Microchip Technology Incorporated
Q3 2007 Earnings Call Transcript

Published: 26 Feb 2008

[Operator:]

Good day everyone and welcome to the Microchip TechnologyThird Quarter Fiscal Year 2008 Financial Results Conference Call. As areminder, today's call is being recorded. At this time, I'd like toturn the call over to Microchip Technology's Chief Financial Officer,Mr. Gordon Parnell. Please go ahead, sir.

[Gordon W. Parnell:]

Thank you very much and good afternoon everyone. During thecourse of this conference call, we will be making projections and otherforward-looking statements regarding future events or the futurefinancial performance of the company. We wish to caution you that suchstatements are predictions and that actual events or results may differmaterially. We refer you to our press release of today as well as our10-K for the fiscal year ended March 31st, 2007 and our 8-K currentreports that we have filed with the SEC that identify important riskfactors that may impact Microchip's business and results ofoperations. In attendance with me today are Steve Sanghi, Microchip'sPresident and CEO, and Ganesh Moorthy, Executive Vice President. I willcomment on our third quarter performance reviewing geographic data anddiscussing balance sheet and cash information. And Steve and Ganeshwill then give their comments on the results, outline our guidance forthe March quarter, and update other prevalent matters regarding ourbusiness. We'll then all be available to respond to any specificinvestor and analyst questions. So let’s begin with net sales for the December quarter, whichwere $252.6 million. They were down approximately 2.3% from net salesof $258.6 million in the immediately preceding quarter and upapproximately 0.6% from net sales of $251 million in the prior year’sthird quarter. On an earnings basis, we are continuing to include someadditional information in our press release related to the adoption ofFAS 123(NYSE

[Ganesh Moorthy:]

Thank you, Gordon and good afternoon everyone. I'll nowcomment on the individual product lines after which Steve will walk youthrough our guidance for the next quarter. Starting withmicrocontrollers, our microcontroller business was down approximately1% sequentially and was up approximately 1.5% from the year-agoquarter. Our Flash microcontroller business hit another record and wasup 0.5% on a sequential basis and up 10% from the year-ago quarter andFlash microcontrollers now represent 73% of our overall microcontrollerbusiness. Calendar 2007 culminated with the shipment of our 6 billionthmicrocontroller late in December and calendar 2008 started with theshipment of our 600,000th development tool in early January. Both keymilestones that mark our leadership position in the microcontrollermarket. Speaking of our development tool shipments, which are a verygood leading indicator, we shipped a record 28,722 new developmenttools last quarter and through the first nine months of fiscal year’08, we have shipped a record 83,360 development tools, about 40%higher than the corresponding period in fiscal year '07. These strongdevelopment tool shipments results are indicative of continued strongdesign-in activity and acceptance of our solutions that should bodewell for future growth. Moving to 16-bit microcontrollers, we had another strongquarter with revenue up almost 28% sequentially and up over 138% fromthe year-ago quarter. A strong design-in momentum continues to buildacross a broad range of customers and applications. We shipped 3,79316-bit development tools in the December quarter, bringing the totalnumber of 16-bit tools shipped to date to 40,569. And significantly, inthe first nine months of fiscal year '08, we have shipped twice thenumber of 16-bit development tools as we shipped in the equivalentnumber of... equivalent time frame in fiscal year ‘07. We currently have 101 16-bit products in production with manymore sampling and we expect to exit the March quarter with over 150products in production. The number of 16-bit volume customers grew to1,117 in the December quarter from 1,018 in the September quarter andin terms of 16-bit customers of all volumes, that number remains in theseveral thousands. As most of you must be aware, we introduced our 32-bitmicrocontroller product line in November, thus giving us access to anincremental $4 billion of serviceable market. We are launching the32-bit product line at a time when our 16-bit business is very strongwith lots of momentum in all the leading indicators and as we've toldyou before, our 16-bit product line competes effectively with the lowend of the 32-bit market and we now believe we can address an evenlarger portion of 32-bit market with the new product line. Since the November introduction, customer interest has beenhigh and industry accolades have already started to commend, mostrecently, with EDN Magazine selecting the product line for itprestigious Hot 100 Products of 2007 list. While we expect to design-incycle for 32 bit to be long, we are optimistic about its contributionto our overall microcontroller growth and leadership position. Finally, while the microcontroller market share informationfor 2007 is not yet available to compare to the results of our 8-bitmicrocontroller business, we believe that the performance of our 8-bitbusiness in 2007 was purely the result of environmental factors and wefirmly believe we are continuing to maintain or gain market sharethrough the combination of our strong product line offering andenhanced demand creation and sales. Moving to our Analog business, it was down 2.4% sequentiallyand down 4% in the year-ago quarter. While we are not satisfied withthese results, they are reflective of current industry conditionsthat’s seen in many of our peer company results as well as the normalseasonality in this business segment. We continue to be encouraged bythe level of design-in activity and the breadth of customers asactivity is occurring at. Our Serial EE memory business was down approximately 9%sequentially and was down approximately 1.5% from the year-ago quarter.Sales were impacted in part by excess inventory that resulted from somespot shortages in the market during the September quarter as well asnormal seasonality in this business segment. Pricing declinedmoderately quarter-over-quarter. Let me now pass it to Steve for some general comments and our guidance for the March quarter. Steve?

