth was 15.8%. We're not guiding to that.

We're not expecting that. We're expecting a growth going forward of 7% and 9% with the December quarter guided at about 12.6% over the prior year December. So growth will moderate from these high numbers, and some of that excess is driven by the industry conditions..

All right. And as a follow-up, in the last few days, there's been a lot of M&A excitement in semis. And I'm wondering how you were thinking about M&A given that your leverage is at a very, very comfortable level.

And at what point would you decide that it is better to resume buybacks instead of maybe going after assets that might be marked-up but with all the excitement in the industry?.

Well, our capital allocation strategy and our thoughts have not changed since we discussed with all of you many times. Our first reference is to utilize our cash for our operations, R&D and other activities, but those are very well-funded into the P&L, and we do not need to really reach out into the balance sheet to spend excess cash.

The second priority is to utilize our cash towards M&A. Our second priority is to maintain the dividend, keep growing its small amount incrementally, like we are, but not really have a very large incremental dividend program. Then our next priority is to utilize our cash for M&As.

And our last priority is really to buy stock back, which we only do opportunistically..

And we'll now take our next question from John Pitzer with Credit Suisse..

I guess, I just want to go back to the increase in the CapEx budget. Eric, you did, in your prepared comments, gave a sort of a good rundown of what's driving that. You did say there will be some cost savings because of that.

I'm just kind of curious, does that put you sort of towards your target margin or above the target margin? And if you can help me understand what percent of the increase in CapEx is going because you just feel better about the demand, overall demand environment, versus bringing more stuff in-house?.

Well, we've been talking about, for the last several quarters, there are a lot of margin improvement that we can get by bringing a lot of the outsourced Atmel activity in-house, and the percentages of our internal production versus where they've historically are out of line with where we'd like them to be.

So we're making these incremental investments, and there are significant gross margins to come. We think that by making these investments, we can get to our 40% operating margins and the 62.5% gross margin goal. And it's gradual. These things come over a steady period of time.

There's only so much our manufacturing and operations teams can do in any given quarter. But we've laid out a pretty aggressive plan for us to increase the production capabilities in-house, and the gross margin will improve from there..

That's helpful. And then Steve, maybe as my follow-up, just to follow-on to Vivek's question about M&A. You've always been very disciplined about the price you're willing to pay for an asset. I think in the past, you've said, for every deal you've done, you've probably vetted and walked away from 3 or 4 deals. I'm just kind of curious.

With Microchip 2.0 and your confidence level increasing that you can grow revenue faster than the industry, does that change the parameters around asset value you're willing to pay on the M&A front? And just given where the SOX index is now, any comment around asset value to your perception there would be helpful..

There is really no change. We have strong filters in place in our M&A analysis, which are multidimensional in terms of multiples and revenue and gross margin, operating profit growth rates and others. I can't give you all those filters, but it's a fairly complex metrics that we have to check off.

And really, at various times, the assets available outside could be on the lower end of that metrics or could be on the higher end of the metrics. But they're always companies that fit the metrics.

And if they go on the higher end of the metrics and even beyond that, and they're too expensive and we won't do it, but there are always companies available which still fall in the metrics..

And we'll now take our next question from Craig Hettenbach with Morgan Stanley..

Just a question on just the microcontroller share and as you tick through some of the things that should allow you to grow above the industry in high single-digit growth, any particular end-markets or product segments that you'd call out in terms of where you're seeing the best market share positioning?.

We don't go-to-market with an end-market view in order to be able to grow. We have a very broad approach to markets, applications, and a broad product line to go after them. Clearly, as the end markets strengthen in one area and other, we get participation incrementally from there.

We've shown you how our automotive and industrial market share, when we presented it about 6 months ago, was that 60% of the overall revenue for us. And of course, those industries have been helping as they've had some strength. But we don't have a particular end-market that is driving us in one direction or another..

Got it. And then just a follow-up question for Steve. Appreciate all the color on some of the cyclical barometers around lead times and book-to-bill.

As you try to kind of navigate to a soft landing, is there anything different in terms of this cycle versus prior cycles, whether it's competition with distributors and customers, inventory you're holding to kind of help navigate through that?.

Well, I think, the lead times did not get as long this time as, clearly, they have gotten some other times. The customer behavior and the distributor behavior has been much more normal this time than we have seen in the other times. So I think everybody has behaved.

