微晶片科技 (MCHP) 2003 Q4 法說會逐字稿

Good day, everyone and welcome to Microchip Technology Quarter 4 fiscal year 2003 earnings 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, Gordon Parnell.

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 release of today, as well as our 10-K for the fiscal year ended March 31st, 2002, our 10-Q for the quarter ended December 31 -- that was March 31 statistics 2002 for the K. The Q for the quarter ended December 31st, 2002, and our 8-K current reports that we have filed with the SEC, and those identified important risk factors that may impact Microchip's business and results of operations.

In attendance with me today is Steve Sanghi, Microchip's President and CEO. I will comment on our fourth-quarter and fiscal year 2003 performance, giving information by geography and product segment. And Steve Sanghi will then provide our update on our manufacturing capacity actions announced in our April 7th 2003 press release, and discuss our guidance for the June quarter, the current quarter.

We will then be available to respond to specific investor and analyst questions at the end.

To remind everyone, on March 18th, we announced our plans to change our revenue recognition relating to sales to regional Asian distributors. We changed from recognizing sales when a product is shipped to these distributors, point of purchase basis, to recognize revenue when product is shipped to their end customers, point of sale basis. This gives Microchip a uniform, consistent method of recognizing revenue in all distribution channels worldwide. It focuses our distribution sales force on demand creation and sell-through to the end customer. Our revenue does not -- does and will reflect end market demand through the entire distribution channel for all our products, which we see as an extremely important factor going forward.

To implement the change in revenue recognition, Microchip has recorded a charge related to the cumulative effect for the change in accounting principle of $11.4 million as of April 1st, 2002, the beginning of fiscal 2003. Quarterly operating results for the first three quarters of fiscal 2003 have been adjusted to conform with the change in accounting. These adjustments resulted in a cumulative revenue reduction of $8.7 million for the first three quarters of fiscal 2003, and a cumulative net income reduction of $2.4 million for that same period.

Comparative data referenced in the call today is based on the adjusted information. We did include the adjusted quarterly income statements as part of our press release today, and hope that can assist investors and analysts and others in understanding the adjusted P&L information.

Net sales for the March quarter were $159.7 million, which is down 5 percent sequentially from sales of $167.5 million in the December quarter, and an increase of 7 percent from sales of $148.8 million in the prior year's fourth quarter.

Geographically, Europe grew by approximately 13 percent, while both Americas and Asia declined sequentially by 12 and 14 percent, respectively. Total revenue rate down for the quarter resulted in sales for Asia representing approximately 38 percent, America's at 32 percent, and Europe at 30 percent.

Net sales for micro controller products represented approximately 81 percent of revenue in the quarter, analog products represented approximately 7 percent of revenue, and memory products represented approximately 12 percent of revenues.

Sequentially, microcontrollers were down approximately 3.5 percent, analog products were down approximately 18 percent, and memory products were down approximately 4 percent.

Net sales for fiscal 2003 were $651.5 million, an increase of 14 percent from sales of $571.3 million in the previous fiscal year. Net income for the March quarter was $33 million, or 16 cents per diluted share, a decrease of 9 percent from net income of $36.4 million or 17 cents per share in the December 2003 quarter, and an increase of 25 percent from net income of $26.3 million, or 13 cents per diluted share from the prior year's fourth quarter.

On a pro forma basis, net income for fiscal 2003 was $133.9 million, or 64 cents per diluted share, an increase of 41 percent from net income of $94.8 million, or 45 cents per diluted share in the prior fiscal year. Pro forma earnings exclude the effect of the impairment charge taken on the Peolat (ph) Washington facility and process research and development charges related to the Paraslot (ph) acquisition and the cumulative change in accounting adjustment that I mentioned earlier in the call.

On a GAAP basis, net income for fiscal 2003 was $88.2 million, or 42 cents per diluted share, a decrease of 7 percent from net income of $94.8 million ,or 45 cents per diluted share.

Gross margin for the March quarter was 54.3 percent. Gross margins in the March quarter were primarily impacted by increasing startup costs in Gresham, the product mix of microcontrollers and analog products, manufacturing yields and fixed cost absorption. Factory utilization levels were at 85 percent in the quarter.

Startup costs for our Gresham, Oregon facility were approximately $4.5 million in the March quarter. Excluding these costs, our product gross margins for the quarter were 57.1 percent.

Operating expenses were 27.3 percent of sales in the March quarter compared to 26.7 percent in the previous quarter. Research and development costs were $21.7 million, representing 13.6 percent of sales. Sales and general administrative expenses were $21.9 million, representing 13.7 percent of sales.

