Semtech Corp (SMTC) 2003 Q3 法說會逐字稿

Good day and welcome to this third quarter fiscal year 2003 results conference call. Today's call is being recorded, and a question-and-answer session will follow after the presentation. For additional remarks and introductions, I will now turn the call over to Mr. John Bauman, the treasurer and manager of investor relations. Please go ahead, sir.

Thank you operator. Good afternoon, ladies and gentlemen. Welcome to Semtech Corporation's fiscal year 2003 third quarter earnings conference call. I'm John Bauman, treasurer of the company.

We have just released results for the third quarter ended October 27, 2002. For the next 45 minutes or so, we'll be discussing the results with you and answering your questions.

Before I turn the call over to Jack Poe, I want to remind every one of the following two notices. First, this call was open to all interested parties, in accordance with Reg FD. If you have questions about our future performance or estimates of future financial results, we will consider them now. We are unable to say if there will be another Reg FD compliant opportunity for you to ask questions before the next quarterly conference call.

Second, this call will include projections and forward-looking statements which involve risk and uncertainty. As highlighted in the press release, risks include but not limited to: overall economic conditions; the timing and duration of semiconductor market upturns or downturns; demand for communications infrastructure equipment, cellular phones, computers, automated test equipment; demand for the company's products; competitor's actions; relations with large strategic customers; risks associated with the businesses of major customers; and other risk factors. Please refer to the company's form 10-K for the year ended January 27, 2002, as filed with the Securities and Exchange Commission or the risk section of our earnings release for further information.

Although a replay of this call will be available on Vcall's website until December 25, 2002, the company undertakes no obligation to update or revise forward-looking statements to reflect subsequent events or changed assumptions or circumstances. Any written transcript of this call that may be posted or published is unauthorized by the company, as is any replay or broadcast of this call via the internet or otherwise after December 25, 2002.

I will now turn the call over to Jack Poe, chairman and chief executive officer and Semtech.

Thanks, John. We reported our third quarter 2003 results in the press release issued in the past half hour. Over the next 30 minutes or so, David Franz and I would like to review those results with you and discuss our outlook for the fourth quarter of fiscal year 2003.

I would like to take this opportunity to introduce Jason Carlson, who has joined Semtech as president and chief operating officer. Jason was most recently employed as the general manager of the Crystal Products division of Cirrus Logic Corporation. As the company's president and COO, Jason will oversee all day-to-day operational activities and play a key role in the creation and implementation of plans for product development, quality assurance and human resources, as well as sales and marketing. Semtech has continually added strength and diversity to management by hiring experienced professionals from other companies in the semiconductor industry, and Jason brings a fresh perspective to our existing business as experienced with other products, markets and customers outside of Semtech's traditional strengths will allow the company to examine new opportunities for growth. Jason will have the opportunity to meet with many of you personally over the next few quarters as we schedule our Investor Relations visits.

I'd like to start talking about orders. Third quarter orders decreased about 3% from the second quarter to about $42 million. Test and measurement orders fell by nearly 50% in the third quarter from a very robust order rate in the second quarter. Test customers appear to have returned to a wait-and-see approach. Power management orders increased about 13%, of which the increase was virtually all due to portable power applications. Protection orders increased about 3%, and the rest of the product lines were flat or down.

Communication products continue to be weak as funding for many smaller customers has been curtailed and larger communication customers are not deploying new systems. We recorded more retrofit design wins for communication products, which indicates that there is still a good market opportunity for those products even in this difficult market.

Revenues for the third quarter decreased about 9% sequentially from the second quarter, which was somewhat lower than expected to be at the start of the quarter. Power management revenues declined about 10% from the second order, and protection revenues declined about 12% from the second quarter. The decline in revenues in power management was in desktop computer applications. Some specific OEM programs were outsourced to Taiwan ODM manufacturers that use a non-Semtech power solution.

Test and measurement revenues increased about 7% in the quarter, compared to expectations earlier in the quarter that we thought would be perhaps as high as 20% increase over the second quarter. Other product line revenues declined somewhat in the third quarter as well.

In the area of profitability, the company reported GAAP EPS of 17 cents in the third quarter, compared to 14 cents in the second quarter. In the third quarter last year, the company reported net income of 12 cents per share. As David will share with you in his analysis of profitability, the company repurchased about $65.2 million of convertible debentures in the quarter which, resulted in a gain of about $10.7 million for the quarter.

Gross margins decreased slightly in the third quarter. Power management for desktop computers and protection products continued to experience a very competitive pricing environment. However, we expect to improve gross margins as cost reductions come online in the next few quarters in both these product areas. And David, again, will discuss gross margins a little bit more in detail in his presentation.

Sales G&A declined about 3% in the third quarter after removing about $1.2 million of lease termination and asset impairment cost.

In design activity for the third quarter, the company reported about 500 new design wins that are expected to generate more than $63 million of new annual business. Product line design win dollars were led by portable power management, desktop power management, and protection products. Cell phone handset wins were especially robust as the colors screen drivers, charging circuits, and TVS protection devices all gained market share. Notebook computer design wins also gained sockets. Desktop motherboard design wins increased about 30% from the second quarter.

New customers accounted for about 28% of new design wins and about 14% of design win dollars. New customer activity was split among many market segments. Geographically, Asia and Japan reported 40% of total design win dollars, Europe reported 14% of new designs, and North America represented 46% of new designs.

