微晶片科技 (MCHP) 2004 Q2 法說會逐字稿

Good day, everyone, and welcome to the Microchip Technology quarter 2 fiscal year 2004 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. Gordon Parnell.

Please go ahead, sir.

Thank you.

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 10K for the fiscal year ended March 31, 2003 and our 8K and 10Q current reports that have been filed with the FCC that identify 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 second quarter fiscal 2004 performance, giving information by geography and product segment and Steve will then give his comments on the September quarter, discuss product line performance, outline our guidance for the December quarter, and update our Fab capacity.

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

Net sales for the September quarter were $168.5 million, up approximately 4.5% sequentially from sales of $161.3 million in the June quarter and up 1% from sales of $166.8 million in the prior year second quarter.

Geographically, Asia and America both grew sequentially by approximately 9.5% and 6.3% respectively, while Europe declined sequentially by 4.4%.

The total revenue rate then for the quarter resulted in sales for Asia, representing approximately 41%.

America's at 32%, and Europe at 27%.

Net sales for microcontroller products represented approximately 80% of revenue in the quarter.

Analog products represented approximately 7% of revenue and memory products represented approximately 13% of revenues.

Net income for the September quarter was $36.1 million or 17 cents per diluted share, an increase of 7.8% from pro forma net income of $33.5 million or 16 cents per share in the immediately-preceding quarter and an increase of 5% from pro forma net income of $34.4 million or 16 cents per diluted share from the prior year second quarter.

On a gap gap basis, net income for the September quarter was $36.1 million.

This was up 168% from the prior quarter and up 280% from the second quarter of the previous fiscal year.

Gross margin for the September quarter was 54.13% and factory utilization levels were at 90% for the quarter.

The tax rate for the September quarter was 25.5%, in line with our guidance, and we expect that actually to stay at this level for the next several quarters.

Start up costs for our Gresham facility were approximately $4.5 million in the September quarter, modestly lower than expenses in the prior quarter of $4.7 million.

Excluding these costs, our product gross margins for the quarter were 56.8%.

Operating costs were 25.9% of sales in the September quarter, compared to pro forma operating expenses of 26.9% in the previous quarter.

Research and development costs were $21.1 million, representing 12.6% of sales.

Sales on general and administrative expenses were $22.5 million, representing 13.3% of sales.

Microchip's total inventory position at September 30th was approximately $103.8 million, a decrease of approximately $4.5 million from the prior quarter levels.

Inventory returns are at 3.0 with days of inventory representing 123 days, and this is down from days of inventory at the end of June of 134 days.

We expect to be at approximately 110 days by the end of December, which will be one quarter earlier than our previous guidance.

At September 30th, Microchip's receivable days were 47 days, compared to similar days of 48 at the end of the June quarter and 46 days a year ago.

Our overall receivable balance increased by approximately $2.6 million sequentially, while the revenues grew 4.5%, as I indicated earlier.

As of September 30th, Microchip's cash and short-term investment position was $350.9 million with no debt on the balance sheet.

During the quarter, Microchip generated free cash flow from the business after capital costs, working capital costs, dividend payments and treasury activities resulting in adding $78 million in treasury.

Our capital spending was approximately $10 million for the quarter and our anticipated capital spending for fiscal 2004 is approximately $50 million.

Depreciation expense for the September quarter was $26 million, versus $28 million for the same quarter last fiscal year and $27 million in the June quarter.

Microchip shipped 10,602 new application development systems to our customers during the quarter, bringing the cumulative total to over 284,000 systems.

With that, I'll now ask Steve to discuss the performance of our business, both last quarter and our current conditions, our guidance for December, and the Fab 4 ramp schedule.

Thank you, Gordon, and good afternoon everyone.

Today I would like to cover four subjects: First, I would like to reflect on the results of the September quarter;

Second, I would like to comment on the product lines;

Third, I would llike to discuss the guidance for the December quarter;

And finally, I should talk about the Fab 4 startup and ramp.

So let's begin.

I am proud of our solid execution during the quarter.

Our sales and earnings per share were both at the high end of our projections.

Gross margin was a solid 54.13% and operating profit was 28.25%, which puts us amongst some of the best companies in the semiconductor industry.

Our business model is especially noteworthy, considering that a number of our competitors are still losing money.

We also generated a record $78 million free cash flow in the quarter.

Now I shall talk about the product lines.

