萊迪思半導體 (LSCC) 2006 Q2 法說會逐字稿

Welcome to today's conference call.

Copies of the Lattice Semiconductor second quarter, ending June 30, 2006, earnings press release may be obtained from the Company's website, which is www.lscc.com.

This call is being recorded and broadcast live over the Internet by CCBN.

A live broadcast and replay of the call will available on the Lattice Investor Relations website, www.lscc.com.

At this time, I would like to turn the call over to the Chief Financial Officer, Jan Johannessen.

Mr. Johannessen, please go ahead.

Thank you, and good afternoon, everyone.

Joining me on the call today is Steve Skaggs, our President and Chief Executive Officer.

Before we begin, I would like to read a Safe Harbor statement, and then give a financial review of the second quarter.

Then Steve will provide a business review, followed by our third quarter outlook.

We will then hold a question-and-answer session.

I will now read the Safe Harbor statements.

This conference call may contain forward-looking statements within the meaning of the Federal Securities laws, including statements about future quarterly financial results, revenues, gross margins, customers, product offerings, and the Company's ability to compete.

Estimates of a future revenue are inherently uncertain, due to the high percentage of quarterly turns business.

In addition, revenue is affected by such factors as pricing pressures, competitive actions, the demand for our products, and the abilities to supply products to customers in a timely manner.

The potential impact of designing activity on future revenue is inherently uncertain because it is unknown whether or when any particular designing may ultimately result in sales of a significant volume.

Actual gross margin percentage and operating expenses could vary from estimates, due to changes in revenue levels, product pricing and mix, wafer assembly and test costs, manufacturing yield, stock-based compensation charges, and other factors.

In addition to the foregoing, actual results may differ materially from our forward-looking statements, due to the SEC's informal inquiry and any resulting actions, the Company's dependencies in its silicon wafer suppliers, technological and product development risks, and other risks that are described in our filings with the Securities and Exchange Commission.

The Company does not intend to update or revise any forward-looking statement, whether as a result of events or circumstances after the date hereof, or to reflect the occurrence of unanticipated events.

I'll now start the financial review.

We had another excellent quarter, as we returned to profitability, and posted strong revenue growth.

We recorded quarterly net income of $2.1 million, and a non-GAAP net income of $5.5 million.

Revenue for the second quarter was $62.7 million, up 9% sequentially from the first-quarter revenue of $57.5 million, and up 20% from revenue of $52.4 million in the same quarter last year.

The gross margin for the second quarter came in at 56.7% up from the 56% we posted in the first quarter.

The improvement in gross margin was primarily due to cost reduction and yield enhancement for new products.

Quarterly R&D expense was $21.1 million, which includes $400,000 in stock option expenses, and was flat with the prior quarter, and down $3.9 million from the second quarter last year.

Quarterly SG&A expense was $13.8 million, including $200,000 in stock option expense, and was up $1.2 million from the first quarter expense of 12.6 million, down $2.6 million from the comparable quarter a year ago.

The increase from the first quarter was partially due to a special legal credit of $544,000 in the first quarter, higher commission and selling-related expenses, and a reduction in sublease income.

The sublease income of approximately $240,000 per quarter we have been receiving since the acquisition of Vantis in 1999 terminated during the second quarter, and we will no longer benefit from this credit to operating expenses going forward.

Intangible asset amortization was 2.7 million for the quarter, down $100,000 from the first quarter.

Intangible asset amortization for the third and fourth quarters will be flat, at $2.7 million; and the total for 2006, about $10.8 million.

Amortization of intangible assets will be substantially eliminated in 2008.

Total stock-based compensation expense for Q2 was $0.6 million, which includes 0.4 million for R&D and 0.2 million for SG&A.

We're in the process of buying out the U.K. office lease, which we closed down as part of the Q4 2005 restructuring.

As a result, we booked an additional restructuring charge of $139,000 in Q2, which effectively closes this matter.

Other income for the second quarter was $4.5 million and included $1.3 million gain related to the sale of foundry investments.

Our ongoing quarterly level of other income is approximately $3.2 million.

We recorded a tax provision for foreign taxes during the second quarter of $256,000.

We currently expect to record a quarterly tax provision in the 200 to $225,000 range for the remainder of 2006.

The company currently enjoys a net operating loss carry-forward in excess of $200 million.

The June quarter net income was $2.1 million, or $0.02 per share, a significant improvement over the net loss of $8.2 million, or $0.07 per share for the comparable quarter a year ago, and compared to a $0.8 million loss, or $0.01 per share in the first quarter.

These losses include charges of 2.7 million, 3.5 million, and 2.8 million respectively for the amortization of tangible assets.