Operating expenses overall showed a decrease of $1.2 million from the December quarter.

Microchip's total inventory position at March 31st was approximately $102.3 million, an increase of approximately $8.3 million from the prior quarter level. Inventory turns are at 2.9, with days of inventory representing 128 days.

At March 31st, Microchip's receivable days were 48 days, compared to 46 days at the end of the December quarter, and 47 days a year ago.

Our cash position at March 31st was $216.5 million, with no debt on the balance sheet. During the quarter, Microchip generated approximately $51 million in cash from operations, offset by capital expenditures of $17 million. We also repurchased 871,000 shares in the quarter, at a cost of $19.6 million. This is related to our stock buyback program. Free cash flow from the business, after capital costs, working capital investments, and treasury activities resulted in adding $18 million to treasury in the quarter.

Capital spending, as I mentioned, was $17 million for the quarter, and $264 million for all of fiscal 2003. Capital spending includes the purchase of Fab 4 in Gresham. That was for $185 million, approximately. Anticipated capital spending for fiscal 2004 is expected to be between $40 and $45 million. Depreciation expense for the March quarter was $27 million, versus $26 million for the same quarter last fiscal year, and $28 million in the December quarter.

Microchip shipped 10,562 new application development systems to customers during the quarter, up from approximately 6,500 systems in the prior quarter. The current quarter shipments resulted in a new record for development systems, an indication of continued strong design momentum for our products. To date, we have now shipped over 262,000 systems.

With that, I will now ask Steve to discuss the Fab 1 and Fab 2 combination activities, and outline our guidance for the June quarter.

Thank you, Gordon.

I would like to give you an update on our Fab 1 and Fab 2 consolidation efforts and provide guidance for the June quarter.

Since our announcement of Fab 1 and Fab 2 consolidation on April 7th, we have made significant progress. The lead wafer lot of our highest volume process are already running in Fab 2, and we expect first-time, fully functional and high-yielding wafers to come out in early May. We have defined the last time build requirements in Fab 1 based on such requirements we currently expect Fab 1 to close by the end of this quarter in June. By that time, several high-volume products will already be running in Fab 2, and the rest of the products will have enough inventory build which will last until these products are running in Fab 2.

Fab 1 closure and consolidation of work into Fab 2 will result in savings of approximately $34 million per year. The resulting capacity decrease will allow our inventory to come down from approximately 141 days at the end of June to about 110 days at the end of March 2004.

After Fab 1 closure, Fab 2 will be running at approximately 90 percent utilization, which gives us excellent manufacturing efficiency. Any upside in revenue will be covered out of the inventory as well as Fab 4.

On the people side of the equation, about 60 employees have requested transfers to Fab 4 in Gresham, Oregon. Based on the skill set match, we expect about 40 employees to accept a transfer to Oregon. These employees, we believe, will further enhance the startup team that we have in place in Fab 4. These employees are knowledgeable about our systems, processes, and methods and will be a great asset in Fab 4.

On the Fab 4 startup project, the results continue to be very good. The first fully processed Fab 4 wafer lot yielded 91 percent good die yield, which is a tribute to the excellent startup team as well as the quality of equipment and processes.

Qualification wafers are proceeding in the line on schedule, and we expect qualification to be completed in July. We expect production to begin in Fab 4 in October of this year.

Now, let me talk about June quarter expectations.

With the geopolitical situation improving, we have seen a renewed buying activity from our OEM customers. Our last quarter ended with a book-to-bill ratio of 1.01. And we need approximately 57 percent turns to make the midpoint of our guidance.

After several quarters of increasing turns requirement, we are finally seeing a decrease in turns requirement for the June quarter. This may be an indication that customer and distributor inventories have finally bottomed out. One indication of that was that distributor inventories hit 2.5 months at the end of March versus 2.7 months at the end of December. The all-time low of distributor inventory was 2.4 months. So we are very close to all-time low right now.

Taking all these observations into account, and after considerable checking and rechecking of expectations through all channels and geographies, we expect our net sales for the June quarter to be between $157 and $164 million, which is down approximately 2 percent to up approximately 3 percent compared to the March quarter.

Excluding the accelerated depreciation and expenses related to the Fab 1 closure, we expect pro forma and gross margins to be about 54 percent, and pro forma earnings per share to be between 15 to 16 cents.

With that, Lynette (ph), would you please poll for questions?

Thank you, Mr. Sangh.

