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Cypress Semiconductor Corporation (NASDAQ:CY)

Q3 2007 Earnings Call

October 18, 2007 11:30 am ET

Executives

T. J. Rodgers - President, Chief Executive Officer, Director

Brad W. Buss - Chief Financial Officer, Executive VicePresident - Finance and Administration

Christopher A. Seams - Executive Vice President - Sales andMarketing and Operations

Norm Taffe - Executive Vice President, Consumer andComputation Division

Ahmad Chatila - Executive Vice President, Memory and ImagingDivision

Dinesh Ramanathan - Executive Vice President, DataCommunications Division

Analysts

John Barton - Cowen & Co

Chris Danely - JP Morgan

Adam Benjamin - Jefferies & Company

Tim Luke - Lehman Brothers

Sandy Harrison - Signal Hill

John Pitzer - Credit Suisse

Srini Pajjuri - Merrill Lynch

Glen Yeung - Citigroup

Douglas Freedman - Amtech Research

Operator

Good morning and thank you for standing by, and welcome toCypress Semiconductor’s third quarter earnings release conference call.(Operator Instructions) I would now like to turn the call over to Mr. T.J.Rodgers, President and CEO of Cypress Semiconductor. Thank you, sir, you maybegin.

T. J. Rodgers

Good morning. We’re here to report the third quarter of 2007, in which we recorded recordrevenues. As usual, we’ll do finances by Brad Buss, our CFO; and then themarket by Chris Seams, our VP of marketing and sales. I’ll add a few technicalnotes and then we’ll go to questions. Brad.

Brad W. Buss

Good morning. Thanks for attending. As usual, I just want todo the Safe Harbor and forward-looking statement disclaimer. Please make sureyou take a look at our press release, as well as our SEC filings, for a detailof all of those. We also have a full reconciliation of all the non-GAAP to GAAPmeasures in the press release and on our website, so please feel free to checkthem out.

I’ll take us through Q3 and then I’ll take a quick look atguidance for Q4. As you can probably see for Q3, I was very excited as the CFOto see the results that we posted. We had consolidated GAAP revenue that hit anall-time high, as T.J. mentioned, at $450 million and exceeded our guidance aswell as the Street First Call estimates quite significantly.

Revenue increased 21% sequentially, 55% on a year-over-yearbasis. SunPower continued to grow strongly and accounted for 52% of theconsolidated revenue, which was a new record.

Our semiconductor revenues totaled $215 million, which is astrong 8% sequential increase, and it was actually 12% if you adjusted for thePSRAM divestiture in Q2. It did not repeat again in Q3, so a very strongsequential growth.

All divisions grew sequentially on a divestiture adjustedbasis. BCD was the star. It surged 21% sequentially, driven by PSoC and USB,which both set new quarterly records due to really strong design wins rampingin cell phones and PCs, and obviously a very strong consumer seasonal buildthat we normally see in Q3.

BCD grew 8% sequentially, driven by West Bridge productionramps that were consistent with our expectations, and MID actually grew revenuein SRAM by 6% and offset a good portion of the revenue loss from the PSRAMdivestiture that I talked about.

On a GAAP basis, we had net income of $30 million withdiluted earnings per share of $0.18, versus last quarter’s $2.29, which you’llremember was favorably impacted by the sale of the SunPower stock. On ayear-over-year basis, that’s up significantly from the $0.06 that we posted inthe third quarter of ’06.

Our non-GAAP net income was $45 million and resulted indiluted earnings per share of $0.26, and again this is the highest diluted EPSon a non-GAAP basis that we’ve seen since Q4 of 2000, so a very big increase.And again, that compares to $0.16 in the prior quarter, as well as $0.16 in theyear-ago third quarter.

We’ve been talking pretty heavily about how we’ve expectedto see a lot of the strategic actions start to flow through to our financials,and I think as you see, that happened quite nicely in Q3. The semi business,which we break out separately from SunPower in the press release, actuallyincreased sequentially on a non-GAAP net income basis by 100% and contributed$0.18 of the $0.26 that reported, up from $0.09 in Q2. And I expect to seecontinuing operating leverage from the semi business during 2008 as theirrevenue and gross margins are expected to increase.

The consolidated non-GAAP gross margin was 33.2%. It wasdown from the previous quarter, basically just due to the mix of SunPowerbusiness which, as I mentioned, was 52% of the business versus 47% in Q2.Obviously it’s important that most of you do, you look at SunPower’s grossmargins and ours separately. And again, we provide all of that informationeasily accessible in the press release for you.

The non-GAAP gross margins for our semiconductor businesswas 47.2%, up from 44.9% in the previous quarter, as we expected, due tofavorable product mix and higher utilization in our fab.

Our direct margins continued to remain strong across alldivisions and our corporate ASPs increased again sequentially, and that’s theseventh consecutive quarter that that’s happened.

Our non-GAAP consolidated operating expenses in dollars,which is R&D as well as SG&A, increased from the prior quarter, mainlydue to SunPower but also to some slight increases in the semi business, justdue to timing of certain expenses in the quarter.

Our total consolidate non-GAAP op-ex is at 23% of sales, ourlowest level ever. Semiconductor R&D in absolute dollars continues to stayat historically low levels, even while we continue to invest heavily in designand software for future programmable solutions that will continue to drivelonger term revenues and gross margin expansion.

Turning over to the balance sheet, it’s looking really nice.We had consolidated cash, equivalents and investments that totaled $1.4billion, which is all-time record high. The semiconductor cash and short-terminvestment balances continued to grow and totaled $942 million -- again, ourhighest balances ever.

Operating cash flows from the semi business was a strong$52.3 million for Q3, due to our strong profits and tight working capitalmanagement.

Turning over to inventory, our net consolidated inventorywas $196 million, which was down $6 million from the prior quarter and of thatdecrease, the semiconductor business was $5 million of that. So we managedinventory very well in the quarter.

We had stated that we planned to bring inventory down, whichwe did. We took it down in MID, partially due to sales but also partially dueto managing our profiles, and we increased slightly DCD and PSoC, as weexpected to support our PSoC and West Bridge growth ramp.

Inventory in the channel with our disti partners decreasedand is down over 18% from levels in mid 2006, so that’s a positive indicator oflow inventory in the supply chain, which I think is goodness. I expectsemiconductor inventory dollars to be flat to slightly down in Q4.

Accounts receivable was in good shape again. It decreased aswell as DSO did, and no issues there.

CapEx was $65 million for the quarter, of which $59 millionwas for SunPower, and we only spent $6 million in the semiconductor businessand again, consistent with our discussions of flexible manufacturing and[inaudible], we have a very low CapEx spend this year and I expect to see thatcontinue in the quarter.

Depreciation was broken out in the press release for you andit was basically $25 million in total, of which 19 was the semi business andthe balance was SunPower.

With respect to our ownership of SunPower, our basicownership was 57%. Fully diluted, it was 53, and it declined slightly from Q2due to SunPower’s offering. Cypress did not sell any shares in SunPower duringQ3. We currently control 90% of the voting rights due to our Class B structure.We continue to won 44.5 million Class B common shares and as of yesterday, theyhad a market cap of $4 billion.