On a non-GAAP basis which includes -- excludes the aforementioned intangible asset amortization, stock-based compensation expense, and restructuring charge, we posted net income of $5.5 million, or $0.05 per share for the second quarter.

This compares to a net loss of $4 million, or $0.04 per share, posted in the comparable quarter a year ago, and net income of $2.7 million, or $0.02 per share, posted in the first quarter.

Turning now to the balance sheet.

Cash and short-term investments at June 2006, were $262.7 million, up $12 million from March 2006.

We received proceeds of $10.4 million from the sale of the aforementioned foundry investments.

And we were also cash flow positive from operations for the quarter.

Accounts receivable increased from 25.4 million to 33.1 million at June 30th.

The increase is attributable to higher billings and revenue, and to lesser extent, the timing of billings during the quarter.

Days sales outstanding increased to 48 days, slightly higher than our target of 45 days.

We have no concerns about the quality of our receivables and expect to return to our days outstanding target.

Inventory increased $3.6 million from March 31st, to $35.8 million, and now stands at about four months on a cost of sales basis, which is within our target range.

The increase was due to building of inventory of the Company's new products.

We spent $5.5 million on capital expenditures during the second quarter, mainly for increasing test capacity and tooling for our new FPGA products.

And the quarterly depreciation expense was $3 million, flat with prior quarter.

Deferred income at June 2006, was $11.4 million, up 3.8 million from the March quarter.

The increase from March was primarily due to increased inventory at distributors, consistent with the strong resale we experienced in the second quarter.

To conclude, I'm very pleased that the actions we've taken over the past year are paying off, and that the Company has, after years of losses, finally returned to profitability.

This concludes the financial review portion of the call.

I would now like to turn the call over to Steve Skaggs.

Thanks, Jan.

Last quarter we posted sequential revenue growth for the sixth consecutive quarter, and also posted accelerating sequential revenue growth when compared to the first quarter of 2006.

These strong results were mainly due to new product revenue growth, although we did also benefit from favorable market conditions across most geographies and end markets.

Initially, as Jan mentioned, we reported a profit for the first time since 2001, and also positive operating income, after the exclusion of non-cash charges.

I personally am very pleased with these results, and would like to compliment each and every Lattice employee for a job well done.

Geographically during the quarter, Asia made up 45% of our revenue; the Americas, 30%; and, Europe, 25%.

Asia grew 16% sequentially.

North America grew 6% sequentially, while Europe grew 2%.

Revenue by end market for the quarter was as follows -- communications made up 51% of revenue; computing, 17; and the other market segments, 32%.

All three end market segments that we report upon grew sequentially last quarter, with the communications market posting the highest growth rate.

Distribution represented 42% of revenue last quarter, while the direct channel accounted for 58%.

Distribution revenue grew 14% sequentially, driven by strong resale, particularly in North America.

During the second quarter, FPGA product revenue was $13.1 million, or 21% of total revenue, and also grew 21% sequentially and 33% on a year-over-year basis.

As anticipated, we achieved record quarterly FPGA revenue and reported the highest level of sequential growth in our short history as a FPGA supplier.

We clearly gained market share during the quarter, and this performance was due to the growth of our new FPGA products.

PLD product revenue accounted for $49.6 million, or 79% of revenue and grew 6% sequentially and 17% on a year-over-year basis.

During the quarter, we saw solid growth from our several product families in this business segment, particularly our MACH 4000 and ispPAC-POWER and Clock mixed-signal products.

During the quarter, we also saw the first volume shipments of our newest PLD product line -- the 130-nanometer embedded flash, MachXO family -- which more than doubled its revenue on a sequential basis.

Going forward, we expect continued growth from all of these new PLD product families.

On an overall basis we posted another strong quarter of revenue growth from our new products, as historic customer designs continued to move into volume production.

During the second quarter, new products accounted for 14% of total revenue and grew 60% sequentially.

Mainstream products accounted for 51% of revenue and grew 11% sequentially, while mature products accounted for 35% of revenue and declined 4% sequentially.

I'd like to turn now to a brief update on our product development activities for our next-generation FPGA products.

We are now well into the market rollout phase of our first 90-nanometer FPGA products -- the high-performance LatticeSC family with embedded SERDES transceivers, and the low-cost LatticeECP2 family.

During the last quarter, we made strong progress towards fully implementing the system-level support required to assist broad customer adoption of these important new families.

We now have extensive IP core availability in place for both families, and at present have 27 total available IP cores for the CP2 family and 42 total available IP cores for the SC family.

During the quarter we also delivered important IP support for PCI Express in the x1, x4, and x8 mode for both the ECP2 and SC families.

In addition with the recent release of our ispLever 6.0 software, we now have a very high-quality software design environment to support 90-nanometer customer designs.

