Atmel Q3 2007 Earnings Call Transcript

| About: Atmel Corporation (ATML)
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Atmel Corp. (NASDAQ:ATML) Q3 2007 Earnings Call October 30, 2007 5:00 PM ET

Executives

Robert Pursel - Director of IR

Steven Laub - President and CEO

Bob Avery - VP of Finance and CFO

Analysts

Edwin Mok - Needham& Company

Doug Freedman - AmTech Research

Jingo - Wedbush Security

Robert Burleson - ThinkEquity Partners

Dennis Reed - ClevelandResearch

Kevin Cassidy - Thomas Weisel & Partners

Operator

Good afternoon. My name is Stephanie, and I will be yourconference operator today. At this time, I would like to welcome everyone tothe Atmel Third Quarter 2007 Earnings Release Conference Call. All lines havebeen placed on mute to prevent any background noise. After the speakers'remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you. Mr. Pursel, you may begin your conference.

Robert Pursel

Thank you, Stephanie. Good afternoon, and thank you forjoining us for Atmel's third quarter 2007 earnings release conference call. Ourrelease crossed the wires today after market close and is available on thecompany's Investor Relations website at www.atmel.com. A 48-hour telephonereplay of this call will be available after 5:00 PM today Pacific Time. Thereplay phone numbers are 800-642-1687 in the U.S. and 706-645-9291 for all otherlocations. The access code is 19444605. The webcast will be archived on theAtmel website for one year.

Joining us for the call today are Steven Laub, AtmelPresident and CEO and Bob Avery, Vice President of Finance and Chief FinancialOfficer. Bob Avery will begin the call with a review of our Q3 financialresults and Steve Laub will provide a business update. At the conclusion ofSteve's remarks, we will open the call for questions.

During the course of this conference call, we may makeforward-looking statements about Atmel's business outlook, including statementsregarding our expectations for cost savings for 2007 and 2008, target gross andoperating margins and revenues. Our forward-looking statements and all otherstatements that are not historical facts reflect our beliefs and predictions asof today and, therefore, are subject to risks and uncertainties as described inthe Safe Harbor discussion found in today's pressrelease.

Now, I would like to turn the call over to Bob Avery for a discussionof our third quarter financial results.

Bob Avery

Well, thank you, Robert. As most of you may already beaware, today I announced my planned retirement to be effective sometime in thefirst quarter of 2008, after a successor has been named. My decision to retirecomes at a point when the company has successfully executed on many of thestrategic initiatives announced last December, and I am confident that Steveand the management team will lead the company to continuing successes. I lookforward to devoting more time to my family and my many other personalinterests.

Let me provide some details of our statement of operations.Revenues for the third quarter ended September 30, 2007 were $418.1 million, a 3.4% increasecompared to the $404.2 million for the second quarter of 2007, and a 3.2%decrease compared to the $431.7 million for the third quarter ended September 30, 2006.Excluding our RF CDMA foundry, revenues in the third quarter grew 4.5%sequentially and 4.2% year-over-year.

Gross profit was $149 million for the third quarter or 35.6%of revenue, an increase of 60 basis points from the prior quarter, and a 50basis points improvement from the same period last year. This was up $7.4million from the second quarter due to higher revenue and enhanced product mixand improvements in manufacturing efficiencies. It was down $2.5 million fromthe year ago quarter due to lower revenue.

Research and development expense was $63.6 million for thethird quarter. This was $5.7 million lower than our prior quarter due to theefforts to focus R&D on core technologies as well as the recent sale of ourNetwork Storage Products Group in the third quarter. R&D expense decreased$11.6 million from the year ago quarter, mostly due to the restructuringinitiatives that have been implemented.

Selling, General and Administrative expense was $58.5million for the third quarter. This was a decrease of $9.4 million from theprior quarter, primarily due to the reduction of one-time expenses associatedwith a special meeting of stockholders in May 2007 and various independentinvestigations which has been partially offset by higher ongoing legal fees andstock-based compensation expenses.

SG&A expense was up $8.3 million compared to the yearago quarter, due primarily to increased stock-based compensation cost,resources added to increase investments and sales and administrativeorganizations, as well as the weaker dollar in the third quarter of 2007.

For the third quarter, stock-based compensation expense was$4.9 million, of which $500,000 was included in cost of sales, $600,000 wasincluded in R&D, and $3.8 million in SG&A. Stock-based compensationexpense totaled $3.3 million in the prior quarter and $1.5 million in the yearago quarter.

Operating profit was $25.4 million for the third quarter ora 6.1% of revenue, and included net non-recurring charges of $1.5 million. Thiswas increase of $18.3 million from the prior quarter due to higher gross profitand lower operating expenses. Operating profit declined $800,000 from the yearago quarter, primarily due to current quarter restructuring charges. Excludingnet non-recurring charges, third quarter 2007 operating profit would haveincreased $700,000 from the same period last year.

Other income and expense net was $1.3 million in income forthe third quarter. This was an improvement of $700,000 from the prior quarter,and a decline of $400,000 from the same period last year, primarily due totranslation adjustments.