We had a really nice stock price increase in Q2 and Q3 sofar. The one negative of that is that goodness obviously impacts the sharecount due to the higher stock price. So the average stock price in Q3 for EPSwas $25.76 and that was up from $21.50 in Q2, so it impacted the options, itimpacted convert, which became slightly dilutive for the first time. And theconvert, as you know here, the conversion price is $23.90, but unlike our oldconvert, there is no interest add back, okay? So people need to kind ofremember that because this is cash settled and you use the treasury stockmethod. So don’t mess that up in your model.

And another note, under the accounting rules, the note andthe related call spread must be treated separately for the EPS calculation. Sofor the call spread, neither the warrant nor the call option impacted EPS inQ3. However, the warrants will have an EPS impact once the quarterly averagestock price is greater than 27, which we currently are at in this quarter.

Under the accounting rules, the call option portion is notincluded in diluted EPS because it is anti-dilutive. So as such, the accountingtreatment for EPS actually paints a worse dilution impact than what will reallyhappen upon settlement in 2009. So again, just to reiterate, upon thesettlement, the net economic share dilution of Cypress will be zero, up to astock price of 27 due to the call spread, and it will move up with every dollarof stock appreciation, which in my mind is not a bad thing to have. I kind oflike seeing the stock up in the 30s.

So just to give an example, at a settlement in a stock priceof $37, the net economic share dilution will only be 5.7 million shares, whichis substantially less than the 13.7 million shares that would be required underEPS accounting rules at that same stock price before settlement.

I know it’s confusing. I wanted to spend a little time on itbecause I’ve have a few calls. And we’ve actually posted some worksheets to thewebsite so you can look at the stock price you want to model, look down thecolumn, boom, here’s some numbers and you can put it in your model. If you haveany questions, please feel free to give me a call.

Guidance for Q4 -- we are pleased to report that ourestimated performance for the second half of 2007 will be higher than the FirstCall estimates before we enter the call. So just to put that in perspective,the First Call estimate on a non-GAAP basis for the second half was for revenueof 838 consolidated and diluted EPS of $0.45. We now estimate the second halfwe’ll have revenue of 875 to 892 and the diluted EPS will move up to 52% to54%. And again, that even includes a little higher share count than I think anyof us had expected due to the stock price increase, so I am very pleased withthat guidance.

So the revenue for Q4 is expected to be in the range of 425to 442, which is a year-over-year increase of 48% to 54%, and it is equal tothe First Call or up to $17 million higher than the current First Callestimates for Q4, due mostly to higher revenue in the semi business.

SunPower revenue will decrease, as they previously guided,due to the timing of certain large projects, and our semi business will be flatto up 3%, which I was very pleased to see because we did have a blowout Q3 inthat business. So things are looking very good from that perspective.

And also, don’t forget that’s for the piece of the NFCbusiness late in Q2 or Q3 that doesn’t repeat going forward, so please adjustyour models.

Gross margins will increase for SunPower and are expected tobe in the range of 24 to 25. We expect semiconductor gross margins to move upagain and be in the range of 48 to 49, and we do continue to expect ASPs andcustomer direct margins to remain strong.

No real major changes to the tax rate. Q4 should be around 8to 9 for the semi business, 11 to 12 for SunPower, and our basic share count --this will be kind of a wildcard, depending on the stock price, but the basicshare count should be around 158. But it could be as high as 177 to 185 on afully diluted basis, again due to a lot of the impacts of the convert in thecall spread, which I talked about, which obviously the economic impact onsettlement will be vastly different.

CapEx for 2007 should be at $50 million or slightly less,which is again is a decrease of over $60 million from 2006 as we continue toenjoy the benefits of some of our new strategies and I expect CapEx to remainflat around that level going forward.

As I mentioned, we continue to own 44.5 million shares ofSunPower and we currently have no lock-up agreements with respect to thoseshares. The prior lock-up agreement expired at the end of September.

Our consolidated fully diluted non-GAAP EPS is expected tobe in the range of $0.26 to $0.28 cents and again, that’s currently higher thanthe First Call estimate of $0.24.

All the guidance is obviously subject to change due to a lotof things that you can take a look at in our risk factors. And I just want towrap it up by saying I was really pleased with the performance that the Cypressteam has turned in, as well as the SunPower team. We had some really goodnumbers and I think we are shaping up for a very strong 2008, assuming theeconomy holds up.

And I’ll turn it over to Chris now. Thanks a lot.

Christopher A. Seams

Thanks, Brad. Let me give some of the usual indices for thesemiconductor business for the third quarter.

Our revenue splits by geography: Asia climbed to 55% ofsales, driven by a large ship-to in the consumer end segment and PCs, PCperipherals and handsets also aided that. North America was 25% of sales andEurope and Japan were 11% and 9% respectively.

Again, we have no customers greater than 10% of sales. Unitsclimbed in the quarter as our revenue grew. We were up to 166 million units.That’s up from 156 million in the previous quarter. As Brad noted, the pricingenvironment continued to be very stable for us. We had another rise in ASP to$1.29. That’s up from the second quarter at $1.26.

Book-to-bill was stable at 1.01 and our semiconductorbacklog was slightly down at $229 million as we brought lead times slightlydown in the quarter. And we enter the fourth quarter 78% booked, which is stilla real strong booking number and the order patterns, booking patterns two weeksinto the quarter appear to be normal so far.

Let me turn the call back to T.J. now for more details onthe quarter.

T. J. Rodgers

Let me give a little bit more financial information first onthe divisions. First, we have DCD and consumer computation, that’s where ourprogrammable products, including PSoC, are. It did $103 million, up 20.5%quarter on quarter, still very strong growth, 49% gross margin.

We no longer report because we can’t come up with a GAAPnumber by division. We no longer are allowed to report, I should say,profitability of the divisions. I will give them verbally here. I think theyare important and I think the SEC takes information away from investors indoing this. DCD had a 20% pretax profit in the quarter. Data com did $29.7million. It’s only 6.6% of the company. They were up quarter on quarter 8.4%.They made 63% gross margin and put 16% in TBT.

Memory and imaging division did $79.6 million. That’s 17%,18% of the company, and they dropped a little bit, 4.6% quarter on quarter.They delivered 41% gross margin, which is the lowest of our three divisions,but they are also organized the leanest and still produce 15% pretax profit.

Chris commented that our ASPs were up to $1.29, the seventhconsecutive quarter of rising ASPs for us.

Business and technical comments, our PSoC customer base hasnow grown to 5,300 customers. That’s a lot for us. We are on our way. Ourlong-term goal is 40,000 customers.

Among our customers, global customers that have now engagedin PSoC are Hewlett-Packard, Cisco, Lucky Goldstar, Lenovo, Nintendo, andPentax.

We shipped our 250 millionth PSoC in the quarter and acouple of the interesting designs we have that will be significant in volumeare the Marion Global GPS system and Haier Group's washing machines. Haier is aChinese company that makes appliances for the Chinese market, obviously highvolume. And they used Capsense, our PSoC no mechanical button solution,waterproof, on their washers.

We introduced a first touch embedded design starter kit. Itsounds like something that probably wouldn’t be interesting to investors but Iinvite you to e-mail me, tjr@cypress.com, and I will send you one and you willactually be able to plug it in and play with PSoC and see some of the features.You can plug it into the USB port of your computer. We sell it for $29.95 andit will show you the four different demos of what a single PSoC can do when youreprogram it.