In fact, our own internal benchmarks show that, for the first time in our history, we can now offer FPGA customers both performance and utilization advantages versus the comparable FPGA products from our competition.

Whether customers desire a low-cost product family in the ECP2 or high-performance, high-density offering with SERDES transceivers in the SC family, we believe we now have very compelling alternatives on all relevant customer dimensions.

At present we are sampling the first two devices of the ECP2 family and expect to release the entire [65] device family to volume production by year end.

We are also sampling two devices in our SC family and expect to have four devices in the market by year end.

Finally, last quarter we continued to make strong progress on our key 2006 corporate goals.

We are once again reporting new product lead revenue growth.

We are bringing a highly competitive portfolio of 90-nanometer FPGA products to market in a timely fashion.

And, of course, as we mentioned, we have now achieved profitability.

We remain pleased with the progress we have demonstrated towards all three of these goals during the second quarter and look forward to further progress on all for the remainder of the calendar year.

Turning now to the 2006 third quarter outlook.

We entered the third quarter with a higher backlog and anticipate continued sequential revenue growth from our new products.

However, we are also aware that the summer quarter has historically been a seasonally slow quarter for our industry, particularly in Europe, and have taken this factor in account in developing our outlook.

Consequently our current estimate for total sequential quarterly revenue growth for the third quarter is a range of flat to 4% growth.

For the rest of the P&L, we currently have the following expectations for the September 2006 quarter.

We expect gross margin, as a percentage of revenue, to be approximately flat at the current level, plus or minus 50 basis points.

Total operating expenses, including an estimate of $1 million non-cash charge for our stock compensation expense, are expected to be approximately $35 million.

We expect intangible asset amortization to be flat, at approximately $2.7 million.

We expect approximately $3.2 million in other income.

And, finally, we expect the share count to be relatively flat.

That concludes the opening remarks.

And with that, we'd like to now open the call for question.

[OPERATOR INSTRUCTIONS] And now let's go to Shawn Webster with JPMorgan.

Hi, this is Shawn for Chris Danely.

Good quarter, guys.

Congratulations on the profit improvement.

Thank you.

On the -- can you give us a little bit more color on your backlog, where you saw the best improvement sequentially?

Can you talk about, also, what your book-to-bill ratio is and what the terms required are?

Sure.

We typically don't give a quantitative breakout of our backlog.

But I will say that the -- that backlog grew nicely, in double-digit rates in terms of sequential growth.

The book to bill was above 1.

With regard to turns, let me just share some data that we typically discuss with regarding turns.

And then I have some new data for the investment community.

Historically, we've given turns data for the direct channel only, and as many of you know, the direct channel accounts for slightly more than half of our overall business.

For the direct channel, turns last quarter were about 40%.

Recently, we've been able to gain agreement from our major distributors to provide us data on their quarter-beginning end customer backlog.

And that data allows us to calculate distributor turns on an equivalent basis to the direct turns number, as well as being able to calculate an overall turns number.

Therefore, going forward in this forum, we plan to only to provide the overall turns number, as we believe that number is more useful than the direct turns number in evaluating our business.

So let me now give you the overall turns number for the last two quarters.

For Q1, overall turns were 56%, and for Q2, overall turns were 50%.

Now, to achieve the midpoint of the guidance that we just gave, the overall turns number needs to be approximately 45% for the third quarter.

So hopefully that answers all your questions.

That's very helpful.

Thanks.

Sure.

Next we'll hear from David Duley with Merriman Curhan Ford.

Yes, congratulations on nice quarter, return to profitability.

A couple of things here.

On the new FPGA families, can you give us any more statistics about these new families, either design wins, cumulative totals, either this quarter or in total?

And maybe give us an idea what those two new product families did sequentially.

Sure.

I can touch on that.

New FPGA designs continued to grow nicely and established a new record last quarter.

Those designs grew at about a 35% rate on a sequential basis, and I believe on a year-over-year basis, actually improved about five-fold.

We don't plan to continue to disclose the specific number, as I alluded to last quarter in the call, because at this stage we believe revenue trends and, specifically, new product revenue trends are a more useful indicator of the success of those new products.

Revenue from our new -- newest products -- namely, ECP, XP, and XO -- grew at about a 60% sequential rate last quarter, and almost 10 times when measured on a year-over-year basis.

Additionally, the ECP product family, which as you know, Dave, was the first family to be introduced, that family broke the $1 million quarterly revenue barrier for the first time last quarter.

And I would also say, collectively, those new products accounted for about 20% of our total sequential revenue growth last quarter.

So that, hopefully, provides you with some more granularity on the revenue performance of those products.

Going forward, we expect those products to continue to generate strong revenue growth and contributions to top-line growth.

I'll ask one follow-on, then turn it over to somebody else.