The top ten customers for new design win dollars included Intel, Sony Ericsson, Dell, Quanta, Samsung, FIC, Elite, Motorola, HPQ and Sony. The company recorded seven design wins on the Microbuddy family, which was formally launched at the end of the second quarter, and we're expecting a ramp up of design wins in both Microbuddy and in industrial and networking power management over the next few quarters.

New products, the company released 19 new product families in the third quarter. We also did an analysis on revenues for the third quarter to determine the aging of products represented by these revenues. What we found is that the lives of our products continues to be long. Semtech's revenues for the third quarter were generated from products introduced over the past six years. Each year's products contributed somewhere between 15-20% of total revenues. So under our model, we must therefore introduce sufficient products each year to offset revenue decline of about 10-15% just to stay flat with revenues the previous year. To grow revenues at a rate substantially higher than market growth rates, we have to introduce many more new products and new products with much higher revenue potential, and that has been one of the company's primary objectives in the past two quarters.

Looking at the outlook, take the opportunity to discuss the outlook for the fourth quarter. Overall, we expect revenues to be somewhere between $43-45 million. We expect fully diluted EPS to be somewhere between 9 cents and 11 cents per share. Most products should be flat with Q3 revenues; however, we expect to see revenues decline in test and measurement and some in computer gaming.

In summary, the second half of fiscal 2003 has certainly been disappointing for us. The semiconductor market has slowed from what looked like a reasonable rebound earlier in the year. The financial markets were very weak early in the third quarter before recovering. And Semtech uses its strong cash position to repurchase debentures in stock in the open market to increase the company's net cash position. By the end of the fourth quarter, we will have closed the last of the commercial wafer fab productions -- production fabs.

Our focus in the third and fourth quarters has been to develop a solid growth path for next year. Industry growth numbers were recently reduced to somewhere between 7-9% for next year. Based on the strength of our new products and the design wins we have won and expect to continue to win, we think that we can far outpace this growth which we will discuss briefly.

First and foremost, I think we executed poorly in desktop power management early this year. Our market share has fallen to about 17% in Vcore solutions from about 30%, although the market share for other power management in desktop sockets has been quite steady. We have totally revamped our desktop technology and product offering in the last two quarters. And with the introduction of our leadership Combi-Sense products last quarter, the market share loss that we suffered earlier in the year has begun to turn around and will show improved design win penetration over the next couple of quarters.

Revenue should pick up in the desktop market early next year and accelerate into the second half. We think we have the best products and cost structure for desktop, and we're going to compete vigorously. We believe the sustainable market share in this market for Semtech is between 30-40%. There are several initiatives under way upon which we will report for the fourth quarter conference call related to desktop design wins.

We continue to penetrate notebook computers and cell phone handsets for both power and protection. We have a leadership position in both terms of display drivers and charging circuits for color handsets that we will expand upon next year. Handsets with color screens are expected to grow from approximately 80 million units this year to 160 million units next year. We've also introduced specialized protection devices for these models as well.

Platform sales for BANYA space notebook computers continued to fare well. We recorded a number of large design wins and expect some revenue in the fourth quarter from these design wins.

Other product areas that will contribute to growth next year include industrial and networking power management, Microbuddy supervisory products and timing synchronization. We do see more confidence building both in our customers and internally in the product groups for sustained revenue growth next year. We have continued to build diversity into our product lines especially in power management, and we have added new product lines to build overall diversity within the company. Our customer base continues to expand as well, and all these factors will play an important part in our growth next year.

This concludes my remarks. I'll now turn the call over to David Franz, CFO.

Good afternoon, ladies and gentlemen.

While the third quarter was disappointing from an operating performance standpoint, we were able to substantially improve our balance sheet during the quarter and position the company for improved profitability next year.

Our short-term results are not indicative of the strength building of several of our businesses, particularly in the areas of power management. First quarter is expected to usher in a return to sequential improvement in our business and for all of next year we are forecasting our revenue growth will far exceed the forecasted industry growth rate with acceleration in the second half of the fiscal year.

I will now review Semtech's results for the third quarter of fiscal year 2003. Revenues for the third quarter fiscal 2003 were $47.1 million, a decrease of 9% compared to $51.1 million for the second quarter of this fiscal year. Third quarter revenues increased 8% compared to revenues of $43.8 million for the prior year third quarter. Revenues for the first nine months of fiscal 2003 increased 3% to $148.4 million compared to $144.8 million for the prior year nine month period.

Gross margins for the third period fiscal 2003 were approximately 56%. The decrease in gross margins in the quarter compared to the second quarter was principally due to the recording of additional inventory reserves. Gross margins for the third quarter were benefited by the sale of $218,000 of previously written-off inventory. Gross margins improved on a quarter-over-quarter, year-over-year basis by 100 basis points.

As sequential revenue growth returns next year, we expect to see improvement in our gross margin. Our target is to achieve gross margins of 60% when our revenue reaches its previous high of $70 million per quarter.

Net income for the third quarter of fiscal 2003 was $13 million or 17 cents per diluted share. While we were the disappointed in our operating performance for the quarter, the weakness in the financial markets allowed the company to retire approximately $65 million face value of its convertible subordinated debentures. This resulted in a pretax gain of $10.7 million for the quarter.