We introduced PSoC Express III, that’s our latest generationof our software. This is software that allows designers in our customers’companies to design a system by dragging and dropping block icons for chunks ofthe system and connecting them with lines and specifying the relationship bytruth tables and state diagrams. In other words, it’s a totally visual designsystem that allows our customers to design a system without writing a line ofcode, hugely enhancing their productivity.

This software is five years in the making and we currentlyhave over 50 people in the software. It is a huge differentiator for us.

As we know, the world is turning to more efficient solutionsfor lighting and that includes fluorescent bulbs and LEDs would be the nextgeneration after that. Philips has a division called Luma Led, which makes highbrightened LEDs and we’ve now put the Philips library of LEDs into PSoC Expresssoftware.

What that means is one of our customers who wants to use LumaLed can drag and drop an icon for a given Luma Led product, plug it into a PSoCdesign, and PSoC will comprehend what it’s driving and create all the softwareand drivers to drive it.

In addition to the efficiency I mentioned a minute ago, theother reason that this is important is that one of the things holding back LEDsin the market right now is that they are very non-uniform in manufacturing,though the way to solve that problem has traditionally been to create bins, sowhat happens is Luma Leds creates dozens of bins of products, meaning two LEDsthat are supposed to be blue will be different brightnesses from each other andslightly different colors from each other.

If you want to match color and brightness perfectly, youhave to supply a specific bin and you get charged a premium for that.

What happens with our software is that you can grab a bin,the machine knows what bin it is and it knows what correction factors arerequired for it. So this is an example where you can embed intelligence to takea complexity away from your customer in a new market which is growing rapidly,the LED market.

We shipped our 20 millionth wireless controller, 2.4gigahertz, and we call it wireless USB. We also have another product calledprogrammable radio on-chip, PROC, which is in fact a PSoC chip plus a radio. Wenow have 200 design wins on the radio and we are starting to get significanttraction as we combine it with PSoC.

SunPower, as you saw in the report, had a great quarter.They announced their first plant is running at full capacity. They announcedthe opening of their second plant. It’s a massive building, 10 acres under one roof. It is threetimes -- twice the size of the first plant and it will be three times theoutput, doing 330 megawatts. The first plant is rated at 100 megawatts and I thinkit drifting up as they increase the efficiency of the plant. But this will maketheir total capability go up by a factor of four, relative to what it is now.

SunPower signed a continuous supply agreement with HemlockSemiconductor. That’s a polysilicon and ingot company, one of the largest inthe world. As you know there is a shortage of silicon in the world right nowand SunPower is signing agreements to guarantee supply.

They also got a big win where they are installing solarsystems in 28 Macy’s stores in California. They also got what I consider to bea premier win in Santa Rosa, California, Adjulant, which is showing its greenin a very visible installation, a one million watt installation in Santa Rosa.

We sampled our first non-volatile static ram device. Acomment on that; a non-volatile static ram is a static ram, but it is a staticram which can store data when the power goes off. That is a big deal. Itcombines the best features of static rams, which are fast and have excellentpower speed product, infinite endurance with non-volatile memories, which canstore data permanently even when the power is off.

We think over the next few years, this will grow slowly andbecome a very high profit margin generator for us. We are also planning tocombine non-volatile static rams with PSoC to make systems that can sensesignals and store information when the power goes off. So in effect, anelectronic black box.

Finally, we sold our network search engine, or CAM business.This was a business that we had with Cisco in the second half of -- the CAMbusiness we’ve been in for years, both to NetLogic, got $12 million for it, andsold inventory. We are now 100% out of the CAM business, which never made moneyfor us and will help us become more efficient in producing gross margin andprofit in the future by refocusing those resources.

Those are the highlights for the quarter, technical andbusiness. We’re ready for questions.

Question-and-AnswerSession

Operator

(Operator Instructions) John Barton, you may ask yourquestion and please state your company name.

John Barton - Cowen& Co.

Thank you. T.J., with all the PSoC design wins under yourbelt, and I realize it’s touch to talk about averages, but can you give us asense for the typical design in cycles as far as how long does it take, time torevenue, revenue per design, and again, if you want to vary from averages, talkabout the extremes, that would be great too.

T. J. Rodgers

Let me first answer generically. Our foam is quantifiedmathematically. We have a model which has seven parameters in it. It startswith an opportunity or as we call it, an active if the customer engages with usin some way. There is then a delay from an active to a design win, and thatdelay is customized for every single product. We have about 20 differentmodels, the products are very different.

We then have a percent probability of turning an active intoa design win. We then have a second delay from a design win to revenue, and youhave the second probability which says even though you’ve got the design win,the customer’s system didn’t work.

So you suffer from an active, you suffer two delays and twoyields, if you want to call them that, until you get some money. And then moneyis -- I think it is six quarters for PSoC. Six quarters for a design win andyou get so many units in a quarter. So we model each design win that way and wehave models for each of our product lines.

For example, you might imagine rams are different from PSoC.So the details of that model are as follows. Chris.

Christopher A. Seams

T.J. gave away I think some of the yields. The latencies,John, from going from the active stage to the design in stage are typicallybetween two and three quarters, more towards two, and going from the design instage to the first revenue stage, which we would call a design win, are on theorder of two to three quarters again, right in the middle.

T. J. Rodgers

So if you add those two together, you get five to sixquarters. So the results we are reporting for PSoC today actually got created,that is, we knew about them, we knew about them for sure three quarters ago andwe had a very good idea mathematically over a year ago.

A year ago when we were saying PSoC is going to be a bigdeal, the numbers weren’t all that great but this is why we knew it. And now inthis quarter, we’re saying -- did we set a record in this quarter? Yes, we setanother record for PSoC design wins and that makes us confident for 2008.That’s why Brad’s talking about it, unless there’s a problem in 2008, it willgo up.

And it’s completely different and better than the life Iused to live in the ram business, where you literally in the middle of aquarter could turn from everything is great to everything is awful, andsurprise investors.

This long cycle time requires patience but it is also verystable.

Christopher A. Seams

One added comment, John; as we expand into the longer cyclemarkets, like automotive or industrial, and even some of the wirelinecommunications with PSoC, those latencies or cycles push out somewhat, but thewins live longer as well.

John Barton - Cowen& Co.

Sure. And basic revenue for PSoC in the last quarter?

Norm Taffe

We don’t break it out, basic revenue. Hey, John, this isNorm. Frankly, in the last call, you could reverse calculate it and there’s thegrowth in this press release, but I can tell you that year over year, we expectto grow more than 50% in PSoC off of last year’s total number, and we did set,it said in the press release, a revenue record again this quarter.

T. J. Rodgers

Two-hundred million rate and growing at 30%-ish per yearright now.

John Barton - Cowen& Co.

Thanks. And just real quickly, T.J., an update on the twofabs as far as utilization? Obviously you are not spending much on CapEx. Whatare your visions now with respect to how long those fabs remain and potentialexit strategies, please?

T. J. Rodgers

Shahin Sharifzadeh, our VP of fabs, is in Chinaright now, so I would ask Ahmad Chatila, who runs MID to answer your questionon fabs. Ahmad.