[Steve Sanghi:]

Thank you, Ganesh and good afternoon everyone. Today, I wouldlike to first reflect on the results of the December quarter, then Iwill discuss the macro environment as we see it, and finally I willprovide guidance for the March 2008 quarter. I’m pleased with theexecution in the December quarter amidst challenging industryconditions. Our net sales were down 2.3%, slightly better than themid-point of our guidance but we exceeded gross margin guidance andachieved an all-time record high gross margin of 61.2% on a non-GAAPbasis. We also achieved the high end of our earnings per shareguidance, both GAAP and non-GAAP. During the quarter, we also completeda $1.1 billion convert transaction and in the last six months, we havenow bought… bought back 31 million shares of our stock worth $965million. Now I will discuss the macro environment as we see it. WhenMicrochip first revised our guidance on October 8th, some investors andanalysts did not agree with the market data that we were providing.They did not believe that the conditions we were experiencing were morepervasive in the industry. Many believed that Microchip was losingmarket share and that our gross margin would not besustainable. We went to great length to explain in our conference call thatwe were seeing the effects of the housing market filter into thebroader economy and Microchip often sees the effects of industry events1 to 1.5 quarters ahead of our competitors and peers. It is somewhatbecause of our more conservative revenue recognition policy, our focuson relatively smaller customers who react more quickly, and our endmarket focus which is more consumer dominated than our peers andcompetitors who are more exposed to PCs and cell phones. Another reasonwhy we see the effect of economic events earlier is ourindustry-leading short lead times allow customers to be more dynamic inhow they adjust to demand or not. Now we believed that the other companies would start to seethe effect in a quarter or so. We have certainly seen this scenarioplay out at several industry and macro events in the past and theindustry results in the current environment show that the scenarioseems to be playing out as we had predicted. Now with another quarter behind us, the market has respondedto the changing conditions in the industry and has affected valuationsbased on all the data now available. The effect of the housing marketon the broader economy is now being acknowledged by many analysts. Fromour pre-announcement date of October 8, 2007, PhiladelphiaSemiconductor Index, SOX, is down much more than the decline inMicrochip stock price. SOX is down about 29% versus Microchip downabout 20%. And the stock of most of our peers and competitors are downvery significantly and more than Microchip stock price. Now, with this result, the market is obviously recognizing thestrength of our business model and the results that we are delivering.Now, some investors and analysts were concerned after October 8 thatMicrochip would see unusual pricing pressure in the microcontrollermarket and gross margins would not be sustainable. Our gross marginsactually increased to another record high of 61.2%, up 80 basis pointsfrom the previous quarter. So there continues to be very encouragingnews for the business, which certainly reflects in our forwardguidance. We saw some stabilization in the Housing segment of the marketand let me explain that. Our shipments to the Housing customers consistof product going into new houses as well as going into existing housesfor remodeling as well as replacement. For many appliances, up totwo-third of the shipments go into existing houses. We have seen thecomponents going into the new houses fall to very low levels,consistent with the housing data. The Microchip U.S. Housing Index wasactually up last quarter from the previous quarter. We believe that theU.S. Housing Index for Microchip is currently bumping at the bottom.While the new housing market will probably go down further, we believethat the new designs from hundreds of our new products may put a flooron the index here, we therefore project that this element of ourbusiness will be flattish from here. As I sum up the environment, I note that while we are sittingat the trough of our revenue curve for this business cycle, we areenjoying record gross margins and record earnings per share on anon-GAAP basis. We are keeping expenses and capital expenditures in thecompany very tight and will be able to weather any economic storm thatmay be on the way. We are getting very good traction in our 8-bit flashmicrocontrollers as well as 16-bit microcontrollers. As the revenue onthese product lines grows, it presents excellent opportunities forfurther gross margin expansion and earnings per share gains. I would like to add that 2007 was sort of a year of PCs andcell phones, especially in the last six months and Microchip has lowerexposure to these segments. Now, you are seeing that PCs and cellphones are going through inventory corrections which are really lesslikely to affect Microchip's business. Our segment has really gonethrough significant correction already and that's why we believe thatour revenue is almost sitting at the bottom. Our book-to-bill ratio for December quarter was approximately1.02, up from September quarter book-to-bill of 0.94. The startingbacklog for March quarter is also significantly higher than thestarting backlog was for the December quarter; however, as I've toldyou before, book-to-bill ratio and starting backlog have not correlatedwell to our results in the past. We are also giving consideration tothe effects of the Lunar New Year holidays in Asia in the currentquarter. So based on our review processes, we expect that our net salesto be down 2% to up 4% sequentially. We expect to achieve another record gross margin of 61.3% to61.5% on a non-GAAP basis. Now, the earnings per share calculation thisquarter gets really complicated with the effects of convert transactionand stock buybacks which are very positive and the one-time favorabletax matter in the December quarter which isn’t repeatable. In addition,Fed’s lowering of the interest rates knocks a penny out of theearnings. We have $1.6 billion of cash. So it knocks a penny out of theearnings because of reduction in interest income and we have not madeany assumptions about any further interest rate moves from the Fed. Sotaking all these into account, our non-GAAP EPS is expected to be $0.39to $0.42 and our GAAP EPS is expected to be $0.35 to $0.38. With that, operator, would you please poll for questions? Question and Answer