Revenues for the third quarter were derived from the following geographic regions: 35% was derived from customers located in North America, 6% from customers located in Europe and 59% from Asia. The percentage of revenues generated from the Asia Pacific region is reflective of the contribution of our desktop, notebook and wireless handset businesses.

Net turns orders accounted for 43% of shipments in the third quarter. This compares to 32%, 34% and 23% in the previous three quarters. The vast majority of all new bookings are for delivery within a 60-day window.

The three big end-market segments, computer, communications and industrial, represented approximately 96% of our total revenue. Revenues from computer market, which includes graphics, notebooks, computers, gaming and PDAs, represented 48% of total revenues. Communications market revenues represented approximately 29% of total revenues and revenues from the industrial market were approximately 19% of total revenues. Revenues from OEM sales represented 56% of total revenues for the third quarter while distribution represented 44% of total revenues.

In terms of contingencies, the customer dispute we disclosed has not been resolved. We had discussions with the customer during the quarter and exchanged technical information. We will not be taking any questions on this pending matter.

As Jack discussed, we are forecasting that revenue growth for the fourth quarter of fiscal 2003 will be between $43-45 million. To attain the midpoint of the fourth quarter forecast, net turns orders of 47% of revenue are required. The gross dollar amount of turns to meet this forecast is approximately the same as we achieved during the third quarter. The turns rate is reflective of short lead times from customers ordering product for short-term needs and certain book ship arrangements that the customers have, and these facilitate customers just in time for inventory models. Based on bookings for the end of last week, we need approximately $10 million of turns over nine weeks to achieve the midpoint of this revenue forecast.

Looking at gross margin, as I previously mentioned, gross margins for the third quarter of fiscal 2003 were approximately 56%. Gross margins were impacted by principally increased costs associated with excess and obsolete inventory. Gross margins should begin to improve as sequential revenue growth returns. On a year-over-over basis, margins improved slightly from the 55% level reported in the third quarter of last fiscal year, and we continue to believe that our gross margins will continue to move toward our long-term goal of 60%. For the fourth quarter we are forecasting that gross margins will improve slightly based on the current revenue forecast due to improve mix and cost reductions.

Research and development expenses were $7.9 million which was down approximately $350,000 compared with the second quarter. The decrease in R&D spending was principally due to the absence of certain technology licensing costs incurred in the second quarter, and we are forecasting that R&D will be down $100,000 on a sequential basis for the fourth quarter due principally to a reduction in variable compensation expenses.

SG&A expenses were approximately flat with the prior quarter. SG&A spending was higher than forecasted at the start of the quarter due to costs associated with recruitment and legal. For the fourth quarter SG&A is forecasted to be down approximately $200,000 compared with third quarter levels.

During the third quarter, the company incurred one-time costs of $1.2 million. Approximately $850,000 of this was for projected losses we will incur in subleasing our former New York location. The loss results in a sharp drop in the projected sublease rates for this office space. The remainder of these costs, $350.000, are for asset impairment at our Corpus Christi wafer fab. We are on target to be out of this facility by the end of the fiscal year and additional costs may be incurred in the fourth quarter in relationship to the cessation of activities at this facility. Such costs are projected not to exceed approximately $600,000.

Interest and other income were approximately $10.7 million for the third quarter. We repurchased $65.2 million face value of our convertible subordinated debentures during the quarter for a total cost of $54.5 million. For the year we have repurchased $107.4 million face value of our debentures at a cost of $94 million. For the fourth quarter we are forecasting interest in other income of $2 million which includes an estimate of $1.4 million of gains on debenture repurchases. This could be higher than forecasted based upon our repurchase activities during the quarter, and we plan to continue to retire long-term debt as the opportunities present themselves.

The company's effective tax rate for the third quarter was 32%. The rate increased during the quarter because of the much higher than expected gain from the repurchase of debentures. This income is taxable in the U.S. at marginal rates which are higher than our projected effective rate. The company is projecting that the effective tax rate for the fourth quarter will be 25% based upon the earnings forecast that I just delivered. The company's effective rate can vary based on variations in income and the source of that income.

The diluted share count decreased during the quarter to 76.7 million. The share count is expected to be approximately flat in the coming quarter. During the third quarter, the company repurchased 729,300 shares of its common stock at an average price of $10.70 per share, and based upon the guidance just delivered, diluted earnings per share for the fourth quarter are forecasted to be approximately 9-11 cents per share.

Turning to the balance sheet, Semtech ended the quarter with approximately $484 million of cash and investments on the balance sheet. Operating cash flow for the quarter was $10.7 million. Operating cash flow for the year to date is $44 million and for the full fiscal year is forecasted at approximately $60 million.

During the third quarter, the company spent approximately $2.6 million on property and equipment. Depreciation and amortization for the third quarter was approximately $2.5 million and operating cash flow will remain positive for the foreseeable future. During the third quarter, the company spent $53.3 million on the repurchase of convertible subordinated debentures and $7.8 on the repurchase of common stock. There is remaining a balance of $32 million under the company's existing buy-back plan. We will plan to continue to buy back stock and debentures under this authorization and despite the uses of cash during the quarter to repurchase debt and repurchase stock, the company was still able to grow net cash position by $11 million to $227 million as of the end of the quarter.