In these new FPGA families, you're obviously growing those families at a very, very rapid rate, and your overall growth rate here sequentially, 21%.

I think it might be the second quarter in a row, your FPGA families have outgrown your competition.

Could you help us understand what -- which products or features in these two families you're seeing the most success.

What's the key differentiator here as to you taking share?

Well, the XP family is, obviously, very differentiated.

It offers a non-volatile FPGA.

That offers some important advantages to the customer base that aren't available in, basically, the mainstream volatile FPGAs.

Those are advantages involving design security, instant-on functionality, and a more robust field upgradable solution, as well as the ability to implement an FPGA without extra componentry that can provide board space and cost savings.

So, really, dependent on the customer and the application, many of those advantages can be important, but all are differentiated.

So that product really provides some substantial differentiation across those dimensions that I discussed.

With regard to the ECP family, really, our strategy there has been to provide more bang for the buck.

Our competitors have low-cost solutions.

They also have -- they basically have a two-brand strategy.

We don't offer, kind of, a high-performance mainstream FPGA.

We do offer one at the very high end with embedded SERDES, but we're not offering, kind of, a mainstream, high-end FPGA.

We prefer to use the low-cost architecture to pack in as many features and performance in that architecture.

So we're able to provide slightly better performance, better DSP functionality, and additional features that typically aren't available in the low-cost fabrics.

That's what we've done with the ECP1.

We've really furthered that emphasis strongly with ECP2 on 90 nanometers.

And that's essentially the product differentiation.

I will also say that our market is not really a monolithic market.

There are many, many customers across the world.

So there are ample opportunities to exploit differences in the pricing tactics of our competitors and difference in the support and relationships with customers.

So, really, we're utilizing the ECP architecture to exploit those opportunities in the marketplace.

And we believe, at this point, particularly with our 90-nanometer ECP2 architecture, we have a compelling solution that can be meaningful to a broad part of the customer base.

Thanks.

I'll come back.

Our next question will come from Bill Dezellem with Tieton Capital Management.

Bill, your line is open.

You may want to check your mute function.

Hearing no response, we'll move on to Aalok Shah with D.A. Davidson.

Hi.

Good quarter.

Couple quick questions for you.

On the inventory front, one of your competitors last night mentioned there could be a build of inventory taking place, especially with CPLD product in the industrials end market.

Are you guys seeing any kind of an inventory build, maybe at the end market?

And is that, maybe, reflected, I guess, in your flat to up 4% guidance?

And, then second question is -- When we look at -- and now that you're profitable, is there any consideration to maybe pay off that zero-convertible debt or maybe buy back some stock at this point?

I'll take your first question first.

We're not seeing any inventory built to speak of.

Really, the way we keep track of that is by trying to keep our lead times in a reasonable level.

If you look at our PLD business, at this point, it's still primarily made up of, kind of, mainstream products.

Those did enjoy good growth last quarter.

But the lead times on our mainstream PLDs currently sit at about the four- to six-week area.

It's dependent upon product and package types.

But that's essentially where it was last quarter.

So there's really been no appreciable movement in our lead time.

And we believe those lead times are manageable by most of the customer base to achieve their business plans.

We are getting, I would say, historically, a larger number of expedites and pull-in requests.

And for the most part, our operations team and suppliers are able to really satisfy the vast majority of those requests.

And that's been something that's been ongoing during the entire year so far.

Further, if you look at our PLD business, you've seen the growth actually been relative linear and smooth, which I know is in stark contrast to the experience of our larger competitor in the PLD space.

So they may have some more unique circumstances going on in their business that I don't believe we are experiencing.

So we don't have any unusual concerns to report about inventory builds or inventory corrections within the PLD business.

The guidance for the third quarter really relates to the fact that summer, in a typical year, tends to be seasonally soft because of vacations in Europe and a slowdown in resale and that geography.

And that's what we've tried to build into our guidance at this time.

With regard to your second question, we have opportunistically repurchased convertible debt when we feel that it was in our best interests.

And we'll consider to view that as a financial alternative, which we believe is more preferable to repurchasing our stock, given our current capital structure and the price of the convertible bond.

Steve, a quick follow-up.

In terms of your first answer, if I were to -- if we were kind of handicapping in terms of what risks that you may see potentially down the road -- and we've seen a lot semiconductor names report some higher inventory levels this quarter -- is that a concern at all in that there's maybe some inventory maybe further up the chain than maybe you're looking at right now?

Well, it's always a concern.

I gave you the reasons why I didn't think it was a large risk.

Really, the inventory that we built on our own balance sheet relates to our newest products.

We believe that it's very important to have ample inventory to support the production ramps of our customers who choose to adopt those new products.

We don't really want to disappoint those customers.

