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Microchip Technology Incorporated (NASDAQ:MCHP)

Q3 FY08 Earnings Call

January 24, 2008, 5:00 PM ET

Executives

Gordon W. Parnell - VP, CFO

Ganesh Moorthy - EVP

Steve Sanghi - President, CEO and Chairman of the Board

Analysts

Christopher Danely - JPMorgan

Simona Jankowski - Goldman Sachs

Steve Maresca - UBS

Doug Freedman - American Technology Research

Mark Lipacis - Morgan Stanley

Sidney Ho - Merrill Lynch

Kevin Cassidy - Thomas Weisel Partners

Romit Shah - Lehman Brothers

Operator

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

Gordon W. Parnell - Vice President, Chief Financial Officer

Thank you very much and good afternoon everyone. During the course of this conference call, we will be making projections and other forward-looking statements regarding future events or the future financial performance of the company. We wish to caution you that such statements are predictions and that actual events or results may differ materially. We refer you to our press release of today as well as our 10-K for the fiscal year ended March 31st, 2007 and our 8-K current reports that we have filed with the SEC that identify important risk factors that may impact Microchip's business and results of operations.

In attendance with me today are Steve Sanghi, Microchip's President and CEO, and Ganesh Moorthy, Executive Vice President. I will comment on our third quarter performance reviewing geographic data and discussing balance sheet and cash information. And Steve and Ganesh will then give their comments on the results, outline our guidance for the March quarter, and update other prevalent matters regarding our business. We'll then all be available to respond to any specific investor and analyst questions.

So let’s begin with net sales for the December quarter, which were $252.6 million. They were down approximately 2.3% from net sales of $258.6 million in the immediately preceding quarter and up approximately 0.6% from net sales of $251 million in the prior year’s third quarter. On an earnings basis, we are continuing to include some additional information in our press release related to the adoption of FAS 123(NYSE:R) share-based compensation. Non-GAAP results exclude the effect of the adoption of this accounting standard and in the December quarter, a one-time favorable event related to the resolution of a foreign tax matter.

Earnings per share on a non-GAAP basis were a record $0.39 per diluted share in the third quarter of fiscal 2008 compared to $0.38 per diluted share in the immediately preceding quarter and $0.36 per diluted share in the prior year’s third quarter. Non-GAAP net income for the December quarter was $81.2 million, a decrease of 2.5% from non-GAAP net income of $83.3 million in the immediately preceding quarter, and an increase of 3.1% from non-GAAP net income of $78.7 million in the prior year’s third quarter.

GAAP net income for the December quarter was $80.1 million or $0.38 per diluted share, inclusive of all share-based compensation expenses and the one-time favorable event related to the foreign tax matter. The impact on earnings related to the adoption of share-based compensation in the December quarter was 7.4% and the tax matter increased earnings per share by $0.03 in the quarter.

The financial results of the December quarter include the incorporation of the convertible debt transaction completed in December. As we indicated in our conference call where we discussed the positive impact of the transaction, the December earnings per share results have been impacted and increased by $0.01 from our original guidance.

With respect to the convertible offering and share repurchase, I want to briefly outline the accounting methodology, as there have been some questions recently as to how the structure will impact our earnings per share. As we discussed in the call in December, the impact of the convertible was approximately $0.15 accretive to annual earnings. The structure of this transaction does not require that the shares underlying the deal will come back into the earnings calculation when the stock reaches the conversion price. Rather, this convertible is an annexure of several convertible. This means that Microchip will pay a $1.15 billion principal back in cash at maturity, 30 years and pay any appreciation above that price, the 34.16 conversion price, by delivering shares.

So there is no dilution until the stock price is above 34.16, and as an example, at a $40 stock price, the dilution would be approximately 5 million shares or 2.5%. I certainly hope this helps the overall understanding for the structure and the accounting for the transaction.

So back to the current quarter, and on a geographic basis, both the Americas and Europe were down sequentially while Asia revenues grew in the December quarter. Our results in Asia were in line with our expectations, growing 1.8% sequentially. The Americas regions were down 5.6% sequentially and that region was impacted by economic conditions as well as the effect of the Christmas holidays. Europe net sales were also impacted by seasonal effects, with net sales being down 5.5% sequentially.