Accounts receivables to day sales outstanding calculated on a quarterly basis was 41 days for the third quarter. Inventory levels were down 850,000 as compared to the second quarter and days of inventory calculated on a quarterly basis were 88 days in the third quarter.

As we look forward, the opportunities are significant for Semtech in fiscal 2004. If we execute in the macroeconomics conditions and semiconductor growth is as currently forecasted, fiscal 2004 and fiscal 2005 should be good years for the Semtech corporation.

Thank you for participating in our third quarter fiscal 2003 conference call and I will turn the call back over to operator for questions.

Thank you. The question and answer will be conducted electronically. If you would like to ask a question, please press the star key followed by the digit 1 on the touch tone telephone. If you are on a speaker phone, be sure your mute function is turned off. We will proceed in the order that you signal us and take as many questions as time permits. Once again press star-1 on the touch tone telephone to ask a question. We'll pause for just a moment to give everyone an opportunity to signal for questions. We'll take our first question from Rick Schaffer from CIBC World Markets. Please go ahead.

Thanks. Pardon the voice. I lost it screaming this weekend. A couple quick questions. The first one really is could we get more color on the competitive environment out there. We heard recently that maybe you guys started winning back slots. You eluded to, Jack on the call, also winning back slots, that was the buzz out there, give us more color on other competition or what you're seeing in that environment and also how -- you talked about your market share on power heading back north of 30%, should we start looking for the gains in the January quarter? What's the timetable you guys have internally for that?

Look at desktop power management, obviously Intercel has the largest market share and ADI and Semtech somewhere in the second and third in the Vcore. If you look at power management across the rest of the board, we probably still feel we have 30-40% of the other power management and a lot of those sockets compete with more discreet level solutions. I think that earlier this year, the issue we had was we stayed with the topology that we had using remote sense resisters too long and we now have converted over to the Combi-Sense approach which is cost effective for our customers. It's very cost effective for us to manufacture and the ease of layout is there. The other key thing is the Combi-Sense will work across any AMD or Intel platform as well. The work is a lot easier and as mix gets shifted back and forth between different microprocessor solutions, you don't have to reengineer the power solution. The other thing that is nice about this is the ramp from 35-40 amps up to 100 amps or more by adding drivers --into drivers and MOSFETs into phases. This is the best we have had and the response to these products has been outstanding. We are doing a pretty good job winning sockets right now. If you look at the timing for that, yeah, it's hurt us here in the third quarter but we'll start seeing ramp on this next year as we get into the second quarter and get ramped up into next year you'll see that accelerate.

And a quick follow-up on gross margin. You talked a little bit about, I guess lower volumes and stuff. I was curious about pricing in the quarter?

Pricing is tough right now especially I would say in desktop. The price leader right now in the desktop arena is analog devices. They seem to be the most aggressive. It takes 15-20 cents more to make share Vcore solution work. They are discounting that back in their price. I think that we can and will compete very vigorously in this market. We think we've got the best cost position. ADI is running an incremental pricing strategy. Those work for a while but not long-term. We have cost reductions we will drive in the next quarter or two. We have a great cost position now, we've got new technologies we'll bring on when these hit high volume production by late second quarter next year, we will have had substantial cost reductions on these products.

Thank you very much.

We'll take our next question from David Woo from Webush Morgan Securities. Please go ahead.

Good afternoon. Two quick ones. First if you look at revenues, I was looking for 50 million and came in at 47. It does not appear that the turns business, you missed a turns business by that much. The ratio hasn't changed from guidance. Should I take away that the revenue miss came out of T and M and desktop management side? That's the first one. The second is guidance for Q4 moving forward. The gains business has a seasonally strong fourth quarter. I was wondering why you would guide down and with the measurement business bottom in your opinion in Q4 to allow your overall revenue to grow in Q1. The only $10 million left to do for, to hit your turns target for Q4, that's even if we have a shut down in the last two weeks of December, it should be easy for you to hit. Am I correct?

Well, let's see. Where do we start.

This is David, I'll start on the turns question. The turns were 43% and we forecasted 47%. Maybe the number and then for the fourth we forecasted 47% turns.

Oh, I see. The difference came in where, the T and M and the desktop?

If you remember our comments last quarter, David. We thought in the test and measurement area we would grow 20%. Obviously that turned around in the quarter. We saw pushouts in the area so the growth was only 7%. It was lower than anticipated and desktop was the other area.

Okay. Going to this quarter, I was wondering why you were looking for a down games business. Seasonally, isn't this the peak quarter for games companies.

Gaming, our quarter is November, December and January, you know I think what you're going to see is ramp-down of gaming activity as we get closer to Christmas.

As far as this quarter's term's business, only 10 more to go, I assume even if you shut down the last two weeks of December, that shouldn't be a hard thing to do.

We think it's conservative, but, you know, under the circumstances, we think that's appropriate for us.

Joe, do you think that a T & M business is otherwise bottoming in Q4?

It's hard to say. Usually we look at a two quarter cycle behind the rest of the semiconductor business for test and measurement. Q4-Q1 time frame.

Thank you.

We'll take our next question from Joe Osha from Merrill Lynch. Go ahead.

Hi, guys. Can you hear me?

We hear you fine, Joe.