The question-and-answer session will be conducted electronically. If you would like to ask a question, please do so by pressing the star key followed by the digit 1 on your touch-tone telephone. If you are joining us today on a speakerphone, please make sure your mute function is turned off, to allow your signal to reach our equipment.

We will proceed in the order that you signal us, and we'll take as many questions as time permits.

Once again, that's star 1 if you have a question.

We'll pause for just a moment to give everyone an opportunity to signal for a question.

And Mr. Sangh, we'll take our first question from Chris Caso (ph). And he is with Sound View Technology Group.

Hi, good afternoon. I just wonder if you could just elaborate more on the comments on some of the resumed buying by your customers and the lower turns requirement. I guess what -- what is it that your customers are seeing that's causing the change? Is this -- you know, just better confidence in the end markets there?

The turns requirement last quarter was about 61 percent or so, and this quarter it is about 57 percent. So after many, many sequential quarters of, you know, increasing turns requirement, which would be lower and lower visibility, we have seen a turn-around of that. That's certainly a good point.

On the OEM customer side, basically as we have mentioned before, the -- the OEM customer turns and buying activity basically, you know, went deeply down, you know, at -- in the middle of March. I mean, it's really -- there was a very significant impact. As you recall, we had an update on March 18. So really in the last 12 days, and maybe a week preceding that, there was a significant slowdown of OEM customer buying activity. Driven by the -- you know, the macro disruptions around the world.

And we have really seen, in the -- in the days of April and the first three weeks of April, we have really seen a reversal of that, you know, few sample customers seem to have returned to their old run rate they had prior to the macro disruptions.

Now, they did not return to the old rate on April 1. They returned over the last several weeks. So there were about three weeks of weaker March and there were about two to three weeks of weaker April. So when you look at it quarter-over-quarter, you know, it reflects in our guidance being flattish, but it's a good sign for things to come where we have seen a resumption of activity, which again points out to really it was not any kind of market share loss. It was, you know, pointed problems at OEM customers who happened to have excess inventories of their own products of whatever macro disruption issues decided not to purchase the product and hang on for a while.

Also, you know, curiously, there was a comment today from LSI Logic's report by Will Corrigan, their CEO, who said excess retail inventory in consumer electronics led to greater than anticipated seasonality in our consumer business. So, you know, there's -- there's plenty of sign of that. We've also seen weakened announcements earlier this quarter from Target, Wal-Mart, Best Buy, Circuit City, all the major electronics retailers, so I think there's plenty of confirmation that what we said in our April 7th conference call clearly was significant slowdown of the OEM activity, especially in the consumer segment in late March, and that seems to be now reversing.

Right. I'm sorry, just to follow up, though, on the turns commentary, then, with the decrease in percentage of turns, actually what you're talking about is a decrease in the dollar amount of turns for the June quarter, versus the March quarter, right?

That's right. The requirements to make the June quarter to the midpoint of our guidance, we need less turns than we needed for the March quarter, yes.

But I guess so is that indicating, you know, just -- like again, a slower -- a slower environment? Or is it indicating more willingness on the parts of OEMs to place bookings on backlog?

No, I think it's a result of larger book-to-bill ratio the quarter before. The terms never change what the customer is going to use in that quarter. Turns simply is a mathematical calculation of what backlog they placed on you before and what they may buy in the quarter. Higher turns does not mean more demand. Higher turns sometimes simply means whatever the customer needed, he bought. He placed less orders last quarter and therefore he needs the balance now. So the lower turns -- you know, the lower turns simply means we started the quarter with a stronger backlog than we started the January quarter. .

Okay. That's fair. Just one last question. On the European commentary as well, it seems like that increased as a percentage of total revenues. Could you just comment on what you saw in Europe during the quarter?

You know, Europe is -- I think as we said in one of our earlier releases, is more distribution-centric than the other two geographies. We saw -- this is typically -- the March quarter is typically a very strong period for our European business. It tends to have very little dislocation from all of these and other events. So this is relatively typical of what we term the Euro curve in terms of looking at the overall business, but, you know, both distribution and OEM -- OEM business was strong in the period.

Okay, guys. Thanks very much.

Before we move to our next question, I would like to -- everyone to note that due to the interest of time, we do ask that you limit yourself to one question.

At this time, we'll move to Chris Danely (ph) with J. P. Morgan.

Thanks, guys. Yes, just to follow-up on Chris' question, Steve Sanghi, when your customers start talking to you about, okay, we're -- you know, we feel a little bit better about our business, et cetera, I was just wondering, you know, what reasons they're giving you for feeling better about their business? And then in terms of the June quarter, could you just give us a little color on which products you expect to do better or which geographies you expect to do better?