[Operator:]

Thank you. [Operator Instructions]. We'll take our first question from Craig Ellis with Citi.

[Steve Sanghi:]

Go ahead, Craig.

[Operator:]

We'll go next to Chris Stanley with JPMorgan.

[Christopher Danely:]

Hi guys, can you hear me?

[Steve Sanghi:]

Yes, we can, Chris.

[Christopher Danely:]

Okay, great. Can you just talk about what I guess percentageof revenue your sort of housing index represents of Microchip now andthen what it was at the peak or how much it's swollen?

[Steve Sanghi:]

Well, Craig… sorry, Chris, those numbers are very, very roughto get as we mentioned when we put the index together that customersmove the designs back and forth from here to Asia. There are a lot ofnew designs that constantly go to production every quarter. So, whilethat index was actually up from last quarter, it's a combination of alot of these moving parts and a very complex equation. So you can'tcleanly get it to… trying to do a whole bunch of analysis out of that.When we originally announced the index, we believe that our U.S.housing exposure was about 8% and it probably was even higher last yearbecause we created the index in the March quarter where the numbers hadalready gone down. And we think it's down substantially from thatnumber today. Do you have a follow-up?

[Operator:]

We'll take our next question from Simona Jankowski with Goldman Sachs.

[Simona Jankowski:]

Yes, hi, thanks. Just curious on your revenue guidance, itsounds like you implicitly are assuming a lower level of turns thisquarter than last quarter, considering you are starting with a higherbacklog and interestingly, a lot of the other companies in the analogspace like Linear and Intersil and Fairchild actually were assumingflat or higher turns for this quarter. I was just curious, are you guysjust being more conservative because of the macro environment or werethere specific things we are seeing in the behavior of your customersthat are causing you to both kind of guide below what your backlogwould suggest but also have a higher range of the guidance than you’vehad historically?

[Steve Sanghi:]

Simona, if you look at the history of what we had said on thisconference calls, we don't believe in book-to-bill ratio or thestarting backlog. And when book-to-bill and starting backlog looksbetter, I’m consistent and not using it to take advantage of that thenumbers could be a lot better. And when the book-to-bill is lower andthe starting backlog is lower, at that time, I always say that itdoesn’t matter either. So I am consistent on both sides. We believethat starting backlogs and book-to-bill just kind of vary randomlysometime where lots of customers could place the order before the endof the quarter versus in another quarter, they happen to place theorder in the beginning of the quarter for February and the ratio hasnever really correlated very well to our business. I've produced dataon that before. So we really go back to a bottoms-up analysis, by sales guy,by channels, by customers, by regions, and by market segments and fromthere, we have really constructed that number. So if you purely do amathematical calculation, yes, the turns acquired are much lower. Butwe also have to go through Chinese New Year when, for couple of weeks,the largest market is closed and so you have to account for all thosethings.