First looking at the profile of the October quarter, can you give me some sense as to whether October was a decent month in some parts, the pc business was for you and the $10 million turns target seems conservative. May I deduce that you're seeing parts of your business roll off earlier than you would or better sense to what seems to be a conservative turns target?

I don't see anything rolling off at this point in time. The thing we anticipate gaming for sure, test and measurement as we've stated gives us concern, there seems to be uncertainty now with what's going on in the test marketplace and trying to be conservative in those areas.

Can you give me more color on what the progression has been in the PC, laptop or desktop business, a pop or not?

We're on a continual ramp. Notebooks and cell phone included, that continues unabated. In the desktop area from an order viewpoint we did see pickup in orders but it wasn't huge. Of course, that says also the rolloff for us in desktop is less as well. That gets back to what we're trying to do here is create diversity as well as diversity overall. Try to minimize some of the seasonality we have had in our business. That's part of what's going on.

Thank you very much.

We'll take our next question from Alex Ghana of UBS Warburg. Please go ahead.

There are some new gaming platforms coming out at present. Any dislocation, you're seeing some of the gaming rollout seasonally, what about some of the platforms, does the Combi-Sense help you the same as the desktop market for some other dynamic going on there?

Let's talk about gaming. Going from Xbox and X Blade. Less content in the X Blade. Prices have come down. Going to be some shift there and that's ramping up late in the fourth quarter. In terms of Combi-Sense, yes, we have included Combi-Sense technology in a number of areas. We have this Combi-Sense solution is interesting because this is the first time I think that any manufacturer is proposing basically the same Vcore solution for desktops and notebooks so that's a big advantage that I didn't hit on before. That's a another reason customers are excited about it. We've also taken the Combi-Sense technology and moved that same scheme, that same topology into our industrial and networking power management. It's going to go pretty much across the board in a broad way.

How does the Combi-Sense do, in terms of we've talked about lower phase counts, higher counts, is there a sweet spot in the market for the Combi-Sense in that regard?

Set up to basically go up to four phases but no reason we couldn't take it up further. We haven't seen the need to go beyond four phases. Even when you look at the new processors that I better not say the code name, if you look at it, we have a solution qualified so it works. Whether or not these currents continue to go well up past 100 amps, we'll have to see when the time comes.

Do I understand you have a four phase solution qualified already? Is that what you're saying?

We haven't qualified internally already, it's at the customers.

Is it correct to assume that with the economics of the Combi-Sense it's particularly appealing at the higher phase counts when implemented?

It certainly it from a control and cost viewpoint, yes.

Thank you.

We'll take our next question from Jeff Rosenberg from William Blair. Please go ahead.

I wanted to follow up on things you talked about last quarter on the midshifts towards two-phase versus three-phase solutions on the driver side this quarter?

Jeff, certainly the mix to two-phase happened, I think in the quarter it took some of the content down in the drivers. I'm not sure I've got an accurate number. I would guess that around 50% are three-face and above and close to 50% are two-phase systems now would be my best guess.

So that mix is stabilized at this point?

Yes, but as I look forward to some of the new design wins, it's again, I would say it starts to trend back up probably within two quarters. It starts to trend back up into higher phase counts again.

Okay. And you had talked about how you started to lose market share early in the calendar year yet your business seemed to be trending well through a couple of quarters. Can you talk about what happened within your mix of power management business?

We had a couple of OEM designs that they went and sourced on the outside into boards in Taiwan. We didn't have the power solutions on them.

In terms of your mix with Vcore versus other parts of the power management solution, had that changed from the early changes of the Vcore ramp to where it is today? Some flavor on how your business mix looked to what it is today?

Before it was more of a 50/50 mix with Vcore solutions and peripheral power and now probably more is on peripheral power than Vcore. Over the next quarters I think that will come back more in line so the content is probably more evenly split.

Okay.

If anything, I think it will go more to Vcore short-term within a couple of quarters.

And the visibility of that, you talked about design wins but then it sounds like a lot of it is based upon extrapolating customer reaction. How well positioned are you now with design wins you've got or business that needs to be locked up in the next couple of -- quarters.

We have design wins now but I don't want to make them public.

One last question, on the other income, if we back out the games from the convertibles down to basically lower than what I was looking for in terms of other income for the quarter, what it's been, any color there, David?

Our interest in -- just pure interest in the range of 300 grand. Other costs, nothing material in that section as well, just some of our investments that we had longer maturities on have matured and reinvested the funds. The average yield on the portfolio has declined. And compared to the interest that we're paying on the debenture, it's moved us closer to parity. For the quarter coming up, we are still forecasting around 400-500 k of net interest in the upcoming quarter.

But the guidance assumes a certain degree of gain to get to the range, you're just using the 4-500 K to get to the 9-11cents .

The guidance is a GAAP number and does include approximately 1.4 million of gain on planned repurchases of debentures during the quarter.

Okay. Thanks.

We'll take our next question from Edward Hemigram from Shaker Investments.

My question has been answered.

Next to Alex Bergman of Pemgia.

Hey, how are you doing. Can you help me more, too, on market share losses. Earlier in the year, it wasn't something you saw coming. Trying to get a feeling for how this sort of seems to coming , did this ambush you and what's going on with the graphics because that's an area you were strong in, too, and a couple of follow-up questions, among other things.