Well, in response to your first question, customers don't tell you why they're not placing orders and they don't tell you why they're placing orders. They give you an order or they don't give you an order. It's as simple as that. And I think as we have said before, the issues in our business really resulted from, you know, macro disruptions. And when that happens, customers simply pulls back and goes into an indecisive mode and uses up the rest of the inventory he may have on our products, and in some cases, his own end product inventory. You know, having that depleted, I mean he can only go for so long, you know. If their business, you know, requires buying parts, then they're buying parts. It's really simple as that.

The end effect of all that is a significant inventory correction. The cause of that could be whatever macroeconomic factors scared him off. We see that moderating. Like I said, you know, a few customers hand-check data. Their weekly run rate seems to have returned back to the old rate.

And I didn't quite get the second part of your question.

Second question, Chris, was geographically what we expect and by product what do we expect?

Yes. If you could just -- you know, just give us a little color on which geographies and products you expect to be, you know, up, down, flat in the quarter. In June.

Minus two to plus three, there is just not a lot of room to divide that in six different ways. As we have done the channel checks and OEMs and distribution in U.S., Europe and Asia, they're all in that range, minus a little to plus a little.

That's fair. So you don't expect any particular strength and weakness in any product or geography?

Expecting recovery both in U.S. and Asia where two channels where our business was fairly weak last quarter.

Sure. And then product?

Product, you know, it's like, again, such a small guidance. It is such a small difference. I believe the strongest growth internally, forecast seems to be coming out of the analog group, where they're expecting, you know, good -- good sequential growth, but it's also the smallest portion of our business. Only 7 percent of our business. The microcontrollers hopefully have some growth and memory could be just a balance difference.

I think micros will be in the range of our -- the range of our guidance.

Okay, thanks, guys.

And Michael Burst (ph) from Morgan Keegan has the next question.

Hi, guys, good afternoon. Just a quick question. I think we've kind of hit the linearity pretty heavily. I want to flip to talking about Fab 4 for a second. You had indicated that processes are working. If demand did return a little bit more aggressively, how fast could you ramp production there, and could that happen before October?

The Fab 4 will be qualified in July, so therefore if needed to be, the Fab 4 can be brought up significantly earlier than October in production. However, there is no current intention, because by the end of June, we'll have 141 days of inventory, and any kind of upside in the June or September quarter can very easily be satisfied out of the 141 days of inventory. Right now we're seeing inventory will come down to 110 days by the end of March next year. If the demand comes back very strong, then inventory will simply come down faster. As far as Fab 4 is concerned, we can still start it in October, but ramp it harder and faster. Right now, we're planning to start Fab 4 at a very, very moderate level of wafer starts. Which can be substantially increased without a whole lot of effort.

Okay, great, guys. I'll hold myself to the one question. Thanks.

Thank you.

Moving on to Torrice Van Burg (ph) with U.S. Bankcorp Piper Jaffrey.

Yes, good afternoon. First of all, you mentioned you may see some stronger growth from your analog business in the June quarter. Is this coming from any particular area or is it both from Powersmart and TelCom?

The power smart is not countered in our analog business. Powersmart is a microcontroller-based product. So it's really coming out of analog business.

Last quarter, we took a very significant hit in the cell phone portion of our business. A lot of that was in Korea, and a lots of them was in CDMA and that portion of the business we are going to have. The core microcontroller non-cell phone business did okay. And we're expecting significant strength in the rest of the analog business this quarter. Analog has the strongest backlog going into the current quarter.

Very good, and can you also give us an update on your digital single controllers? I know it's been sampling. How are things moving along there, and when do you expect more meaningful production?

The product has been in the sampling mode. It goes to production this calendar fourth quarter. The sampling activity is pretty heavy. We have a large number of data site customers already committed. You know, the feedback is very, very good. There is a, you know, very large interest in the product, and the product would be officially start shipping in the fourth quarter.

Great, thank you.

Joel Osha (ph) from Merrill Lynch. Your line is open. Please go ahead.

Okay, thank you. Gordon Parnell or Steve Sanghi, either one, looking at your margin comment of 54 percent, that was kind of where people had been before. You do have some additional savings here. Is there something counterbalancing that, such that we're still at 54 percent? And secondly, just to clarify, when you say pro forma, Steve Sanghi, that does include still the costs from -- from Gresham, right?