[Simona Jankowski:]

So is there anything in the behavior of your customers so farthis quarter that’s suggesting any kind of concern over the turnsyou're expecting this quarter?

[Steve Sanghi:]

Well, just the overall macro environment, your question wasrelative to Linear and others and we have already shown in the last sixmonths or so that our business does not correlate with them. Theirexposure is different than our exposure is. We go to these events aquarter to quarter-and-a-half ahead actually than everybody else. Mostpeople are guiding down now this quarter while we are guiding flat toup. So our results already do not correlate with these other companies.So therefore, the behavior of our customers and the turns model doesn’tcorrelate either.

[Simona Jankowski:]

Okay, thank you.

[Steve Sanghi:]

Yes.

[Operator:]

Take our next question from Steve Maresca with UBS.

[Steve Maresca:]

Yes, this is Steve Maresca for Uche Orji. Your guidance aboutseeing a trough here in the housing and potentially overall in sales isencouraging. But without asking you to try to be an economist, how doyou see it going beyond the current quarter? The concern is the shapeof the recovery will be very much a U shape recovery with the concernsthat whatever recovery is very slow and gradual.

[Steve Sanghi:]

Well, number one, we haven't really given you any longer-termguidance, so really you have to put your own assessment. Secondly, Ihaven't counted the number of times this event has happened, but Iremember during SARS and during prior inventory corrections and againnow, every time, when we have a revenue miss, very often, it's aquarter to quarter-and-a-half ahead of the industry and when we come upwith that, nobody kind of intends to believe it. And if you just …. ifyou just had… if the world had believed what we said back in October8th, and taken some actions, stocks are down 30% from that. But at thatpoint in time, it was just a Microchip problem and really everybodyelse was fine, and you can see in about a quarter, quarter-and-a-half,everybody has caught up to that. So we at the same time see thisrecovery ahead of everybody else and we have shown that before also.It's clearly evident in our book-to-bill ratio. I listened to another company's call that announced thismorning whose book-to-bill ratio was 0.88 in semiconductors. Ourbook-to-bill ratio was 1.02 and our backlog was higher and we arecalling for… so there is a significant difference in the marketsegments. Their market was lot more… had lot more exposure to PCs, oursis more industrial, automotive, consumer, and less PC and less cellphones. So, it’s a very, very different model and it continues to bevery predictable. We have done this over and over and over and it justtakes a lot of effort to really get through it every time to expand itand it does not really get the footing until the numbers come out,which are coming out now. So now, the question becomes going forward, why would werecover? Well, same reason why we recover every time. The new productsare growing, the traction is very good, and designs, development toolsare a record, 16 bit was up 28%. So even in a bad market, the newdesigns are happening, people are converting, they are upgrading theirproducts, and so on and so forth. In the Housing segment, large portionof our product is going into Housing segment is really now going intothe replacement market, as I tried to explain, although the new Housingsegment could go down further and probably will, but it’s so small nowthat really can't really affect very much. So while we kind of sufferedin 2007 because of lower exposure in PCs and cell phones, this nowworks for us because those are the segments now hurting and we see oursegments doing better.

[Steve Maresca:]

Great. That's very helpful and just as a follow-uphousekeeping question, on the tax rates, should we assume the 18.5%going forward or is that just for Q4?

[Steve Sanghi:]

Gordon?

[Gordon W. Parnell:]

Well, beyond into 2009, that seems like the range of our taxrate, always be.., it might vary depending on where we invest our cashbalances and our mix of geographic profits, but somewhere in that rangeis probably reasonable for fiscal '09.

[Steve Maresca:]

Great. Thank you.

[Operator:]

[Operator Instructions]. We will take our next question from Doug Freedman with AmTech Research.

[Doug Freedman:]

Hi guys. Thanks for taking my question. Congratulations onseeing the turn in the business. Could you talk a little bit about thepace at which you are seeing sort of the design activity? Are yourcustomers also starting to sort of feel better about the environment inwhich they are [inaudible]?