The income tax provision was $10.1 million for the thirdquarter, primarily due to statutory income at our foreign subsidiaries. Thiswas an increase of $3.1 million from the prior quarter and $4.5 million fromthe third quarter of 2006. Net income for the third quarter of 2007 totaled$16.6 million or $0.03 per diluted share. This compares to net income of$700,000 or zero pennies per diluted share for the second quarter of 2007, andnet income of $124.3 million or $0.25 per diluted share for the year agoquarter, which included income and gain from disposition of discontinuedoperations of $102 million or $0.21 per diluted share. Excluding the income andgain from the sale of our former Grenoblesubsidiary, net income for the third quarter of 2006 would have been $0.04 perdiluted share.

Turning to the balance sheet, total cash, which is cash andcash equivalents for the short-term investments, was $251 million at the end ofthe third quarter, a decrease of $225 million from the end of the priorquarter. During the third quarter of 2007, the company used $250 million torepurchase shares of its common stock, under an accelerated stock repurchaseprogram, and reduced its debt, current and long-term, $20 million from theprior quarter.

Cash flow from operations totaled approximately $46 millionin the third quarter. Capital expenditures were approximately $9 million forthe third quarter and $54 million year-to-date. Capital spending decreasedapproximately $10 million from the prior quarter and $19 million from the yearago quarter due to lower expenditures for semiconductor manufacturingequipment.

Depreciation and amortization was $30.9 million for thethird quarter. This was a decrease of $800,000 from the prior quarter, and adecrease of $25.6 million from the year ago quarter, approximately $15 millionof which relates to the sale of our North Tyneside, United Kingdom manufacturingoperation.

Accounts receivable were $226.3 million at the end of thethird quarter. This was an increase of $1.7 million from the prior quarter dueto the higher comparative revenue, and a decrease of $19 million from the yearago quarter due to a lower comparative revenue. Days of sales outstanding were49 at the end of the third quarter compared to 50 at the end of the priorquarter, and 50 at the end of the year ago quarter.

Inventory was $348.8 million at the end of the thirdquarter. This was a decrease of $12.9 million from the prior quarter due tohigher shipments and lower inventory bills. Compared with a year ago, inventoryincreased $45.3 million, primarily due to replenishment of MCU and buffer stockinventory from less than optimal levels. Days of inventory at the end of thethird quarter were 117 compared to 124 at the end of the prior quarter and 96 ayear ago.

The company's effective average exchange rate in the thirdquarter of 2007, was approximately $1.36 to the Euro, compared to $1.35 to theEuro in the second quarter of 2007, and $1.28 to the Euro in the year agoperiod, a $0.01 increase in the dollar/euro exchange rate reduces operatingincome by nearly $1 million each quarter.

On August 27, 2007, Atmel announced that its Board of Directors approved astock repurchase program, under which the company has repurchased $250 millionof its common stock. As of this day, an initial 43.4 million shares have beendelivered to Atmel, and under this program, the company may receive additionalshares during the period of up to four months from September 20, 2007.

The purchases under this program and actual number of sharesremaining to be purchased depend on a variety of factors, including the marketprice of the company's common stock, regulatory and contractual requirements,and other market factors during the period of up to four months from September 20, 2007.

Now, let me turn the call over to Steve for a discussion ofour business this quarter.

Steven Laub

Thank you, Bob, and good afternoon. First, let me say thatit's been a pleasure to have the opportunity to work with Bob during the past15 months. He has made innumerable contributions to Atmel during the past 18years and has been an invaluable partner to me, as we transform Atmel into ahigher growth, more profitable and valuable company. On behalf of the Board andother members of the management team, we thank him for his many years of supportand wish him the best in his well-deserved retirement.

Let me now turn to discussing the results for the thirdquarter. I am pleased to say that we have exceeded the upper end of our revenueguidance for the third quarter, as our overall revenues grew 3.4% sequentially.I am also particularly gratified by the increase of our operating profitabilitythis past quarter, excluding non-recurring charges of one-time events. Wegenerated operating profit of $26.8 million, our highest quarterly operatingprofit since the first quarter of 2001.

Now, let me provide you an update on the operating segments.Revenues for the Microcontroller segment, which set a record this quarter, were$119 million, up 7% sequentially, and up 11% from the same period last year.8-bit AVR products continue to be the major driver, achieving record revenues,and delivering 7% sequential and 17% year-over-year growth. 32-bit ARM revenuealso set an all-time high, growing 33% sequentially and 29% year-over-year. MCUdesign kit shipments remain strong, as the company shipped more than 22,000 inQ3 and over 60,000 since January.

We are particularly pleased to see that our decision tofocus on microcontrollers and related products as our core product area isbeing to positively impact our results, as we experienced strong sequential andyear-over-year growth. We continue to be the fastest growing major 8-bitmicrocontroller supplier and expect to continue to gain market share in Q4 and2008.

For the ASIC segment, our revenues were $128 million for thethird quarter, up 3% sequentially and up 1% from the same period last year. Smartcard IC sales were robust, with 11% sequential and 3% year-over-year growth.Advanced products also showed significant strength during the quarter, up 24%sequentially and 68% year-over-year. I am also pleased to mention that Atmel'sCAP customizable ARM-based system-on-a-chip product was voted one of China'stop five MCUs in a recent survey.