Asia continues to be our largest geography, now representing approximately 46% of total sales. Europe represented approximately 28% of sales and Americas approximately 26% of sales. And again just to remind you, this measurement is based on where the product is delivered for manufacturing purposes on our customers’ request, but doesn't obviously necessarily represent where the design activity is taking place or certainly where the consumption eventually occurring.

When operating P&L information, initially I'm going to use gross margin and operating expense information prior to the effects of share-based compensation. The gross margins were 61.2% in the December quarter, reaching record levels even at this point in this cycle.

Operating expenses were 26.5% of sales in the December quarter compared with the prior quarter, which was 25.5% of sales. Research and development costs were $27.6 million, representing 10.9% of sales. SG&A expenses were $39.4 million, representing 15.6% of sales.

And on a full GAAP basis, gross margins were 60.6% including share-based compensation; research and development and SG&A expenses and total were $73.8 million or 29.4% of sales.

The tax rate for the December quarter was 18.5% on a non-GAAP basis and the GAAP tax rate, which calculated at 12.2% includes the one-time adjustment of $5.7 million I mentioned earlier in the call. Our tax rate is impacted by the mix of geographical profits and the percentage of our cash that is invested in tax-advantaged securities.

The dividend we declared today of $0.32 per share was an increase of approximately 3.2% sequentially and an increase of 20.8% over the same quarter in fiscal 2007. The dividend payment that we will make in the March quarter related to the $0.32 will be approximately $60.6 million.

Turning to the balance sheet, our inventories were essentially flat at $124.8 million in the December quarter compared to the prior quarter and represent approximately 114 days of inventory. Our deferred income on shipments to distributors was also unchanged quarter-to-quarter at $93.3 million. At December 31st, distributors were holding up 1.9 month of inventory based on sell throughs.

The combined inventories on our balance sheet and at distributors now represent 149 days of total inventory, which is an increase of 7 days from the prior quarter. Microchip’s receivables were $114.4 million, a decrease of $11.5 million or 9% from balances as of the end of September. Payment performance by our customers continues to be excellent with minimal balances beyond terms.

On a cash position, Microchip’s cash and total investment was approximately $1.653 billion as of December 31st. During the quarter, Microchip generated net cash flow from the business of $131 million. Payments related to our cash dividend of $0.31 was $66.4 million and the cash used in our stock buyback was approximately $814.6 million. We anticipate building approximately $105 million in operational cash flow in the March quarter.

Capital spending in December quarter was approximately $11.8 million. Depreciation expense for December was $23.4 million versus $29.1 million for the same quarter last fiscal year and $25.4 million in the September quarter. Our capital expenditures forecast is currently $65 million for fiscal 2008 and depreciation forecast is $98 million for the same period.

With that, I'll ask Ganesh and Steve to discuss the performance of our business, our guidance for the March quarter, and to update other business matters. Ganesh.

Ganesh Moorthy - Executive Vice President

Thank you, Gordon and good afternoon everyone. I'll now comment on the individual product lines after which Steve will walk you through our guidance for the next quarter. Starting with microcontrollers, our microcontroller business was down approximately 1% sequentially and was up approximately 1.5% from the year-ago quarter.

Our Flash microcontroller business hit another record and was up 0.5% on a sequential basis and up 10% from the year-ago quarter and Flash microcontrollers now represent 73% of our overall microcontroller business. Calendar 2007 culminated with the shipment of our 6 billionth microcontroller late in December and calendar 2008 started with the shipment of our 600,000th development tool in early January. Both key milestones that mark our leadership position in the microcontroller market.

Speaking of our development tool shipments, which are a very good leading indicator, we shipped a record 28,722 new development tools last quarter and through the first nine months of fiscal year ’08, we have shipped a record 83,360 development tools, about 40% higher than the corresponding period in fiscal year '07. These strong development tool shipments results are indicative of continued strong design-in activity and acceptance of our solutions that should bode well for future growth.