Well, I think we saw the trend coming in terms of the shift from three-phase to two-phase so that was content loss. In terms of the Vcore market share reductions, I think that we didn't really see some of the OEMs making plans early enough to go to Taiwan so that was more of an impact that happened in the last four or five months, I guess.

How -- what do you think since obviously competitors were more ready to take to Taiwan, why do you think you weren't able to?

The competitors already had a socket.

You're saying if P 4 business shifted building in Taiwan, they won it.

They had the design already.

The question would be how come they were more successful in getting key wins in Taiwan?

I think that competitors had better solutions in some cases and we recognized that and that's why we have really brought out this Combi-Sense technology because it leap-frogged what competitors had to offer. I think that was, you know, that was an issue of weaknesses in the product line that we recognized, but didn't probably have an opportunity to change as quickly as we should have.

Okay. So you think even though Intel is still going to be a P-4 platform, you think you can -- won't be harder to win back share in Taiwan given that these are going to be P-4 based solutions.

If you look at the market share data in a mature market like this, it's reasonable to assume that you can get at least 30%, maybe 40% of a mature market. It's hard for me to believe that long-term we could hold a 50-60% market share nor could anybody else so I think from that aspect it presents opportunity for us to go up a lot faster than other people.

Fair enough. The thing about the gaming, you said it would be down this quarter to seasonal build-down. How much was it up last quarter, the gaming related business?

Gaming was up 30%? About 30%.

Occurs in Q3 and starts to slow in Q4.

A lot of share in that socket.

In those sockets, still sourced.

Should remain that way.

Can you talk about the extent of erosion in the Vcore and other parts of desktop power management? Is it just on Vcore or other parts of the puzzle.

Definitely price pressure across the board in the desktop area. That's one of the reasons we pushed this technology and cost reductions in the area. Definitely a lot of pressure. EDI appears to be leading the way in terms of pricing. More expensive to implement the solution.

Finally it's hard to predict the future, staying confident about next year, given how difficult last year it was for everybody and the fact that that's hard to predict near term fundamentals, what gives you a sense you can outgrow the market by so much next year by how things just seem to change so much.

They do. What gives us some confidence is the discussions we had with customers. You see a little bit more confidence developing on this front plus our internal guys with the product road maps we developed looking at the design wins and the position we have in these sockets compared to competitors and we've done quite a bit of work that we now can see some things ramping. This is not about us predicting there's going to be a huge turnaround in the market. I think that we do sense a change in confidence both at our customers and some of our people in the field. And appears to be broad-based this time. I think that could be encouraging.

That's great. This litigation, you can't discuss it, did you say whether it was over?

There's no litigation on this, by the way.

Oh, the dispute with the customer. There's no litigation, just a dispute you're trying to resolve?

Yes.

Was that desktop on a laptop issue.

We haven't disclosed the details.

Thanks, a lot.

Once again press star-1 on the touch tone telephone to ask a question. We'll take our next question from Lewis Gerhardy from Morgan Stanley. Please go ahead.

Good afternoon. Question was on the net turns you had. Did you mention the change in your cancellations was in the quarter?

I don't think so, Lewis. David, don't you -- do you have a number?

I don't have a number for you but we didn't have a significant amount of cancellations in the quarter.

Definitely some pushouts in the test and measurement area.

Okay. So what are you assuming next quarter? Assuming 47?

47% turns? Lewis? I think he got cut off. Yes, 47%.

And also on your gross margin guidance, can you talk about what you're assuming in terms of increase in inventory reserves and the sellout of inventory? Is that going to net itself out?

It's hard to project how much we are going to sell the previously written off stuff. Particularly our protection line as demand comes back, some of that inventory is getting sold. I wouldn't expect it to be much different than what we achieve this quarter, kind of the 200,000 type of range. Just in terms of gross margin next quarter, the primary factors driving the improvement is continued improvement in mix and growth in our power management products, for example, seen some improvements in the overall mix within the product line deriving improvement there.

In terms of the protection business you mentioned a few times, can you talk about end market trends you are seeing and from a competitive landscape you see most aggressive now?

The protection business continues to improve all albeit more slowly. Just to kind of hit on gross margins again, closing the fab at the end of the fourth quarter will have improvement throughout next year. Our cost structure will improve. I would say in the end markets handsets are doing well. Notebook applications. We don't see a huge snap back in some of the infrastructure stuff in the Telecom area. There has been a few spotty orders. Bay stations, for instance. We've seen a few things. I would say it's more portable appliance driven. In terms of competitors. It's the usual suspects with ST. We see Protech, microdevices, Philips on semiconductor and a couple of sockets here and there. I don't see a great deal of change in the competitive landscape.

Thank you.

We'll take our next question from Woody Kaleri of Midwest Research.

I had a question for David. The deferred revenue account looks to be up about $1 million. Can you talk about what goes into that and what caused that to rise sharply.

It's principally distributor inventories that have return privileges on them or revenue where there's some continuing obligation relative to that revenue where we can't take the revenue or revenue that was shipped on terms such that the ownership might not transfer until the customer physically takes position of it. Basically things that is fall into those three categories.

Would it be more inventory that was put into the distribution or revenue or product shipped late in the quarter.

I'd say more inventory that's in the distribution channel where they have some returns. There's also an item on there where there's continuing obligations where we can't recognize revenue yet. It's a combination of things.