Ahmad Chatila

Our utilization of the fab are excellent. They are in the88% to 90% range. We continue to see strong utilization going forward. We arelooking at options for Fab 2, the Texasone, because it is older generation technology and we’ll keep you posted onthat one.

Our Minnesota fab, on the other hand, is leading edgetechnology and we will continue to utilize this for a long time to come.

John Barton - Cowen& Co.

Great. I’ll leave it at that. Thank you.

Operator

Thank you. The next question comes from Chris Danely.

Chris Danely - JPMorgan

Either T.J. or Chris, can you guys just give us your senseof how the end markets are doing out there? And are you worried about any sortof double ordering?

Christopher A. Seams

Let me answer in reverse order; double ordering I’m notworried about. I made a comment about lead times for us are in about the six toeight week range, which doesn’t precipitate those types of actions.

End markets for us, I’ll comment on. I’m probably not thebest barometer of the overall end markets because we are penetrating some verybig markets with some very new and exciting products, so we don’t get a truegauge on the overall market. We get a gauge on our penetration into that endmarket.

So with that said, my comments in the wireless handsets,that is a great market for us. We had a very good Q3 and we see that continuinginto Q4, as we penetrate not only with PSoC but with our high-speed USB and ourAntioch offerings into the cell phones as well.

Consumer, we expected it to be strong. Second half is alwaysstrong for us in consumer across the board and it didn’t disappoint and Q3 andQ4 continues to look solid off of Q3.

PC and PC peripherals, I lump together. We’ve always had astrong peripheral heritage and now we’re penetrating the notebook portion ofPCs, which as many of you probably know is the fastest growing and mostexciting portion of the PC market.

We are penetrating that with PSoC with multimedia Capsensecontrols. That was a growth segment for us as well in Q3 and we see a solid Q4ahead of us.

Two of our more traditional markets, wireless base stations,which have been in the news of late and for probably about a year now, wecontinue to see a mixed market out there. It varies by account, whether theyare recovering or growing or not, and so we are seeing what the basic market isshowing but for us, across the board it’s not been a growth market for us butwe don’t see it declining either.

Wireline networks has always been a strong market for usfrom our heritage point of view. That remains healthy going forward and wedon’t see anything changing.

Chris Danely - JPMorgan

Great, and you said overall book-to-bill was above 1. Couldyou give us the book-to-bill by segment.

Christopher A. Seams

I can’t give it to you by segment. I can give it to you byproduct line.

Chris Danely - JPMorgan

Sure.

Christopher A. Seams

CCD is 1.05; MID, with the image sensors counted, is 0.97;and Data com is 0.95.

Chris Danely - JPMorgan

Last question; Brad, how do you expect options expense totrend going forward?

Brad W. Buss

I think it will be fairly consistent for us. I can’t quitespeak for SunPower, but I don’t see any real major changes there. We’ve got anannual process coming up but we’ve also got stuff that declines off, so we’remanaging it pretty tightly.

Chris Danely - JPMorgan

Great. Thanks, guys.

Operator

Adam Benjamin, you may ask your question and please stateyour company name.

Adam Benjamin -Jefferies & Company

I just want to clarify. You guys threw out a lot of stats onthe PSoC business. I think, Norm, you said it would be growing year over yeargreater than 50%, and T.J., you said it’s at a $200 million run-rate and 30%growth. So based on that and given what you did in CCD, can you clarify alittle bit? Is it the $200 million run-rate was from Q3? And would you expectto grow sequentially in Q4? It would seem to indicate that you wouldn’t, giventhe year-over-year growth.

T. J. Rodgers

My comment of a $200 million run-rate and 30% growth wasforward-looking, talking about 2008. The 50% growth rate quoted was growth ratein the quarter relative to last year, so as we get bigger, our growth rate isstill high but it is tapering off from a doubling every year. That is why two differentnumbers, two different timeframes.

Adam Benjamin -Jefferies & Company

Okay, and the last piece of that, would you be upsequentially, from Q3 to Q4?

T. J. Rodgers

The answer is yes. Not as dramatically as we were in Q3 onPSoC but we do expect to set yet another record in Q4.

Adam Benjamin -Jefferies & Company

Okay, and then I know you guys talked roughly about themargin being better than the CCD group margin. Is that -- was that the maincontributing factor in terms of mix for the CCD margin improving sequentially?

Norm Taffe

Actually, two factors; one, PSoC growing, the other one isalso our USB margins are improving as well as some of the high-speed, highermargin business grows in handset applications. Both of those contributed toimproving gross margins in CCD and we expect that trend to continue.

Adam Benjamin -Jefferies & Company

And just to clarify regarding DCD, you saw a dip down ingross margin, which you are generally pretty stable there. I know the NSCbusiness is coming out. Can you talk a little bit about any changes in mixthere? I know that West Bridge comes online in terms of the ramp there, so canyou just clarify what was driving the margin decline and whether we can expectthat to continue, or if that’s a function of just a temporary mix?

Dinesh Ramanathan

It is actually just a function of temporary mix. The NSCbusiness, as you mentioned, was very low gross margin and we basically soldthat business. And then the rest of this business comes in at margins that areless than the old traditional communications business, so it is essentially amix that is actually driving the gross margins in that direction.

T. J. Rodgers

We shipped our first significant amount of West Bridge thisquarter and we are in early ramp phase and the gross margins are currently notwhat they will be in a couple of quarters, so that dinged gross margins in DCDa couple of points.

Brad W. Buss

You can expect their margins to still run in the low 60slike we talked about.

Adam Benjamin -Jefferies & Company

Dinesh, just to clarify, your NSC business had been runningabout $5 million or $6 million per quarter. You sold off $2 million perquarter, so we should expect it to still run kind of cash-cowing into $3million? You seemed to indicate that that business goes away, but you stillhave a couple million a quarter there, correct?

Dinesh Ramanathan

No, there is no NSC business at all, so it goes to zero.

Adam Benjamin -Jefferies & Company

Okay, thanks for the clarification.

T. J. Rodgers

A year ago, we sold the bulk of our NSC business and keptone product that the acquirer did not want at that time. In the last quarter,we sold the rest of our NSC business and it now will be zero going forward.

Adam Benjamin -Jefferies & Company

All right. That’s all I have. Thanks.

Operator

Tim Luke, you may ask your question and please state yourcompany name.

Tim Luke - LehmanBrothers

Congratulations on your execution. I was wondering, on thebookings number, it’s at 78%, which is a little lower than the 86% you had lastquarter and how do you see that and how do you feel about that level ingeneral?

T. J. Rodgers

If you look at the graph -- I’ll go to it, the beginning ofquarter booked is the statistic you are talking about.

Tim Luke - LehmanBrothers

Yes.

T. J. Rodgers

The number when we’re having bad times is 60% and the numberwhen we’re having good times is between 65% and 80%, and above 80%, the fact iswe’re typically in trouble, scrambling and delinquent on orders. So 78% is avery good number, meaning we’ll have 22% of the quarter to turn in the quarterfor us and it is just normal noise.

Tim Luke - LehmanBrothers

Just on the -- do you have the book-to-bill by businessunit?

Christopher A. Seams

Let me just repeat it -- it is 1.05 for CCD; 0.97 for all ofMID; and DCD is 0.95.