We're confident that those new products will have successful revenue ramps.

And we'd like to be able to support the end product ramps of our own customers who adopt those newest products.

So we -- we've actually made an investment in building some inventory on our own balance sheet to support that.

And I gave you the lead times of our mainstream products.

The lead times of our new products are really down at the two- to three-week level because we want to make absolutely sure that we're able to ship all the demand that we might have, whether it's forecasted or not, for those newest products.

Okay.

Great.

Thank you.

Sure.

[OPERATOR INSTRUCTIONS] Next we'll hear from Lawrence Borgman with Jesup & Lamont.

Congratulations on the success of your new products.

I'd like to ask something about the communication business.

You mentioned that was, I think, your fastest growing segment.

Of course, it's your largest segment.

Wondering if you could kind of break that down by the pieces, which areas are doing the best?

Sure, Larry.

Last quarter, communications experienced strong growth, once again, with double-digit sequential growth.

And, as was in the first quarter, again, that strength was generally broad based.

Growth was really led by both the wireline and wireless segments.

I'd say the wireline segment was slightly stronger.

And that strength came from both domestic and European suppliers.

We also saw good growth from the satellite and set-top box segment last quarter.

So, as was the case in the first quarter of the year, we had very broad-based strength in the communication market across most end applications and most OEMS, with particular strength in the sub-segments that I pointed out.

Okay.

Just one other question.

With regard to the new products, the products that are non-volatile, are you finding that's a big factor in people's decision to use the product at this point?

Yes, it is.

Because, by definition, the products are more expensive than the SRAM products.

So everybody who's adopted those products has chosen pay some form of price premium.

So, really, that's not because they like us or the product's any different, because it does the same function, it's because they value the non-volatile approach and technology and what it can do for their application.

Is there any particular class of applications where that's particular valuable?

Well, if you look at the designs, the end markets really cut across the normal spectrum of FPGA design, so I would say, no.

But there are certain classes of applications that value non-volatility more.

Those would tend to be the high-reliability applications, and they would also tend to be applications that value security and applications that require field upgrades, because we believe we have a better and more robust field upgrade solution with a non-volatile product.

Thank you.

Our next question will come from [Kitlin Wolford] with Trellus Management.

Thanks.

Can you hear me?

Yes.

Must feel -- hang on a sec, I'm going to take this off this.

See if I can figure out how to make my phones work.

I don't think it has Lattice parts in it yet.

We can upgrade that in the field for you.

That'd be awesome.

That's got to feel a little bit better.

I can't -- I'm going to -- just want to pick a little bit more on some color on the split of the business.

And if -- first of all, does the FPGA business, as it's starting to become fairly material at this point, is the split that you gave for the overall business kind of the same way, the FPGA market segment split is going?

Or is it skewed more toward communications?

Could you put a little color on that?

It's non-materially different from the overall business.

So, I mean, is it suggest that, predominantly, we're getting -- I mean, is that -- is a lot of the traction coming into accounts that are already using PLDs?

Or are you seeing some greenfield opportunities that are ramping, as well?

Well, we believe and our experiences suggests that most consumers of FPGAs also have some PLD business, and that's the case of -- with our experience.

That's kind of different whether somebody who designs in one of our new products is a Lattice customer, not because they could be using our competitor's PLDs.

So we find that, of the new FPGA products, actually about half, or, actually, a little bit more than half of the designs are at customers that historically haven't been a Lattice account.

So, really, those new FPGA products are allowing us to expand our customer base.

But we find that those customers that we enter into with the FPGA products also have some PLD opportunity, as well.

Okay.

And -- thanks.

And, also, if you could, Steve, maybe give a little bit -- I'll kind of harp on the last question.

But a little bit better color in terms of -- I mean, can you describe an application or a geography that you're excited about?

I mean, is there a specific -- is there a specific place where you're seeing -- where you're seeing this go in?

I know it's not driven just by pricing, it's also functionality and the technology that you guys are delivering.

But, I mean, what -- help me put a little color --

Well, the FPGA and the PLD business, historically, is not one that's overly dependent on single applications.

Right.

So we've architected our products and intend to be successful across multiple market segments and multiple geographies.

On the margin, Asia is obviously an area that's historically grown well for us and our competition.

And we're excited about the indigenous demand in Asia.

And it tends to be a very dynamic market, and one that -- where there's a lot of new design activity.

And that's a market where we focus on and we believe that we're being successful.

In the rest of the world, the communication market is still over 50% of the market opportunity.

And that's an area where we're very focused on and where our SC product, which is not contributing revenue today, but is targeted, clearly, towards that market.

So we do have a particular focus on the communication market.

Additionally, beyond that, there is a substantial amount of diversification going on in our industry.

