Semtech Corp (SMTC) 2006 Q2 法說會逐字稿

Good afternoon, my name is Jason, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Semtech Corporation's fiscal year 2006 second quarter earnings conference call.

All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer period. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you.

I will now turn the call over to our host, Mr. John Baumann, Treasurer. Please go ahead, sir.

Thank you, Operator.

Good afternoon, ladies and gentlemen, and welcome to Semtech Corporation's fiscal year 2006 second quarter earnings conference call. I'm John Baumann, I'm the Treasurer of the Company, and I also handle Investor Relations.

We've just released the results for our second quarter that ended July 31, 2005. For the next 45 minutes or so, Jason Carlson, Semtech's President and Chief Executive Officer, and David Franz, our Chief Financial Officer, will be discussing those results with you and answering your questions.

A reminder that Semtech reports results based on Generally Acceptable Accounting Principles commonly referred to as GAAP. The second quarter results will be published today or that were published today in our press release were unaudited.

Before I turn the call over to David, I want to remind everyone of the following two notices. First, this call is open to all interested parties in accordance with Reg FD.

If you have any questions about our future performance or our 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 conference call will include forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as Amended, and Section 21E of the Securities and Exchange Act of 1934 as Amended.

Forward-looking statements or statements other than historical information or statements of current conditions and related to matters such as future financial performance, future operational performance, the anticipated impact of special items on future earnings or plans, objectives and expectations. Some forward-looking statements may be identified by use of terms such as expects, anticipates, intends, estimates, believes, projects, should, will, plans and similar words.

Forward-looking statements involve risk and uncertainties that could cause actual results to differ materially from those projected. These risk and uncertainties include worldwide economic and political conditions, the timing and duration of semiconductor market upturns or downturns, demand for cellular phones, personal computers and automated test equipment, demand for semiconductor devices in general, demand for the Company's products, in particular competitors' actions, supply from key third-party silicon wafer foundries and assembly subcontractors, manufacturing costs and yields, relations with strategic customers and risks associated with the businesses of major customers.

In addition to considering these risks and uncertainties, forward-looking statements should be considered in conjunction with the cautionary statements contained in the risk factors section and elsewhere in the company's annual report on Form 10-K for the fiscal year-ended January 30, 2005 in the Company's other filings with the SEC and then material incorporated therein by reference.

In light of the risk and uncertainties inherent in forecasts of revenue and gross margin and other projected matters, forward-looking statements should not be regarded as representation by the Company that its objectives or plans will be achieved or that any of its operating expectations or financial forecasts will be realized.

Although a replay of this call will be available on the Investor Relations section of Semtech's Web site, the Company assumes no obligation to update or revise any forward-looking statements whether as a result of new information, future events, or otherwise.

I will now turn the call over to David Franz, Semtech's Chief Financial Officer.

Thank you, John. Good afternoon, ladies and gentlemen.

The second quarter was an important time period for the Semtech Corporation.

We acquired XEMICS SA during the second quarter. XEMICS is a Swiss-based developer of ultra-low power analog radio frequency in digital integrated circuits aimed at adding value in next-generation highly integrated battery-powered wireless and sensing applications.

XEMICS' current revenue stream comes from a portfolio of standard and custom products that are used in battery-powered applications, remote metering, embedded systems and medical devices. XEMICS contributed $2.9 million of net sales to the second quarter of fiscal year 2006.

The combination of XEMICS and Semtech's IP is going to allow us to pursue some exciting industry-leading solutions in the areas of portable devices, networking, industrial, medical, and wireless communications.

Semtech's other businesses were impacted by increased competition in the second quarter, particularly Power Management for the handset market. This impact will continue into the third quarter though we expect the third quarter to represent a bottom for power products sold into portable applications and we would expect improvement in the future quarters.

We have introduced many new products already this year in the portable power area and expect some significant product introductions over the coming quarters.

The products being introduced broaden our focus in portable beyond our traditional business in notebook and handset battery chargers and LED drivers. The products are more complex and reflect a higher level of integration.

Our Protection Products are currently experiencing accelerating demand, our bookings and revenues for this product line were at record levels. We expect continued growth for the next several quarters as we are shipping into many new applications and platforms and the underlying demand for higher performance and smaller form factor protection devices is increasing.

The test and measurement product line grew in the quarter and we are near completion of the technology refresh on these products, which should drive this product line over the next five years. We believe that the product introduction in test and measurement put us in a strong competitive position.

Finally, power products sold into the broader end-markets of networking, industrial, consumer, and servers are doing very well and are expected to generate growth over the coming quarters and years.

In the very short-term, as we look at the next quarter, we are expecting $60 million of revenue, which is benefited by a full quarter of XEMICS results, and GAAP earnings of $0.13 per share, which is net of an estimated $0.01 per share negative impact in the quarter from legal costs associated with our suit against an insurer as well as amortization of intangibles.

The lawsuit against the insurer, in which Semtech is seeking approximately $9 million, is expected to go to trial this quarter.

At a high level we are able to achieve these earnings due to stable margins, cost containment on the operating side, and less negative foreign exchange impact in other income and lower share count for the quarter.

Starting with orders. Orders in the second quarter improved by 8% compared to the first quarter.

Orders excluding the impact of XEMICS increased by about 1%. Orders were at record levels for our protection and networking in the Industrial Power Management product lines.

Over the last two years, the Company has introduced over 30 products within our Industrial and Networking Power Management product line. We are seeing broad-based growth in these products from diverse end-markets, including communications, industrial, consumer, and servers, and we expect continued growth from this product line for the next several years.

Protection Products also experienced record demand. The market for our Protection Products continues to expand the breadth of the markets into which we sell our Protection Products is growing.

We forecast continued growth from this product line for the next several years.

Orders for our test and measurement products rebounded from the first quarter levels as we are seeing stronger overall activity in this product area.

Orders for the Company's portable power management products weakened in the quarter, due to competition and ASP pressure in the handset market, particularly in the area of displays. Orders from the notebook market strengthened in the quarter.

We are introducing several important products into the handset market, which are forecasted to drive improvement in these revenues. Further, we are introducing products in the area of portable power, which address applications in a broader set of portable devices beyond handsets and notebooks.