Moving to 16-bit microcontrollers, we had another strong quarter with revenue up almost 28% sequentially and up over 138% from the year-ago quarter. A strong design-in momentum continues to build across a broad range of customers and applications. We shipped 3,793 16-bit development tools in the December quarter, bringing the total number of 16-bit tools shipped to date to 40,569. And significantly, in the first nine months of fiscal year '08, we have shipped twice the number of 16-bit development tools as we shipped in the equivalent number of... equivalent time frame in fiscal year ‘07.

We currently have 101 16-bit products in production with many more sampling and we expect to exit the March quarter with over 150 products in production. The number of 16-bit volume customers grew to 1,117 in the December quarter from 1,018 in the September quarter and in terms of 16-bit customers of all volumes, that number remains in the several thousands.

As most of you must be aware, we introduced our 32-bit microcontroller product line in November, thus giving us access to an incremental $4 billion of serviceable market. We are launching the 32-bit product line at a time when our 16-bit business is very strong with lots of momentum in all the leading indicators and as we've told you before, our 16-bit product line competes effectively with the low end of the 32-bit market and we now believe we can address an even larger portion of 32-bit market with the new product line.

Since the November introduction, customer interest has been high and industry accolades have already started to commend, most recently, with EDN Magazine selecting the product line for it prestigious Hot 100 Products of 2007 list. While we expect to design-in cycle for 32 bit to be long, we are optimistic about its contribution to our overall microcontroller growth and leadership position.

Finally, while the microcontroller market share information for 2007 is not yet available to compare to the results of our 8-bit microcontroller business, we believe that the performance of our 8-bit business in 2007 was purely the result of environmental factors and we firmly believe we are continuing to maintain or gain market share through the combination of our strong product line offering and enhanced demand creation and sales.

Moving to our Analog business, it was down 2.4% sequentially and down 4% in the year-ago quarter. While we are not satisfied with these results, they are reflective of current industry conditions that’s seen in many of our peer company results as well as the normal seasonality in this business segment. We continue to be encouraged by the level of design-in activity and the breadth of customers as activity is occurring at.

Our Serial EE memory business was down approximately 9% sequentially and was down approximately 1.5% from the year-ago quarter. Sales were impacted in part by excess inventory that resulted from some spot shortages in the market during the September quarter as well as normal seasonality in this business segment. Pricing declined moderately quarter-over-quarter.

Let me now pass it to Steve for some general comments and our guidance for the March quarter. Steve?

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

Thank you, Ganesh and good afternoon everyone. Today, I would like to first reflect on the results of the December quarter, then I will discuss the macro environment as we see it, and finally I will provide guidance for the March 2008 quarter. I’m pleased with the execution in the December quarter amidst challenging industry conditions.

Our net sales were down 2.3%, slightly better than the mid-point of our guidance but we exceeded gross margin guidance and achieved an all-time record high gross margin of 61.2% on a non-GAAP basis. We also achieved the high end of our earnings per share guidance, both GAAP and non-GAAP. During the quarter, we also completed a $1.1 billion convert transaction and in the last six months, we have now bought… bought back 31 million shares of our stock worth $965 million.

Now I will discuss the macro environment as we see it. When Microchip first revised our guidance on October 8th, some investors and analysts did not agree with the market data that we were providing. They did not believe that the conditions we were experiencing were more pervasive in the industry. Many believed that Microchip was losing market share and that our gross margin would not be sustainable.

We went to great length to explain in our conference call that we were seeing the effects of the housing market filter into the broader economy and Microchip often sees the effects of industry events 1 to 1.5 quarters ahead of our competitors and peers. It is somewhat because of our more conservative revenue recognition policy, our focus on relatively smaller customers who react more quickly, and our end market focus which is more consumer dominated than our peers and competitors who are more exposed to PCs and cell phones. Another reason why we see the effect of economic events earlier is our industry-leading short lead times allow customers to be more dynamic in how they adjust to demand or not.

Now we believed that the other companies would start to see the effect in a quarter or so. We have certainly seen this scenario play out at several industry and macro events in the past and the industry results in the current environment show that the scenario seems to be playing out as we had predicted.