Turning to the Nonvolatile Memory segment, revenues for thissegment were $97 million for the third quarter, up 9% sequentially and up 3%from the same period last year. Serial EEPROMs and serial DataFlash productscontinue to penetrate new accounts and markets, as new customers convertapplications from parallel to serial interface. And applications, such as DVDdrives, LCD monitors, disk drives and PC BIOS. Serial EEPROM delivered 8%sequential and 10% year-over-year growth, while serial Flash was up 32% and 28%respectively.

For the RF and Automotive segment, revenues were $74 millionfor the third quarter, down 7% sequentially and down 28% from the year agoquarter. Excluding the RF CDMA foundry business, the segment is down 3%compared to the second quarter of 2007 and up 1% from the same period lastyear.

Atmel's recently launched LIN transceiver product, which isdesigned in combination with the AVR MCU, is being enthusiastically received byseveral major automobile OEMs. Our RF CDMA foundry business declined 22%sequentially and nearly 70% year-over-year and currently represents 3% of thirdquarter sales.

Dealing our business from a geographic perspective for thethird quarter, Atmel experienced growth in all regions worldwide. For thequarter, Asia was up 5% sequentially andrepresented 50% of total revenues. Europe was up 1%, representing 34% ofrevenues and the Americaswas up 7%, representing 16% of total revenues.

I now want to highlight two major events that occurredduring the third quarter that add significantly to shareholder value. First wasthe announcement in August of a $250 million stock buyback to return capital toshareholders. The second event is with the initiatives we announced lastDecember. Earlier this month, the company announced that it has entered intoseparate agreements with TSMC and Highbridge BusinessPark Limited for the sale of its North Tyneside, U.K. property and wafer fabricationequipment for $125 million, which has to be substantially completed during thefirst quarter of 2008.

The sale of this facility was part of a strategic restructuringinitiative announced last December to increase Atmel's competitive position andenhance shareholder value by optimizing manufacturing and refocusing thecompany for profitable growth. We have many hardworking and dedicated employeesat North Tyneside. We serve our customers andour company admirably, and we are committed to helping easy transition asproduction is concluded.

To ensure a seamless transition for customers, Atmel willcontinue to manufacture products at the North Tyneside facility into the firstquarter of 2008, and then redeploy production to our other fabs located at Colorado Springs, Coloradoand Rousset, France, as well as to externalfoundries.

These restructuring initiatives were announced last Decemberin addition to the sale of our North Tynesidefab. We have sold our Irving, Texas manufacturing facility. Wehave divested or curtailed further investment in over eight product lines,consolidated this Serial EEPROM and flash memory businesses into one streamlinebusiness unit, and are currently transferring test operations from NorthAmerica to Asia.

In total, the steps taken since December have enabled us toexceed our headcount reduction targets of only 300 non-manufacturing personnelby the end of 2007, and stay ahead of schedule to achieve previously announcedcost savings for 2007 of $70 million to $80 million, and $80 million to $95million for 2008.

Despite the progress we have made in refocusing Atmel, inits core businesses and in reducing its manufacturing cost as we transition toa fab light model. Atmel continues to remain heavily exposed to adverse changesin the dollar/euro exchange rate. As we enter the fourth quarter, we anticipatethat Atmel expenses are likely to be significantly impacted by recent changesin the dollar/euro exchange rate. To mitigate this impact in 2008, we intend totake additional strategic and tactical actions to reduce our exposure toeuro-based expenses.

Now I’d like to turn the call back over to Bob to discussthe expected financial impact of the sale of the North Tyneside fab, and the outlook for Q4.

Bob Avery

Thank you, Steve. In looking at our expectations for grossprofit going forward, we expect that the sale of our North Tyneside fab will have negligible impact for the fourth quarter. However,assuming the current level of revenues and no changes in the dollar/euroexchange rates, we expect the fab sale to contribute 150 basis points in thefirst quarter, and an additional 100 basis points in the second quarter of2008.

However, we anticipate that the weak dollar in the fourthquarter will have a negative impact on our gross profit, which will only bepartially offset by increased manufacturing efficiencies, and therefore, weexpect the fourth quarter gross profit will decline between 25 to 50 basispoints. We base our assumptions for the fourth quarter on an average exchangerate of a $1.42 per euro.

Separately, operating expenses are expected to beapproximately $128 million in total, plus or minus $2 million for the fourthquarter. Restructuring charges related to the sale of the North Tyneside facility for the fourth quarter will be in the range of$15 million to $25 million, with additional charges and related gains from thesale recorded in 2008.

Looking at the current business environment, we expectrevenues for the fourth quarter will be unchanged to up 2% on a sequentialbasis.

I would now like to open the call for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comesfrom Edwin Mok of Needham & Company.

Edwin Mok - Needham & Company

Hi, congratulations for a good quarter. Let me start withthe product group. It sounds like every product group has shown good growththis last quarter, while on your guidance you guys are looking for a kind of aflattish guidance for the December quarter. Can you Steve, maybe going to movein part to tell me which group you expect to show growth versus which one youexpect to decline?

Steven Laub

Yeah, I'll be happy to, and thank you, Edwin. For the fourthquarter, our expectation is the market controller group will continue to growon a sequential and year-over-year basis. We also expect that we would haveprobably a little bit of growth or pretty much flat, flat to little bit growthin the Serial EEPROM business, and memory's business overall. Our ASICsbusiness will be up also sequentially in the fourth quarter, and we expect theadvance products group will be down in the fourth quarter more significantlythan just slight, probably a roughly, I would say about a 20% down, it’s arelatively small group, but had a very big jump in the Q3 and it will not berepeated. Some of those bookings will be, those will not repeat in Q4. And theautomotive business, we think will be slightly down in the fourth quarter.