Yes, we have not taken out those costs. When I say pro forma for the June quarter, it only excludes the accelerated depreciation and expenses related to fab 1 clover 1 closure and that's 54 percent. If you also take out Gresham's startup expenses, then actual margin is about 57 or so.

Yes. That was the 57.1, Joel that, we indicated for --

-- for the March quarter.

Okay. Just to check.

And then in terms of why, given this additional cost reduction, we're not seeing the margin move up?

Well, the cost reductions are in response to closing the production in the fab, so that the production is moving out commensurate with the cost reduction, so you don't have net-net an improvement from that overall process. Even though those processes are being transferred to fab 2, fab 2 is still being run at approximately the same kind of levels that it has been in the past.

It's simply the fab 4 -- I'm sorry, the fab 2 2 current wafer start capacity would be spread over more products and more processes, and each product and process getting a smaller share, that's what allows the inventory to come down.

So you're telling me that that rationalization is -- you know, you're not -- there wasn't enough running in fab 1 to give you material higher idlization rates or create any material economies of scale.

Well, when you take down a fab, it's very difficult to take out a hundred percent of the costs, so that whole process of combining the fabs, does have some stress that -- in the overall cost, but it does lead to a very high efficient fab 2 at the end of -- at the end of that combination.

Okay.

Fab 2 running at 90 percent utilization. See, anytime you have two fabs on the same site, you have a lot of common expenses, you know. You know, the management, some facilities, safety, security, you know, the probe area. You know, there are a lot of common expenses. And if you shut down one fab, those costs do not go away. Secondly, the things like, you know, it's an integrated campus, so the taxes and insurance and a lot of these costs do not come out one for one.

Okay. That's -- that's good. And then I'm sorry, one quick final question. If you're bringing on production in Gresham in October, does that mean that four-and-a-half million, or whatever it is in costs, related to Gresham becomes productized as opposed to period cost in the December quarter?

It does not get all productized that quarter. We start with a fairly small amount of production, and depending on the demand in October, November, December, and the subsequent year, as fab 4 ramps, yes, it eventually all gets productized (inaudible) 2, 3 quarters.

Right. And that's the indication. Obviously, with product margins as we said in March being at 57 percent, 57.1 percent, that's the indication of where margins can go to when all of those period costs are being absorbed into inventory, as you said.

But that's two or three quarters beginning December?

Correct.

Thank you very much.

That all depends on demand and --

Depends on demand, how fast we ramp --

Right. Thanks very much, guys.

Before we move to our next question, I would like to remind everyone that it is star 1 if you have a question or a comment.

We'll move next to Chris Avery with Deutsche Banc.

Hi. Just a follow-up on that. In regard to the cost reductions with the closing of fab 1 -- and I realize that utilization levels of fab 2 will be the same but you are getting the benefit from the write-off and the depreciation, is that correct?

Right. But that was all being absorbed into inventory for the production of fab 1. So essentially if you -- if you look at the situation in -- in the March quarter, we built inventory to the tune of about $8 million, which is reflective of, let's say, the activities in -- in the fab 1 scenario. We're now going to run that production and we're going to take out costs commensurate with that reduction in production costs, so there is, net-net, no impact or favorable impact.

There's cash savings but not P&L savings. Think of this way: With fab 1 running, our capacity was too high. If sales were flat and the capacity was flat, hypothetically, then you would have built $34 million worth of inventory in the year. By shutting down fab 1, we saved that $34 million in cost and not built $34 million of inventory, so you get significant more cash generation but you do not get P&L savings.

Okay.

Because the value of inventory on the balance sheet, you know, was absorbing those costs and those costs go away and the inventory goes away. It's a wash.

Chris, you don't sound convinced.

No, no. That's fine. I understand that now. Okay. I have one follow-up question. At some point, will you provide the percent of total revenue by product segment for the first three quarters of fiscal '03?

Yes, I can provide that off-line, or we can put that on our website to make that available. Sure.

Great. Thank you very much.

We will move to Jeff Rosenberg with William Blair & Company.

Hi. I wanted to explore a little more trying to understand the sharp fall-off on the North American OEM side. When you look at auto, for example, can you say whether there was a material difference in your U.S. trends versus your European trends, and relative to the flat you saw in total?

Well, you know, (inaudible) although everybody expected the auto to fall off last quarter, our automotive business was flat last quarter, and we kept seeing that all quarter that, you know, automotive production (inaudible) do not always correlate to our numbers but I don't think we got many people convinced on that. When the dust all settled, our automotive business last quarter was flat. And we did see some, you know, reductions related to the same kind of macro factors, and if those reductions had not Hammond in the late March, which really resulted in the inventory consolidation, the automotive business actually could have been up last quarter. But despite, you know, some macroeconomic disruptions, the automotive business was flat. What got pounded was our consumer business. The OEM consumer business was very, very weak. That's where we saw the blunt -- brunt of the fall, and we'd earlier mentioned I think our OEM business was down in excess of 20 percent last quarter sequentially, and a lot of that came out of the consumer segment.