[Steve Sanghi:]

They don't really tell us when their environment isnecessarily good or bad. We know that there is design activity takingplace at all times, we are engaged in these designs, we are winningmore than our fair share in these designs. And so, to that end, thecustomer decides their comfort level of when they want to take productsinto production. But, we are working to ensure that at whatever pacethey take it, we're the choice that they have used in theirdesigns.

[Doug Freedman:]

And is there any way for you guys to sort of quantify what'shappening as far as sort of the move to the higher integratedmicrocontrollers, not just the bits but the ones where you have gotmore integrated functionality on it? Are you tracking that in any way,and is that something that’s continuing?

[Steve Sanghi:]

We don't track it at that level. When we think about it, weare looking at what customer needs there are. In some cases, the simplemicrocontrollers fill those needs; in other cases, the more complexmicrocontrollers fill those needs. As we have grown our portfolio, wehave obviously got a larger number of products that can service abroader market. And so, perhaps designs we could not get to in prioryears we can get to now. But, we are looking for growth across theboard. We are not looking at just the highly integrated or thehigher-end microcontrollers for growth. We are looking for it acrossthe board.

[Doug Freedman:]

All right. And then just a real quick one on in the pressrelease, you mentioned you had 12 million shares remaining availablefor purchase under the program... under the stock repurchase program.Where does that number stand today?

[Gordon W. Parnell:]

[inaudible] number.

[Doug Freedman:]

12 million [inaudible].

[Ganesh Moorthy:]

Yes, that’s the number. We didn't really buy stock in thequiet period while we were close to the end of the quarter. So, when wego into the quiet period, we usually cut off buying any stock. So,window for us would open in the next couple of days and stock prices,we might resume that activity.

[Doug Freedman:]

All right, terrific. Thank you.

[Operator:]

We'll take our next question from Mark Lipacis with Morgan Stanley.

[Mark Lipacis:]

Thank you for taking my question. Just a follow-up on thatlast one. I don't know if I got the data. How much of the convert wasoffered, how much of the over allotment was exercised?

[Steve Sanghi:]

Entire over allotment was exercised.

[Mark Lipacis:]

Okay. So, according to your original intentions, it was to useeverything from that convertible offering to buy back stock. Do Iunderstand that correctly?

[Steve Sanghi:]

Certainly that will retain, that was our intention.

[Mark Lipacis:]

Okay. Over time, okay.

[Gordon W. Parnell:]

By the time the over allotment got exercised, we couldn't buymore stock because we’ve gone into the quiet period. I believe it wasexercised on 20th of December or something.

[Steve Sanghi:]

Correct.

[Gordon W. Parnell:]

So, therefore, the over allotment got exercised where we haven't bought any more stocks in.

[Mark Lipacis:]

Sure, understand. And a follow-up question is, maybe forGordon, the long-term investments came down a couple hundred milliondollars, is that… was that due to timing or anything and kind ofassociated with that question, I guess, some companies have to write...had to write down some of their investments on how comfortable are youguys at that… you are safe on that front? Thank you.

[Gordon W. Parnell:]

The reduction in the long-term investment is timing and reallyhas nothing related to valuation. As we have pointed out in our Qs thatthere are $25 million of auction [ph] REIT securities that are illiquidat this point in time. But that's not a material amount and fromMicrochip's perspective, it's not a liquidity event that  has anyconcern for us at this stage?

[Mark Lipacis:]

Great. Thank you very much.

[Operator:]

We'll take our next question from Gil Alexander [ph] with Darphil Associates [ph].

[Unidentified Analyst:]

Hi, you've answered the question, thank you.

[Steve Sanghi:]

Thank you, Gil.

[Operator:]

Our next question comes from Chris Danely with JPMorgan.

[Christopher Danely:]

Thanks guys. Hope we don’t get cough this time. Can you justdiscuss what you expect your gross margin and inventory trends to doafter the March quarter?

[Steve Sanghi:]

Well, I think, we have guided our longer-term non-GAAP grossmargin to be 62%, 61.2% in December quarter. We are guiding 61.3% to61.5% in the March quarter. So from there, center point of that, wehave 60 basis points to go and we will just continue to go up, 20, 25basis points from there, probably marching towards the 62%. And interms of the inventory, Gordon?