Microcontrollers.

Microcontroller business grew 3% sequentially.

It started out slow in July because of remaining high inventory in Asia from the earlier quarters.

Once inventory was flushed out, business strengthened into August and was very strong in September.

We are seeing strong demand and expect to see healthier growth in this quarter and beyond.

During the quarter, we also compared our microcontroller revenue to the total microcontroller shipment reported by the semiconductor industry association.

The data clearly indicates that Microchip has continued to gain market shares.

Digital Signal Controller product, which is our entry in the 16-bit microcontroller and low end of DSP space is now fully functional and undergoing qualifications.

Preliminary production shipments should begin by the end of this quarter.

Analog products--analog business was up 6% sequentially, the growth was driven by new customers as well as existing customers.

Last quarter our stand-alone analog customer base grew by 264 new customers.

The number of customers grew to 8,336.

It is clearly an evidence of our attack strategy working, gross margin percentage in the analog business is approximately 60%, well above the corporate average and approaching that of the high-end analog companies.

We are seeing strong demand on analog products and expect continued strong sequential growth in this quarter and beyond.

CD lease core products, the biggest change in the business that we have seen is on the CD lease core products.

This business was up 12% sequentially, reflecting strong market conditions.

We have seen lead times from third-end competitors stretch out to as much as 12 to 18 weeks and their prices move up.

While Microchip is in a good inventory position, we are using this environment to selectively move prices up from the low ASP's of the last three years.

Lead times on certain select products from Microchip have also stretched out to a 6 to 8 weeks because of very high demand on select products and packaged types, depleting our inventory position.

We have adjusted weight for the package mix and we expect to be able to take advantage of the strong demand this quarter.

Now, let me discuss our guidance for the December quarter.

The September quarter book to bill ratio was 1.04.

The first number above parity after several quarters indicating the expansionary business environment, however, the December quarter is seasonally a weaker quarter for Microchip because of the large number of holidays in the quarter.

At the same time, Europe, which is seasonally down in the summer quarter, which is of September, Europe is expected to be sequentially up in the December quarter.

The America's and Asia are also expected to remain sequentially up in the December quarter.

Putting this all into account, and after considerable checking and re-checking of expectations to all of our channels and geographies, we expect that our net sales for the December quarter to be up to be between $177 million and $179 million or up 5% to 6% sequentially.

We expect distributors to start rebuilding inventories from low levels, but since we recognize distribution sales only at sell-through worldwide, the rebuilding of distribution inventory will not add to our sales in the current quarter.

So, my guidance of 5% to 6% sequential growth does not include any inventory rebuildup of distributors.

Gross margins are expected to move up sequentially to about 54 1/2%.

Inventory's expected to come down from 123 days to about 110 days.

We expect to generate approximately $65 million to $70 million in free cash, and earnings per share is expected to be between 18 to 19 cents.

Microchip will not be providing a scheduled mid-quarter update.

Mid-quarter updates do not seem to provide any significance benefit.

It increases volatility and encourages short-term trading with a relatively tight range of guidance of 5% to 6% sequential increase, Microchip will not be providing a scheduled mid-quarter update.

We're attending several conferences during the quarter, which provide excellent forums to update the street in a fair disclosure compliant environment , we'll use those opportunities as appropriate.

And finally, let me update you on Fab 4 production startup.

Fab 4 was officially qualified for production during the last quarter.

All the necessary production personnel have been hired and trained.

All the material and processes are in place.

Fab 4 starts production on schedule on October 31st.

Since our inventory is expected to come within our targeted level by the end of this quarter, a full quarter ahead of expectations, we are planning to ramp Fab 4 faster than earlier expected.

We expect this to have a positive impact on our gross margins, which we will model and present at one of the up-coming financial conferences, which would be webcast for RFD compliance.

With that, we'll poll for questions.

Yes, sir.

Thank you.

The question and answer session will be conducted electronically.

If you would like to ask a question today, please do so by pressing the star key, followed by the digit 1 on your touch-tone telephone.

If you are using a speaker phone, please make sure that your mute function is turned off to allow your signal to reach our equipment.

Please do try to limit yourself to one question and if you do have a follow-up question, please re-press star 1 on your touch- tone telephone.

We'll pause for a just moment to assemble our roster.

We will take the first question from Ron Berg of U.S.

Bancorp PJ

Good afternoon.