Now with another quarter behind us, the market has responded to the changing conditions in the industry and has affected valuations based on all the data now available. The effect of the housing market on the broader economy is now being acknowledged by many analysts. From our pre-announcement date of October 8, 2007, Philadelphia Semiconductor Index, SOX, is down much more than the decline in Microchip stock price. SOX is down about 29% versus Microchip down about 20%. And the stock of most of our peers and competitors are down very significantly and more than Microchip stock price.

Now, with this result, the market is obviously recognizing the strength of our business model and the results that we are delivering. Now, some investors and analysts were concerned after October 8 that Microchip would see unusual pricing pressure in the microcontroller market and gross margins would not be sustainable. Our gross margins actually increased to another record high of 61.2%, up 80 basis points from the previous quarter. So there continues to be very encouraging news for the business, which certainly reflects in our forward guidance.

We saw some stabilization in the Housing segment of the market and let me explain that. Our shipments to the Housing customers consist of product going into new houses as well as going into existing houses for remodeling as well as replacement. For many appliances, up to two-third of the shipments go into existing houses. We have seen the components going into the new houses fall to very low levels, consistent with the housing data. The Microchip U.S. Housing Index was actually up last quarter from the previous quarter. We believe that the U.S. Housing Index for Microchip is currently bumping at the bottom. While the new housing market will probably go down further, we believe that the new designs from hundreds of our new products may put a floor on the index here, we therefore project that this element of our business will be flattish from here.

As I sum up the environment, I note that while we are sitting at the trough of our revenue curve for this business cycle, we are enjoying record gross margins and record earnings per share on a non-GAAP basis. We are keeping expenses and capital expenditures in the company very tight and will be able to weather any economic storm that may be on the way. We are getting very good traction in our 8-bit flash microcontrollers as well as 16-bit microcontrollers. As the revenue on these product lines grows, it presents excellent opportunities for further gross margin expansion and earnings per share gains.

I would like to add that 2007 was sort of a year of PCs and cell phones, especially in the last six months and Microchip has lower exposure to these segments. Now, you are seeing that PCs and cell phones are going through inventory corrections which are really less likely to affect Microchip's business. Our segment has really gone through significant correction already and that's why we believe that our revenue is almost sitting at the bottom.

Our book-to-bill ratio for December quarter was approximately 1.02, up from September quarter book-to-bill of 0.94. The starting backlog for March quarter is also significantly higher than the starting backlog was for the December quarter; however, as I've told you before, book-to-bill ratio and starting backlog have not correlated well to our results in the past. We are also giving consideration to the effects of the Lunar New Year holidays in Asia in the current quarter. So based on our review processes, we expect that our net sales to be down 2% to up 4% sequentially.

We expect to achieve another record gross margin of 61.3% to 61.5% on a non-GAAP basis. Now, the earnings per share calculation this quarter gets really complicated with the effects of convert transaction and stock buybacks which are very positive and the one-time favorable tax matter in the December quarter which isn’t repeatable. In addition, Fed’s lowering of the interest rates knocks a penny out of the earnings. We have $1.6 billion of cash. So it knocks a penny out of the earnings because of reduction in interest income and we have not made any assumptions about any further interest rate moves from the Fed. So taking all these into account, our non-GAAP EPS is expected to be $0.39 to $0.42 and our GAAP EPS is expected to be $0.35 to $0.38.

With that, operator, would you please poll for questions?

Question and Answer

Operator

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

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

Go ahead, Craig.

Operator

We'll go next to Chris Stanley with JPMorgan.

Christopher Danely - JPMorgan

Hi guys, can you hear me?

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

Yes, we can, Chris.

Christopher Danely - JPMorgan

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

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

Well, Craig… sorry, Chris, those numbers are very, very rough to get as we mentioned when we put the index together that customers move the designs back and forth from here to Asia. There are a lot of new designs that constantly go to production every quarter. So, while that index was actually up from last quarter, it's a combination of a lot of these moving parts and a very complex equation. So you can't cleanly get it to… trying to do a whole bunch of analysis out of that. When we originally announced the index, we believe that our U.S. housing exposure was about 8% and it probably was even higher last year because we created the index in the March quarter where the numbers had already gone down. And we think it's down substantially from that number today. Do you have a follow-up?