Tim Luke - LehmanBrothers

And if you had shared what the sequential improvement was inUSB and whether you could just remind us of what percentage range that is ofthe overall CCD business. Chris, I don’t know if you had a comment on theoverall linearity of how the business has proceeded through the calendar thirdquarter.

Norm Taffe

The percentage increase on the USB business, which I want tohighlight actually includes our wireless as well, and we include that in thesame business, which has grown strongly. So wireless USB and USB business grewvery healthy in Q3, around the order of 20% quarter over quarter. And itrepresents roughly 40% of CCD.

Christopher A. Seams

Tim, your question on linearity, it was right in the slotfrom what we expected and what we’ve seen historically.

Tim Luke - LehmanBrothers

And then, any commentary on West Bridge in terms of how you’ve seenit develop and traction with large OEMs? I think you’ve talked in the past abouthow one Midwestern handset guy has been pretty -- has shown interest in theproduct and how is that developing in terms of broadening out the customer set?

Dinesh Ramanathan

So the Midwest customer is actually now putting phones inthe market with our parts in it. We also have another North American customerthat will put phones into the market, plus we are working with pretty much allthe top tier handset customers that will either put phones in the first half orin the second half of next year. So we are seeing fairly broad adoption acrossthe customer base. Actually, interest and adoption across the customer basethat we have for that particular product.

Tim Luke - LehmanBrothers

So that business could be what sort of percentage range ofDCD, perhaps in ’08 and ’09?

Dinesh Ramanathan

It could be anywhere between 20% and 30%.

Tim Luke - LehmanBrothers

T.J., [inaudible] lastly, commentary on the generalenvironment and following up on Chris’ question in terms of how you perceivethe outlook, maybe visibility the beginning of next year?

T. J. Rodgers

That’s for me?

Tim Luke - LehmanBrothers

Yes.

T. J. Rodgers

The environment is not really hot right now. We’ve been --2007 was not a great year in general in the market. It was okay. It was not adisaster. We were very happy that our divisions all made it through everyquarter making money all year long, which is very different than old Cypresswas when we had a tough year.

Right now, the market is the same as 2007. We are doingwell. We’ve got a lot of new products. That’s driving our momentum but I amlooking forward to better markets into the future. This is not a greatsemiconductor environment. It’s stable. It’s not bad. It’s stable at a B-minuskind of level.

Tim Luke - LehmanBrothers

Thanks, guys.

Operator

Sandy Harrison, you may ask your question and please stateyour company name.

Sandy Harrison -Signal Hill

As far as the PROC, you had talked a little bit about itstarting to come into its own, and given the timeframe you had talked about foryour PSoC adoption of say three to six quarters from sort of design win torevenues, the PROC’s been out now going on three to four quarters, as I recallcorrectly. What sort of layering do we see PROC coming in? And if you couldspend a little time reminding us of the ASPs here and what sort of applicationsthose could play in?

Norm Taffe

You’re right. We came out with -- we introduced PROC aboutthree quarters ago. It hasn’t contributed significantly to our revenues yet,although I think we did break our first $1 million quarter, so it’s off themark. It is getting designed in quite heavily. It is primarily just what you’dexpect -- places where people want to combine a radio and a micro. We actuallyhave quite a bit of applications in toys, toy applications. We have quite a bitin the industrial space where people are trying to do wireless sensing kind ofapplications.

It is very much a many-broad customer type market, like PSoCwill be over time. We’ve broadened the customer base, as we’ve broadened thecustomer base for PSoC, so it is very broad in that perspective.

Therefore, even though it incorporates our wireless USBradio, it does have better margin portfolio in general than USB products, moreconsistent with the margins we have in PSoC.

Sandy Harrison -Signal Hill

Okay, and again, where do you think that -- are we seeinganother, consistent with your sort of path to revenues, another couple ofquarters before it really starts to drop in meaningful levels? Are there someparticular design wins out there that give you that confidence or is it justsort of a rising of the tide inconsistent with your PSoC?

Norm Taffe

I think it’s mostly rising of the tide. There’s a couple ofbig wins that could make it even more special in terms of percentage, but oneof the ways we look at PSoC is a core device that allows us to have a varietyof interfaces. We have PSoC with a USB interface, we have PSoC with wirelessinterface. In general, the broad strength of PSoC, this is just another way inwhich we exploit that in a select set of applications that use wirelesstechnology.

Sandy Harrison -Signal Hill

Okay, and just a commentary, kind of combining T.J.’scomments on the industry and where it stands on an earlier question, as well assome of the inventory and seasonality that the industry is expecting, given thelead times being relatively short but hearing out there that fab capacity istight, not only now with you guys but as well some of the merchant providers,do you think that there is any risk potentially that on a strong Q4, thatinventory and availability of products might become an issue out there in thebroader markets?

T. J. Rodgers

Let me comment on that. One of the reasons we are startingto take off and have our fall through gross margin go right down to the bottomline and our EPS accelerates, is that we’ve got Fab 4 full. And in the future,instead of adding equipment to Fab 4 and doing the old game or doing Fab 5,we’ll be buying wafers at foundries outside and keep Fab 4 full.

So back on your comment, is capacity full? Our internalcapacity is pretty much full and we are now overlapping in the foundries andour foundries are reasonably full. And we have contractual arrangements to getthe wafers we need, but it is true, despite what I call the B-minus demandenvironment, it is also true that worldwide, fabs are pretty full right now andany surge would lead to a shortage of product.

Sandy Harrison -Signal Hill

And then lastly, sort of taking a step back and looking inthe crystal ball, T.J. and Brad, you guys have done a heck of a job financiallychanging the company, both from a fundamentals perspective, from amanufacturing as well as managing your costs by outsourcing and others.

What’s next? You guys, again you’ve done a great job and inthe spirit of Wall Street, what have you done for us lately kind of question?What could we look for and what could be some potential next steps that youguys are looking at internally?

T. J. Rodgers

We’ve still got some more clean up to do inside. There are acouple more small-ish business units that aren’t all that visible to you thatwe are going to sell the businesses and basically transfer the people on to ourmain event.

We have some cleaning up to do in manufacturing and thatwill show up in terms of better gross margins for [inaudible], price, we’recertainly revamping all of our manufacturing methods in the company to reduceour costs, take advantage of the very low cost Chinese foundries we’vetransferred our technologies into.

With regard to initiatives, things that we can talk about,we have a new internal start-up called Cypress Systems. They recorded firstrevenue this quarter I think in the order of $100,000. I don’t remember theexact number.

For a long time, I’ve looked at making chips, for example,radio chips and selling the radio chip for -- PROC, let’s say, for $2 or $3,and it allows you to hook up something, let’s say a temperature or humiditysensor to a radio, have the radio transmit to your computer, go into another [download]that’s got a couple of Cypress chips in it and take remote data from a radiofrom any sensor you want into your computer.

It has always aggravated me that we get a couple of bucks oneach end for that kind of amazing capability and yet when I buy stuff like thatpersonally, weather station type stuff, I pay anywhere from $50 to thousands ofdollars, depending upon the number of channels that come in.

So we started Cypress Systems to make small systems. Weobviously face the potential risk of some competition with our customers. We’reavoiding that but basically, we’re taking our products and making systems whichsell for hundreds of dollars instead of single-digit dollars, our ASP being$1.29 in the company.