Orders for our Advanced Communications, or SETS products, were negatively impacted by order delays from one major account but are expected to increase in the third quarter as compared to both the first and second quarter levels. Orders for our Power Management desktop HID and legacy products were as anticipated.

Orders for our Wireless and Sensing business, formerly known as XEMICS, for the five weeks they were included in our quarter were as expected and resulted in a book to bill in excess of one to one for that business area.

The current order patterns are consistent with our expectation of short leadtime orders. However, we are currently forecasting that we will build some backlog during the third quarter.

As we look at the income statement, revenues for the second quarter of fiscal 2006 were 58 million, an increase of 3% compared to revenues of 56.2 million for the first quarter of fiscal 2006. This was benefited by the inclusion of five weeks of XEMICS revenue for the quarter.

Revenues declined compared to the second quarter of last year. By the fourth quarter, consolidated quarterly revenues, including XEMICS, on a year-over-year basis should show improvement.

Gross margins for the second quarter of fiscal 2006 declined to 55.4%. The gross margin for the second quarter was slightly lower than forecasted due to the mix of revenues, competition in portable power, higher than forecasted inventory reserves, and the inclusion of XEMICS' results.

The XEMICS gross margin will be favorably impacted in coming quarters as negotiated price reductions with suppliers come into effect. Further, the Company is forecasting improvement in gross margin driven by mix of revenues in coming quarters.

Gross margins for the prior year reflected higher shipments of our test and measurement product line as well as greater pricing power in certain sectors. Our business model still supports our targeted gross margins of 60%.

GAAP net income for the second quarter of fiscal 2006 was $7.4 million or $0.10 per diluted share. As I previously mentioned, these results included a net negative impact of $0.04 per share from the write-off of intangibles associated with XEMICS and the insurance recovery.

Revenues for the second quarter increased including XEMICS sequentially by 3% from the first quarter as I previously mentioned. Protection revenues increased 7% sequentially again this quarter due to very broad-based diverse end-market demand for our Protection Products.

We are introducing several new products in this product line, some of which take us into adjacent market areas, which should allow this unit to continue its sequential growth.

Power Management revenues declined approximately 11% during the quarter as compared to the first quarter of this fiscal year. Despite the performance of our handset segment within Power Management, we have building momentum within our Industrial and Networking Power Management products.

Further, the revenue levels forecasted for our portable power business in our third quarter should represent a bottom with improvements starting in the fourth quarter.

Revenues from the test and measurement unit increased by 126% compared to the first quarter. Some of this improvement was due to some one-time end of life sales, but overall activity levels are up and there has been significant interest in the new products being introduced by test and measurement.

We forecast growth in fiscal 2007 and fiscal 2008 based upon these new products and new design wins as well as forecasted end-market improvement.

Revenues from our Advanced Communications, or SETS business, declined by 10% sequentially as we experienced delays in buys by certain customers. We are forecasting that this business in the third quarter will grow both against second quarter revenue levels as well as first quarter revenue levels.

Revenues from Semtech's HID, or Human Input Device business, declined in the quarter. The Company's high reliability aerospace and military businesses also declined during the quarter but are expected to record growth in both the third and fourth quarter.

As I mentioned previously, the Wireless and Sensing business unit performed well during the quarter, representing approximately $2.9 million of revenue.

Revenues for the second quarter were derived from the following geographic regions: 21% was derived from customers located in North America; 9% from Europe; and 70% from Asia.

Net turns orders accounted for 47% of shipments in the second quarter. This compares to 46%, 40% and 26% from the previous three quarters. This increase was consistent with our forecast and an industry-wide contraction in lead times.

Revenue by end-market changed somewhat. Revenues from cell phone handsets and base stations accounted for 27% of revenue, desktop computers and servers accounted for 12% of revenue, notebook computers, PDAs, and other portable items and devices accounted for 18% of revenue, test equipment accounted for approximately 4% of revenue, communications infrastructure accounted for 19% of revenue, general industrial, which includes medical, military and other, accounted for 19% of revenue, and graphics accounted for about 1% of revenue.

The large increase in industrial was primarily due to the inclusion of a significant amount of XEMICS revenues from the medical area into this consolidated end-market.

Revenues from OEM sales represented 40% of revenue in the second quarter while distribution represented 60% of revenues.

Looking at the outlook for next quarter, we are forecasting that revenue will be approximately $60 million for the third quarter of fiscal 2006.

In the third quarter, we are seeing strengths in most areas of our business with the exception of some segments of portable power. To attain the third quarter forecast, net turns orders of 46% of revenue are required.

Gross margin for the second quarter of fiscal 2006, as I mentioned, was 55.4%. Gross margins for the second quarter were impacted by the sale of $107,000 of previously written-off inventory.

On a year-over-year basis, second quarter gross margins declined. This was due to the overall mix of revenues, competition in certain areas of Power Management as well as higher inventory reserve charges.

The new products we are introducing are forecasted to drive gross margin improvement. We continue to focus our Power Management R&D budget on business areas that can support 60%-plus gross margins prior to any potential impact of stock-option expensing, and for the third quarter we are forecasting that our gross margins will approximate 56%.

We will continue to see the impact of cost reductions in the third quarter. The significant rate of new product introductions also is forecasted to drive improvements in our revenue mix in future quarters, and two of our emerging product lines, the SETS, or Advanced Communications product line, and the Networking and Industrial Power Products should drive favorable improvements in mix.

At the forecasted gross margins of 56% while lower than our targeted model, it still gives us one of the higher gross margin models in the semiconductor market. Additionally, we are working on several technology initiatives which should continue to drive our cost structure.

Research and development spending for the second quarter was approximately $9.3 million. This included XEMICS, which spends on R&D at a higher rate than Semtech.

With the inclusion of XEMICS we are forecasting that R&D spending will be approximately 10.3 to $10.5 million for the third quarter. While R&D spending is currently higher than our targeted model of 14 to 15%, we believe this will come back to the targeted levels with revenue growth.

SG&A spending was $10.9 million during the quarter. With the inclusion of XEMICS we are forecasting that G&A spending will be $11.5 million approximately for the third quarter.

During the third quarter, Semtech settled with two of the three insurers which we had a lawsuit filed against. This yielded the Company $3.05 million.