You have FPGA and FPLE technology gets adopted in new segments, where, historically, there's been no penetration.

Those are primarily the consumer market and the automotive market, as well as in some industrial applications.

But, really, there's no particularly single application that I would point out within those markets.

But all those are areas of focus for us, as well as our competition.

So broad base is the order, I guess?

I think so.

I mean, that's the nature of our business, and we are definitely not architecting products for specific applications.

All our products are targeted towards broad applications, with the single exception of the SC, which has got some unique functionality, designed to be very attractive for the communications market, which is the biggest market.

And without naming specific customers, I know that if you look into Japan, your -- obviously your fab partner is one of the large consumers -- or one of the large consumers of FPGA, PLD product.

Have you -- is there headway in more than a manufacturing relationship with your fab partner?

The intention of the -- to the two companies is to develop a sales partnership, as well.

And we have engaged our fab partner in Japan, Fujitsu, to actually distribute our products in the Japanese market for a very small number of accounts at present.

But the intention -- the mutual intention is to grow the market demand for FPGA products that are manufactured by Fujitsu using the Fujitsu sales presence both within Japan and within Fujitsu itself.

So that's a very long-term, strategic objective of both companies.

It's a win-win objective, obviously, and it's one that we'll be working diligently towards over the long run.

Okay.

Thanks.

I appreciate that.

And just one more quick one.

The substrate issue that was impacting a couple of your competitors in previous quarters, do you think that's worked its way through?

No.

Substrate lead times are still unacceptably long, and really has a constrain effect on, kind of, the higher end products.

Where we feel it is in, kind of, the release schedules of some of our newer products with flip chip technology, I guess it's a good news-bad news thing.

We don't have the base of business that uses those very advanced packages that contribute a lot of revenue to date.

But we are working like -- working very rigorously to release these types of products in a timely fashion.

I haven't seen a substantial change in substrate availability and lead times.

Has that been part of the reason why there's been some expedited orders in there, is just -- in order to -- in order to meet and get the -- ?

No, because today, the base of our business, really, is more lower-end, lower-ASP products, PLD products and lower-end FPGAs that don't use these very advanced packages.

So I really can't, obviously, comment on my competitors' business situation, but I can say that, with regard to lead times for very advanced substrates, high ball-count substrates for high-end FPGAs, the lead times are still unacceptably long, and there is some constraint in getting those.

And that really impacts my new product release schedules, which we're actively trying to work through.

Doesn't impact our revenue, because we don't derive a lot of revenue from those type of packages today.

And is that why we haven't heard a whole lot about the DDR2 interface recently?

Or is it just because I'm not listening well enough?

That's not related to this issue.

Okay.

Great.

Thanks a lot.

Sure.

And keep up the good work.

Appreciate it, thanks.

Yes.

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

Hi, guys.

Good job.

This is actually Sanjay Devgan on behalf of Mark Edelstone.

I just had a quick question regarding the demand environment.

I noticed you talked about double-digit sequential growth in your backlog, and I was just wondering -- Have you seen any instances of double ordering?

Or what kind of checks do you put in place to kind of ensure that double ordering doesn't take place?

If you could just comment on that?

We -- the best thing that we can do to ensure that double ordering doesn't take place is to keep our lead times at acceptable levels and to respond to the expedite requests that end customers have to make their build schedules.

And I gave you some data and some perspective on that.

Sure.

And we believe we're doing a reasonable job.

We could always, of course, do better.

But doing a reasonable job responding to that and not leaving a lot of business on the table.

So that's, basically, I think the best way to reinforce that.

We, obviously, work with those customers and those distributor partners who have high levels of business with us and rapidly increasing demand to ensure that we respond to them, including getting forecasts and working on a day-to-day, week-to-week basis to respond to upsides to those forecasts and so forth.

Because, really, double ordering is, I think, a knee-jerk way to try to respond to a basic need, which is the need to get more parts.

So we have groups in place and processes in place to service our major customers and to respond to their upside requests.

And as I mentioned, I believe, for the most part, obviously, there's exceptions to everything.

But for the vast majority of cases, we're able to respond to that last quarter and believe we'll be able to respond to what we likely expect this quarter.

So that's how I would answer your question.

With regard to the backlog being up, that's obviously a -- it's better than the opposite condition.

And we are tending to, each quarter, to book out more the next quarter.

And our turns have come down slightly, as I gave you in the data.

So that helps us schedule our business better and to manage the business in a more proactive fashion.

Great.

Thank you very much.

Sure.

[OPERATOR INSTRUCTIONS] We'll hear from David Duley with Merriman Curhan Ford.

Yes, just a couple follow-ons here.

With the introduction of all -- of a lot of the new FPGA products, what kind of improvement are you seeing in your across-the-board ASP?