We’ve been working on the company for two years, ayear-and-a-half. We invest about $2 million a quarter, so it takes a penny perquarter out of our earnings and that will become a million dollar per quarterbusiness I think late in 2008. We have a chance to hit some homeruns in thatbusiness.

We’ve been working on that for a couple of years and it justnow will become visible to investors. I’ll let Terry Sim, the President ofCypress Systems, come in either next meeting or meeting after that and describewhat he’s doing.

Brad W. Buss

If I could just add a couple of things, I appreciate yourcomments. I mean, the team has done a lot but I think the big thing is thefinancial impact, the market expansion we’re going into, we’re still leavingfirst base. We are going into these multi-billion games we’ve never been in.

So even if semis don’t grow, we’ve got a ton of CAMexpansion across the board that is just starting, so that’s driving revenue.The gross margins we’ve talked about between the switch to programmableproduct, more impacted in our COGS structure. We only see that moving up intothe right as well, so we’ve got -- and then plus the new products we arecurrently developing, next gen of PSoC and a handful of other things, we’recranking up a pretty heavy organic revenue stream. And to T.J.’s point, we’redropping more and more of the incremental dollars to the bottom because ourcost structure has been streamlined.

We’ve got years of that ahead of us, so maybe you guysshould start looking at the stock value appropriately.

Sandy Harrison -Signal Hill

So we’ll look for a bricks wireless sensor in the winemakermagazines coming forward?

T. J. Rodgers

There is actually a company that is outside of Cypress'family called Provena. You ought to check them on the web. They make a -- Ilicensed them the technology I developed in my own winery using PSoC technology.You can buy a fermenter, a real fermenter that does real, professionalfermentations to put in your house to put up the web and actually be connectedto instructions on how to make wine properly and you can look at the parametersin the fermenter. It is an RF connected Internet appliance, and if you want toget an example of somewhat of the more bizarre things that you can do with PSoCand radios, go take a look at Provena on the web and given that you guys areall pretty much yuppies in your jobs, you guys maybe all want to buy one foryour house and start making your own Cabernet.

Sandy Harrison -Signal Hill

All right. Thanks, guys.

Operator

John Pitzer, you may ask your question and please state yourcompany name.

John Pitzer - CreditSuisse

Thanks, Credit Suisse and this is Ahmad. Just taking a highlevel look at PSoC, when you see growth next year, do you see most of thegrowth coming from an expansion of the market or do you see yourself takingmarket share from some of the traditional MCU guys?

Norm Taffe

I think we’re entering a very, very large TAM which grows ata growth rate of 7% or 8% a quarter and we’re going to grow a lot more thanthat, so clearly we -- starting [inaudible], excuse me. So clearly we willcontinue to take market share in the space.

I do want to highlight that our TAM, and we take pains topoint this out, really extends well beyond just the microcontrollers. We are --we really find ourselves often replacing four markets -- a microcontroller,essentially ASICs, in the lower end of the ASICs base; programmable logic,because there is a significant amount of programmable capability in theproduct; and then importantly, analog. And in all four of those markets, it’san enormous TAM which we’ve just barely touched, and we see our value beingability of a flexible integration of all those technologies.

So in the end, do I think all four of those markets willgrow anywhere near where -- no way, but I expect us to grow very, very quicklyby taking share within that space and there is plenty of TAM for us to growinto.

John Pitzer - CreditSuisse

And then, on the non-volatile SRAM, do you see that as amarket in and of itself, or is that really the way we should think about it, assome type of an attach market with other products? What is the market potentialthere that you see in 2008?

Ahmad Chatila

You know, NVSRAM goes into what is called battery-backedmarket, battery-backed ram market, as well as [inaudible], NRAM, and NVSRAM,and that’s a multi-hundred million dollar market, as well as the low-poweredSRAM plus a battery that is homegrown solution. So if you go to some companies,they buy the battery themselves and they buy a micro-powered SRAM from us.

So actually, if you look at the overall potential, it’s a $1billion market. With our solution, it is the only one that you do not have tous esoteric material that is difficult to manage and attack that market.

So initially, we are just trying to develop our market therein the $1 million to $2 million a quarter, and we will get there in shortorder. But our aspiration is to grow and go after the $1 billion market. Butthen as T.J. said, we are going to add PSoC to that and that will grow oursolution even further and make it a proprietary product.

T. J. Rodgers

Let me give a little more color on the last two answers. Theanswer is yes, we are taking market share in the microcontroller business. Ifyou’ll remember the pitches I was giving in 2000 and 2001 when we launchedPSoC, we were planning on getting the microcontroller business. We looked atone of the more attractive competitors in that market, which is Microchip, andthe problem we had in trying to enter the market is we had 10,000 products.

So PSoC actually got invented to be a programmablemicrocontroller where we could take over the function of approximately 5,000Microchip products with only six chips, where the microcontroller would be inthe center but the peripherals, the digital and analog peripherals, would beprogrammable. So you could spin your own microcontroller and we actually in thebeginning mapped our offering on to Microchip’s product line with the conceptof dislodging them in the market.

It turned out that wasn’t the best strategy but it put us inthe right place. By emulating their capability in the marketplace of 5,000parts, we basically created a capability that stood on to itself. With thesystem on chip, you could do stuff you couldn’t do with a fixed functionmicrocontroller.

Therefore, one way to look at our market is that we aretaking share because we can give you a microcontroller and we can integrateanalog functions that you would have to buy otherwise from Linear Technologyand digital functions you might have to buy otherwise from [AllianceSemiconductor], and our big sell is not we are going to take thatmicrocontroller socket. Our big sell is put a circle on your board, look at theanalog and digital functions surrounding your microcontroller, they’re on boardour chip. Our chip is therefore more cost efficient and more flexible.

By the way, you can change the actual hardware in amicrocontroller five times in the last month before production and not getshafted because you are actually changing hardware.

So the IT base of our design maps on the microchip but we’vereally created a new category of product -- a programmable system on chip andit now has a life of it own and we are not really competing head-on in themicrocontroller business. We are taking greenfieldsystem design.

The second comment on non-volatile static ram, I told youwhat it was before. The static ram, which is the most convenient, efficient andpower friendly of all memories, with the ability to store data when the power goesdown, and that’s to store data without using a battery. The energy required tomove the data from the static ram cell into the non-volatile cell and theirmapped 4 million of each, so there is a non-volatile cell directly next to astatic ram cell inside the memory.

The energy to do that is stored in the capacitor, so itdoesn’t require a battery. So any system where there is a battery-backedmonitoring system, so when the system goes down, you can remember what happenedand that’s basically any router, any blade server, any system with which needsto recover from a crash currently uses battery back-up ram. The problem withbatteries is that they are very unreliable, relative to solid-statesemiconductors. They are difficult to solder on the boards because the batterymay or may not be able to take the temperature, and that’s gotten worse when wego lead free, which is higher temperature.

So the non-volatile static ram I think is a major initiativeand I think when we combine it with PSoC, it is going to create a whole newclass of product. This is a product which can sense the environment.