Okay. Was there any particular end market that saw the increase in inventory?

The increase in inventory, inventories declined.

No, for the deferred revenue. More products shipped into computer markets because you were light on inventory in the distribution channel or just across the board?

Generally across the board.

Okay. Second, on the issue with the outsourcing to Taiwan, has that stopped because the OEMs were moving stuff there?

Only on the major boards. This goes on constantly. It's a make or buy decision for all the name brand guys. They mix and match models all the time. They might run seven, eight, nine platforms and some of those they will build themselves. Some will go to Taiwan to be totally outsourced. It's always an issue of how do they fill up their product lineup between what they do outside and what they buy on the outside.

And you talked about seven new wins with Microbuddy. Can you give us an outlook when you see that ramping?

Start to ship the few units this quarter. It's not huge. I think the activity you'll see a lot more here in Q4 and next year. A lot of things we are seeing again are in the portable appliance area. A couple medical applications, portable monitoring applications. So it's a product that will take us into a number of market areas that we traditionally haven't done much business.

More in the second half than the first half?

I think so.

And last I know this is a tough question, looking at PCs, any way you can pull out the share losses and share gains in notebooks and give us a sense of what you're seeing over the last month and a half or so?

If you look on a year to date basis for power management, I think we are up about 14% year to date when you combine desktop, notebook power management. Obviously a mix shift, some of that by design, we wanted a much more diversified business and some of that was by design to get more notebook business. Some of that has been these market share losses we've had here in the last three or four months.

Thank you.

We'll take our next question from Gus Richard of First Albany Corporation. Please go ahead.

Yes, can you talk a little bit about lead times and what they've been doing across the product lines?

I would say, Gus, lead times have been steady for us. Obviously we work hard to drive down delinquencies. Third quarter is a period you pick up on forecast business, I think we've been able to keep lead times low and in some of the new products, in fact, we've been able to do a reasonable job bringing lead times down.

In some of these power management design wins you've gotten, is that going to take a couple of quarters to start to ramp in volume?

Some of that is reasonably early on. As I look at some of the wins we have this quarter, I would say you're going to see stuff probably begin shipments in late January-early February time frame.

Got it. Thank you.

We'll take our next question from William Conroy of Sanders Morris Harris. Please go ahead.

Just a couple of questions. Can you talk about the graphics power management business and any thought what the share looks like there?

I know some of the major OEM stuff, we're doing a good job. We have good design wins driving revenue. We probably lost some market share in the low end in Taiwan. Probably three or four Taiwan manufacturers eating away at the lower end of things. Probably one of the thing that is did hurt a bit this quarter did not execute too well this quarter so some of the stuff expected in Nvidia did not happen. We have a great road map in the graphics controllers and I think that will continue to be a significant portion of our business.

And this, I think, is going to relate to Combi-Sense specifically, is it too early to tell whether you are getting more traction on the notebook side or desktop or uniform across?

Obviously we put the technology into the desktop first but having the same discussions with the OEMs, the importance of being able to get a lot more bang for the buck in terms of power design. If you can put the same devices in a notebook or desktop solution. You don't have to duplicate your power design resources and don't have to worry about inventorying a bunch of parts. That has resonated well across accounts who do desktop and notebook designs.

And finally can you detail a bit more of the cost reductions you have talked about? Like more specifically the sources that you see coming down the pike?

It's a combination of three things. It's driving up yields, it is reducing our Silicon cost and that doesn't mean just getting wafer price concessions but also moving into some much more dense technologies, things we had developed specifically for our power devices, and the last is packaging costs. We have definitely worked hard at driving down our packaging costs.

How much control do you have over the yield side?

We have quite a bit. One of the key things that we do have control and responsibility. We also work with our subcontract guys on a daily basis there.

Thanks, very much.

And we do have a follow-up question from Joe Osha from Merrill Lynch.

In trying to figure out what the mix looks like here in PC power management, can you give me insight into what the ASP -- well, that's not the right word but content for boxes looking like for notebooks and desktop as soon as.

Joe, if you look at the average design win we are seeing right now for notebooks, we still have probably close to $5 worth of content in a notebook today and that's just in power. I wouldn't put protection in there or human input device content in there. If you look at a desk top, you probably have the Vcore solutions are somewhere down at a buck, the peripheral stuff that might add 50 to a dollar.

Any sense to where the numbers might be tracking?

I would suspect based on the competitiveness of the desktop, they are not going up.

No. And then secondarily just as you look at the notebook business in specific, are you seeing anything happen there as far as Banios, anything nonseasonal there or tracking like you'd expect it to?

There's some nonseasonal ramps going on for the wins that we have put together here over the last one or two quarters.

And just to be specific, do you have any alongside Banios at this point?

And a follow-up from Alec Bergman of Pamgia. Please go ahead.

Okay. I'm sorry. I forgot what my question was going to be. Let me get back in queue. I apologize. I didn't expect to be asked to quickly.

Once again, we'd like to remind everyone if you'd like to ask a question or a follow-up question press star-1 on the touch tone keypad. And we'll go to Doug Lee of Bank of America Securities. Please go ahead.

Hi, guys. A couple things. Jack, you guys have done a great job penetrating the notebook market. At this point what percentage is notebook compared to desktop compared to a year ago?