This is actually Jeremy Kwan calling.

Gordon you mentioned that analog was up 6% sequentially.

Can you talk about any areas of particular strength in terms of end markets?

No, I mean, as you probably heard us say in the past, any areas of particular vertical market strength are difficult for us to quantify.

The analog business has become more similar to our microcontroller business in the diversity of the vertical markets that it serves.

It's increasing the customer bases, Steve indicated, also makes that a more difficult proposition for us, particularly with a good portion of that business going through distribution.

So I really don't have any particular highlight in terms of segments there that I think we could share.

Okay.

I guess -- could you talk about maybe some of the new products you introduced recently?

And maybe what new areas that you're specifiically targeting in the analog business.

The analog business is divided into five portions: power management, sensors, mixed signal, (INAUDIBLE) and interface products.

Our focus in new product development continues to be on those products which are in the signal chain of microcontrollers.

So typical microcontroller application begins with some sort of sense of temperature, pressure, motion, sensor, and then you have to filter it, amplify it, convert to digital, go into the the microcontroller, devise some sort of voltage regulation or control.

On the output side you have either power amplifiers or a digital to analog converter or drive something and then you have some voltage references and things like that.

So, our priority continues to be such products which will fall in the signal chain of the microcontrollers for our customers' application, which we will be able to attach, and that strategy continues to be working quite well.

We don't really break this out in the more traditional session of what you may be used to, where other companies could be going wherever.

Our focus continues to be heavily into the embedded control market where we're designing our analog products.

great, one last question.

You did a very nice job controlling inventories this quarter and utilization is at 90% currently.

Can you talk about what do you expect that to go to for the December quarter?

The December quarter inventories should go down to 110 days.

How about in terms of the utilization?

Utilization will stay at those same levels for our Tempe facility, approximately 90%, 91%.

We will be bringing the Gresham facility on-line at the end of October and it will start with a modest production load in the December quarter.

Great, thank you very.

We will take our next question from Chris Danely of JP Morgan.

Hey guys,congratulations on a nice quarter, by the way.

On the margin increase, is that due to a increase in memory prices or is it due to the Fab 4 coming on a little bit more quickly and inventory getting burned down?

Can you just tell us that?

Look at our total gross margin for the company of 54.13%.

In reality, the product margins are higher than that, as we have mentioned before, but out of the product margins, we back out the Fab 4 startup operating expense.

Usually we provide a breakdown.

Do we have it today?

Yes, it's at 56.8% without the Fab 4 cost.

The Fab 4 cost was $4.5 million in the September quarter.

Okay, so $4.5 million Fab 4 startup cost of being absorbed.

So that's why the product margin of 56.8 goes down to 54.13 Goss margins.

As we start up production in Fab 4, you start to utilize increasing amount of those startup expenses over the next few quarters, and that's where the gross margin improvement comes from, predominantly.

The memory products are now about 12%, 13% of our business.

We are raising some prices from the bottom of the price spread.

There's a fair amount of back log going into the quarter and back log is not at very high prices, so the effect of the increasing prices is kinda' muted and takes place more slowly, lags a quarter or so.

The predominant increase in gross margin, we're expecting, is coming out of Fab 4 startup.

Okay, so most of the increase in Fab 4.

Then Steve, I think at your recent conferences, you've been saying you could get to 57% gross margin in about a year as Fab 4 comes up.

Now that it's ramping a little bit quicker than expected, can we expect to see that 57% be moved up to maybe 57.5% or 58% or get there a little bit quicker?

Well what I said in my commentary, basically we have given marching orders to Fab 4 to get up for higher end.

We had a meeting with them as early as this morning that we have approved their plan.

You know, all that is really being modeled.

We do see some positive impact, but all the ducks are not together to give the street any kind of guidance today on that, but the gross margin should be performing better as we accelerate Fab 4.

Okay that's fine, thanks, guys.

There is also a portion of the gross margin impact which will be coming out of ramping our back end facility in Thailand.

Essentially, as Microchip has had higher inventories in the last year, the predominant portion of the higher inventories have been kept at the dye level, rather than committing them to the package, which simply adds more cost.

As the business is improving, you know, as customers, distributors will re-build inventories, we're ramping the Thailand facility to put more of the dye into package and test at you know, a basically very, very low incremental cost.

So therefore, there will be a much larger absorption impact contributing to slightly higher gross margins out of the other facility also.