And are you -- is that kind of something that's helping your top-line and profitable?

Or is it something we shouldn't focus in on?

Well, that's -- you can decide whether you should focus in or not.

I would say the ASP went up last quarter, and we'd expect ASP to go up.

With respect to kind of the overall business margins, our margin target for the FPGA business is really the same as the PLD business, there's no different there.

So we have a relatively low ASP today because we're dependent on PLD products.

FPGA products have higher ASP.

Introduction of competitive ASP -- FPGA products will allow us to raise the overall ASP if we do our job.

And I think that's really all to be said there.

We can achieve faster growth on lower units if we're successful.

Okay.

And you mentioned, I think, when I asked you before that the new FPGA design wins this quarter, I think were up 35% sequentially, to record levels.

I seem to remember a total cumulative design number of about 1,500 for both these families, something around there, and a very steep curve of adoption of designs.

I was just wondering if you might be able to kind of give us your best guess or talk about -- Do you think you can continue to grow your FPGA revenues in line with the market?

Or would you expect that you'll be growing faster, let's say, than whatever the 18% growth rate is of this market, whatever -- ?

Yes.

Our goal, clearly, is to grow faster than the markets.

In order to do that we need to have a competitive product line.

We need to grow our designs and have those designs translate into volume production orders.

That's the kind of recipe we've -- trying to follow for the last four to five quarters, and we'll continue to follow that.

So designs were up by the amount I gave you.

Cumulative designs are actually a lot higher than the figure you have.

And, really, our focus, really, is on achieving the revenue ramp required to reach the result that you articulated.

So let's just spin it out a little bit.

With several thousand designs between the two families and your new product revenue this quarter being up 52%, but only really being about 9 million, we could expect that new product number and the FPGA number to continue to grow quite robustly if those designs come into revenue -- into production?

Correct.

That's our -- that's our current expectation.

Great.

One final thing from me is -- You're assuming less turns this quarter, I guess because your backlog's bigger.

But sometimes your customers come in for the same amount of turns business.

So why -- what is the rationale to assuming a lower level of turns this quarter?

And, obviously, if we achieve the same level, that would imply that we'll have a little bit of upside to the revenue, correct?

Right.

That's how the math works.

The rationale for assuming the lower turns is that customers are tending to book out more, so that lowers the turns, because they book in more of their anticipated demand, which is your first point.

The second point is that in Europe in summer, traditionally, it tends to be a down quarter with regard to actual consumption of products.

So we've tried to factor that into our analysis of the -- of our outlook.

Okay.

Thank you.

Sure.

And we'll try again with Bill Dezellem with Tieton Capital Management.

Thank you.

Are you able to hear me this time?

We can.

Hey, Bill.

All right.

My apologies for the technical difficulties before.

Couple of questions.

First of all, as time progresses and as the FPGA families, or just the new products ramp to higher level of volume production, is it reasonable to expect that the gross margin should expand under that scenario, and we're not talking about any specific quarter, but just in the future?

Well, gross margin is very difficult to predict.

We are pricing our new products for penetration.

We expect with yield and cost productions to earn corporate margin targets, which are 55 to 60% on those new products over time.

So we're comfortable with where the margin is today.

And if we're more successful than our plan with regard to yield enhancements and cost reductions, there is opportunity for the margin to improve.

There's also an opportunity for the margin to improve with scale, because a certain proportion of our cost of goods sold is fixed.

Obviously, with a higher revenue base, we get better amortization of that fixed cost, and the margin improved.

Now, on the other hand, actually if we ramp the new products faster than planned, we can have a depressing effect on the margin because of mix issues.

So I would answer your question, Bill, with, yes, it's possible that as business and revenue grows for the margin to expand.

But it's also possible that it doesn't, for the reasons I described.

But we're comfortable with where the margin is.

And if we exceed our internal plans and grow our revenue, the margin could well expand slightly.

That is helpful.

And, then, relative to the sequential FPGA growth that you saw in revenues this quarter, which of the ECXP and SC families were really the primary driver or drivers behind that growth?

Well, it's not the SC family, because 90-nanometer families really have no material revenue contribution.

At this point it's just too early --

Right.

-- to expect that to happen until the next calendar year.

But if you look at the FPGA business, both the new and the mainstream FPGA has experienced some growth last quarter and contributed to the growth.

So, really, the ECP, the XP families, which are our newest families, had healthy growth, as did our FPSC and first-generation XP families, were still in their revenue generation phase.

And did either of the EC or XP family stand out relative to the other?

No.

I looked at the sequential growth of, actually, all those families I just talked about, and all are very healthy, in high-double-digit rates.

That's helpful.

Thank you.

Sure.

And next we'll hear from Peter Schleider with Peninsula Capital.