And -- and I guess but -- well I guess could you give a little more color in North America? Is it a lot of white goods or, you know, how diversified is the OEM customer base on the consumer side, or maybe a little bit of -- because it just seems like such a dramatic fall-off, if there's any additional color on the sorts of customers a lot of different things kind of fall under the grab bag of consumer. Any additional color as to where that sort of weakness was?

Well, it's really quite broad-based. One thing we like investors to understand is that micro controller business is a little more consumer-centric than many of the other things you may invest in. You know -- you know, any of the semiconductor companies, micro controller tends to be -- has more exposure to consumer than just about any other product line you may invest in. And if you look at the largest micro control ever suppliers, now, we do not know their micro controller numbers because the large integrator companies but Motorola semi-was down 7.7 percent, S it. Micro was down 10 percent, Philips was down 16 percent, you know, Microchip's microcontroller business was down sequentially 3-and-a-half percent. So I think once the numbers come out and one can get clarity on this, I believe the micro controller business last quarter got hit, driven by high exposure to consumer, which is now being verified by many of the channels. I earlier mentioned label logic, I mentioned a number of retail consumer chains who were really seeing the same thing. It wasn't really in one simple segment. Consumers pulled back, because of the macroeconomic issues and macro disruption issues and other -- the buying did not take place and in response to that, the customers broad-based in the consumer segment went into a -- you know, a significant inventory correction mode. Because of the fall-off in demand in their own businesses. And a lot of that we're now seeing it come back this quarter, but not starting April 1. Therefore, it does not completely come back this quarter.

All right. And just one follow-up on the auto, just in case we get news during the course of the quarter, and I think forecasts usually hold pretty steady. I mean what -- what does your outlook look like in this quarter sequentially for auto? Is it consistent with your overall guidance?

Well, if you look at, you know, auto, some of the public data available on it, I believe GM has announced production cuts of about 2.8 percent, Ford has announced production cuts of a little over 5 percent, and, you know, there are no such announcements out of Europe or Asia or anyone else. In our business, really spread everywhere, once you try and (inaudible) it all together, we believe our automotive portion of our business could be down in low single digits. And for all we know, that could be made up by lots and lots of new models going to production this quarter, which is historically sort of what we have seen. The automotive business has always done better than really what we hear from the street what it should do and it did that last quarter also, but internally, we're modeling that automotive business to be down fairly low single digits, and it's really made up by the resurgence of, you know, the fall-off of the consumer and other products.

Great. Thank you.

You're welcome.

Moving on to Gill Alexander with (inaudible) associates.

Hi. Wonderful cost control. Could you give us a little color as to where you hope you end up on gross margins next year and two years out?

The only long-term guidance that we've given to the street, Gill, is that we believe that once Gresham gets into OEM production and we are fully capturing their current period costs into -- into our product costs that, we can see margins get to 58 percent.

I thank you very much.

You're welcome.

Summit Dhanda from Bank of America has our next question.

Hi. Actually, this is Bryan Bartholomew pinch hitting for summit. First, I have a quick follow-up on the inventory questions from earlier in the call. Inspect is it any -- is it possible to quantify, of the inventory build during the quarter, the sequential inventory build, how much of it related to lower than expected sales volumes versus like a conscious attempt to build inventory ahead of the fab consolidation?

It was -- it was really all driven by missing the sales. The -- there was no inventory build because of fab consolidation. That did not begin until we actually announced the actions on April 7th. There was -- the consolidation decision was really not made, you know, till like, you know, hours or a day before, really, it was announced to the street.

We could not execute it -- that kind of action in a fab without large number of employees knowing about it, ordering 8-inch mask sets for 6-inch products, ordering, you know, raw wafers for a different fab, in which those products do not run. It would be just running major a foul of reg FD or anything else, so we made that decision through analysis, first announced it to the street, then proceeded to execute.

Okay. Great. And then finally, last month you expressed some concerns about cell phone inventory in Korea. Any update there? Any change in your outlook there?