Does that last for very long as far as the increase there?

Well, it stays there.

It doesn't -- you know, if you fill it up and you run high volume and as long as you keep running that higher volume, the impact stays.

I'm sorry, I meant, how long does the boost last for?

It is it like a one quarter pop or a two-quarter pop?

We ship first in, first out, so the finished inventory has to get shipped first and then the new inventory going in is at lower cost, so you know, it kinda' lags at quarters sometime, but it will basically the impact would happen over the next two to three quarters.

And depending on what the demand environment is, as you look into 2005, we'll determine what the operating cost would be for that facility.

Just as it would be for our weaker Fabs here in the states.

Sure, okay, thanks a lot, guys.

Once again, if you would like to ask a question, please press star 1 on your touch-tone telephone now.

We will take the next question from Andrew Root of Goldman Sachs.

Thanks.

Quick question: Which products -- I know you signed a release when you tested to release great aggression, but what products are going to be ramping first at Fab 4 and what would follow after that?

Fab 4 starts up on like about six to eight products and some of those are (INAUDIBLE) and some of those are microcontrollers. analog is a fairly small business of Microchip and it would not really have any initial production there, but it starts in a good number of products because Microchip's business is so diversified broken over products.

The single product makes half the percent of our business, so we have to do it over several products to consume the capacity we're bringing up.

All right, okay.

And just a point of clarification.

The six to eight weeks of lead times that you mentioned, at the beginning of the comment you were talking about memory, but then I got the sense that was Microchip overall.

Your microcontroller business is six to eight weeks, is that right?

No in that case I miscommunicated.

It was continuing on the CD lease square -- I said select products within the CD lease square where the demand last quarter just came in quite high.

And depleted our entire finished goods stock, so the lead times on third and select products have gone on CD lease square from basically stock to six to eight weeks.

Okay.

And all that is needed is really moving some package mix around, really getting the inventory healthy and in some cases, some wait for start changes to build a model of that product.

The entire front doesn't never seem to rise all together.

It comes in strong in a few products, then builds up and builds up and builds up.

So the early products at this event came very strong got us out of mixed-end.

Those products were all sold resulting into a very high growth last quarter, 12% sequential growth, but then we had to make some quick changes to the package and wait for the mix to react.

Right.

Okay, that makes sense.

Can you make a brief comment on lead times overall for the company?

The lead times on most of our microcontroller products continue to be from start to three weeks, or most products are really in stock.

If you have a unique package, it could be four weeks, but the lead times on microcontrollers are fairly short and Microcontoller lead times of Microchip really never go long because that's a premier product line.

We give it preferential capacity.

We compete against a lot of the custom rom business where the lead times tend to be longer because they have to build it on order.

So part of our strategy is that the Microchip lead times on microcontrollers never go long.

They're the premier choice for design-in.

The analog is kinda' mixed.

Most analog lead times are short also.

But certain analog products also had strong demand, resulting into depletion of some inventory in some of the select analog products have gone a little bit longer, but not as much as memory yet, because there also margins are very high and the strategy there is to maintain short lead times, but analog is so fragmented with 400 products that it's a little more challenge.

Okay.

And Gordon, I apologize if I'm slow in the uptake on the margins, but it sounds like the ramp plan at Fab 4 basically from day 1, product gross margins at Gresham will be additive to corporate gross margins?

Well -- I mean, you've got to look at it in the sense that the expenses is approximately $5 million.

Right, but "X" that.

"X" that, this is a facility that is going to be extremely productive for us, and when it gets to about 30% of its capacity in terms of what we've purchased in the entire Gresham facility, it's waiver costs will be equal to the Tempe facility we have today, and so it's that progression towards that point.

Obviously it depends on the demand characteristics of the business as to how that occurs and as Steve said, we're not ready to make statements as to the timing of that yet.

Okay.

We really understand and realize this is going to be an extremely important addition to the company over the next four to six quarters and beyond as we continue to gain efficiencies in a waiver Fab costs.

Okay,that's helpful, thanks a lot.

Re-emphasize that point Gordon made, in case somebody didn't understand it -- that at 30% utilization, Fab 4 is as efficient and has the same waiver cost as essentially our Fab 2 at 92% utilization.

