Semtech Corp (SMTC) 2010 Q2 法說會逐字稿

Good afternoon. I will be your conference operator today. At this time, I'd like to welcome everyone to the Q2 fiscal year 2010 Semtech Corporation earnings release. All lines have been placed on mute to prevent any background noise. After the speakers remarks, there will be a question-and-answer session. (Operator Instructions). Thank you, I'd now like to turn the call over to Mr. Chris Rogers, Director of Financial Planning and Analysis and Investor Relations. Sir, you may begin your conference.

Thank you and welcome to our fiscal year 2010 second quarter conference call. We just have issued our press release announcing our unaudited results for the second quarter ending July 26, 2009. A copy of our press release is available on our website www.semtech.com as well as national news and financial market wires. A replay of this call is also available on the investor section of our website through September 19.

During this call, Mohan Maheswaran, Semtech's President and Chief Executive Officer; and Emeka Chukwu our Chief Financial Officer will be discussing our results and answering your questions.

Our call today will include forward-looking statements that include risks and uncertainties that could cause actual results to differ materially from those made during this call. We encourage you to review the Safe Harbor statement included in today's press release as well as other risk factors noted in Semtech's most recent periodic reporting documents on Forms 10-Q and 10-Q filed with the SEC for more detailed discussions.

Also during this call we may refer to pro forma or other financial measures not prepared according to generally accepted accounting principles. In conjunction we've provided supplemental information in our press release to help readers understand the Company's comparable financial performance between periods.

I would also like to mention that during the third quarter we'll be presenting on September 10, at the Citigroup 16th annual global technology conference in New York City and on September 21, at the Banc of America-Merrill Lynch 2009 small mid cap conference in Boston.

Thanks for your attention to this important preliminary information. I'll now turn the call over to Emeka Chukwu, Semtech's CFO.

Thank you, Chris. Revenues for the second quarter of fiscal 2010 were $66.3 million a 10% sequential increase and down 15% from the same quarter last year. On a year-over-year basis, revenues declined across all end markets.

Our GAAP net income for the quarter was $7.4 million or $0.12 per diluted share, down from $11.7 million or $0.19 per share for the same quarter last year but up from net income of $4.9 million or $0.08 per share for the first quarter of 2010. In the third quarter of Fiscal 2010, we expect GAAP net income of $0.12 to $0.14 per diluted share.

In the second quarter, 60% of our revenues were derived from our customers in Asia, 25% from North America, and 15% from Europe. Direct sales represented approximately 49% of total revenues, while distribution made up 51% of total revenues.

Bookings were up sequentially in Q2 and our book-to-bill was approximately 1. We saw increases in all end markets with the exception of industrial. Net sales orders accounted for 40% of shipments during the quarter.

During the second quarter, we continued the cost reduction initiatives that were implemented in the fourth quarter of fiscal 2009, including time off and tight monitoring of discretionary spending. Beginning in the third quarter, we have terminated the Company's mandatory time off program. Other initiatives such as planned lower pay out on the Company's bonus program suspension of the Company's matching programs on the suspension of non-critical hiring will continue.

In the second quarter, expenses related to equity based compensation were $5 million or 8% of revenue. This is an increase of approximately $200,000 from the first quarter of fiscal 2010. This sequential increase was driven by mark-to-market adjustments on performance based awards which can be settled in cash. These adjustments were driven by the increase in the Company's stock price. We expect equity compensation expense to be approximately $4.6 million in the third quarter of fiscal 2010 broken down as follows--$300,000 in manufacturing, $3.1 million in SG&A, and $1.2 million in R&D.

In Q2, approximately $923,000 of legal expense associated with ongoing stock option related matters was offset by a $1.25 million in insurance recovery resulting in a net benefit of $327,000 in Q2 compared to a $409,000 of expense in Q1. We expect stock option related legal expenses of approximately $1 million in the third quarter of fiscal 2010. GAAP gross margin for the second quarter of fiscal 2010 was 54.5%, flat from the first quarter of fiscal 2010.

The favorable impact of higher gross margin products from our SC&S and power management product group was offset by weaker demand for industrial products across all product groups. We expect GAAP gross margin during the third quarter of fiscal 2010 to be sequentially flat due to projected higher mix of computer and consumer revenue offset by increase in communications revenue.

GAAP SG&A expenses were $16.6 million for the quarter or 25% of revenue, a decrease of $700,000 from the first quarter of fiscal 2010. This decrease was driven by the insurance recovery discussed earlier offset by higher litigation expenses. We expect GAAP SG&A expenses of $18.3 million in the third quarter of fiscal 2010, a sequential increase of $1.7 million due to the termination of the Company's time off program, higher litigation expenses, higher selling costs, somewhat offset by lower equity compensation.

GAAP research and development expenses were $10.6 million for the quarter or 16% of revenue, up $500,000 from $10.1 million in Q1 due to higher equity compensation expense. We expect GAAP R&D expenses to increase to $11 million in the third quarter of fiscal 2010 due to the termination of the time off program.