Edwin Mok - Needham & Company

Maybe a clarification, you said that the advance productgroup was one that's down a lot, because you see a strong growth in the thirdquarter, is that..?

Bob Avery

Well, that's correct. Just to give you a sense, that groupgrew, it's a relatively small group, that group grew roughly, they grewabout...

Steven Laub

Yeah. It's a 20% up in the third quarter and will be backdown about 20% we expect or more in the fourth quarter.

Edwin Mok - Needham and Company

I see, great. Yes, sorry to cut you off.

Steven Laub

No, go ahead.

Edwin Mok - Needham and Company

Yeah. So my second question is on wafer fab sale, thanks forgiving us some color in terms of the margin expansion going forward. But Iimagine that those numbers that you guys provide is only related to fab sale, Imean that you guys are still continuing to improve your efficiency on the otherpart of your operation as well, right?

Steven Laub

That's correct. These are specifically related to the impactof the North Tyneside fab sale and does not take into account otherefficiencies we're doing in another fabs, as well as other things we're doingon tested other operational changes we are making.

Edwin Mok - Needham and Company

So, historically, you guys have had this, I guess, 50 to 80basis point improvement per quarter, assuming that Forex is stable obviously.Are you guys still looking for similar level of improvement excluding the fabsale or maybe lowering that or how shall I look it on?

Steven Laub

I think that once you get past the fab, so assume that forthe time being that the impacts are as Bob described, so Q4 will have, forexample here is what's going on, Q4 the currency impact based on going from the$1.36 to the Euro to $1.42 to the Euro. The expectation is that the currencyimpact on that, nothing else changing, would be probably somewhere around 100basis point impact on our gross margins because of manufacturing efficienciesand enhanced mix of products and so forth. That's one of the reason we are onlyactually anticipating a decline of 25 to 50 basis points in Q4. So, we'remaking that up as because we are driving efficiencies in our manufacturingoperation.

The other way to look at it, it would have been up 50 to 75basis points in Q4, but for the fact that we're having a currency impactagainst us. So I would assume that what you should find is that for Q4, it iswhat Bob described. For Q1, the 150 basis point improvement, as compared to, ina sense where we are now is something that you should expect to where it willbe at the end of Q4. We'll see a 150 basis point improvement, again assuming noadditional currency change and no, nothing disruptive with respect to thebusiness levels and so forth.

I was expecting Q1 and Q2, expect the current numbers ongross margin we just talked about. After Q2, well, you should continue toexpect increases in our gross margin. We've highlighted to our investmentcommunity that we expect to achieve a 40% gross margin in the second half of 2008,that was based on, and by the way a fact that of a 1.36 exchange rate at thetime that we've made that and we fully anticipate that we would make that atthat exchange rate, given the exchange rates moving against us and given thatwe like meeting our commitments. We're looking, we are endeavoring to do whatwe can to continue to drive that even higher.

Edwin Mok - Needham and Company

That sounds okay.

Steven Laub

A long-winded answer, but I think I given you, well, whatyou are looking for.

Edwin Mok - Needham and Company

Yes, that was a very helpful color. One question on, justmaybe a housekeeping question regarding the stock repurchase. Are we expectingthat based on the full year or I guess three months from the September date.Are we expecting that to just partially kicked in, in the fourth quarter andmore likely kicked in by the first quarter in terms of the share count and howwe model that?

Bob Avery

So, Edwin, this is Bob. In the third quarter, we didn't seemuch of the effect because of this, we got the 43 million shares back towardsthe end of the quarter.

Edwin Mok - Needham and Company

Right.

Bob Avery

But, we'll see a 100% of the effect in the fourth quarter.

Edwin Mok - Needham and Company

Great, thanks a lot for clarifying that.

Bob Avery

Right out of account.

Edwin Mok - Needham and Company

Thanks. That's what I asked.

Bob Avery

Thank you.

Operator

You next question comes from the Doug Freedman from AmTechResearch.

Doug Freedman -AmTech Research

Great, thanks guys. Can you talk a little bit about what youare seeing as far as channel inventories and a little bit of a read onbasically what you are feeling, your customers are feeling, given the uncertainmacro times as the media likes to report?

Steven Laub

With respect to the inventories that we are seeing in ourchannels, I would say, actually inventories are pretty consistent with wherethey have been, probably or approximately two months of inventory in most ofour distribution channels, while actually for some AVR products, they areactually less than that. And so we are expecting some inventory build toreplenish those inventories for the AVR products. But overall, I'd sayinventories are by no means, are they too large or too abundant, in fact theyare where it historically have been or even a little bit light right now.

With respect to sort of our customers and what's going onwith that, I would say that we are a little cautious as you can tell by ourguidance. We just did our guidance in Q3 based on what we are seeing and basethat the macro environment does appear little bit more uncertain. We ourselvesare being a little bit more, I'd say prudent with respect to our guidance forQ4, but we are not saying, we are saying it's still, I'd say considered environmentout there, I wouldn't say it's particularly soft, I wouldn't say it'sparticularly strong, it's still sort of a very much of business as you looktype of environment, is what I would say is what we are seeing right now.