So from there on, as Fab 4 increases, its waiver cost is lower than actually the Fab 2 facility, and over the next two quarters, as we go from like zero towards the 30% utilization, it keeps eating into that $5 million startup expense, so it's basically accretive right from the beginning.

Because it's eating into that $5 million.

Operator, you may take the next question.

Our next question is from Brandy Brandon of (INAUDIBLE).

Just a couple things: How many of the development systems did you do last quarter?

I believe it was about 12,500 last quarter, if I recall.

And the period cost here -- the $5 million we're talking about -- this is primarily things like depreciation on the Fab?

No, it isn't.

There's very limited depreciation until it goes to production in October.

The costs are really in areas of people costs.

We have a team of people who are being qualifying our processes, bringing it to productive readiness.

There are costs with utilities.

There are costs of property taxes, there are the qualification materials that have been running through the facility in terms of chemicals, gases and waivers.

Those are the types of costs that make up the $5 million.

Could you explain exactly how the depreciation kind of ramps on that?

I mean, presumably the clock isn't ticking on it now until you put it into production, but then does it all kick in at once or does it phase in as you phase in production?

Let me just give you--remind you of a sort of breakdown of the entire facility.

We bought it for about $180 million approximately. $90 million in terms of the independent evaluation is on the land for the site, $80 million is for the facility for the infrastructure, etc., in the Fab, and the balance is for the equipment that is in the two waiver fabs located on the site.

Obviously there's no depreciation on land.

The $80 million for the building and the facilities support all comes on-line during the December quarter and the equipment comes on-line as we utilize that equipment and ramp the productive capability of the facility.

When we bring that on initially because we need one of everything, it tends to be a little higher than as we grow the depreciation base.

Obviously that helps because not everything is equally placed and from a capacity perspective, and hence, we start to see improving wafer costs as we ramp towards that 30% utilization factor we mentioned.

Thank you, Gordon.

We will take our next question from Michael Mesdea of CS First Boston.

Hi guys.J.D Desilva for Michael Mesdea.

Quick question on the analog attach rate, seems like a trend.

Can you talk about the quarter to quarter trend you're seeing there?

We do not have that number yet.

Usually the quarter on quarter doesn't tend to change for the last couple quarters.

It has been in the range of about 71% or so, and it doesn't really change very much quarter to quarter.

I think it will change over a longer term.

When we get the numbers it's going to be in the same range we would expect.

Okay, when you say you expect a long-term change, you mean to the up side.

Of course.

A lot of new products which are being designed in are all attached kind of products in the signal channel of microcontrollers.

Some of the older business which we inherited from TELCOM acquisition, some of that is not in the signal channel of microcontrollers, so as we go forward, the mix continues to richen and the quality of it continues to improve together with the microcontrollers, so that part should improve.

You know we should have that data next week and we'll be at the Prudential conference the following week, so certainly that would be an opportunity to share that information.

Okay, I'll look for that.

As a follow-up: What are you seeing on the competitive landscape?

How do you see that framed and how do you see yourselves positioned versus a company like Maximum and other companies?

You know, the analog is a very, very fragmented business.

You know, everybody has the niches and we compete with Maximum on certain products we compete with Linear on come other products, we compete with Micrel on certain other products, we compet with, you know, ADI on some other products.

So essentially we compete with everybody in the analog business, but there is nobody which competes with the entire broad front of our product line.

Even if you look at companies like ADI, Linear and Maxim.

You'll find a totally small overlap.

Everybody has their unique niches and that's the nature of the analog business.

We are competitively very well-positioned.

We believe we are gaining market share for a number of quarters.

Growth of our analog business has been almost the best growth in the industry, albeit at a smaller base, a much smaller base, but we have grown really better than anybody.

Great.

Last question: Any reaction to the Motorola announcement and specifically do you gain more access now to Motorola as a customer and does Motorola perhaps target some of your customers more?

Thanks.

Well, you know, there are two things in it.

Do we gain more access to Motorola?

The answer is totally yes because Motorola was fairly difficult when they have so much more on semiconductors.

Does Motorola gain more access to our customers?

It's never stopped them before, so there really should be no change in that area, but I would think it would be quite distracting for Motorola Semiconductor for a while, as they break it out and try to re-structure that business.

Plus, they won't have a few hundred million dollars worth of hard checks to write anymore, so any illusion of prosperity of independence should really disappear soon and they're gonna have to get down to some hard decisions what to do about some product lines and low-end business and restructuring and all of that, and I can't see how that is not all positive for us.