The company incurred $1.324 million during the quarter on these lawsuits. Thus, the net favorable impact for the quarter of this recovery was 1.726 million.

This net income was taxed at our marginal U.S. rate which is approximately 40%.

We are still pursuing one insurer for approximately $9 million plus interest. This is expected to go to trial during this quarter.

We are forecasting to incur approximately $750,000 of legal costs during the third quarter in pursuing this additional recovery, and at this point we cannot estimate the amount or timing of any recovery or the likelihood of our success in this trial.

For the next three quarters, we will record amortization of intangibles associated with XEMICS acquisition in the amount of approximately $420,000 per quarter. There is no associated tax benefit with these items.

After this point in time for the following four and three-quarters years we will have intangible amortization expense per quarter of 275,000. And once again, there is no associated tax benefit.

Interest and other income was $1.4 million for the second quarter. For the third quarter, we are forecasting interest and other income of approximately 2 million.

Interest income for the second quarter was negatively impacted by foreign exchange losses on the British pound and Swiss franc.

The Company's effective tax rate for the second quarter of fiscal 2006 was 32.6%. This was higher than we had anticipated due to the non-deductibility of the in-process R&D write-off and amortization expense associated with the acquisition, as well as the higher rate of tax on the income associated with the insurance recovery.

Our core tax rate is still approximately 22%. The Company is projecting that its core effective tax rate for the third quarter of fiscal 2006 will be 22% based upon current revenue and earnings forecast.

There are several factors which can cause the rate to be higher or lower. These factors include variations in income, the source of that income, the dollar Swiss franc exchange rate, transfer pricing assumptions, the geographical mix of revenues, timing of any settlement in our insurance recovery suit, as well as other factors.

Certain of these factors can have significant period-to-period impacts on the tax rate which can cause the actual rate to vary from forecast.

The diluted share count decreased by approximately 300,000 shares during the quarter to 76.4 million. The share count is forecasted to decrease by approximately 700,000 shares during the third quarter.

Such forecasts can vary based on the average stock price for the quarter, stock option exercises and the level of stock buy backs.

Based upon this guidance, diluted earnings per share, including an approximate $0.01 net negative impact from intangible amortization and spending on the lawsuit against an insurer are forecasted to be $0.13 per diluted share for the third quarter.

Turning to the balance sheet.

Semtech ended the quarter with approximately 263 million of cash and investments on the balance sheet. During the quarter we spent $43 million on the acquisition of XEMICS.

Operating cash flow for the quarter was a positive $10.6 million. We are forecasting that operating cash flow for the third quarter will be approximately 20 million.

During the second quarter, the Company spent approximately $1.3 million on property, plant and equipment, and as we projected capital spending was significantly less than prior quarters.

Depreciation and amortization for the second quarter was approximately $2.8 million. This included approximately $100,000 of intangibles amortization.

The Company purchased approximately $9.7 million or 558,400 shares of its common stock in the quarter. And as of the end of the second quarter, the Company had remaining under its current buy back authorization approximately $43 million of stock buy back authority.

Accounts receivables days sales outstanding calculated on a quarterly basis remain low at approximately 42 days for the second quarter.

Inventory levels increased in the second quarter as compared to the first quarter. The Company is forecasting to reduce inventory by approximately 2 to $3 million during the third quarter and increase turns back towards the four turns of inventory per year.

Guidance for the third quarter shows revenues of $60 million.

While we are disappointed about the short-term performance of our portable power products, we are still very optimistic about the long-term opportunities for this product line and the improved rate of new products from this unit. We are forecasting further improvements in consolidated revenues and profitability for the fourth quarter of this year.

New product introductions, the last two quarters have been at high levels with a total of 36 new products introduced in these two quarters. We expect continued strong new product introductions for the balance of the year.

We are very excited about the acquisition of XEMICS. We think this provides us good avenues for long-term growth and broadening of our product lines.

We also see very strong positive business trends for our Protection and Networking and Industrial Power businesses. In the short-term we will continue to focus on driving new product introductions, working on cost reductions and cost containments, driving operating cash flow and buying back stock.

We continue to expect improvement in operating ratios, cash flow generation is expected to remain strong for the balance of fiscal 2006, and looking past the third quarter, we plan to grow revenues and control operating spending, which is forecasted to drive growth in earnings prior to the impact of stock option expensing.

Thank you for participating in our second quarter of fiscal 2006 conference call. And I will now turn the call over to Semtech's Chief Executive Officer, Jason Carlson.

Thanks, David. Good afternoon, everyone.

As David mentioned earlier, Q2 was a very exciting quarter for Semtech, having closed our acquisition of XEMICS on June 23rd. I am very pleased with the progress we have made on the integration of what we are now calling our Wireless and Sensing business. And we'll talk more about that later.

Additionally, Q2 did represent another quarter of increased bookings, however, our book to bill still remained just below one. Also, two of our businesses, Protection and Networking and Industrial Power Management again posted record quarters.

Looking at design win data for the first quarter, I will now discuss that data from an activity and end-market perspective. The second quarter again saw a good level of design activity and we recorded more than 750 wins.

From an end-equipment perspective, cell phones saw the greatest activity with wins for both Protection and Power Management products followed next by notebook Power Management. While these two markets have been our largest end-applications, I am also encouraged by the increasing diversity of our design wins.

Our Networking and Industrial Power Management group had wins in various power supplies, bricks, set-top boxes, routers and IP phones.

Our ATE group is seeing renewed interest with new products and recorded four wins at different customers in the quarter.

Our SETS products continue to win designs for IPD slims and network sync cards.

From a regional perspective, Taiwan recorded the most design wins, followed by North America, Korea, and Japan respectively.

Turning to new products, this quarter we introduced 13 new products. While that is down from the 23 products released in the previous quarter, we are continuing to make improvements in our product development process.

I expect that our new products released in FY '06 will be up noticeably from FY '05. This is important for driving growth and dealing with the pricing pressure of products which have been released for several years.

Five of these products were from our Protection group, targeting applications such as xDSL, video, and networking. Four of the products were for portable power management and hand-held applications, and these products represent a move towards a higher level of integration compared to previous hand-held power products.

Networking and Industrial Power Management released two new switching regulators and a new synchronous buck converter while three of these products are applicable to various end-applications. And Wireless and Sensing released a new RF product for Bluetooth applications.