Generally that's not a number we disclose, Doug, but I think looking forward, maybe I would think that our business is probably going to be around 40-45% desktop, 40-45% I would call it portable, and the rest is going to come out of Telecom and industrial and I would say as I look out maybe the next three or four quarters, I could see it shaping up in that way.

Wow, 44% each desktop and notebook?

And the portable area includes notebook and handset.

Okay. I understand. This quarter in particular, any 10% OEM customers?

I don't think so.

And then a question for David. David, we're trying to, I'm out of the office now, getting a sense of pro forma number, is the correct methodology to take out the games at 25%?

If that's how you want to analyze it. We based the forecast at the beginning of the quarter some level of gains on debenture nowhere near what we ended up achieving. Say if it had been 1.5 million or 2 million which was in the range of the forecast and the tax rate would have still been 25 percent.

Okay. And finally, again I don't have my notes with me, trying to remember in the August conference call you had a strong finish to the July quarter and you needed, I think it was $10 million in turns going into the quarter, seems like you're giving a similar assumption this time. Is that accurate.

Yeah, that's correct. At this point in time we may have needed a million more just from the top of my head. And the 10% question, Doug, on the OEM including sales to subcontract manufacturers, we had one gaining account that was about 10% of revenues.

Okay. Can you disclose that customer?

We generally don't mention the customer, but probably shouldn't be too hard.

Thanks, guys.

We'll take our next question from J.P. Skaglios from Franklin Templeton.

I just wanted to see if you guys could give us a dollar amount for the inventory reserves?

The amount that was higher than what we plan to build in there was 120 basis point impact on gross margins quarter to quarter.

And that does not include the 218,000 benefit from power reserve?

Yes, that's correct.

And a follow-up question from Alec Bergman from Pamgia.

Sorry about the last one before. When you said before that you were -- your share shifted to the OEMs on the desktop, help me understand that better. My understanding is that obviously you were talking about motherboard guys. When you say OEM, are you referring to a motherboard maker and is that motherboard dominated, the dominant share made in Taiwan for a while so not much of a shift, is there something I'm interpreting wrong when I you say OEM?

What I said was the market share shift from one of the big brand names. They fill out their portfolio of computers from boards that they design themselves and have built with subcontractors and other boards they fill in the product line we designed original at the ODMs. In this case what we've had is a couple of boards that they had designed themselves that we were in the sockets for and they changed that model and went to a board that was designed by a third party ODM.

Even though we are talking about a motherboard, it's a question whether they designed the motherboard or gave responsibility to the person in Taiwan.

That's true. It goes back and forth. Sometimes shared responsibilities, sometimes it's done by the OEM and sometimes totally by the ODM.

Okay. And the -- okay. I guess that's it. Thanks.

Thank you.

And we'll take our next question from J.D. Paget from Sanders Asset Management.

The inventory charge in the quarter to the extent that's not expected to recur in the January quarter, would we be starting from a higher base and deduct for erosion and revenue?

I guess that's a reasonable way to look at it. We were just pointing out that the reserve level was higher than what we had planned for and what drove down the margin quarter on quarter. Your analysis is reasonable.

And your best at this point I think I heard you say during the scripted part was April quarter up sequential in revenue?

That's a reasonable assumption.

Thank you.

And we do have a follow-up question from Joe Osha from Merrill Lynch.

Hi, this is just a house keeping question. In regards of a onetime gain, that is the difference between the repurchase and the face value that you are realizing? Is that correct? I wanted to make sure I understand the mechanics.

And include the writeoff from the deferred bond issuance cost that goes into the calculation. But that's correct.

And we have a follow-up question from Lewis Gerhardy from Morgan Stanley. Please go ahead.

I understand you're not going to talk about the customer claim issue but can you speak from an ongoing operations point of view, has it impacted your revenue this quarter and do you expect to impact your revenue next quarter from that customer?

I don't think so. I don't think there's going to be an impact that there was this quarter or going forward that I can see at this point.

Could you tell us, give us a sense how large that customer might be in terms of percent of revenue?

As we talked about on the press release, we estimated 1% of revenue this quarter and approximately what they were.

Thank you.

And we do have a follow-up question from Gus Richard from First Albany Corporation. Please go ahead.

One more house keeping question. You gave the breakdown and doesn't add up to 100%. Is the remaining?

Military and aerospace.

14% in the quarter?

No.

Oh, I added wrong. Nevermind. Thank you.

And we have a follow-up question from Alec Bergman from Pamgia. Go ahead.

Just one final question about the, I guess it's a difficult question to answer but I wanted a feeling. Do you think the whole dispute from the customer, has that caused any other customers to get nervous or change their behavior or do you think it's sort of an isolated thing with this one customer that you had pretty much a good control?

We have communicated to all of our other customers that raised concerns. We communicated essentially everything we told the financial community as we could and that's pretty much behind us at this point. I don't hear of it raised as an issue again.

At this time, there are no further questions. Mr. Poe, I'd like to turn the conference back over to you for additional or closing remarks.

All right, operator. Thank you very much. Thank you for all the questions and certainly be talking to you as we get out and make some of our visits during the quarter and be bringing Jason along so you'll have somebody new to grill. Okay. Thanks very much and appreciate your attendance. Bye for now.

That concludes today's conference. We thank you for your participation and you may