Well, first, congrats on a great quarter.

I'm curious about the design tool, kind of, evolution for the FPGA family and where you are there, both with, I believe, you used some internal tools but also with external tools, as well.

Then I have a follow-on.

We continually improve our tools, by both adding functionality, improving the usability, and improving the performance and utilization of the tool as it relates to implementing designs in our silicon.

At this point today, we rely solely on outside third parties to provide synthesis, and our partners are [Simplicity] and Mentor Graphics.

So they provide the synthesis engine and capability for all our architectures and to provide ongoing upgrades to their synthesis support for our product lines and regular release of our products.

So --

Where do they stand on supporting the various families?

They both support all our production [release] families and both provide support for our new families and also for families that are currently in the development phase.

We need to have software tools to do silicon development, to route our own designs and so forth.

So both Simplicity and Mentor provide synthesis support for our full product line, and we're both -- both are good partners, and both provide ongoing road maps and improvements to their synthesis support for our full product line.

All right.

So you're up to date with those products?

We are.

Okay.

Great.

And then on the IP side, what is going on there in terms of either cores that you might provide or third parties?

Right.

For IP, we have an internal IP effort, and then we have third-party partners who provide IP cores.

We've actually substantially expanded our third-party program, particularly with the launch of our 90-nanometer products.

I gave some statistics up front.

Today we have ample availability of cores for ECP2 and SC and 90-nanometer products, both from internal development and from third-party providers.

We try not to compete with our third-party providers and allow them to focus on areas of their own expertise to providing cores.

Essentially, our IP core strategy is, kind of, an 80, 20 approach.

We want to provide the bulk of the cores on what we believe will be the bulk of the market opportunity.

So if you look at where we are today with IP core support for our 90-nanometer products, we're far and away ahead of where we were at a comparable time for 130-nanometer products, simply through experience and being in the market longer.

All right.

And, then, jumping to this turns question.

My recollection was that, after the fourth quarter, you had that same 45% number for the first quarter.

Is that right?

We -- you may have kind of missed the explanation I gave, but we're changing the way we calculate and provide turns.

Prior to this quarter, we were providing turns just for the direct channel --

Right.

-- which was slightly over half our business, because that was really the only data we have.

To provide a turns calculation, one needs to have the quarter-beginning backlog.

In the distribution channel, since we report revenue on resale, one really needs the end customer backlog on the distributor partner, and we hadn't really had sufficient data to calculate turns for the distribution channel prior to this quarter.

So I gave some numbers so you could have a historic perspective for the turns number for the distribution channel.

I don't have the number for Q4 for the overall basis, because I don't have that data from the distributor.

I was thinking more when you gave out the fourth quarter for the guidance going for the first quarter.

My recollection was it was 45%.

Neither here nor there.

And well that's it.

Okay.

I appreciate it.

Thanks.

Thanks.

And we'll take a question from [Brian Tong] with SAC Capital.

Hi, guys.

Thanks for taking my call.

Congratulations on the quarter.

Just a question about your operating leverage.

Could you talk a little bit about how your -- we should be thinking about your operating expenses growing as your revenues grow?

I mean, you had some nice leverage this quarter.

How should we think about it going forward?

And maybe asked differently, is there kind of a revenue run rate that we should be thinking about for this given OpEx level?

Thanks.

We do believe there's operating leverage in the business model going forward.

And, obviously, our expectations are that if revenue grows, operating expenses should grow slower than revenue.

I've said in the past that 2006 is really shaping up to be a transition year for our business and our business model.

Given the magnitude and dynamic nature of the FPGA market, we believe it's prudent to continue a very heavy investment in R&D to push forward with new product initiatives and to become relevant in that market space.

But we have, over the past year or so, treated R&D as more or less a fixed expense.

So should market conditions continue to be favorable, we believe we can migrate to, kind of, the following longer-term business model -- gross margin, 55 to 60%;

R&D, 25 to 30%; and SG&A 17 to 20%; with an operating profit of 10 to 15%.

And, really, the pace at which we approach this model will be driven mostly by how successful we are in growing our top-line revenue, which is -- turn is mostly dependent on overall market conditions and how successful we are in penetrating the market with our new FPGA products.

So assuming that you treat R&D as a fixed expense, you can take those percentages and calculate the answer to your question of the revenue level that we'd expect to be at with the current R&D expenditures.

Great.

Thanks a lot.

Sure.

And at this time we have no further questions coming in.

Mr. Skaggs, we'll hand the conference back to you for any closing comments you may have.

Great.

Thanks, everybody, for your attendance.

As always, feel free to follow up with any more specific questions directly to the Company.

Thanks, and talk to you later.

This concludes today's conference call.

You may now disconnect.