Moving on to the acquisition, as I said previously, we closed the acquisition about eight weeks ago and I am very pleased with the progress we have made integrating the two companies. Our worldwide sales team has completed training on the XEMICS product line and has met with XEMICS' top customers.

Also, we have begun presenting XEMICS technology to current Semtech customers. Additionally, we are making good progress defining synergistic product roadmaps with the combined technologies. We expect to release some of these products in the next four quarters.

The addition of XEMICS RF capabilities is an important building block for us going forward, though it is only a piece of the value that they bring. The real value will be achieved through the integration of the RF together with the ultra-low power, a sensor interface and systems integration which together will deliver a differentiated product.

An example of this today is their product offering for remote metering, which is a best-in-class product. This is only the beginning of this type of integrated solutions.

Also, the acquisition will allow us to expand into markets like remote metering, security, industrial, medical and automotive where we have not historically participated to a significant degree.

Lastly, I believe we are entering a time where anything that can benefit from being networked will be networked. However, given the opposing requirements of data rates, battery life, and interoperability versus proprietary systems, there will be many different solutions driven by each application's individual needs.

Together, Semtech and XEMICS are well positioned to enable these next-generation products and applications.

Moving out of the Q3 outlook in growth, our Protection Products mark the second consecutive quarter of record performance and I expect Q3 and Q4 to grow as well. The trends for this business continue to look very promising as smaller silicon geometries, faster data rates, and more ports all increase the need for Protection Products across many different end-markets.

That, combined with our focus on opportunities where Semtech can provide added value has netted great results.

Networking and Industrial Power Management is in the same position with two record quarters and expected continued growth in Q3 and Q4 of this year. This is as a result of a redirection of resources from desktops several years ago to this large diverse and fragmented market.

While it has taken time to grain traction in this new market for Semtech, we seem to have finally gained critical mass and are now seeing these wins ramping into production.

SETS had a record Q1 but lower bookings in Q2. This was due to the still relatively small size of the business and the fact that minor customer [pertabations] affect quarter-to-quarter growth noticeably.

We do anticipate Q3 to be at or near a record bookings and revenue and overall growth for the year. When you combine a portion of the Protection, Networking and Industrial Power business with SETS, the wireline end-market should continue to grow as an overall percentage for us.

From a computing point of view, desktop has performed as expected and we are continuing to grow the business in server. Combined, this should result in roughly the same level of business throughout the year with the mix improving slightly.

In the notebook market, we expect to see slight revenue growth over the next two quarters while overall notebook units are forecasted to be up more significantly.

Pricing pressures and increased competition are impacting the rate of revenue growth. We have responded to these requirements and are rolling out new product roadmaps.

In the hand-held market we expect Q3 to mark a bottom from which we can grow again in Q4. The combination of greater than anticipated price reductions, many more players in the space, and a lack of products driven by new features resulted in a reduction in Q2 revenues as well as a forecasted decline in revenues for Q3.

We expect that new products, which will support more diverse sockets in the handset market will begin driving growth likely in Q4. As in the past, I expect we will come through this transition stronger as a result of both improved application and customer diversification.

For ATE, Q1 marked a bottom from which we grew in Q2 and I expect Q3 to be about the same and then another small increase in Q4. The combination of older programs coming back to life and smaller new programs ramping should provide an opportunity for some upside over the next several quarters.

For Wireless and Sensing, this will be their first full quarter with us and we expect them to show modest quarterly growth on their existing products. More importantly, we are looking to new products that will drive noticeable growth beginning in about four quarters as we previously have stated.

The end result of these combined markets should provide the opportunity for growth in Q4 with a better balanced split of end-markets as we move towards our goal of increasing diversification and no end-market above 20% if possible.

Finally, this improved mix will enable us to continue to expand gross margins as revenues grow.

This concludes my remarks and I will now turn the call over to the Operator for questions.

[OPERATOR INSTRUCTIONS] Our first question comes from Romit Shah out of Lehman Brothers.

Thanks. Guys, could we get the contribution from XEMICS in fiscal Q3?

You know, we don't break that out separately. You mean from a revenue standpoint?

Yes.

From a revenue standpoint we're expecting that they should be approximately $7 million, possibly a little upside on that but I think that's a, probably a pretty safe number.

Okay. Just looking at the different segments, I mean it looks like you guys had some broad-based strength across, you know, quite a few end-markets. Is the issue, if I have it correct, is the issue just handsets and Power Management?

Pretty much. I mean as you saw, we had record quarters in a couple of the businesses and it's pretty much handset Power Management being down from expectations.

And the other thing, just in terms of our overall revenue to remember, is in our desktop area we've consciously been, you know, I think that business has consciously been declining as part of a plan because we shipped in a lot of resources into the Industrial and Networking Power Management area so, but that's consistent with our plan.

Okay. And then David, just on the gross margins, you reiterated your, I guess long-term target of 60%. Can you just walk me through your assumptions and on what revenue base would you expect to get those, to get back to 60%?

Well, I think if you look what the assumptions are, I mean the assumptions are by product line standpoint that we continue to get some growth out of our Advanced Com product line in the coming quarters, that we see, continue to see the kind of stabilization that we've seen in our test and measurement business unit and then as we drive into next year we see some growth there.

We continue to see some strong growth out of both our Protection and Networking Industrial area which support that targeted gross margin area. And we start to see a meaningful contribution in the portable area from these, you know, these new products.

It's not that all those things have to happen to achieve that target, probably the majority of those type of things need to happen, but just things that we're doing through our R&D and product development, you know, should drive that.

In terms of the revenue level we had talked about the $70 million revenue level, XEMICS obviously layers their lower gross margin at least today, layers a different factor into that but certainly as the Semtech-based business let's just call it, or the Semtech business pre-XEMICS gets back towards that $70 million-type revenue number, I think that same assumption is still a very accurate and consistent assumption.

And as we've talked about on the XEMICS side, they had some very high wafer prices, higher assembly prices. So in the short-term we're driving cost reductions there to improve their margins and longer term the synergistic impact of the two companies IP and the type complexity of the solutions that we'll be introducing to the market, proprietary nature in the markets, should propel their gross margin profile up towards that company target as well. At least that's the plan.