[Gordon W. Parnell:]

It depends on the environment and the revenue. We're certainlyvery happy that our inventory in dollars, both at distribution and onour balance sheet, was flat quarter to quarter. It shows that we're notbuilding dollars of inventory, the increase in days was driven from thefact that the revenue declined by a couple of percent. So hopefully,with a stronger environment, we will continue to see some declines inour inventory in days over the next year or so.

[Christopher Danely:]

So at the midpoint, inventory would be roughly --?

[Gordon W. Parnell:]

Mid point of --.

[Steve Sanghi:]

Midpoint of the guidance.

[Christopher Danely:]

Yes, that sounds normal. And then on your... on the rest ofyour businesses, it sounds like the MC business is doing okay. On theEE business, it dipped 9%. What exactly are you guys seeing out there?Do you see a little bit more aggressive pricing? And if it is getting alittle bit more aggressive because of the broader concerns in semis,would you guys look to shy away and just keep the margins upthere?

[Gordon W. Parnell:]

We have always been very disciplined in how we run the EEbusiness and the margins at which it runs. Really what you saw in the9% decline was, if you go back and look at our September quarterresults, you saw a substantial growth in the Serial EE business andsome of that growth occurred because there were spot shortages ofspecific products. We have the product availability, we took advantageof it in that time frame. And it's versus that September comparison the9% decline comes about. Other than that, there is normal pricingpressure, it's moderate from quarter to quarter. [inaudible].

[Christopher Danely:]

Okay. And then last question for Steve. A little more biggerpicture, we have talked about the whole district [ph] commissionarrangement for a while. Steve, now that you have had some time betweenthat decision and now, do you think it was the right thing to do, areyou looking to change that, do you feel any enmity from thedistributors towards Microchip, if you could just comment onthat?

[Steve Sanghi:]

Well, it was absolutely right thing to do. When we make thesecorporate kind of calls, we do them after a whole bunch of analysis,it's not always understood by the Street; in fact it's alwaysmisunderstood by the Street. We have done a large amount of analysislooking back who was creating what demand and based on that, with a lotof discussion with the Board and among themselves, we took on a task tomove the reward and move the resources in the favor of moredemand-creating channels and less in the favor of the channels thatwere not creating demand. We believe the results have been verypositive. The first step of those changes was taken almost four yearsago and our business has done quite well with tremendous growth in16-bit development tools and the others. We have had a number ofregional distributors around the world in Asia and Europe and otherplaces. So, I think we are pretty happy with what we have. Wecontinuously tweak it, we are always looking for changes, we are alwayslooking for making it better. At the same time, we added a large numberon Microchip’s own people about 18 months ago and with design cycle 18month or two years, I think if you look at sort of the funnel, funnelis our way of… what’s in the funnel, what’s in the opportunity base andwhat’s in the design wins. The funnel is significantly larger than whatit was couple of years ago and as these designs come to maturity and goto production in the next six, eight months, we are quite optimisticthat the changes we made are going to be very, very good for thebusiness.

[Christopher Danely:]

Is there any way you can estimate the amount of additional SG&A that the microchipDIRECT has resulted in?

[Steve Sanghi:]

Well yes, we know that, and I don't think I want to give anumber off the top of my head, but we know how many people we addedfrom that program and what the total cost of that is, yes.

[Christopher Danely:]

I guess the question I was trying to get at is, clearly, it’shelped the margins, because you are not paying as much of commission,do you think that the margin benefit has outweighed the additionalSG&A?

[Steve Sanghi:]

The program was not structured to create net additionalbenefit. The program was created to invest the savings and help forhigher demand creation, so Microchip could grow. So a lot of the moneywe got from the margin side we really reinvested in the SG&A. Onthe net, did it even out, was the margin little bit higher, could be.But it was not… it’s not really huge amount, and it was not structuredto create additional profit dollars for Microchip. It was structured tofree up dollars so we could reinvest them in selling our 16 bit and ourmotor control, our Ethernet products. As Ganesh mentioned earlier, we have lot of highly integratedproducts and lot of them are driving the growth. But these products aremuch more complex, which require much higher level of support for thecustomer. We needed to add specialist around the world who understand16-bit DSP, high-end 8-bit microcontrollers. So these experts are theones who are really helping sell lot of these products. That’s why16-bit microcontroller is up 138% year-over-year, and the non-demandcreation distributors have not created a single design for 16-bitmicrocontrollers when we made that decision.