It won't change our strategy.

We'll continue to do what we are doing and we'll continue to keep getting market share from them.

We'll take our next question from Chris Castle, Soundview.

Yes.

Hi, good afternoon.

Wondered if you could talk about the terms requirement for the quarter and if that may be changing, given some of the comments about some of the customers stretching -- I guess pulling in orders and expediting things?

Our terms business was approximately 58% in the September quarter.

It was about 60% in the quarter prior to that.

And you know, we expect the terms to be hopefully in that same range at this stage for our direct business, Chris.

As Steve indicated, the majority of our business, our business model products, microcontrollers and analog, still have relatively short lead times.

And so some of the phenomena that we have seen in CD lease squared have yet to exhibit themselves on our customers and generally speaking, in the market at this point.

Okay.

And I wonder if you could talk a bit about the automotive business.

That's been an area where you know, production rates have been changing quite a bit this year.

If you listen to the automakers and they sounded fairly positive over the last two days.

I wonder if you can characterize how the business has gone for you in Q3 and Q4?

We do not have any end market breakdown at this point in time.

All the effort has gone into preparing the rest of the data and this release.

So as Gordon mentioned earlier, we don't have any end market breakdown.

As for the automotive production costs and production increase and all that is concerned, that's almost a weekly and monthly volatility that really jerks things one way or the other and impact on us is always much more muted.

We have really not seen that kind of volatility in our business because we don't really supply to the car manufacturers.

We supply to their suppliers.

So we'll supply to like Delphi or Lear, or, you know, Johnson Control or something who then supply to the car manufacturers.

So by the time you get the data from the show rooms and to the car manufacturing production, then the supplies and all the inventories and the net effect on us has never been as large as we always hear from investors and it never seems to correlate.

Our automotive business is fine.

Okay.

And just one final follow-up regarding inventories.

You talked a bit about the distributors starting to take on a little bit more inventory.

I guess it'd be a positive sign.

What have you seen from your OEM customers?

Was there more conviction on your OEM customers to rebuild their inventories right now?

Well, you know, we work with about 80 distributors around the world, so it's a fairly large -- that's 80 distributors.

We work with a large number of distributors in -- just just to correct, it is not all distributors all starting to build inventory when you have such a large network.

They shipped more product last quarter out the door than they took in.

So distributed inventories declined, but many of them noticed it and are starting to build inventories.

Not everybody else is.

So this process always takes one, two, three quarters, just like it goes down over a few quarters.

As far as the OEM customers are concerned, I think the OEM inventories are stable, although we are--as we're visiting the customers, as we're talking to them, they're reading all these press releases, they're reading headlines and electronics buyers news, and others, I believe customers are starting to give indication that you know, they want to be cautious, but with the lead times on most microcontrollers fairly short, I don't expect them to build inventories of microcontrollers.

They might do that some on serial and maybe a little bit on analog.

Okay, great, thanks.

We will take our next question from John Lopez of capital.

Hi two questions if I can.

The first one: The operating expenses.

Are there going to be any impact to the accelerated schedule on the Fab on the operating expenses in particular on R and D?

None whatsoever.

Okay so that will not--the ramp and expenses going forward is not going to be any different than it would have been prior to the accelerated schedule?

It will not be affected by Fab 4.

Okay.

Will there be some increase in operating expenses going forward?

Yes.

It will be driven by additional investments and R & D or whatever, but it will not be driven by Fab 4 ramp.

Okay, but thats just normal, as sales grow operating expenses will grow as well?

Yes.

Okay, great and a second one, just a clarification on the Motorola commentary, do you actually expect market pricing to improve when Motorola is a separate entity?

In other words, do you feel like they've been pricing extremely aggressively because they've been part of the larger entity?

You know, I don't know.

It's too early to -- until Motorola separates out and what their structure is, how they capitalize, where do they get the money, is it independent, is it borrowed, is it like an on kind of company or a different kind of company.

Nobody knows any details and I think I would just be purely speculating at this point in time.

What I meant to say there was, they're losing a lot of money, even at the current rate.

They're writing a couple hundred million dollars worth of hard checks that they're getting from the mother of Motorola, and obviously an independent company would not be able to afford that.

How would they rationalize it?

Close more factories or throw away some more lower-end businesses or raise prices or you know, there are a range of things management does when they look at entire sting and I have really no idea.