I’ll just give you one example. The guy at EMC, for example,and I’m creating a hypothetical example, let’s say the guy at IBM walks up andsay my blade server crashed. Mr. PSoC, what happened? Mr. Non-volatile PSoC?And the non-volatile PSoC says I was monitoring four power supplies every 200milliseconds before the crash and what happened was power supply two started tofade, and furthermore, the temperature on temperature sensor one started to goup. This is what was happening in your system before it crashed. And that datacan be measured and stored in PSoC. You can take it back out after the eventand go back and do root cause corrective action on what’s wrong with yoursystem.

That function, which I call black box, I think is going tobecome more and more pervasive as people demand in effect perfect performancefrom systems. And therefore, the combination of that kind of very specialmemory with PSoC in the future, I think it will be a slowly rising and assomebody said earlier, the tide rising kind of business, but a very important,high quality business that we will build over the years.

John Pitzer - CreditSuisse

If I can just sneak in one last quick one, and that’s aboutvaluation. Can you just update us on your philosophy for monetizing SunPower? Imean, do you see that as a 2009 timeframe or I sit -- what are the factors youthink when looking at that stake?

T. J. Rodgers

First of all, I would like to thank you for asking thatquestion without threatening my job, as in prior meetings. I expected thequestion would get asked, so I got a phone call to their lawyers andaccountants last night to refresh myself on the dynamics and I also read thetranscript from our January 25th meeting to make sure that it was accurate, andI had that in mind when I answered the question.

Bottom line, that transcript is on the web and when I readit, it was a very clear answer and it was exactly where we are right now. It soundslike a blow-off when I say we continue to evaluate options. That doesn’t meanlike the government continuing to study and do nothing. It means we continue toevaluate our options and right now, there are no options which will makeshareholders better off. And as a 3% shareholder myself, I am very interestedin making shareholders better off but right now, we see no deal that is betterthan status quo.

And the details, there’s four options for separation and thedetails of those four options, which take a while to go through, haven’tchanged since the January 25th phone call, which is on the web.

John Pitzer - CreditSuisse

Sounds great. Thank you.

Operator

Thank you. Our next question comes from Srini Pajjuri. Youmay ask your question and please state your company name.

Srini Pajjuri -Merrill Lynch

Just quickly on the PSoC, obviously you had a lot of successand it’s been a very high visible product for you. I’m just wondering if youare seeing anything else out there that is competitively coming close to thisproduct?

Norm Taffe

As far as have we seen anything else, T.J. I think said itwell earlier, where we don’t see anything that’s really a direct competitor tothe product. I will say that I am confident that our success is being noticedand we do see people integrating analog features on maybe a greater scale, andspecifically -- and we’re constantly cautious to make sure we don’t, we arelooking closely.

Haven’t seen anything that we see as directly in response toour product or like it and we are certainly working on the next generation veryactively to extend our position there. But it wouldn’t surprise me if somethinglike that arrived. I just haven’t seen anything yet.

Srini Pajjuri -Merrill Lynch

Okay, great and then one question on the SRAM business. Thatbusiness has been fairly stable and it’s been very profitable, it looks like.I’m just wondering, what’s going on in that business that has changed there? Hasit become less cyclical or if you could talk about maybe what’s your outlookfor the next couple of years, how you expect that business to trend?

Dinesh Ramanathan

We expect in the next couple of years to continue to gainshare and continue to improve our gross margin.

Yes, the business has changed a lot -- less competition andI would say a lot more difficulties penetrating customers. It is not easy justto design an SRAM and throw it at customers. And we have a very broad portfolioand everybody likes to be with us because we can give them from a 16K SRAM to72-meg QDR. So I expect our gross margins to continue to improve step by stepby step.

And our revenue outlook, I can’t tell you a lot because,dependent on the market growth. There’s not much there so between our marketshare growth and market decline or flatness, we might see a little bit of anup, but not much. But the profit will increase over time.

Srini Pajjuri -Merrill Lynch

Okay, and then if -- let’s say if wireless infrastructurecomes back at some point, does it really help your SRAM business or is it lessof an issue?

Dinesh Ramanathan

Let me answer that -- when the market on wireless basestations crashed, it didn’t crash at every account at the same time. Soactually, you start to see it in some accounts and then later on in otheraccounts in other quarters. And in the same fashion, some accounts rampedbefore others, so I do not see a big impact going forward on that.

Srini Pajjuri -Merrill Lynch

Okay, and then more of a longer term question for T.J.;T.J., as you look at the SRAM business, obviously it is doing well right nowbut to me, as PSoC and other proprietary products become bigger and bigger, I’mwondering if there is a real synergy between your SRAM and your otherbusinesses. Longer term, does it make sense for you to stay in this business?

T. J. Rodgers

Very short answer; in the next three years, SRAM is wiredinto Cypress. At a point seven years from now, might Cypress not have an SRAMcomponent? That’s a decision we’ll have to make longer term.

In the short term, SRAM does two important things for us. Ilook at SRAM as being a conveyor belt that takes depreciation money out of myfab and put it back into the bank, so with SRAM, we always have our fab full.We get the depreciation and cash flow out of our fabs. We’re still depreciating-- what’s our depreciation rate?

Brad W. Buss

$19 million, $20 million a quarter.

T. J. Rodgers

$19 million, $20 million a quarter, we want to do that. Thesecond big thing SRAM does for us is that if you look inside a PSoC, you willsee a very dense SRAM cell. Not a typical, half-assed logic SRAM cell, whichmany of our competitors have, but a real honest-to-god full-fledged memorycell, because I’ve got real memory designers in the company.

So as long as SRAM is an inherent part of our product, it isalso nice just to be able to ask the SRAM guys to give me a macro for my otherproduct and I know I will get it, I know it will be robust, it will bereliable, it will be radiation tolerant. So for those two reasons -- and let megive a third reason, too.

The third reason is that the SRAM business is making a niceprofit right now and we believe it is going to get more profitable and morestable over time because the history has been so bad it squeezed out a lot ofcompetitors. And therefore, it’s a great cash flow and profit generator that wecan use to, for example, invest in Cypress Systems, which is costing a penny aquarter, and still put enough money on the bottom line that you guys don’tgripe that our R&D is too high.

So for right now, the longer the core of the company,Cypress used to be an SRAM company. We’re not now. We’re a programmableproducts company but it certainly does add a lot of value to Cypress and wedon’t anticipate any changes.

Srini Pajjuri -Merrill Lynch

Thank you.

Operator

Thank you. Glen Yeung, you may ask your question and pleasestate your company name.

Glen Yeung -Citigroup

T.J., you characterized this year, ’07, as kind of a B-minusyear. When you look out into next year, again thinking industry, do you thinkwe are going B-plus or are we going C?

T. J. Rodgers

I’m a bad person to ask. If you look at my history, I amusually buying steppers directly before a crash. Chris.

Christopher A. Seams

I think that current industry pundits and leading servicesare forecasting or predicting about 3%, 3.5% growth for ’07. I think they’llget the right answer as they get the numbers out of December.

When they started the year, they predicted about 9.5% growthfor the industry. The current roll-up for next year says about the same number,about 9%, 9.5%. So according to the industry forecasters, it says it’s going tobe up versus ’07 but as T.J. said, they are probably not any better than he is.