Interest and other income was $300,000 in the second quarter compared to $1.3 million in the first quarter of fiscal 2010. This decrease is due to foreign exchange losses resulting from a weaker dollar. For the third quarter of fiscal 2010, we expect interest and other income of approximately $300,000 as yields on our investments continue to decline.

Our GAAP tax rate in the second quarter was 15.7% compared to 20% in Q1. This reduction in rate was due to the impact of the regional mix of income. We expect the tax rate of 17% for the remainder of the fiscal year.

The diluted share count for the second fiscal quarter was 61 million shares. We expect diluted weighted average shares outstanding of 62.2 million shares in the third quarter of fiscal 2010.

Now moving on to the balance sheet. In the second quarter, we generated approximately $19.3 million in cash from operations, which is 29% of revenue and ended the quarter with approximately $291 million of cash and investments. In the second quarter of fiscal 2010, no repurchases were made under the 2008 stock repurchase program. However, approximately 63,000 shares were withheld from vested restricted stock for employee payroll and income tax withholding liabilities. The value of the withheld shares was $1 million. We have $15 million left under the 2008 stock repurchase program.

The Company spent approximately $2 million on property, plant and equipment in Q2. Depreciation and amortization for the second quarter was approximately $1.8 million including $302,000 of intangibles amortization. In the third quarter of fiscal 2010, we expect capital spending to be approximately $5 million to support the ramp up of new products and various new process and package developments. We expect depreciation to be approximately $1.6 million and amortization of intangibles to be $302,000 in the third quarter.

Accounts receivable increased by 5% from the last quarter due to higher sales, and days sales outstanding decreased to 34 days from 39 last quarter. Net inventory increased by $500,000 or 2% in the second quarter as compared to Q1 and the days of inventory decreased to 80 days from 90 days in Q1. Inventory at our distribution partners declined approximately $900,000 or 3% from Q1. Channel days of inventory declined to 79 days from 92 days in Q1. We are pleased with both our internal and channel inventory positions.

In summary, we are pleased with the Company's financial performance in the second quarter. We grew income much faster than revenue and manage working capital efficiently.

Before I hand the call over to Mohan, I'd like to inform you that our fourth fiscal quarter of 2010 will be a 14 week quarter. As you probably know, we typically end our fiscal year on the Sunday closest to the end of January using 52 weeks. Approximately every five years we have to add an extra week to our fiscal year so that we can end as close to January 31, as possible. This is one of those years, and we will be adding an extra week to our fourth fiscal quarter. I will now hand the call over to Mohan.

Thank you, Emeka. Good afternoon, everyone. I will discuss our Q2 fiscal year 2010 performance by end market and by product group and then discuss our Q3 fiscal year 2010 outlook.

Q2 of fiscal year 2010 was another very good quarter for Semtech. We achieved net revenues of $66.3 million. This is above the high end of our revenue guidance and represents a 10% sequential increase versus Q1 of fiscal year 2010. We also maintained 54.5% GAAP gross margins and our GAAP earnings per share increased by 50% to $0.12 per diluted share.

In Q2, revenues from communications increased and represented approximately 20% of revenues. High end consumer revenues increased and represented 40% of revenues. Industrial revenues were down and represented approximately 25% of revenues while computing revenues increased and represented approximately 15% of revenues. As we anticipated we saw seasonal increases in our consumer and computing businesses, and there was relative strength from the communications segment. The industrial segment was noticeably softer in Q2, European and North American industrial segments were particularly soft in Q2.

Now let me discuss the performance of each of our product groups in Q2. In Q2, our Power Management revenues increased sequentially by 29%. Strength in our Power Management business was driven by the computing, communications, and high end consumer markets. Our Power Management business continues to become a more diverse business with revenue contributions from all major market segments. New power platforms released in the last 12 months are gaining traction.

As the overall market improves and our new Power Management platform releases, and design wins accelerate, we expect that our Power Management business will continue to evolve into a more balanced business for Semtech. We are very encouraged by the quality of some of our new products and the traction at customers in all our geographical regions.

We recently announced two of the industries smallest 6 amp 28-volt point of load synchronous regulators capable of efficiencies up to 96%. These products complement or 10 amp regulators recently released. Both products incorporate Semtech's smart power safe capability which enables systems to minimize consumer power when in stand-by mode. The high efficiency and wide input voltage range position this platform perfectly for wireless base stations, computer peripherals, digital TV and ultra mobile computing applications.

In Q2 we also announced the miniature ultra thin, feature rich, integrated one amp battery charger with 30-volt input protection targeted at high end handheld systems and ultra mobile systems. Design wins from both these new power platforms are already in the pipeline. We expect our Power Management business to increase significantly again in Q3, driven by demand from high end consumer, computing and communication systems.

In Q2, our protection revenues increased sequentially by 14%. Demand for our protection products remains strong in the quarter, driven mostly by the high end consumer, communications infrastructure and computing segments. The increase in demand for our protection devices is being driven by the increase in the number of ports requiring protection, increasing performance requirements of these ports and the increase in system returns our customers are facing due to unprotected systems.