We wrote a letter back in April informing our customers that the industry conditions were strengthening and the lead times are going out. In the March quarter, our book-to-bill ratio was 1.11. And we wrote the letter on April 4, after we had seen this very strong bookings.

And in the June quarter, our book-to-bill was, again, 1.11, which means, really, there was no panic created. No customers rushed to place large orders. They kept doing what they were doing before the letter and conformed to our lead time and placed the orders to conform to the longer lead times.

And then in December quarter, book-to-bill ratio came down to 1.05 as some of the products where the lead times have moderated, and the lead times right now are anywhere from 4 weeks to 20 weeks with the products all over the place.

But the products where the lead times have become shorter, the bookings on them have moderated because people have the orders in place. So I think it's a much more behaved environment this time than kind of we have seen before. I do not know what's happening with the competitors and the rest of the industry.

There are scattered cases where the customer isn't willing to take one of our products because he cannot complete the kit. There's a product coming from one of the competitors or other analogs or other companies where he needs to build his entire products. And if that one is not available, they don't want ours either.

But same can be said by those competitors that one of our products wasn't available so their product didn't sell. But those are scattered cases. It's not all over the place. I think environment is pretty reasonable and reasonably well-behaved..

And we'll now take our next question from William Stein with SunTrust..

You spoke in the prepared remarks about subsuming competitive microcontrollers when they're next to your analog products. It sounds almost like the cross-selling opportunity is being driven from analog to the digital MCU. I would have thought that the cross-selling opportunity was much more in the other direction.

Can you elaborate on this, help us understand that dynamic a little bit?.

It happens in both directions. So in many cases where we have the microcontroller at the center of the design, we see the breadth of what else surrounds that microcontroller early and are able to attach products.

There are some specific cases where it's very complex analog and especially when it's smart connectivity, where, in addition to the analog and the connectivity function, it needs a microcontroller. And we, in many cases, enter those businesses through some of the acquired entities. We didn't have our micro controllers there to begin with.

But once we now see where we are on the analog from a smart connectivity standpoint, we can begin to see what else can we subsume.

And that's where it goes in the opposite direction, where the strength that came from analog gives us the ability to attach microcontrollers and, in many cases, do an integrated product that gives us more complete total system solutions in that application..

That's helpful. If I can squeeze in one follow-up. I just want to make sure -- it's really clarification point of the last question that someone else asked. It sounds like perhaps the shortages on the passive side have been sort of clipping overall demand.

I think you mentioned a moment ago about if a customer can't get a complete kit because he's short, say, a capacitor and he doesn't want your product, at least not yet until he can do a full kit, did I understand that as sort of the dynamic that might have contributed to sort of soft landing where things didn't get out of hand because, let's say, passives or some other product clipped the peak demand rate?.

So I don't know if the others are seeing a massive number of cases where they're not able to ship the product because some passive product is not available. I think I'm kind of just seeing it sporadically where it's not large enough that, that becomes an excuse, where a number, the one way or the other.

I think it's a noise level, but it's certainly a factor. It's possible that, for some other people, it's a much larger factor..

And we'll now take our next question from Chris Caso with Raymond James..

I just want to talk a little bit about the efforts to build inventory and the timing of that.

With demand slowing a bit seasonally in the December quarter, does that give you the ability to catch up on inventory somewhat? Or is that to wait until more capacity is in place a couple of quarters from now? And then with that, I have to imagine there's some gross margin benefit as you run the fabs a little harder to build the inventory.

Can you quantify that benefit and talk about how that works its way into 2018?.

So the way I will answer is, it's a continuous phenomenon. It is not digital where inventory doesn't grow this quarter, and a couple of years from now, it all grows to the right level. Our inventory grew by 5 days last quarter. Inventory will grow by some days this quarter and grow some again in March. And by June, we expect to try to get to the models.

So it's a continuous phenomenon. In the stronger quarter, like we have had in the last 2 or 3 quarters, inventory was harder to grow because even though we added capacity, produced more units, we largely shipped them into the growth. Current quarter is seasonally a weak quarter, seasonally the weakest quarter of the year.

So this quarter, the incremental capacity we're adding gives us the chance to add a little bit to the inventory because we can produce more than the weaker demand. But it's a continuous phenomenon. It's really not waiting for something to happen 2 quarters from now..