We are not modeling any kind of recovery of analog cell phone business. Analog cell phone business was, you know, down to like 1-and-a-half million dollars a quarter on analog products last quarter, and it's small enough that minor changes don't make a difference. It's an undesirable portion of the business. It's the lowest margin. The rest of the analog business is much, much better, very high-margin business. We are not counting on any recovery, anything that happens would be gravy.

Excellent. Thank you very much.

We'll now move to Tom Smith with Standard & Poor's.

Yes. Hi. I'm -- I think you just hit it. I was going to ask about Korea and whether there was anything that might make you think that the anomalous drop in that region in the March recover would quarter would recover.

Well, some of the, you know, reports that we're reading out of newspaper, not necessarily out of our customers, is, you know, there is, you know, significant concerns by -- because of continued -- you know, the macro and other issues in that -- in that geography, and I don't really know what will happen to the cell phone demand, so we're really not a proxy for the cell phone demand. It's a very small portion of our business, so, you know, whatever happens.

Okay.

Our guidance isn't extremely sensitive to that anymore, being such a small portion of our business.

Okay. Thanks. If I could add one more thing about Asia, or on the -- one of the earlier calls, you were colorful in your description on SARS' effect on dampening business travel. Is that still your view that that's really slowing traffic for buyers and sellers out of Hong Kong and similar places.

I think you don't have to ask me that. Just read any of the website. United cancelled their flights to San Francisco today -- San Francisco to Hong Kong today. And there are travel advisories all over the, you know, place. Just go on any of the websites and you can really find the effect it's having on travel. From Hilton to -- Hilton hotel to airlines to everybody, announcing weakening results because of travel disruptions, so the travel industry is pretty much decimated.

Okay. I might just note to the contrary that Intel and Texas Instruments and some other biggies seem to at least not acknowledge much effect on their business, but maybe that's just backward looking towards March.

Well, I think as Steve Sanghi says, if you -- if you look at press coverage and you look at TV coverage today, it seems that the situation is certainly a difficult one. I think what we try to say in our last press release and our conference call was not that we were associating any issues specifically with SARS, but just that it presented some difficulties in the Asia region and certainly those difficulties are still with us today.

Okay. Thank you very much.

Many of those guys were down, you know, more than we were, and, you know, just -- you know, seems like you don't want to hear that as a reason, but, you know, S it. Was down more than us. Intel was down more than us. Motorola was down more than us. Philips was down more than us. So I don't really know how you want to think of the package. You know, we tell you the truth but you don't like it. Next question, please.

Yes. We will take that from Ben Lynch and he is with Deutsche Banc.

Yes. Hi. Can you hear me? I'm in an airport. I think just on your last point, I think the issue is more that you may have not been down as much as some of your peers, but you change your target a lot during the quarter, whereas other guys have gone -- went into the quarter with lower expectations but that wasn't my question anyway. My question was more -- and maybe it's a difficult one. Before your first profit warning, what would have been your best bet on June revenues versus the level you're sort of expecting now? Hello?

Ben, it's --

Hello?

It's very difficult with all the background noise that you have.

I'll try again. Just Steve Sanghi on your last remark there, I think why people were disappointed in your quarter was not the extent to which you were down but the extent to which your guidance changed, whereas other people they may have been down more but they sort of guided to that, but just a remark I would make. The question I have is if you could give your best shot, you know, before your first profit warning, what would your revenue expectation have been for the June quarter versus what it is now? And further related to that, I'm wondering, given that you're effectively saying there was a short-term (inaudible) in your business and everything sort of seems to be recovering, you made two quite big decisions around this dip, you know, to close fab 1 and delay fab 4, and, you know, I'm just wondering why you made those big decisions and do you still feel they were justified.

Ben, you came out quite broken. We understand most of what you asked, so if you can call us later on, you know, when you're in a place, we'll be happy to really answer and satisfy your question.

Okay. Sorry about that. Sorry.

But I could -- you know, answer it in general, I think let the others listen to the answer maybe. I'm not sure what the exact question was, but I think it was around the actions that we took on fab, and if I tried to explain that, our fab capacity in revenue terms was about $175 million last quarter. And we actually achieved about 160, and we're not guiding to reaching 175, you know, short-term like this quarter. The -- the actions that we have taken allows Microchip's inventory to return to -- a lot more back to normal with the closure of fab 1, you take the capacity in the fab, lower than a revenue for a quarter or two, which allows the inventory to return to normal, and allows fab 4 to begin with guarantee which is what we need really bad because that's where we can do all the advanced technology. If there's any resurgence of demand, strong demand, upside, it's likely to come on products which are an advanced technology which can only be done in fab 4. Fab 1 would not have helped that process because it runs older products and older technology. Therefore, it's the right decision to cut out the fab 1, close that down, and consolidate those processes and products into fab 2 and look forward by starting fab 4, which will really enhance Microchip's gross margin from 54 percent level we are to 57, 58 percent in future. Fab 1 would not allow us to do that, further slipping fab 4 will create further problems for not having advanced technology.