Doug Freedman -AmTech Research

Alright. Can you comment, and clearly you saw some roll offsin the RF foundry business. Can you let us know what the actual revenue was inthe third quarter? How much further of a roll-off is there, that we need toplan on?

Steven Laub

I think we commented on 3% of our sales, the RF foundrybusiness in the third quarter. We don’t even give the exact dollar amount, butthat will get you very, very close.

Doug Freedman - AmTechResearch

Okay.

Steven Laub

That’s what the number was. And we do expect to see somemore roll-offs, sequentially, each quarter through next year. But it is really,from a year-over-year basis, it's down approximately $30 million.

Doug Freedman - AmTechResearch

Alright. You've been very helpful on the gross margin impactfrom the closure. Can you talk about what the utilizations are, that's going tohelp make that happen? So, where was utilization now and where do you thinkthat will go with the closure at the fab?

Steven Laub

Utilization of which fabs?

Doug Freedman - AmTechResearch

In total for the company.

Steven Laub

Okay. So, the impact what we have right now is, give me onemoment. So, the fab in North Tyneside hasprobably been running roughly at about 50% to 60% utilization. Okay. And Iwould say that it will be running a bit higher in Q4, but still well below itsoverall capacity. With respect to the other fabs, they are running closer tobetween 85% and 90% of utilization. That being both Colorado,I will talk to you specifically about the Colorado Springsfab and the Rousset, Francefab.

My expectation is that, since we are building it, what we'redoing right now is, we're building inventory with respect to the products thatare in the North Tyneside fab. So, that willbe sufficient inventories to carry those products depending on which, forexample, the microcontroller products are building sufficient inventories tocarry those products until, really the fall of the next year to give us morethan enough time to convert those products and transport them over to the onesthat are to be built in Colorado Springs.

So, there are certain products to be built in both fabs, andthose ones we're not building excess, extra inventory, and the ones built onlyin that Fab9, we are building the extra inventory, and we will not be buildingreally manufacturing of those products, until the second half of next year in Colorado.

With respect to the smart card products that are built inFab9, we're also building quite a bit of inventory of those parts for ourcustomers as well, depending on the customer, anywhere between 6 and 12 months.Other inventory of those products for the customers, and we will not be, in thesense -- really, we're not going to tell you the exact data basis necessarilyand bring them up in Rousset, France. Whatwe'll do is, as those customers are migrating to our next generation products,those with migrations will be to parts in Rousset.

So again, you really want to see the impact in utilizationof that fab until the second half of 2008. And so that's why we expect a biguptick in those fabs than what we run in those, from the movement out of Fab9.There will be an uptake in those fabs in the first half based on just normalbusiness growth for those products that are currently run there.

Doug Freedman - AmTechResearch

Alright, terrific answer. On the smart card business thatyou mentioned there, can you comment on what you've seen there, as far aspricing and how you are holding, where you believe your share is in thatmarket?

Steven Laub

With respect to the smart card business, we've made adecision to one to diversify from participating almost wholly, and what hasbeen historically telecom SIM card market to other more attractive parts of themarket, which are banking, ID and system applications, which typically havehigh level of security and higher margin. So, that's the area we've beenfocusing a lot of our attention for the future growth or for future part ofthat business. We have also made a decision to not participate as aggressivelyin what I call the low-end or small SIM card business, which is the mostaggressively priced in the lowest price part of the marketplace. We areparticipating there, but we've reduced our participation in that part of themarketplace.

Doug Freedman -AmTech Research

Alright, two last ones. Just the MCU, the microcontrolleropportunity in automotive, you talked in the past about having an opportunitythere to try to get into some of your automotive accounts. Where are you at onthat in any progress that you can report?

Steven Laub

The answer to that is that it's actually growing rapidly forus in a very small number. So, I mean our automotive revenues, I'd say overallfor us and less than 5% than of our total microcontroller revenues. So eitherthe market is roughly probably 35% of microcontroller sales go into automotivefor us is less entire. It's growing very rapidly a year ago, it was probablyabout a 1% - 2%, and today it's probably closer to 3% to 4% sale. Our number isgrowing as our company micros, and that percentage is growing faster, so thatgives you a sense for that.

We think the opportunity is enormous for several reasons. Wehave customers on track through our automotive business unit. So, a lot ofcustomers that uses automotive products, and actually use our micro today, forexample, in the remote keyless entry products uses our micro, for example, arealready used in some of our micros. I don’t count that by the day as part ofour automotive micros, but we are using our microcontroller architectures inautomotive products today, that are used by automotive business units.

So, we have customers on track, we have the high voltagetechnologies and high temperature technologies, and we do have a big focus, wehave all the quality controls and so forth to support it. And we do have a lotof new products that are coming out. I talked about one in the call, about ourLIN Transceiver product that’s recently been introduced, that’s actually soldwith and coupled with our AVR product to send to automotive. So we look at thisas a terrific opportunity for us that we are investing pretty substantially,both from a development standpoint and from a applications and sales andmarketing standpoint.

Doug Freedman -AmTech Research

Terrific, one last detail, it sounds like inventory, shouldwe be planning on inventory increase given the closure of the fab and howshould we think of that over the next, say, two quarters?