The other thing to keep in mind is our distribution inventory is at the low end of their range as well. So us having a little extra inventory helps as we go into the growth quarters. So that combined, we have the right amount of inventory for the market..

And I'm sorry, the margin impact as the inventory is building?.

So margin impact is essentially doesn't care about whether inventory is building or not. It cares about overall production. If you produce more in wafers assembly test, then it has better absorption and has an accretive effect. So we have been producing more units every quarter, and you have seen the margin going up every quarter.

So that's also a continuous phenomenon..

Okay. As a follow-up, you had talked in your prepared remarks about a number of factors for why you think you grow faster than the inventory growing forward and what the impact would be. Can you talk about that looking backwards over the last year? And I know some factors are more difficult to measure than others.

But perhaps give us a walk-through, perhaps some of these factors. And I think market share. You talked about, a little bit, pricing, how that may have affected your revenue growth over the last years compared to the industry, and what we'd say, Microchip 1.0, I guess..

Well, it's very difficult to numerically assign to the history and take our 15.8% growth last quarter over the previous 1 year and figure out what portion happened with price increase, what portion happened with gaining market share, what portion happened with what because it's impossible to do, 115,000-plus customers and 100,000 SKUs we are shipping.

But the 4 elements that drove it in the last year and will continue to drive it going forward is really the traditional market share gains, better ASP management, either stable ASPs or increasing ASPs or less erosion. It depends on various product lines.

And then achieving higher growth from our distributor partnerships, where a number of competitors are pulling back in their distribution programs, and distributions are focusing attention on us.

And the total systems approach where Ganesh talked about is happening both ways, we're able to win the microcontroller where we had a lot of analog parts by giving them a combined integrated part.

And at the same time, where the customer doesn't want an integrated part, we're able to replace the competitor's analog because we have our micro end, so from both of those factors.

When you combine it together, if you take 1% to 2% growth for those 4 factors, it kind of becomes 4% to 8% incremental, and we kind of have judged it down overall to come up with a 7% to 9% growth, counting the growth of the industry, whatever your assumptions are, plus a little bit more that we can do..

And we'll now take our next question from Chris Danely with Citi..

Steve, so you said that as the lead times are coming and the book-to-bill is dropping a little bit, is it possible that if the lead times dropped fairly suddenly in this quarter, that book-to-bill could be below 1 for the March quarter and you could potentially see some below-normal seasonality?.

Well, we are not seeing it, and we're not expecting it because there's not big capacity increments coming in because the lead time for equipment is large. Many of the test equipment, fab and other equipment, there's a lot of semiconductors that go into them. So our equipment suppliers aren't able to produce the product.

And their lead times are long because they can't acquire all the semiconductors they need. So there is not big bulk of capacity coming in. Capacity is coming incrementally. And that's why I said, I think it's -- capacity is coming incrementally, and lead times are moderating slowly.

And that kind of all leads to a soft landing rather than a contraction..

Okay, great. And then for my follow-up. Okay, you're talking about 7% to 9% long-term growth, and like you said, analog slowed down to, like, I think it was 6% year-over-year growth.

So would you expect the microcontroller business to grow faster than analog going forward? And what would be driving like a reacceleration on the analog revenue growth?.

I think what drives the reacceleration in analog is Atmel acquisition was a little over a year ago. And usually, you have 1 year, 1.5 years design cycle. So with Atmel, we acquired a large amount of microcontroller business.

I think it was about $600 million, $700 million of their business was microcontroller, which those sockets had 0 microchip analog around it. We were the enemy. So it was anybody's analog except ours. So that was a very, very large opportunity we identified for you. We are just in the front-end of it going to production.

So I think that's what accelerates the analog. Don't be fooled by just last couple of quarters of lower analog growth because, in some cases, we were already producing the integrated product. It was analog with microcontroller. And we were able to sell the package to the customer. And therefore, the revenue shifted.

Rather than putting it in the analog bucket, we've put it in the microcontroller bucket..

We still have that analog. It's just it's coming in [indiscernible].

We still have that analog, but it's counted as part of the microcontroller revenue. 98%, 99% of our microcontroller has a large amount of analog on it. But the revenue still counts as a microcontroller revenue..

Right. Any product that we ship that has a microcontroller core, we classify as a microcontroller product..

That's not different for anybody. Our competitors do the same. All 32-bit micro, 16-bit, 8-bit micro, they all have some power management, converters, supervisors, LDOs. And analog is built into the microcontrollers.