[Christopher Danely:]

Okay. That's very helpful.

[Operator:]

We will take our next question from Sidney Ho with Merrill Lynch.

[Sidney Ho:]

Hi, thanks for taking the question. In terms of yourinventory, it is still high by historical standards, but not as high asback in 2001, and I assume you still have no intent to slow downproduction.  I understand that most of the products don't really getobsolete, but is there like a policy that you follow that requires youto make inventory adjustments, say, you project these products won'tsell in the next six months?

[Steve Sanghi:]

No, we have been very consistent in applying our obsolescencepolices through good times and in bad, and if there are any affects ofthose in a period, they roll through our gross margin. So there hasbeen no change to our policies in terms of extending the runway interms of looking at products. We have been consistent and will continueto be so.

[Sidney Ho:]

Okay. Just one housekeeping item, what should we model for netinterest expense and diluted share count for the March quarter? Andshould we expect more buyback in the March quarter?

[Steve Sanghi:]

Well, any buybacks in the March quarter is going to be drivenfrom the conditions in the marketplace and we'll make those discussionsas we go through. So we can't really give you any direction on thatspecifically. Interest income and expense… interest expenses isprobably easier to triangulate to, because that's going to be drivenfrom the convert and the expenses on that transaction. It’s going to beabout $6.3 million on a quarterly basis. And our interest income isgoing to be a factor driven from the type of investment that we make,whether they are tax advantaged, whether there is any furtheradjustments in the rate of… in the interest rate from the Fed, if thereare any additional changes. That's probably somewhere in the range of$12.5 million to $13 million as we look at it today. But again, as wesay, we have to take into consideration any changes in the rates andhow that would affect the continuity or the roll-over investments from…into future periods,! which maybe go beyond the end of the current period.

[Sidney Ho:]

And share count?

[Steve Sanghi:]

Share count is going to be somewhere in the 195 million sharesin terms of the current quarter, and that's taking into considerationthe full impact of the convertible transaction for the entirequarter.

[Sidney Ho:]

But no additional buyback?

[Steve Sanghi:]

But no additional buybacks. And again, those would be… those would be additional… incremental.

[Sidney Ho:]

Okay. Thanks.

[Operator:]

[Operator Instructions]. We will take our next question from Kevin Cassidy with Thomas Weisel Partners.

[Kevin Cassidy:]

Thank you for taking my question. A lot of my questions havebeen answered, but when you are looking at first quarter, how do yousee it geography wise? Do you see Americas being flat and Europe beingflat and Asia being the only geography down?

[Steve Sanghi:]

When you say first quarter, you mean the fiscal fourth quarter?

[Kevin Cassidy:]

I am sorry. Yes, the March quarter.

[Steve Sanghi:]

Yeah. So, as far as Americas is concerned, nobody really wantsto do manufacturing in America. So, what I would say, I‘d almost make abold statement that America would be almost flattish almost forever.And to measure America by simply what we are shipping into America isjust increasingly not right, it doesn't tell anybody anything, but it’svery, very hard to really recapture… when you have 60,000 customers,it's very, very hard to capture who is manufacturing where and whatsubcontractor. So you almost… it’s a very difficult equation, because alot of the Americas business really books in Asia. So when I tell youabout the fourth quarter, the biggest growth will come out of Europe,because Europe just has very large number of working days in the firstquarter. They have… in this current quarter. They had significantnumber of holidays in the last quarter. Asia usually is flat toslightly down driven by the Chinese New Year and Americas isflattish.

[Kevin Cassidy:]

Okay. Thank you.

[Steve Sanghi:]

Yes. So, most of the growth really comes out of Europe this quarter.

[Operator:]

We will take our next question from Romit Shah with Lehman Brothers.

[Romit Shah:]

Thanks. Hi, Steve. If my memory serves me correct, about ayear ago, I think it was the fiscal fourth quarter of ’07 when you guyswere coming off for the inventory correction, you had made the commentthat you were saying an increase in expedite requests and that wasfeeling some of the belief that we were heading into a recovery, areyou seeing that time around as well?

[Steve Sanghi:]

Yes, we are seeing incredible number of expedite requests, absolutely.

[Romit Shah:]

Okay. And is it tied to as best you can tell to a particular region or particular end market?