Operator

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

Simona Jankowski - Goldman Sachs

Yes, hi, thanks. Just curious on your revenue guidance, it sounds like you implicitly are assuming a lower level of turns this quarter than last quarter, considering you are starting with a higher backlog and interestingly, a lot of the other companies in the analog space like Linear and Intersil and Fairchild actually were assuming flat or higher turns for this quarter. I was just curious, are you guys just being more conservative because of the macro environment or were there specific things we are seeing in the behavior of your customers that are causing you to both kind of guide below what your backlog would suggest but also have a higher range of the guidance than you’ve had historically?

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

Simona, if you look at the history of what we had said on this conference calls, we don't believe in book-to-bill ratio or the starting backlog. And when book-to-bill and starting backlog looks better, I’m consistent and not using it to take advantage of that the numbers could be a lot better. And when the book-to-bill is lower and the starting backlog is lower, at that time, I always say that it doesn’t matter either. So I am consistent on both sides. We believe that starting backlogs and book-to-bill just kind of vary randomly sometime where lots of customers could place the order before the end of the quarter versus in another quarter, they happen to place the order in the beginning of the quarter for February and the ratio has never really correlated very well to our business. I've produced data on that before.

So we really go back to a bottoms-up analysis, by sales guy, by channels, by customers, by regions, and by market segments and from there, we have really constructed that number. So if you purely do a mathematical calculation, yes, the turns acquired are much lower. But we also have to go through Chinese New Year when, for couple of weeks, the largest market is closed and so you have to account for all those things.

Simona Jankowski - Goldman Sachs

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

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

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

Simona Jankowski - Goldman Sachs

Okay, thank you.

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

Yes.

Operator

Take our next question from Steve Maresca with UBS.

Steve Maresca – UBS

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

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

Well, number one, we haven't really given you any longer-term guidance, so really you have to put your own assessment. Secondly, I haven't counted the number of times this event has happened, but I remember during SARS and during prior inventory corrections and again now, every time, when we have a revenue miss, very often, it's a quarter to quarter-and-a-half ahead of the industry and when we come up with that, nobody kind of intends to believe it. And if you just …. if you just had… if the world had believed what we said back in October 8th, and taken some actions, stocks are down 30% from that. But at that point in time, it was just a Microchip problem and really everybody else was fine, and you can see in about a quarter, quarter-and-a-half, everybody has caught up to that. So we at the same time see this recovery ahead of everybody else and we have shown that before also. It's clearly evident in our book-to-bill ratio.

I listened to another company's call that announced this morning whose book-to-bill ratio was 0.88 in semiconductors. Our book-to-bill ratio was 1.02 and our backlog was higher and we are calling for… so there is a significant difference in the market segments. Their market was lot more… had lot more exposure to PCs, ours is more industrial, automotive, consumer, and less PC and less cell phones. So, it’s a very, very different model and it continues to be very predictable. We have done this over and over and over and it just takes a lot of effort to really get through it every time to expand it and it does not really get the footing until the numbers come out, which are coming out now.

So now, the question becomes going forward, why would we recover? Well, same reason why we recover every time. The new products are growing, the traction is very good, and designs, development tools are a record, 16 bit was up 28%. So even in a bad market, the new designs are happening, people are converting, they are upgrading their products, and so on and so forth. In the Housing segment, large portion of our product is going into Housing segment is really now going into the replacement market, as I tried to explain, although the new Housing segment could go down further and probably will, but it’s so small now that really can't really affect very much. So while we kind of suffered in 2007 because of lower exposure in PCs and cell phones, this now works for us because those are the segments now hurting and we see our segments doing better.

Steve Maresca – UBS

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

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

Gordon?

Gordon W. Parnell - Vice President, Chief Financial Officer

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

Steve Maresca – UBS

Great. Thank you.

Operator

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

Doug Freedman - American Technology Research

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

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

They don't really tell us when their environment is necessarily good or bad. We know that there is design activity taking place at all times, we are engaged in these designs, we are winning more than our fair share in these designs. And so, to that end, the customer decides their comfort level of when they want to take products into production. But, we are working to ensure that at whatever pace they take it, we're the choice that they have used in their designs.