And just final question on the test and measurement business it sounds like that's rebounding. Is that Semtech regaining some share or do you see the overall environment, you know, for orders improving?

Yeah. Romit, I think as I say that I think Q1 clearly marked a bottom. So relative to the actual revenue numbers for us, it's just the market improving a little bit.

As I said in the design win commentary, we actually recorded four design wins at various customers in the quarter but that wouldn't reflect revenue right now. So for the current quarter and the next quarter that's just the market getting a little healthier but for out quarters I think the fact that we're getting some new design wins should provide an opportunity for growth as well.

Thank you.

Our next question comes from Craig Hettenbach out of Wachovia Securities.

Yes. Thank you.

On the wireless handset side of things, can you talk about your confidence of Q3 being a bottom in that business? Is it some of the design-win activity you're seeing there? And also within that area, what are you seeing in Protection for handsets?

Craig, could you repeat the last part of the question on the Protection piece? I didn't quite get that.

So within wireless handsets, how is Protection tracking within handsets?

Okay. So as far as the confidence in the Q3 being a bottom, I mean we're actively engaged in some programs with customers that we're feeling pretty good about. There's always some degree of risk until those new platforms actually ramp.

But we've got some pretty active programs going on there. So I think we're about as confident as you can be at this point in the quarter, I guess I would say.

As far as Protection, I think Protection in handsets is doing pretty well. Sort of for the reasons that I mentioned.

It's no different in handsets, that you just see this continued trend of, as these processors are getting to smaller and smaller geometries, you know, off the main chip protection is absolutely a key. Faster data rates on these ports are requiring more sophisticated protection devices. You've got more ports on these devices so all of that is true for handset as well.

Okay. And then on the XEMICS acquisition, can you discuss any anecdotes from customers about the potential to layer on additional dollar content through XEMICS, how those talks are going?

Yeah. I think we've had some good early meetings there. Anecdotally, this probably isn't as quantified as you'd like.

Just one example would be that we recently had a meeting with a large OEM, it's a current customer of Semtech, presenting the XEMICS technology and this is with their advanced development group. And this was just something that they were very excited about that for us sort of validated I think the strength of the product from a technology perspective.

But unfortunately it's not going to meaningfully impact revenues say this quarter or next. It's really part of our new product roadmaps.

Generally, there's a pretty good recognition I think of their technology, but there's also at the same time some question as their supplier to kind of a tier-one OEM base.

Thank you.

Our next question comes from Richard Schafer out of CIBC World Markets.

Good afternoon, guys, this actually Dan Morris calling for Rick. Could you comment first just about bookings increased this past quarter, but could you just talk a little bit about the linearity of the trend within the quarter and also what it's looking for the month of August?

Yeah. I think the linearity was pretty good within the quarter. If anything, I think from a booking standpoint, you know, things strengthened a bit towards the back part of the quarter and in terms of August, I think August has kind of been, has been right on forecast. I think we're very pleased with the activity levels in August, the turns have layered in as we anticipated in August and I guess that would be my comment.

And I think the third quarter is once again, you know, should be a fairly linear quarter, maybe with some, hopefully some strength building towards the back half of order into October the thing can carry us with some momentum into the fourth quarter so that we can see both bookings and revenue growth in Q4.

Okay. On handsets, could you talk a little bit more about the competitive landscape? I know you said that pricing pressures increased there, could you talk a little bit about who you're seeing and maybe what affect that's having on your market share?

Yeah. I mean you know, I think a lot of this goes back to, honestly we probably had a little more customer and socket concentration in a perfect world than we'd like to have going back to the, I think the early days of the backlight products for color displays, being an early guy there, and now that market's gotten relatively mature and the amount of competition has increased pretty significantly.

And so while we're working on next-generation products, I think a little bit of our surprise was the rate at which some of these price decreases on current generation products and so we just made the choice to actually walk from some of that business rather than going down the gross margin curve with it.

Great. Thank you.

Our next question comes from Cody Acree out of Legg Mason Wood Walker Incorporated.

Thank you. Outside of handsets and portable power can you talk about what's going on there and maybe what you expect for the coming quarters?

Could you repeat that question one more time, clarify it?

Yeah. In portable power outside of the handset space, what are you seeing this quarter and maybe going forward?

Yeah. As I said in the previous part, Cody, notebook I think we're actually going to grow a little bit quarter-on-quarter. While it's probably not as much as overall notebook industry units, I think some of that is being offset by a combination of some ASP erosion there as we're seeing more and more industry focus on $500-type notebooks.

Also at the same time some increased competition in that market as well. But net-net, I still think it's going to grow a little bit quarter-over-quarter and throughout the rest of the year.

In addition to that, the whole area of MP3 players, portable music players, digital still cameras, all of these types of products are really areas that we have traditionally not had a large percentage of share in and have really consciously been working at looking at targeting some of our switchers and battery charging towards those products. So I would expect to see that grow over the next several quarters. Probably not to the point of being a meaningful percentage of revenue but it'll be a good diversification of that overall portable power business.

And then back maybe your comments there on the notebook space. We've seen obviously a very difficult pricing environment in handsets, first in desktops then in handsets. Does the notebook market follow those same trends? Is that what we're painting a picture of for future quarters, or does this, do you find a place where this starts to stabilize a bit?

Yeah. I mean my sense is, you know, it's challenging but maybe different in the sense that I think in some ways there are more barriers to entry today into the notebook market for new entrants.

So for example, if you previously haven't been in that space coming up the curve on being sort of IMVP compliant, you know, dealing with all of the issues around those different products and applications. But if we stay in a mode of where, you know, an ever increasing share of notebooks are $500 notebooks, I would think that's going to drive some challenging pricing for everybody involved.

And then just lastly, back to the handsets. You said that you walked away from business. Was this, do you believe the bigger impact was simply that business was left on the table, not necessarily that prices declined and depressed revenue throughout the space but simply that these are sockets you chose not to focus on and now you've just got to wait for new designs to kick in or is this just different pricing pressure from here on out?

I think it's a combination of the two. You know, it's a little bit hard to tell where it's, you don't sit in the meetings and say, okay, I'm taking my ball and bat and going home, they just throw out a price and you don't meet that price and you come back with a different price.