Steven Laub

You should expect that there will be some increase ininventory because of the fab closure. Bob, why don’t you talk about what kindof levels increases.

Bob Avery

There is a variety of factors going to inventories and Ihave learned over the years, a solid prediction of absolute number on inventoryis a dangerous thing to do. But generally, Steve is right. The inventories willincrease somewhat. I don’t expect that will increase dramatically, though.

Doug Freedman -AmTech Research

Alright. Terrific and congratulations, Bob, on yourretirement and thanks Steve and guys, nice job on the quarter.

Bob Avery

Great. Thank you very much.

Operator

Your next question comes from Steve Park of WedbushSecurity.

Steve Park - WedbushSecurity

Hello. Steve.

Operator

Mr. Park, your line is open.

Jingo - WedbushSecurity

Hello. Yeah. This is [Jingo] for Steve. Steve is on theother line. Just a quick question, you mentioned gross margin improvement in Q4and Q1 What’s the particular impact on the MCU and the smart cards?

Steven Laub

The MCUs and smart cards, we'll actually see effectively thevast majority of that gross margin improvement. Those are the two product linesthat are built in the North Tyneside fab. Ifyou think about taking the gross margin improvement that we've articulate,which is 150 basis points in Q1, another 100 basis points in Q2, those would bepretty much equally shared between those two business units. I don't have thecalculations, so I can't exactly tell you exactly what happens to them, butit's a pretty substantial increase, I would say for microcontrollers, itprobably takes the gross margin up about 5%, and for the smart cards itprobably takes them up about even more than that I think. Bob, do you thenumber there?

Bob Avery

No. I don't. But it's going to be a substantial differencebecause they were observing considerable amount.

Jingo - WedbushSecurity

Yeah. Okay that's fair enough. And then the, can you commenton about lead times. You mentioned the inventories levels, the cargo sale, howabout the lead times?

Steven Laub

Lead times are typically 4 to 6 weeks for most of ourproducts for which we provide. We sell through distribution and so forth, someautomotive products typically have much longer lead times because they are morebuild to order, but the, our lead times are fine.

Jingo - Wedbush Security

Okay. How about the ASPs? Can you comment any ASP declinesacross your product lines?

Steven Laub

There has been no substantial decline in the ASPs across ourproduct lines. I'd say it's the normal orderly declines of the industry andthere has been no unusual pricing behavior that we experienced this pastquarter.

Jingo - WedbushSecurity

How about Q4 ?

Steven Laub

We don't anticipate, the usual pricing, even Q4 either.

Jingo - WedbushSecurity

Okay. Thanks. Any plan for the another fab sale in Europe.

Steven Laub

I am sorry.

Jingo - WedbushSecurity

Do you plan for, do you plan to sell another fab in Europe?

Bob Avery

We haven't made any announcements of any intentions withrespect to, but besides our fab in Germany, which we do plan onselling, so I just spoke there. We do plan on selling that fab we hadarticulated previously that we would be putting our energy into selling theNorth Tyneside fab first, because that had greater impact on our operationalperformance, but we do anticipate selling the Heilbronnin Germanyfab is well. We have no plans at this current time to sell any other fabs in Europe.

Jingo - WedbushSecurity

So you don't have a timeframe for the sale?

Bob Avery

We don't a specific timeframe for the sale. Our anticipationis that it would probably, so it would sell probably over the next 12 months orso.

Jingo - WedbushSecurity

Okay. Fair enough. Thanks.

Operator

Your next question comes from Robert Burleson of ThinkEquityPartners.

Robert Burleson -ThinkEquity Partners

Hey. Good afternoon. Thanks for taking my question.

Steven Laub

Sure.

Robert Burleson -ThinkEquity Partners

I wanted to just get a sense when just stepping back fromthe current environment that everybody is worried about. It seems like one ofthe stories here is that you guys are doing a really good job taking marketshare in microcontrollers. I want to get a sense in the automotive market, whatyou guys see that's kind of the key differentiator, that's allowing you to dothat, let's say over the next 12 months?

Bob Avery

Specifically, one of the key differentiators are Atmel'smicrocontrollers is that our products besides having a sort of a higherperformance in that product than any other on the market, from the standpointof architectural efficiency, at the same time combining the higher performancewith very low power is a combination that has been very successful for us. Ourplans that can succeed in automotive are to utilize the advantages of our, in asense, more advanced architecture and that's offered by our other competitors.So again the lower power, the higher performance, now combined that with thehigh voltage, our technology capabilities that we have and also combining itand the high temperature ones. And then adding to that, the qualitycapabilities that we have through automotive business unit that they offer, aswell as some, we'll do more product will be in combination with them as well,so that we sell our AVR product to our microcontroller products in con serviceof our automotive products. We think it will be very successful because, wecontinue to make a lot of progress and continue to penetrate in the commercialmarkets, because we have this slightly superior architecture, and we also haveoutstanding design tools. And so, we will combine that, that will be also bevery relevant for the automotive segment as well.

Robert Burleson -ThinkEquity Partners

In terms of competition, do you guys look at the competitivelandscape being more competitive or competitors being more in Europe or more inNorth America at this point, in terms of whereyou see most of the competition going forward?

Steven Laub

I'd say the competition is everywhere.

Robert Burleson -ThinkEquity Partners

Okay.