Maybe they will do nothing, we'll simply grow into it, who knows.

Okay, great, thanks for the clarification.

And once again, if you would like to ask a question today, please press star 1.

We will take our next question from Jeff Rosenberg of William Blair.

Hi, I wanted to ask a little bit about sort of the little bit weaker than seasonal growth in this quarter and then a little bit better seasonal growth in the December quarter and in this quarter, could you maybe talk a little bit more about how weak things were at the beginning of the quarter and how pronounced that was?

And then also, at the time of your mid-quarter update, I got the sense that you were seeing things not necessarily improving as much as companies that have more concentration in specific areas of strength, like cell phones or PC.

Have you seen a real acceleration in demand over the last month, maybe just a little bit more on sort of how the last four weeks compared to earlier in the quarter?

I think you're trying to split the hairs too fine there, but I'll help you what I can.

If you look at the analog business, which had a 6% growth and the serial business which had a 12% growth, I think it was solid, so a very, very good quarter.

The Micro, which was at 3% growth, it did suffer because there was a fair amount of micro inventory going into the quarter, which was really driven by the weaker prior quarters because of SARS.

And just today I was reading a commentary by another company, Fairchild actually which was very similar in their press release, that they had a fairly strong September relative to July.

You know, our results were fairly similar.

July was kinda' weak because of that inventory.

August returned and September was very strong, so that momentum has continued into this quarter.

So, with micro being 80% of our business that weak July kind of actually destroyed the seasonality there but analog and micro did very well.

This quarter the growth is actually slightly higher than last quarter because we are seeing the broad-based recovery in full.

Okay, and a lot of times -- or not a lot, but sometimes in the past you've seen things fall off in December, North American, that sort of thing.

Any pronouncement of that as you sort of -- as you're now looking through point of sale on all your regions?

Or any reason you feel like the end of the year will keep going strong where sometimes that hasn't been the case?

Well you know,Jeff, to the best of our ability and belief in giving this guidance, we will have modeled that, so we think we're seeing a fair amount of strength and we have accounted for the holiday's and Europe shutting down early and U.S. distribution and the effect on Christmas and all that and you know, the Chinese new year is early this year.

It starts January 22nd.

Sometimes it's in the mid of February and all that, so, you know, usually Asia keeps going.

Asia does not really have the Christmas effect, and China is becoming a major consuming entity and a lot of our business is in China.

It's the second largest country where we do business in, after the United States.

And as the present season and all that comes up in China and Asia, more and more of that is turning from whatever to electronics goods, which tends to have microcontrollers and other products, so we think some of that seasonality starts getting masked by China continuing to build and Asia continuing to build into late December for their own new year coming up.

So we've tried to model all that to the best of our ability and every year is different and every year you know, Chinese new year's at a different time and every year Christmas is strong or Christmas is weak and we don't know how it will shape out, but I think we have tried to model it and hopefully understand it.

Okay, thank you.

We will take the next question from Fillipe Docca of Banc of America Securities.

Hi, a couple of quick questions.

First off: Steve, you mentioned select products with Microchip, you've seen an extension of lead times.

Are they particular applications that you can talk about, where these products are going into, where you're seeing the increase in lead times?

No.

You know, you can never triangulate our business to applications.

I think we're pretty much a broken record on that.

We do business with 40,000 customers and in analog now we have about 8,500 customers CD lease square has a lot of customers and a lot of business goes through distribution and you know, we're just -- no, we can not give you application or information.

Okay, that's Fine.

Then in terms of DISDI versus OEM, it seems like DISDI was a little bit stronger in September.

Do you expect the trend to continue into December?

Do we have that?

You know, I think that DISDI will continue to be about the same percent of our business overall.

I think if you look at the mix of business and with Europe being--returning to a pattern of sequential growth in December, as we mentioned, a larger proportion of their business so yeah it's going to be in that same range, plus or minus a point.

Okay, thanks.

We will take our next question from Ambrish Shirasta of Harrison epic.

Hi it's actually Patrick Ralph for Ambrish.

Most of my questions have been answered, but just a quick follow-up on the DISDI inventory.

Do you anticipate that DISDI's are going to replenish your inventories fairly uniform across all your different product lines or might could be one product line you feel is more pressing than others?

Thanks.

Nothing is ever uniform, so I think the answer actually -- it will not be uniform.