And so I think it's a combination of both, like I said, I think what caught us off guard was just the rate at which other people are maybe willing to go to these prices, you know.

Great. Thanks, guys.

Our next question comes from David Wu with Global Crown Capital.

Yes. Hi, good afternoon.

I just want to get in order of magnitude of the things we are talking about. How big was handsets in Q2 and the portable power part, which is where the weakness is?

David, handsets were 32% of revenue.

Uh-huh.

In Q1 and then 27%.

Of Q2? Right. The part that is in, that the portable power part is handset and then there are others, right? How big is that?

Um, say that one more time, David? I'm sorry.

The portable power part, which is also sort of weak, how big was that?

Well, you know, we don't break that out per se separately but just kind of to give you some color.

Uh-huh.

The Protection business into handsets was I think relatively flattish in the quarter. So most of the impact in the, you know, in the decline in the cell phone business, you know, was power related, if that helps you.

Okay. I assume most of the business in that thing is really Power Management Protection relatively smaller [inaudible]?

No, no. I mean the Protection business into handsets is, you know, is a fair-sized business.

Oh, I see. Okay. The part that I think I didn't hear too well was the, you were talking about fourth quarter coming back on the Power Management side. I assume that's new products, right?

Well, just to clarify that. I mean the Power Management business and the Networking and Industrial area we're forecasting strong growth in both Q3 and Q4 for that product area.

The desktop business, there's a somewhat of a, I would call it a planned decline that is more than offset by the growth in Networking and Industrial, which is where we shifted some of those resources. And then I think what we said was that the portable power business, you know, we are expecting to bottom basically in the third quarter.

I assume that that's because of all these new products you've been coming out with in the last couple quarters beginning to hit P&L in Q4?

Absolutely.

Yeah.

Okay. That's basically it.

To get to the 60% gross margin let's say of $70 million revenue, how would you put the various categories of products weighting on to hit that number?

Well, I'm not going to put out right now exact percentages for the product lines.

Uh-huh.

But clearly we, you know, we'd need some level, we need good growth out of the Advanced Com business, we need a test and measurement maybe to contribute slightly higher as a mix. Not materially higher, maybe just slightly higher. You know, and we need the new products alone in the Portable area, you know, should drive margin improvement as well.

So I think as you look across our business now, and even some of our legacy businesses, the margins there we're pulling up, you know, per se and with the desktop business shrinking down there's really no one business that really pulls us materially below the 60%, you have a lot of businesses that are all targeted around that 60% level.

And then maybe you have a couple of businesses like Advanced Com and test and measurement which run a fair bit higher than that so that they can compensate for the legacy business and maybe certain parts of our power business which might be more of kind of a mid-50s type business.

Okay. Last question I have was on the, if you look at your core business, it looks like it's been declining in Q3. I assume that based on everything we've said so far we should get the core Semtech business begin to grow in Q4 on a sequential basis.

That's correct.

Thank you.

Our next question comes from Jeff Rosenberg with William Blair.

Hi. First question I wanted to ask was on, a XEMICS question. I think you've talked about eventually getting XEMICS gross margins up to the corporate average level and similarly being able to reduce SG&A to the same percentage in the core business.

Can you give us a time frame on what, how long do you think that should take and then maybe some sort of a ballpark as when we get there if we think about next fiscal year what sort of operating margin we should be thinking about in terms of modeling the contribution of XEMICS?

I'll answer, Jeff, this is David, just the first part. I think in terms of the XEMICS gross margin, we don't want to be too aggressive in the forecasting so I'd probably say 18 months because a lot of the new products we're introducing will start to hit the market say mid-next year, you know, so that probably allows those to get more into the revenue mix. What was the second part of your question?

Well, basically I guess it's just sort of try and give us some feel as to what kind of profitability level we should be assuming as we layer in the impact of this incremental revenue in fiscal '07?

Yeah. I mean in terms of operating profit levels, you know, they will be below the levels of the core business until we get some of these new products ramping, which is really more of a back half of next year type issue.

To get into more detail than that, you know, I mean we probably haven't, we haven't broke it out that way but that rationalization of the operating models should start to happen as we get more of the new products out there into the mix. You know, as we've said, we expect some contribution from XEMICS beginning in the fourth quarter and that still looks on track and look for some contribution or accretion from them, you know, next year.

Okay. And then on the gross margin commentary you had in total for this quarter, I'm just looking for the relative importance of the various factors.

The first question there is I'm trying to understand why the gross margin mix was weaker. It seems to me with ATE going up and that the portable power management being weak that maybe, I'm try to struggle to understand why gross margin mix was a negative factor.

It was probably a very, you know, minor factor and I was referring more to the fact that we didn't get the growth out of the Advanced Com unit that we had expected so, you know, some, we, some of the revenues we missed there were obviously higher gross margin revenues.

Okay. And any quantification on the impact of the inventory reserve?

Yeah. I mean we, I normally don't break that out but I'd just say we did book, it's just part of our ongoing operations but we did book a fair amount of inventory reserves and in terms of impact above maybe where we had planned for at the beginning of the year. I mean that probably could have been at least a half a point, you know, if not, about a half a point of gross margin.

Obviously with some of the demand coming down in portable power and what not, it drove calculations in our formulas that required us to book higher inventory reserves.

Okay. And my last question is just to explore a little bit on the nature of the products that you're seeing helping you to see a recovery in portable power management in Q4.

I mean, are these very recent products that represent this greater level of integration and get away from the applications you've been strong in before or are you seeing some uptick in higher functionality-type, you know, LED drivers and the things that you had maybe out there in the market or earlier in the year but just weren't really being put into design, or into production by your customers?

It's probably a little bit of both. From a display driver point of view what we're hoping to kind of drive the next wave of performance there is streaming video type displays on phones requiring a higher performance phone or higher performance display, you know, such that the market is going back to choosing those sockets based on performance rather than just cost as well as just some higher integration products as well. And so it's sort of a combination of the two, I would say.

So you feel a little bit better about this higher level of technology being adopted as we move toward the end of the year than you did, say, you know, a quarter ago?

Well, there continues to definitely be more press in the market I think about people doing different services, offering different sort of TV on a phone or different things like that, the volumes are still pretty small. But there definitely seems to be more momentum around that.