Steven Laub

This is a worldwide marketplace.

Robert Burleson -ThinkEquity Partners

And then just lastly, looking at this distribution, what'shappening with distributors recently? Are your distributors more cautious withregards to their end customers and did you see change at some point within Q3or early Q4 that with regards to distributors that prompted you to be cautiousin your outlook?

Steven Laub

I would say, I am not so much basing it on what's happeningtoday with our distributors. Our outlook is based on many different variables.It's based on impact from our sales force, it's based on our backlog that we'vegenerated, it's based on the specific shipments and resource inputs we have onspecific individual customers that are business units where business units areinterfacing with, and also inputs from our distributors. So, it's really manydifferent things that go into formulating our perspective, as well as whatother people in the marketplace are seeing as well, that obviously is going toinfluence our decisions.

Robert Burleson -ThinkEquity Partners

Okay. Great, thank you very much.

Robert Pursel

Thank you.

Operator

Your next question comes from Kevin Rottinghaus of ClevelandResearch.

Dennis Reed - Cleveland Research

Hi, this is actually Dennis Reed for Kevin. A couple ofquestions. First, just a clarification on the OpEx. I think you had mentionedOpEx would $128 million roughly in the out quarter. Is that including thecurrency that you had baked in or out the actual currency?

Bob Avery

That has the currency baked into it.

Dennis Reed - Cleveland Research

Okay, thank you. Secondly, if you look at the competitivelandscape, worldwide in microcontrollers, based on the success you guys haveseen over the last 12 to 18 months, have you seen any changes from any of yourcompetitors and how they have reacted?

Steven Laub

In how they reacted to what?

Dennis Reed - Cleveland Research

To your success in the marketplace.

Steven Laub

I don’t know if they're reacting specifically to us. I kindof think that the market -- it’s a very competitive marketplace, with a lot ofvery substantial large company competitors. My sense is everybody is focused onwinning and succeeding in their marketplace. It’s a very attractive marketplaceand the reason we were focused on it, is that has tens of thousands ofdifferent customers in different application areas, different segments. And so,you don’t compete against the same people all the time. You're competing withmany different people in many different areas, different markets and differentapplications, and I think in that respect is, one of the reason it’sattractive, it also allows you, I think to compete more effectively because ofthat as well. I don’t see any unusual or different, a different behavior that Isaw a year ago.

Dennis Reed - Cleveland Research

Okay. Yeah, if you look at the microcontroller, yourmicrocontroller business, how you see AVR 32 being received?

Steven Laub

AVR 32 is actually received quite well. Currently, therevenues for that product line are very small, so we don’t break it out andreally talk about it. But we do track are designed total shipments and ourdesign wins, and from that measure it’s ramping up nicely for us.

Dennis Reed - Cleveland Research

Okay. And I guess just lastly, if you look at over the lastnine months, so, is there any end markets in particular with yourmicrocontroller business that you had success in, whether it's competitive orjust market growth?

Steven Laub

I think one of the areas that are, this is the largest endmarket for us in microcontrollers is industrial. We continue to have a lot ofsuccess in the industrial marketplaces, which does include by the way housingand things like that. We are also having success in consumer electronics aswell. So some of the portable consumer electronic products are also usedmicrocontrollers, and we are having success in that marketplace as well.

Dennis Reed - Cleveland Research

Okay.

Steven Laub

The kinds of applications are, for example, the touchsensing is an area of growth for any good microcontrollers.

Dennis Reed - Cleveland Research

Okay. And I guess lastly, I know in the past year you'veprovided the backlog coverage for the quarter. Could you provide that again?

Steven Laub

Yeah. Currently our backlog coverage, lets say, as of wherewe are in a sense, going into say this week, our backlog coverage is roughly75% for Q4 to our guidance.

Dennis Reed - Cleveland Research

And what was the last quarter, I mean I can go back andcheck.

Steven Laub

Last quarter was a little bit higher. It was about 80%, andthen last Q4, it was about the same as it is this Q4.

Dennis Reed - Cleveland Research

Okay. Alright, well, thank you very much andcongratulations.

Steven Laub

Thank you.

Bob Avery

Thank you.

Operator

Your next question comes from Kevin Cassidy of Thomas Weisel& Partners.

Kevin Cassidy -Thomas Weisel & Partners

Thank you for taking my question. A few more questions aboutthe microcontroller business. Has there been, is the growth coming fromdistribution if the strength is in industrial or has it, are you doing thatdirect?

Steven Laub

We are growing in both distributions and direct.

Kevin Cassidy -Thomas Weisel & Partners

But is it percentage phases up about the samequarter-over-quarter?

Steven Laub

I don’t actually have that in front of me. I would have togo check that. I just know that both channels are growing for us in the micros.

Kevin Cassidy -Thomas Weisel & Partners

Okay.

Steven Laub

We don’t often have clean breakouts, because we stillrecognize what our revenue on a ship to not a sell through.

Kevin Cassidy -Thomas Weisel & Partners

Right.

Steven Laub

And so, we don't have all the sell through information ofour distributors that could tell us this sell through from this distributor forthis product. It's not tracked cleanly here yet.

Kevin Cassidy -Thomas Weisel & Partners

Okay. And just from your comments, that you are expectingdistribution inventory, say, constant in fourth quarter?