I think it will -- the first re-building of the inventory may happen at U.S. and European distributors, Asia may lag.

They usually do.

They always have more money concerns and credit lines than others.

Secondly, the distribution re-building of inventory may happen slower than later on micro and later on analog and memory, where you know, where the product lines are more fragmented and we can get out the mix a little more easier.

Micro's a huge business, large volumes and we have lots of stock.

Right.

Just one comment here, and just generally as we go into the cycle.

We recognize revenue on shipments from DISDI.

Not all of our competitors do that.

Something for the street to remember over the next several quarters, hopefully, that some of those facets and a number of our competitors will be driven from the inventory growing in particular areas and not related to true end market demand.

I'm not sure if I'm speaking out of turn or hoping that things will maybe change here relative to people's memories, but I hope it's something that will be born in mind as we go through that cycle.

Great, thanks.

We will take the next question from Jason Sam.

Hey, guys, can you hear me?

Yes.

Hey, just a few quick questions.

Steve, on the Q3 gross margin of 54.5%.

That doesn't include the ramp from the efficiency from Fab 4, right?

Gross margin is gross margin.

All things counted, and at end we're still gross margin.

Yes, it does.

So it does price in some contribution from Fab 4?

Well the contribution is very little because we're just starting out, but yes, it's inclusive of it.

Okay.

And any you know, given your current visibility, any thoughts on you know, what your utilization goal's gonna be by the end of the quarter?

By the end of this quarter?

Yes for Fab 4?

What we said is Fab 2 stays flat at about a 90% to 92 percent utilization, and Fab 4 is just starting out and we're starting to ramp and the end of the quarter utilization goal is really meaningless because Fab is too big and we're going to be a very low number.

Okay.

On the distributor side, any comments on what the industry, the channel inventory is on the distributor side?

Because last quarter, I think you mentioned two and a half months.

Are we still around there or did that change a bit?

I think we said that was 2.4 months at the end of last quarter.

At the end of September it's between 2 and 2.1 months.

A couple factors involved in that, obviously as was mentioned by an earlier question, the distribution proportion of our business increased.

Therefore, on the same inventory levels, you have lower months of inventory.

And I think there's still facets here where asset managers are really not all responding uniformly across our 80 distributors in terms of their business needs, and so we're seeing a reflection of that in terms of our discussions and representation in our business as we look into the current quarter, and as we suggested, these are historical lows and we expect so see inventory grow modestly from these levels.

Okay, and in Q2, what percentage of your revenues are from distributors?

That we should know.

Yeah.

We will take our last question from Edward Similbarn of Shaker Investments.

Hi, Steve.

A couple years ago or a year ago you had talked about a new product line that you were trying to get into with RF microcontrollers, you know, real low-cost things.

Now with the announcement by Wal-Mart that they're really going to be requiring their major suppliers to start you know, including that -- at least on their deliveries and their pallet size you know, product shipments -- is anything coming from your desire to move into that area?

Steve?

Did I lose you?

Hello?

Mr. Sanghi?

Did you hear the question?

Yes, I heard the question,the hum has gone away.

Hopefully everything is quiet.

Let me start from the question of the earlier gentleman who was asking for a percentage of the business in distribution.

We'll get that in a couple of minutes and then we'll answer that.

Hold on.

We didn't cut you off there.

The next question was regarding Wal-Mart's announcement that they're going to be asking for these odd FID kind of chips in the channel.

You know, this we've kinda' known for a while.

Lots and lots of U.S. government is asking that there will be ID chips in passports and Wal-Mart is requiring it at the checkout and airlines have been talking about it always for luggage handling and all that.

That business is very, very slow to develop.

It's a wonderful solution, really waiting for the problem.

It requires a fair amount of infrastructure of readers and everything else to make these things happen.

I will not expect any quick results in that business.

We do have some products for that, and whether that business is doing business with Wal-Mart is any margin in that business, I don't really know.

So, do not become to any kind of upside from that kind of business yet.

Anything else?

The distribution business is about 62% of our revenues, approximately the same as it was in the prior quarter.

There are no further questions at this time.

I'll turn the conference back over to you, sir, for any additional or closing remarks.

We just want to thank all the investors for attending this conference call.

We'll be around here for longer, you can call our investor line if you have any other questions.

Thank you.

And that does conclude today's conference.

We appreciate your participation.