Doug Freedman - American Technology Research

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

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

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

Doug Freedman - American Technology Research

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

Gordon W. Parnell - Vice President, Chief Financial Officer

[inaudible] number.

Doug Freedman - American Technology Research

12 million [inaudible].

Ganesh Moorthy - Executive Vice President

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

Doug Freedman - American Technology Research

All right, terrific. Thank you.

Operator

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

Mark Lipacis - Morgan Stanley

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

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

Entire over allotment was exercised.

Mark Lipacis - Morgan Stanley

Okay. So, according to your original intentions, it was to use everything from that convertible offering to buy back stock. Do I understand that correctly?

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

Certainly that will retain, that was our intention.

Mark Lipacis - Morgan Stanley

Okay. Over time, okay.

Gordon W. Parnell - Vice President, Chief Financial Officer

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

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

Correct.

Gordon W. Parnell - Vice President, Chief Financial Officer

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

Mark Lipacis - Morgan Stanley

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

Gordon W. Parnell - Vice President, Chief Financial Officer

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

Mark Lipacis - Morgan Stanley

Great. Thank you very much.

Operator

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

Unidentified Analyst

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

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

Thank you, Gil.

Operator

Our next question comes from Chris Danely with JPMorgan.

Christopher Danely - JPMorgan

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

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

Well, I think, we have guided our longer-term non-GAAP gross margin to be 62%, 61.2% in December quarter. We are guiding 61.3% to 61.5% in the March quarter. So from there, center point of that, we have 60 basis points to go and we will just continue to go up, 20, 25 basis points from there, probably marching towards the 62%. And in terms of the inventory, Gordon?

Gordon W. Parnell - Vice President, Chief Financial Officer

It depends on the environment and the revenue. We're certainly very happy that our inventory in dollars, both at distribution and on our balance sheet, was flat quarter to quarter. It shows that we're not building dollars of inventory, the increase in days was driven from the fact that the revenue declined by a couple of percent. So hopefully, with a stronger environment, we will continue to see some declines in our inventory in days over the next year or so.

Christopher Danely - JPMorgan

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

Gordon W. Parnell - Vice President, Chief Financial Officer

Mid point of --.

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

Midpoint of the guidance.

Christopher Danely - JPMorgan

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

Gordon W. Parnell - Vice President, Chief Financial Officer

We have always been very disciplined in how we run the EE business and the margins at which it runs. Really what you saw in the 9% decline was, if you go back and look at our September quarter results, you saw a substantial growth in the Serial EE business and some of that growth occurred because there were spot shortages of specific products. We have the product availability, we took advantage of it in that time frame. And it's versus that September comparison the 9% decline comes about. Other than that, there is normal pricing pressure, it's moderate from quarter to quarter. [inaudible].

Christopher Danely - JPMorgan

Okay. And then last question for Steve. A little more bigger picture, we have talked about the whole district [ph] commission arrangement for a while. Steve, now that you have had some time between that decision and now, do you think it was the right thing to do, are you looking to change that, do you feel any enmity from the distributors towards Microchip, if you could just comment on that?

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

Well, it was absolutely right thing to do. When we make these corporate kind of calls, we do them after a whole bunch of analysis, it's not always understood by the Street; in fact it's always misunderstood by the Street. We have done a large amount of analysis looking back who was creating what demand and based on that, with a lot of discussion with the Board and among themselves, we took on a task to move the reward and move the resources in the favor of more demand-creating channels and less in the favor of the channels that were not creating demand. We believe the results have been very positive. The first step of those changes was taken almost four years ago and our business has done quite well with tremendous growth in 16-bit development tools and the others. We have had a number of regional distributors around the world in Asia and Europe and other places.

So, I think we are pretty happy with what we have. We continuously tweak it, we are always looking for changes, we are always looking for making it better. At the same time, we added a large number on Microchip’s own people about 18 months ago and with design cycle 18 month or two years, I think if you look at sort of the funnel, funnel is our way of… what’s in the funnel, what’s in the opportunity base and what’s in the design wins. The funnel is significantly larger than what it was couple of years ago and as these designs come to maturity and go to production in the next six, eight months, we are quite optimistic that the changes we made are going to be very, very good for the business.