And Ben, if we haven't answered your question, please call me separately and we'll be happy to discuss it.

We will move on to our next question, and that will come from Brandy Brandon with Eaton Vance.

Thank you. I'd just like to second that, if you'd put the revised revenue breakdown on the website, I'm sure there's more than one person that's interested in that.

That is the revenue by division?

Yes, please.

We can do that.

Thanks, Gordon Parnell.

Mr. Brandon, were you done?

Yes. Thank you.

We'll move to Jason Sam.

Just a quick question. In your guidance -- and I apologize if it's been asked already, but in your guidance of -- revenue guidance of 157 to 164 million, it's a pretty big range and given the fact that, you know, the effect of SARS has been known and has been mitigated and seems like your customers returning in -- you know, to their normal order patterns, what -- what's your -- what are you hedging? I mean, what's going to -- what's going to happen in the quarter that's going to either determine 157 or 164?

We have given our guidance. You can -- you may make your own assumptions if you don't like that.

Minus two to plus 3 is a 5 percent range. Intel guidance is plus/minus 5 percent. Many other companies are broader than that. We do not feel like pigeonholing our self with a very, very narrow guidance with major macro factors still facing us. So if you think that effect has fully been mitigated, then -- then that's your belief.

Remember, although terms in percentage reduced, we still have 57 percent turns to take, and it's still a very low visibility environment. Nothing has really changed from that perspective at all, so those -- those are some of the factors that we certainly take into account.

Okay. Thank you.

We'll move to another follow-up, and that will come from Chris Danely with J. P. Morgan.

Hey, guys. Actually hopefully this is a little more cut-and-dried. It's on the balance sheet. I know you guys changed your revenue recognition policy and deferred income on shipments to (inaudible) went up by, I don't know, I think 30 million bucks. Is that the reason why deferred income to (inaudible) went up, because I think you guys said inventory in the channel went down. I'm just trying to reconcile that.

No. That's the effect of changing the revenue recognition in Asia.

Yes. So all that 30 million is due to the revenue recognition change then? that's what I'm asking. Is it all due to that?

It's all due to that.

Okay. Thanks.

And we will move to our next question, and that will come from Andrew Root with Goldman Sachs.

Hi. Just a question on the inventories. The combination of the dice tee inventory that you're expecting at the end of June plus your own inventory, would that be -- where is that in the context of history. Is that at a peak or is that sort of near a peak or midpoint of the range? Just contextuallyize that for us a little bit.

Think they're both at opposite ends of the spectrum here. As Steve Sanghi said, dice tee inventory is about 2.5 months, which is very much at the low end of the range and we expect inventory days on our balance sheet to be about 141 days, which is towards the high end of the range on our balance sheet. So --

Well, the two different quarters, though. Last quarter was 128.

Right. But I thought you were saying for the June quarter, Andrew?

Yes. June quarter expectation would be 141 plus 2-and-a-half.

Yes. I don't expect distribution inventories to change substantially in the current environment.

Okay. And then what would be -- what would have been the peak for dice tee inventories? You're using what you know as your product in the dice tee channel or are you using the -- what's reported by the distributors in terms of their own COGS.

Well, it was about -- you know, the distribution inventory was about 3-and-a-half months.

And we're using information that they report to us about inventory that they're holding. They do that every month.

Of your product.

Of our product.

Yes. Okay. That makes sense. And then the second question relates to the progression of your tax rate here. It's still benefitting from some -- benefitting from some subsidies from various regions. Can you just sort of remind us how that progresses over time and if it ticks up at all in the fiscal '04 year.

No, it doesn't change in the fiscal '04 year. It benefits from tax holidays that we have in Thailand over 7 years for each of the investment processes and they are layered over -- process over a period of time. So we are looking at 25-and-a-half percent for the '04 period at this point.

Okay. Thank you.

And Mr. Steve Sanghi and Mr. Gordon Parnell , it happens we have no further questions in our queue. I'll turn the conference back over to you.

Thanks, Lynette. I appreciate everybody's time and attention this morning. Steve Sanghi and I will be available for any follow-on questions at our Chandler facility. Thank you very much.

And that does conclude today's teleconference. On behalf of Microchip, we do thank you all for your participation.