Also, for example, with higher megapixel cameras requiring either a flash or even a better performance flash, yeah, those things are definitely in my opinion gaining momentum. You know, it's a little bit hard to always predict the rate of adoption, you know, as this next quarter and the quarter following really going to be a major inflection point there or not.

We've got a customer telling us that in the back half of this year they think that these higher performance displays are going to be pretty important.

Okay. That helps. Thanks.

Our next question comes from Michael Bertz with WR Hambrecht.

Thanks very much, guys. Just a couple questions and a couple these are kind of follow-on to some other questions that you've had earlier.

First, and kind of I think, to go to more of the point of what Dave was asking about inside of handsets. If you could give us some sense of the split between Power Protection and Power Management. Is that something that's on the order of magnitude of maybe 50/50 or is it one, twice as big as other? How would that kind of break out?

I mean as you look towards the second quarter, I mean historically we've always, the business has been more 60/40, maybe even, you know, when we had some very strong growth last year and some of the LED drivers might have even been as much as 70/30 in the handset area, but I would just kind of generally say probably in the handset area coming back to closer to maybe 50/50, you know, closer to 50/50 in terms of Protection versus Power, just to allow you to calibrate.

Okay. Great. Thanks.

And then in the, and this just kind of follows a little bit with a question we just had about sort of how you're winning some of these designs for the handsets and it sounds like there's this transition again towards higher performance displays which we're certainly seeing. When you look at businesses you sort of, like you said, walked away from currently, is that based more on cost and you're going to see more of your own sockets being one on performance versus cost or will there be some cost involved in that in the future in the next couple quarters or so?

I think I understood everything but the last sentence there.

Well, I guess what I'm, my point is, are we going to see more on, more just on performance or will there still be some cost performance involved in these new designs as you go forward? I mean basically are you going into new designs where it's going to be completely integrated and that's really what wins designs for you or are you still going to be facing some cost pressures?

I think in the handset market you always say it's cost pressure. It's just a question of, you know, is this a new application driving a level of performance that you're the only guy that's got that and it's required to enable that feature to be displaced in the market?

That's where obviously we have the least pressure versus, you know, maybe there's five other guys and they all have similar products but you've got slightly higher efficiency or some bottom class advantage, you know, then there's still pressure but greater than, it's just that.

I think a little bit of what we've experienced recently is almost the opposite where maybe you've got a socket that we had early on that was a pretty full-featured product and maybe others have come out with either less featured or less-performance driven versions of those at what they're willing to take as a substantially lower price and there just aren't the new features in the handset driving those makers to go for the performance-driven sockets in a large percentage of the business today.

Okay. Great. That's very helpful. Thank you.

And then the last question, you talked last quarter about having a significant number of wins in consumer in terms of orders sort of ramping up and about some of the different applications there. Is that something that you guys would [track] improving here into Q2 and then sort of looking to the back half of the year as something that we'll see ramping on the consumer side and if you can identify some strong applications there for us.

Yeah. I mean we aren't reporting that as a segment yet but I think that's going to continue to grow for us. And frankly, we probably should start breaking it out, maybe at the beginning of our next fiscal year or so, you know, two more quarters from now.

But we did see growth there again. And it's in things like flat-panel televisions, be it plasma or LCD, a little bit in some of these media players. I think a little bit in digital-still cameras.

You know, we're going to have some of, probably some relative to XEMICS, a little bit in the area of gaming and so, you know, yeah, it's like I said, it's not a meaningful percentage yet but it's a growing trend for us that we expect to continue.

Okay. Terrific.

And last question. In terms of R&D, the rate you guys have talked about 10.3 to 10.5 in Q3, is that something that would be reasonable to think about kind of on a steady basis for the next two quarters or is that going to meaningfully tick up or down?

I think if you look at a cost containment standpoint we are going to work to keep operating expenses, I would actually say relatively flat in Q4 even in spite of some higher variable costs with the revenue growth and I'd say once again relatively flat in Q1.

Okay. Terrific. Thanks, guys.

Our next question comes from Lewis Gerhardy out of Morgan Stanley.

Hi. Good afternoon. You've got most of my questions. Can you just remind me on XEMICS, did they operate with a lower turns requirement relative to the Semtech business?

Yes, Lewis, they did.

Okay. And then the, you gave 56% gross margin guidance for fiscal Q4, is that right?

Fiscal Q3.

Okay. And the rationalization of that is that you're going to be taking some costs out of the XEMICS products from your subcontractors and then a slightly better mix from Semtech?

That's correct.

Okay. And for XEMICS and the July quarter, what was the full quarter of revenue there? I'm just trying to understand from the earn-out schedule perspective how I can keep track of that.

You know, at this point I don't have that, I have that number, I don't have it on any of the numbers here. But, you know, we are expecting in this coming quarter a little bit of growth. They do have to hit some decent growth ramps in the next couple of quarters to be able to achieve that earn-out.

I think at the end of the next quarter we'll, I think we can probably give a forecast of where we think that's likely to be but they still have to hit a pretty good ramp in the next, in Q4 and Q1 from the amount that we have forecasted for Q3 to be able to achieve even the first, to achieve the first level of payout.

So to do the low end probably close to double digits sequential type of growth in the back half?

Yeah, yeah.

Okay. And then, you know, I think XEMICS, correct me if I'm wrong, only had about 20% of revenue in Asia. I know it's early, but any sense of the progress in terms of introducing them to your customer base and when we might see some impact of that?

Yeah. You know, I think for the current revenue stream it's probably more Europe based than it is Asia based, Lewis. I think, you know, longer term there's some potential there for Asia.

I think some of the interaction we've had with our sales guys and some of their customers looks promising but as I said earlier, there's nothing there that I would call material yet for Q3 as far as upside.

And, you know, to go a little bit further on David's comment, I think relative to the four quarters, I think basically assume them kind of being in line with this first quarter expectation but the plan assumes some pretty good growth in the back two quarters relative to their 12-month earn-out.

Great. Well thank you.

Our next question comes from Sumit Dhanda with Banc of America.

Hi. Good afternoon, guys.

A couple of questions. First, in terms of the turns outlook for the October quarter here down slightly from what you reported in the July quarter, is there any reason why you believe that will be the case, have August turns been lower than the corresponding months in the second quarter, or is that just what you're preferring to put out there at this point in time?