So that's why you saw -- and there were some large designs where we captured that, and it can depress that analog sequential growth for a couple of quarters. I will not be fooled by it. There's a large amount of analog attach rate coming around Atmel's microcontrollers soon..

[Operator Instructions]. We'll now take our next question from Harlan Sur with JPMorgan..

You were at your target OpEx ratio in the September quarter. You'll be there as well in the December quarter. Actually, a bit better than that. So clearly, you guys are continuing to drive OpEx leverage. And I think on a go-forward basis, I think the team is going to continue to drive revenue growth faster than OpEx growth.

So is there a new OpEx ratio target that we should be thinking about?.

We have not revised them, and we're not thinking of revising them. We believe our long-term target is 22.5%. In good times, we happen to be slightly below that. And in discretionary time in the future, we could be slightly higher than that by 25 bps or something. Basically, within the range. We're not calling for substantial OpEx leverage going forward.

And if the times continue to be very, very strong and the growth happens to be well above the mean, you could temporarily be in that situation. But longer-term, we've got to make the investments to grow the business..

Okay. The team is clearly executing on the Microchip 2.0 initiatives, system-level focus, more content per board. You guys have a lot of analytics platforms in-house that tracks design wins, tracks content per board. It seems like this is a contributor to the strong year-over-year growth.

Can you guys quantify content increase per board on a year-over-year basis? Or any other metrics that you use to gauge success in terms of value capture per system?.

Well, we have a propriety indicator. We certainly don't want competitors or anybody else to know. So for the last several years, we have been tracking average number of Microchip's parts per customer design. And that is growing, and growing significantly. So that is the measure of the success of the TSS effort.

We want to share that success with you qualitatively, not quantitatively..

And we'll now take our next question from Kevin Cassidy with Stifel..

Just within your microcontroller business, can you say which products are growing the fastest, both on units and revenue?.

I would think 32-bit microcontrollers are growing the fastest, 16-bit microcontrollers next and 8-bit microcontroller next. Given that, all 3 are making record quarter-after-quarter..

Right. So not so much on a like-to-like basis. Your ASPs, in general, are trending up because you're selling more 32-bit..

That could be true if you just look at the average microcontroller ASP. But then the average COGS would be going up, too, because 32-bit products cost more to make it than 8 or 16..

Right. Yes. Just some investors are concerned about you outgrowing your end-markets. But if your end markets are shifting to higher ASP devices, then it justifies why you'd outgrow your end-market..

Yes. Okay..

No, just checking to see if you agree with that..

Yes. I agree with that..

And we'll now take our next question from Christopher Rolland with Susquehanna International Group..

So your lead times have increased, but some others, like some European MCU guys, their lead times have expanded well beyond yours.

So overall, do you think you guys have net gained or lost share because of competitive lead times in the industry?.

Well, the numbers say we have gained share, and I've given you the numbers. The year-ago in the September quarter, our microcontroller revenue divided by SIA revenue was 14.46%. And in the September quarter that we are announcing today, our share was 15.84%. So that's an increase of 130 bps in 1 year.

That's one of the significant increase in market share in 1 year. We used to gain that kind of share years ago. And lately, the gains have been slower. So this was a very significant increase. But I don't think the reason for the share gains is just because the competitive lead times have gone longer than ours.

In microcontroller, you cannot gain the share like that. You have to have design done with your product, which is 1.5 years, it takes to put your part in the design. So these were the designs we won 1 year ago, 2 years ago. The lead times of competitors does not have an effect on it.

It may have effect onwards because we're winning more designs now, and some of the more designs we're winning today could be because customers are unhappy with their competitors. That will lead to higher share next year and the year after. But the share we gained last year had nothing to do with the lead time..

I see. And then you guys had some interesting commentary, I thought, on the direct energy access provider in Oregon. I'm assuming maybe direct hydroelectric or something.

What's the nearly $20 million upfront charge? And then what kind of benefit do we get, maybe gross margin or something like that, going forward from that?.

So there's a transition fee that you have to pay when you make that change. And that fee essentially covers a 4- or 5-year period. And so from a cash flow perspective, the cash flow savings come at a later date.