Glen Yeung -Citigroup

Okay, and there’s nothing that you can detect in your own businessthat can give you any visibility, partially because you are gaining so muchshare in your products, I guess, it’s a little masked --

T. J. Rodgers

We’ve said it before -- no matter what the end market does,we’re going to take share and plan on growing.

Glen Yeung -Citigroup

Brad, just thinking about, just researching the semibusiness, can you talk about where you think margins are going to, grossmargins, that is, really over next year is what I’m thinking about? And can youremind what gross margins in the semi business were in the June quarter?

Brad W. Buss

Sure. The June quarter, you said?

Glen Yeung -Citigroup

Yes, the one -- last quarter.

Brad W. Buss

Yes, hang on. I’ve got the spread there in the pressrelease. It was total semi gross margin, 44.9, and then they went up to 47.2.

Glen Yeung -Citigroup

And how do you think we look next year?

Brad W. Buss

They are going to go up. I expect them to go up actuallyalmost every year. There’s a lot of factors to it, right, and we’ve talkedabout the switch in the business. T.J. went into all of our programmable stuffis well north of 50%, number one.

The value selling that we’ve been doing as a company, againa big switch from memory roots to programmable roots, is just going into allthe new designs that won’t even hit revenue yet. That provides enough lift.

The more business that goes through foundry, which is whereour track is going, provides more benefits to gross margins.

I think if you add all of them together, it bodes very wellfor gross margin.

We are in the midst of looking at our 50-30-20 model. I ampretty comfortable we’re going to hit that next year and we will be upping the50% and I am hoping to up the 20% target for our next few years of future.

Glen Yeung - Citigroup

Do you think upping the 20 is purely a function of uppingthe 50, or do you think you can lower the 30?

Brad W. Buss

I think it will be mostly on the 50. I mean, there will besome room potentially, but we are trading off op-ex dollars. I mean, we’ve donea very good job of decreasing op-ex and reallocating, even within the dollarswe have, to the high growth areas and I think you’ll see us continue to dothat.

We’re going to need to continue to invest in FAE and appsengineers to keep seeding these big markets that we are going after. But Ithink overall, you are not going to see the cost structure get too crazy.

And to T.J.’s point, SLM and Cypress Systems are actually adrag on op-ex right now and aren’t contributing to the bottom line. They bothwill continue and add revenue and dollars to offset costs going forward aswell.

So I am pleased with where the cost structure is and theleverage will come, as we mentioned, from increasing revenue and dropping ahigh majority of the incremental GP dollars to the bottom line going forward.

Glen Yeung -Citigroup

Do you have any feel for what you think capital spendingwill be next year?

Brad W. Buss

I think 50 is probably a good number you can model in forthe future. It will be plus or minus, depending on timing but I think that’s agood number.

I mean, even if you look at a fab-less company, as a percentof revenue, that’s a pretty low percent of revenue, so I am real pleased withwhere we are going on CapEx and I think you start adding that, plus theincremental earnings, you see tremendous free cash flow being generated goingforward.

Glen Yeung -Citigroup

That’s really where I was going with this. We’re seeingaccelerating revenues, expanding margins, falling spending -- it looks like weare going to have pretty interesting cash flow next year, so any thoughts aboutuses of cash, and sort of traditional uses -- buy-back, dividends, et cetera,but also thinking about -- you’ve been divesting businesses. Any chance you maybe looking to acquire anything?

Brad W. Buss

I think from a capital structure standpoint, I’ve beenpretty vocal that I’m not a big believer in a ton of cash piling up, so we’llput it back to work in some of the traditional things. We could exploredividend longer term for sure. I think buy-backs are a real big part of ourfuture and we’ll -- we definitely always continue to look at acquisitions ifthey make sense.

But like I said, we’ve got a tremendous amount of organicrevenue growth. If there is something that could complement our strategy, fillout a product line, or some kind of key core, but I think -- you don’t know.There is a lot of stuff in play, though. There’s a lot of guys that I think aretrying to figure out scale and where they could play and if something presenteditself at the right synergistic look and valuation, we would look at it.

But I wouldn’t say personally it’s a core part of what weneed to do because we’ve got a lot of good things going on.

T. J. Rodgers

We had an acquisition binge in the 2000 timeframe. Some ofthe stuff worked. For example, the radios we talked about were a combination oftwo small companies we acquired. Some of the stuff didn’t work; for example,the CAMs that didn’t work out and we’ve now gotten rid of them.

So acquire to get a new capability is probably not in thecards. We’ve got enough interesting stuff to work on in a $10 billionmicrocontroller market to grow what we need to grow.

If we considered an acquisition, which to me is something Ido if it’s compelling only, to consider an acquisition now, it would have tofortify a position in the market we’re in and make sense, not off in some newthing.

Brad W. Buss

And just to tag on about the internal start-up concept thatT.J. has pioneered here has paid very good dividends. You’ve seen it in PSoC.We’re seeing it Systems. We’ve had a quasi-impact of that with SunPower and SLMstarting to come into fruition, and I think that’s a good strategy that wecould keep doing going forward, but to build into the areas we want on a lostmore cost-efficient and focused basis.

Glen Yeung -Citigroup

Yes, that’s a good approach. All right, thanks a lot.

Operator

Thank you. Douglas Freedman, you may ask your question andplease state your company name.

Douglas Freedman -Amtech Research

Thanks for taking my question. A lot of them have beenasked. Brad, clearly cash flow is improving, profitability improving, any helpon tax rate going forward? I know there are some NOLs left there. Any updateyou can offer?

Brad W. Buss

Well, I gave you the guidance on the tax rate. Pretty low --I mean, we’re going to run at 8% to 9% in the semi business, I think fargreater than the vast majority of companies so I don’t see the rate changingmuch.

I mean, we do have a substantial amount of NOL, that theonly way they are going to get eaten up would be a SunPower sale of stock andwe have a ton of tax coverage going forward.

Douglas Freedman -Amtech Research

So continue to hold the overall trajectory that you -- Ibelieve you talked about a 15% rate for next year. Does that sound about right,consolidated?

Brad W. Buss

No, I think it will be lower. I mean, I haven’t lookedtotally into that but I think SunPower’s rates came down. Probablyconsolidated, 11%, 12% but again, I’d caution you to really do the rate basedon each bucket, depending on how you are forecasting revenue and income andthen let it blend naturally.

Douglas Freedman -Amtech Research

All right. You just made some --

Brad W. Buss

-- look at the two pieces separate in your model.

Douglas Freedman -Amtech Research

Perfect. I guess I’ll leave it there. Thanks, guys, for allthe detail. I’ve gotten a lot of the questions answered.

Brad W. Buss

Thanks, Doug and thanks for your very intuitive researchreport.

Operator

Our last question comes from Thomas [Domek]. You may askyour question and please state your company name.

Thomas Domek -Goldman Sachs

Thanks very much. My question’s already been answered andcongratulations on the quarter.

Operator

Thank you, sir. At this time, we are showing no furtherquestions. I will turn the call back over to your for any closing comments.

T. J. Rodgers

Thank you very much. We just reported the third quarter,$450 million, a record, $0.26 above the Street. We’re happy. Thank you forcalling in.

Operator

Thank you. This does conclude today’s Cypress Semiconductorconference call. Have a nice day.

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Source: Cypress Semiconductor Q3 2007 Earnings Call Transcript

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