[Steve Sanghi:]

No, it's pretty broad based. Well, a lot of them really comefrom distributors because we do a lot of business from distribution,results in all geography, it's driven by very low inventory in thechannel, very low inventory at the customers, everybody has lowvisibility, our customers don't have any visibility, so they'rebuilding product on shortly timed request from their customers. So theentire chain is just getting expedited because nobody wants to take therisk, nobody has inventory, nobody has any visibility. So yes, expediterequests are just incredible.

[Romit Shah:]

Yeah, Avnet had pretty reasonable numbers today. Are thesedistributors… the distributors then that you work with, are they… doyou feel like they are ordering at a rate that's faster than what theyare selling to the end [ph] customer?

[Steve Sanghi:]

Well, last quarter --.

[Gordon W. Parnell:]

No, I mean… yeah, our distribution inventory is flat quarter to quarter.

[Steve Sanghi:]

So, the answer is no, they are buying what they are sellingthrough and that’s really the situation that we would expect. Ourdeferred margin, as I mentioned, was unchanged quarter toquarter.

[Romit Shah:]

Because usually when inventories are low and you are comingout of a period where you’ve had a few quarters of negative growth,they tend to order at a faster rate than they are sellingthrough.

[Steve Sanghi:]

We tend to have very short lead times which really accommodatetheir ability to manage their working capital very effectively, thatdoes result in some expedites on occasions because they obviouslysometimes misread their own market.

[Steve Sanghi:]

Well, let me again say that any time you apply the commonindustry wisdom to our business, you’re probably going to get the wronganswer. And that's why we tend to be so… have different cyclicalitythan the rest of the industry. A majority of our distributors are verysmall regional distributors. So approximately, let’s say, a good andgood portion of our business is distribution.

[Gordon W. Parnell:]

About 65%.

[Steve Sanghi:]

It’s about 65%, so over 40% of that 65% of the business isthrough very, very small distributors which we call regionaldistributors that are demand creators with dedicated resources forMicrochip around the world. These don't tend to be the guys who areheavily capitalized. So they keep a relatively small amount ofinventory and because of a very, very short lead time, very quickly,we’re able to deliver it to them and they are able to deliver it totheir customers. So what you call the traditional large global distributors arerelatively much smaller portion of our business than could be maybesome of your other investments. Those are the guys who are capable ofholding more inventory but they are not either because they are drivenby return on the assets. So the people who have cash and could holdlarger inventory aren't holding larger inventory either. So theinventory in the channel is quite low and we do not see… we haven'tseen distribution inventory grow in five years.

[Gordon W. Parnell:]

Sure.

[Steve Sanghi:]

We have gone through cycles and inventory corrections andexpansions, it's basically sitting at 1.8, 1.9, 2 months. So, I don'treally expect the distribution inventory to grow. We believe it's ourjob to make sure the product is available to our end customer at amoment’s notice and our manufacturing system is geared to be able toexpedite that and produce it, and that's why customers prefer to designwith us. And many times, those customers want to buy that from thedistribution. So, we provide the product through the distribution andthen the distribution makes the appropriate amount of margin for theamount of work he has done. It's not one thing that drives everybody.Everybody doesn't get paid the same. The distribution gets paidequivalent to the amount of work they have done in creating thatdesign.

[Romit Shah:]

Okay. And if I could just on 16-bit, are you… are you satisfied with the performance in that business?

[Steve Sanghi:]

Absolutely. 16-bit is doing extremely well. We will increasethe number of products in the market by 50% this quarter. The businessis up quite substantially, 138% year-over-year. We are gettingtremendous traction. Do we want to be larger, could we have donebetter? Yes. I could say that about any parts of my business, we wantimprovement everywhere.

[Romit Shah:]

And does that come upon where you disclose the size of that business?

[Steve Sanghi:]

No.

[Romit Shah:]

Okay. Thanks.

[Operator:]

It appears there are no further questions at this time. Mr.Sanghi, I would like to turn the conference back over to you for anyadditional or closing remarks.

[Steve Sanghi:]

Well, we want to thank all of our investors to stick by. Wehave gone through a fairly difficult environment here. We are out ofthis. So, I think we are sitting, bumping at the bottom and looking forgood things to happen in the coming year. And we will see many of youon the road shows and conferences, we’ll start going as this windowreopens. So, thank you very much. Bye, bye.

[Operator:]

Thank you for your participation. This concludes today's conference. You may now disconnect.