But the P&L, just with the way the accounting works, the income statement benefit will start getting that impact in our cost here over the next couple of quarters. And then it will get capitalized to inventory, and we'll get the benefit later. So there are incremental savings. That's a good change for us.

We think it's going to drive better cost and better cash flow for us in the future. But essentially, it's a transition fee that were being paid, and that's why we have the onetime charge..

And can you quantify at all? Or is it just too small?.

It's too small in the big-picture overall gross margin..

Clearly, it was good enough for us to be able to make a substantial investment, and it accrues for many, many years..

It will be 1 of our 3 fabs, plus 40% our business comes from foundries. I mean, it's one of the factor in gross margin, along with all the other drivers, which are more analog, higher yields, shrinks, taking Atmel products, bringing them in for assembly and test.

And all of these other margin drivers we have talked to you about, this is kind of just one of them, but not really on the top of the list..

And we'll now take our next question from Gil Alexandre from Darphil Associates..

In the past, you only use to go out to 1 quarter on giving results. And now you talked 7%, 9% gain, which is great. And I'll have to go through what you said in your last commentary.

But what do you see? Is it just the addition of products that you sell which is giving your 7% to 9% gain? And how long does it continue like this?.

So Gil, in the last conference call commentary, I had talked about high single-digit. And somewhere along on the investor circle, it got translated into 7% to 9%. But my exact words were high single-digit if you go back and listen to it. And I didn't disagree with that. High single-digit sounds like about 7% to 9% or somewhere there.

In this conference call, I broke them into 4 different events, as I said earlier, which was traditional market share gains, TSS attach, distributor partnership approach, and I don't which was the fourth one..

ASPs..

Stable ASPs or increasing ASPs. So when you said in the past, we only did not talk about long-term. We didn't have these 4 differentiated drivers. We didn't have a portfolio rich enough to drive the total system solution. A few years ago, we were not driving ASPs to be as stable or higher.

Some of the industry consolidation as well as our own efforts have created the environment where you can keep the ASP stable. So things have changed. Years ago, our competitors were not pulling away from distribution. Today, they are. And we are approaching them, and they're putting more focus on it.

So things have happened, which had given us the opportunity. And we're capitalizing on those opportunities so we're able to quantify and guide that we can grow higher. And the last part of your question was, how long does it continue? I don't know. I really don't know..

And we'll now take our next question from Mark Delaney with Goldman Sachs..

Congratulations on crossing that $1 billion mark with revenue. First question is actually on some of the proposed tax reform changes in the U.S. I guess, a couple of parts related to that topic.

I know it's early, but any sense at this point what it may mean for Microchip's consolidated effective tax rate? And given the proposed rate for repatriating foreign cash, how is Microchip thinking about managing its overseas cash balance?.

I think a general answer on that is that we haven't fully evaluated it. And proposed is just a proposal. A lot of other proposals that have come out on tax rate, health care and other, and not much has happened in Washington. And there's really not much reason to burn calories on it.

I don't really know if there is support in Senate with a number of senators against anything that they want to do. So I think it's kind of too early.

But if something were to happen, tax law were to change, we'll be upfront in fully understanding it, utilizing our foreign cash and thinking about all the possibilities that exist to take advantage of it and I think may add some more..

I think that's exactly right. It's too early. Our tax group and advisors are looking at what's being proposed. So we kind of have to see what actually comes to fruition here, and we'll respond accordingly..

That's helpful. And as for follow up on IoT. I know that's been a part of the company's growth strategy in the past. And I realized, Microchip has a more stringent criteria over what counts as IoT versus not IoT.

But maybe if you can just level for us at this point how much revenue you think is tied to IoT and what your outlook is for that part of the business..

We haven't broken out IoT as a revenue segment. We have done it a couple of times in the past just to provide some more insight at that point. The strategy for the company that we've explained is around providing smart connector and secure solutions. And all of what IoT requires are those 3 big ingredients.

And a large chunk of our product line today is feeding the requirements of what would be classified as IoT. So it is a growth driver for us. We see a lot more applications that are building the connected and the secure capabilities. And we have the strong product line to be able to take advantage of that.

But unfortunately, I don't have a good way to estimate the IoT-specific revenue..

And we'll now take our next question from John Pitzer with Credit Suisse..

Eric, just going back to the CapEx. If you look with the raise that you guys announced today, it puts your CapEx to rev over 5% for this fiscal year. It has historically run at sort of 4% to 4.5%.