Christopher Danely - JPMorgan

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

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

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

Christopher Danely - JPMorgan

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

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

The program was not structured to create net additional benefit. The program was created to invest the savings and help for higher demand creation, so Microchip could grow. So a lot of the money we got from the margin side we really reinvested in the SG&A. On the net, did it even out, was the margin little bit higher, could be. But it was not… it’s not really huge amount, and it was not structured to create additional profit dollars for Microchip. It was structured to free up dollars so we could reinvest them in selling our 16 bit and our motor control, our Ethernet products.

As Ganesh mentioned earlier, we have lot of highly integrated products and lot of them are driving the growth. But these products are much more complex, which require much higher level of support for the customer. We needed to add specialist around the world who understand 16-bit DSP, high-end 8-bit microcontrollers. So these experts are the ones who are really helping sell lot of these products. That’s why 16-bit microcontroller is up 138% year-over-year, and the non-demand creation distributors have not created a single design for 16-bit microcontrollers when we made that decision.

Christopher Danely - JPMorgan

Okay. That's very helpful.

Operator

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

Sidney Ho - Merrill Lynch

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

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

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

Sidney Ho - Merrill Lynch

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

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

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

Sidney Ho - Merrill Lynch

And share count?

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

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

Sidney Ho - Merrill Lynch

But no additional buyback?

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

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

Sidney Ho - Merrill Lynch

Okay. Thanks.

Operator

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

Kevin Cassidy - Thomas Weisel Partners

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

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

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

Kevin Cassidy - Thomas Weisel Partners

I am sorry. Yes, the March quarter.

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

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

Kevin Cassidy - Thomas Weisel Partners

Okay. Thank you.

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

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

Operator

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

Romit Shah - Lehman Brothers

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

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

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

Romit Shah - Lehman Brothers

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

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

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

Romit Shah - Lehman Brothers

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

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

Well, last quarter --.

Gordon W. Parnell - Vice President, Chief Financial Officer

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

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

So, the answer is no, they are buying what they are selling through and that’s really the situation that we would expect. Our deferred margin, as I mentioned, was unchanged quarter to quarter.

Romit Shah - Lehman Brothers

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

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

We tend to have very short lead times which really accommodate their ability to manage their working capital very effectively, that does result in some expedites on occasions because they obviously sometimes misread their own market.

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

Well, let me again say that any time you apply the common industry wisdom to our business, you’re probably going to get the wrong answer. And that's why we tend to be so… have different cyclicality than the rest of the industry. A majority of our distributors are very small regional distributors. So approximately, let’s say, a good and good portion of our business is distribution.

Gordon W. Parnell - Vice President, Chief Financial Officer

About 65%.

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

It’s about 65%, so over 40% of that 65% of the business is through very, very small distributors which we call regional distributors that are demand creators with dedicated resources for Microchip around the world. These don't tend to be the guys who are heavily capitalized. So they keep a relatively small amount of inventory and because of a very, very short lead time, very quickly, we’re able to deliver it to them and they are able to deliver it to their customers.

So what you call the traditional large global distributors are relatively much smaller portion of our business than could be maybe some of your other investments. Those are the guys who are capable of holding more inventory but they are not either because they are driven by return on the assets. So the people who have cash and could hold larger inventory aren't holding larger inventory either. So the inventory in the channel is quite low and we do not see… we haven't seen distribution inventory grow in five years.

Gordon W. Parnell - Vice President, Chief Financial Officer

Sure.

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

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

Romit Shah - Lehman Brothers

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

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

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

Romit Shah - Lehman Brothers

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

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

No.

Romit Shah - Lehman Brothers

Okay. Thanks.

Operator

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

Steve Sanghi - President, Chief Executive Officer and Chairman of the Board

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

Operator

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

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Source: Microchip Technology, Inc. F3Q07 (Qtr. End 12/31/07) Earnings Call Transcript
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