Steven Laub

No, I didn't say, we'll stay constant. Distributioninventories, right now for us overall, are relatively, I look at it from astandpoint of, are they stable on a weeks. How many weeks of inventory they areholding relative to sales.

Kevin Cassidy -Thomas Weisel & Partners

Right.

Steven Laub

Okay. So, overall, since our business is flat to up 2%, weare expecting the Q4, and assuming distribution maintains its percentage ofyour business, it would be probably slightly up, the distribution inventoriesin Q4 as well. The AVR business, we expect to grow more than that in Q4. AVRinventories are actually, or micro inventories are actually a little bit downrelative to the normal inventories they hold. I expect they're going to beboosting our inventories back up in Q4.

Kevin Cassidy -Thomas Weisel & Partners

Okay. Thank you.

Steven Laub

Sure.

Operator

(Operator Instructions) We have a follow-up question fromEdwin Mok of Needham & Company.

Edwin Mok - Needham & Company

Hi. I actually have three questions. First one is on, justgoing back to the memory group. Do you guys see that as just, is it that youguys are gaining share against your competitor or are you guys actually justseeing general positive longer term in that group?

Steven Laub

Are you specifically about Serial EEPROMs or the Flashmemories?

Edwin Mok - Needham & Company

Actually, both of them, if you don't mind going through thedetails.

Steven Laub

Okay. So Serial EEPROMs, I think other people have noted,was relatively strong last quarter, not just for us, but for other people inthis marketplace. I believe that one or two other suppliers who are significantsuppliers had relatively robust sales. So I think we all kind of experiencedthat this past quarter. We don't expect that, that can continue as strongessentially going forward. I'd have to, I am not positive, we gained share, Ithink we did. We at least maintained, if not gained share, I would think ofSerial EEPROMs last quarter.

With respect to Flash memories, when we consolidated theFlash group from the serial EEPROM group, at the very end I believe of Q2. Andas part of that, the operations, was transferred over to the people who run theoperations of serial EEPROM. There were a number of delinquencies and otherthings with respect to the shipments of Flash. A lot of that was newly ratedduring Q3, and some of that is still being taken care of in Q4. And so, I thinkto some extent you saw a bit of the growth there was because of that.

Edwin Mok - Needham & Company

Great. The second question is on seasonality. Historically,you guys don't have to see a lot of seasonality in the first quarter. Now thatyou guys have more of these [seats] seems like you have more opportunity onmicrocontroller and relate to the consumer end market. Do you expect to see abigger seasonality in the first quarter going forward?

Steven Laub

Probably, yes. I think we will be seeing more seasonality. Ithink the industry is becoming more seasonal, frankly, overall. But for us, themicros, we expect to see some seasonality through our business. I would alsothink certainly, the memories are that way, some of the ASIC product, the smartcard products are that way. So that is my expectation.

Edwin Mok - Needham & Company

Great. And one last question, just CapEx and maintenance,so, it is right now that you guys sold the U.K. Fab. Do you, what are you guysexpecting for your CapEx that you need to maintain on your existing profit thatyou have, going forward?

Steven Laub

Well, you know, the nature of our CapEx changes overtime,just to put a little color on it. So our Fab and Fab 7 and we will say, ispretty mature, and we don't expect to make huge capital investments in that.So, it'll be primarily replacement and technology upgrades. Same as, it is evenmore true of our 6 inch fab in Colorado Springs. They'll both remain productive of course. Andthen, it looks like a large part of our CapEx in the next year or two willprobably be directed at items like probers and backend testers, final testers.So, as we look at the landscape for the upcoming year, I’d say that we couldexpect our CapEx to be similar or maybe a little bit higher next year than thisyear, probably in the $80 million to $90 million range.

Edwin Mok - Needham and Company

So basically, this pass quarter you guys just have lowerthan normal CapEx this quarter, is that right?

Bob Avery

Yeah. We’ve been very careful about acquiring what we need,and just haven’t had the real need for it.

Edwin Mok - Needham and Company

Great. Thanks for answering my question.

Bob Avery

Thanks, Edwin.

Operator

He is still online, sir.

Steven Laub

Edwin, are you still there?

Edwin Mok - Needham and Company

Yes. I am done. Thank you.

Bob Avery

Well, Steve had another comment.

Steven Laub

First, I have to punch you. Well, I think the company isbecoming, well, it is become a little more seasonal, so, I think the industryis becoming that way with respect to Q1. I'd like to think that in the microbusiness, that given our fast growth in our business and the opportunities wesee and the fact that we are gaining market share, my expectation is that we’llcontinue to grow, not just in Q4, but sequentially again in Q1 in the microbusiness.

Edwin Mok - Needham and Company

Great. Thanks.

Operator

At this time, there are no further questions. Do you haveany closing remarks?

Robert Pursel

Thank you, Stephanie. During the month of November, Atmelwill be participating and Steven Laub will be presiding at the UBS GlobalTechnology Conference in New York City onNovember 13 and the Credit Suisse Annual Technology Conference in Scottsdale on November28. In January, Atmel will also be presenting at the Needham & Company TenthAnnual Growth Conference in New York City. Webcast information for these events will bepublished in the Company’s investor relations website. This concludes our thirdquarter financial conference call. Thank you for joining us today.

Operator

This concludes today's conference. You may now disconnect.

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