Should we expect CapEx to come back down to that range in fiscal year '19? Or how do we think about the long-term target for CapEx?.

So you're right. The percentage is higher. And we mentioned in our prepared remarks that we have 3 buildings in Chandler, India and Germany that were -- that are kind of, I'll call them, onetime items to help with future lease cost or avoidance of lease cost. So that's one thing.

And the other piece is we've got all the Atmel products that were outsourced historically, where we can get very fast return on those investments from a cash flow payback perspective that were -- that it's very much worthwhile from gross margin perspective to make those investments. And those are bit out of the ordinary.

So we don't expect, long-term, to be at the 5% rate, but the investments that we're making today definitely are worthwhile and cost-beneficial. So hopefully, that's the color that you're looking for..

And we'll now take our next question from Craig Ellis with B. Riley FBR..

Steve, I wanted to follow-up with the earlier comments regarding some of the company-specific drivers to the high single-digit growth. You mentioned lower ASP declines, distribution, analog attached and traditional share gain.

My question is, as we look at those 4 company drivers for Microchip, is the company getting optimal benefit from each of those right now? Or are there things that are more formative or early innings that would give us more benefit next year? And if so, what are they?.

Yes. I think he's trying to kind of figure out which are more fully baked in, which ones coming in time. I would say, when you look at TSS, the gains from TSS are going to be accruing as we go into in that coming 1, 2 years of time. Those are typically design-driven.

It takes complete design cycle from when we begin to engage, are able to attach and those attached designs to go to production. So I think that's one of the larger ones ahead. Clearly, some of the changes in distribution took place within the last year. That change in engagement, again, takes time. It's new designs that you're affecting, I think.

So I think the best of what's to come is ahead of us from some of the changes that Steve described..

And we'll now take our next question from Rajvindra Gill with Needham & Company..

Steve, you had mentioned -- or Ganesh, sorry, you mentioned your smart connectivity strategy. And obviously, you talked about attach rates for analog increasing as a drive for overall growth.

Can you talk about a little bit -- if you can maybe quantify where we are in terms of the attach rates maybe for the Atmel products? And kind of where do you expect that to go in the future?.

Qualitatively, it's still low because when we inherited the Atmel product lines and those designs with our customers, they didn't have much microchip attached in them.

Now our sales teams and our overall microchip teams have been working on new designs as they come up to be able to showcase the rest of the Microchip product line and to increase that attach. Now we can see the leading indicators in how we see our own design-in activity.

Some of the indicators Steve talked about, which is as we measure the rate of attach that's taking place over time. And so in the revenue numbers themselves, they are still yet to come, especially on the Atmel part of the product line. And there may be small things that have taken place.

But as time goes on, all these designs, as they go through the 12- to 24-month incubation period, start to go into production, and that's when you begin to see the growth and the revenue that comes from that attach..

And just a follow-up.

So is it fair to assume of that $600 million of Atmel microcontroller revenue that they've generated, that over that design period, whether it's 24 months or more, that a certain percentage of that will start to be attached with the microcontroller core? Can you maybe talk about what the adversive effect on the ASPs would be?.

So in general, when you look at the dollars per board, we're driving towards increasing the dollar content per board. So attach is taking place, as we mentioned earlier, in 2 ways. And one way, it is where we have the microcontroller. Ours or what came to us through the Atmel acquisition.

In that case, the microcontroller is still the microcontroller that Microchip or Atmel had been shipping, but that incremental dollar content of the board.

And the other way is where, if we have some of the richer analog product lines, and they don't always come from Atmel, only they come from some of our older acquisitions as well, where we are now providing a higher integration solution, a microcontroller with that analog, perhaps with security, something else onboard.

Now those products, the ASP will go up because more often than not, we didn't own the microcontroller portion of that design. We have the analog portion and we are subsuming other people's silicon with our new products. And there, the ASP, we do expect and we do see going up..

And it appears there are no further questions in the queue at this time. And at this time, I would like to turn the conference back over to Chief Executive Officer, Steve Sanghi, for any additional or closing remarks..

Well, we want to thank everyone for joining the call. I think the next conference we go to is CSFB..

Credit Suisse..

Yes, which is in our backyard here in Scottsdale. So we'd love to see you, all of you, at the conference. Thank you very much..

And ladies and gentlemen, that concludes today's conference call. We thank you for your participation..