Well, you know, I think it, as I just responded to Lewis, I mean part of that decline is obviously related to the fact that XEMICS, given their product line and the custom nature of some of the products, they come into the quarter with a little bit better coverage than we have for our other businesses.

But the turns business, as I mentioned earlier in August was, you know, kind of I would say on target and continues up in pretty good shape to hit that revenue number. And also, like I mentioned earlier, we are forecasting that we should actually build some backlog this quarter. So ...

And then to clarify your comments on operating expenses heading into Q4 and Q1 where you said we can think about you guys holding at roughly flat, is that even, you know, Q4 you're expecting some growth, is the anticipation there that that incorporates some level of growth again in Q1, or is that, you know, the expectations over the expectation from a top-line perspective as these --

You know, I think the Q4 expectation of flat certainly does incorporate the revenue growth. We not only have put in some cost containment measures but we typically get in that time frame because of all the holidays we get some benefit from all the vacations people tend to take, which benefit operating spending during that time period.

I mean into Q1 it's going to depend on what the business environment is looking like, if we're seeing a better rebound in our portable business then certainly we might be a little bit more willing, you know, to add resources. So that's going to depend somewhat on the kind of growth we see, what kind of resources we're willing to add.

But just generally, we should be able to support some growth off of, with the current operating spending base. So we're going to try to keep expenses in check here for the near-term and drive some improvement in our profitability based on the improvement in revenue. In other words, get some, hopefully some pretty good fall through on the revenue growth.

A couple more questions.

You know, when you announced the XEMICS acquisition to begin with you'd indicated that it would initially be neutral to earnings and then accretive, perhaps accretive overall. Clearly your base business is undergoing some contraction, which you probably hadn't anticipated heading into the July quarter and the October quarter. But if you were to normalize for that, how do you think, you know, it's tracking versus your initial plan meaning if you normalize out the base business do you still feel that the acquisition is working out to be neutral and then accretive, or how should we think about that?

I think it's tracking according to expectation. I mean I think it's, you know, it'll be neutral in the next, relatively neutral the next couple, [yesterday] it was relatively neutral this quarter and next quarter it will be, and then as we get into Q4, you know, it, we I think are still forecasting that it will be, should be additive to earnings. I mean we're just hopefully being somewhat conservative about the earnings outlook, you know, in Q4.

One final question.

Again, it seems like the handset segment was a [hole] for you here in the last quarter. If you were to think, if you were to tell us about Semtech's base business and how orders did excluding the handset segment, could you give us an idea about how the rest of the business did from a quarter perspective?

Well, the, I don't have the exact, that exact breakout here. Let me see. Just take me one second to look for that. Okay. I don't have that, I don't have the handset and notebooks broken out separately here but clearly the growth number would have been, you know, would have been better than the 1%. I don't have an exact number, but I'm guessing at kind of a mid-single digit-type growth numbers in orders excluding the handset segment as it pertains to power.

Okay. All right. Thank you very much.

Our next question comes from Steve Smigie with Raymond James.

Great. Thank you.

I was hoping you might be able to comment a little bit on the gross margins on the Protection Products. It seemed like you indicated in the call that that was improving some. I thought it previously might have been maybe a little bit lower than corporate average but you had indicated it might be helping mix going forward?

The, I would say the Protection business, we've continued to move into some smaller packages, more proprietary products, and maybe once, if you go back three, five years on that business, we, that business was a business that had gross margins which were lower than some of our, than our average.

But clearly that group has just done an excellent job in driving both process technology, package technology, and as a result, you know, introducing some very proprietary high-performance Protection devices and so we are getting gross margins in that business, you know, that I would say are at our corporate average today if not, you know, higher.

And I just had one other quick one. Human Input Devices has been I think a little slower to get going here. Is that something you continue to focus on or are you start to reallocate R&D dollars there elsewhere?

I think it's something that, you know, being honest I remain disappointed on our performance there.

All right. Okay. Great. Thank you very much.

Our next question comes from Gus Richard with First Albany Corp.

Hi. Thank you for taking my question.

On XEMICS, most of the revenue went into the Industrial product line. Could you sort of give the split for the quarter as to where you allocated that just so you can get a better look at organic versus XEMICS?

Gus, it was principally industrial and a lot of that is medical. There's some, you know, if I had to break down their revenue, it's largely medical or pure industrial and then there are some small contributions from automotive, consumer and audio.

So the 2.9 was all put into general industrial?

Yeah, most, yeah, largely.

Okay. So that business actually organically was down sequentially?

I'd have to do the --

It was up 2.6 sequentially and XEMICS was 2.9 so that would have declined about 3, 300,000.

I'm looking at some of the detail here. But the, got the wrong schedule.

Yeah, the overall business was up pretty significantly but obviously, yeah, a lot of the XEMICS revenues did go there. Our military and legacy business I know was down about 2 or 300,000.

All right. That makes complete sense. And then just one more. Are you guys seeing any increased competition in the Protection business?

I think it's pretty much the same group of competitors that we've been dealing with for a number of years there.

What's the, you know, if you compare the design win revenue on average in Protection to say, like a white LED or a notebook, Power Management circuit, how do those use Protection more fragmented or is it as sizeable per design win?

No. It's definitely smaller per design win. You know, just starting with on average, you know, lower ASPs and so, yeah, it's much more fragmented than you would typically see for Power Management.

Okay. Thanks a lot. That's helpful.

Our next question comes from William Conroy with Sanders Morris Harris.

Good afternoon, guys. Really just one left.

I was hoping you could comment a little bit on your manufacturing capacity situation, just what you're seeing in terms of the front-end and especially also the back-end?

I would say we're seeing pretty good availability of both.

Any comment on pricing, Jason?

You know, we've been working pretty hard with all of our suppliers on cost reductions over the last several quarters and they've been generally pretty receptive there. And as David mentioned, we're continuing to do some of that right now on the XEMICS products as well, you know, just leveraging our higher volume compared to theirs.

Great. Thank you.

There are no further questions at this time. Are there any closing remarks?

No. I'd just like to thank everyone once again for participating in our call and we'll look forward to updating you at our next quarterly conference call. Thanks for joining us today.

That does conclude today's teleconference. You may now disconnect