Our protection business unit continues to execute quite superbly and we are very encouraged by the design win momentum of our protection products across all our target end markets. In Q2 we released our first high performance protection devices targeted at the power over ethernet segment. These high speed low capacitance devices are ideal for notebooks, voice-over-IP phones and industrial power over ethernet applications. In Q3, we expect our protection revenues to increase nicely again driven by strength from all market segments.

Our Power Discrete revenues were down approximately 8% sequentially in Q2 as the overall industrial sector which has lagged the broader market caught up with softening demand. Our Power Discrete business is driven by demand from the aerospace, military, industrial and high end medical markets.

In Q2, while we started to see softening demand from the military industrial and high end medical sub segments, our JANS shipments increased nicely. Our main focus areas in the Power Discrete business are A) accelerating the release of new products that expand our SAM in the Power Discrete market and B) improving on the supply throughput of our JANS products as we improve our fab yields.

Our fab yields are improving and should be back to pre-file levels this quarter and we expect yields to be optimized by the end of the year. In Q2, we released four new JANS specced products targeted at the satellite sector and we anticipate these products will generate new design wins almost immediately. We also expect to see a doubling of our JANS shipments in Q3. In Q3 we expect our Power Discrete revenues to be approximately flat.

Revenue for the advanced communications and sensing business decreased 5% sequentially. Softness in the industrial segment in North America and Europe due to the overall macroeconomic conditions was noticeable in Q2. Despite the industrial softness, our advanced communications and sensing business continues to do quite well from a new platform execution, design win and bookings standpoint.

In Q2 bookings of our advanced communications infrastructure products achieved a record high driven by momentum of our new timing synchronization platforms in the 3G, 4G and WiMAX infrastructure segments. We are seeing very good momentum at all of the major infrastructure OEMs as they deploy new IP backhaul and multi-standard access base station solutions. Also in Q2, we continued to see very good design win traction of our new RF platforms in the energy harvesting, security and home automation sub segments as well as some new emerging applications and consumer segments.

This month we announced two ultra low power RF devices targeted at next generation energy harvesting systems, industrial security systems and wireless remote controls. These two new devices allow customers to turn to Semtech for all of their ultra low power ISM wireless needs. The design win momentum in this segment is impressive and we are confident this momentum will continue as the market moves into a growth phase.

In Q3, we expect revenues from our advanced communications and sensing business to increase significantly. From a distribution POS standpoint in Q2, we saw total POS increase by over 12% driven mostly by Asia. Distributor inventory was down again in Q2 from 92 days to 79 days. We believe that our channel inventory is at the levels necessary to appropriately support our customers as we entered Q3 with a strong demand outlook.

Moving on to new products and design wins. In Q2 we released 18 new products and recorded over 760 new design wins which represents another strong product release quarter and an extremely strong design win quarter for the Company. The design wins were once again well balanced across our product groups and across all target markets and regions.

Our design win momentum in fast emerging applications and existing markets is impressive and encouraging and will help us to continue to outperform. We believe that we are uniquely positioned to benefit for many fast growing segments and we do expect to see a continuation of the strong design win momentum within these segments as we bring out more new platforms in Q3.

Now let me discuss our outlook for Q3. Q3 demand appears to be robust and channel inventory levels appear to be lean. Bookings towards the end of Q2 and into Q3 have been linear and strengthening, and visibility continues to improve. As a result we expect Q3 revenues to increase sequentially between 6% and 10%. We expect GAAP earnings per share to be between $0.12 and $0.14 per diluted share.

To attain the mid point of our Q3 guidance or our 8% we need net turns orders of approximately 38% at the beginning of Q3. I will now hand the call back to the operator and Chris, Emeka and I will be happy to answer questions. Operator?

(Operator Instructions). Our first question is from the line of Harsh Kumar with Morgan Keegan. Please go ahead with your question.

Great quarter. I've got two questions for you. We listened to a competitor's call, if you will. They mentioned the China base station business had paused for them, a little bit and expected it to come back. I'm hearing sort of maybe something similar on your call if I'm not mistaken. You said Com was a little off and then again you were expecting it but what do you think is going on in that business? Any clarity would be very helpful.

Yes, I think there's two elements to the China Com market. One is the kind of existing infrastructure. And what we saw back in Q1 was the stimulus kind of driving more demand for existing infrastructure. But also what's going on not only in China, I would say in other parts of the world, is deployment of more greenfield infrastructure; 3G, 4G, WiMAX infrastructure that doesn't exist.

And I think that demand continues to be quite strong. It is up and down quarter to quarter but I think in general the trend is upwards and we saw, as I mentioned, record bookings in our advanced Com infrastructure was really driven by the new infrastructure versus the mature infrastructure.

Okay, fair enough. Thanks for that explanation, Mohan. Then as you look out, let's just say, and I hate to put you in a spot. But let's just say you look out further than your current Q3 quarter. Are you taking orders or do you have any kind of visibility into the end of the year at this point in time?

Well, we have demand forecast that looks out. Obviously we don't guide for Q4 and seasonally Q4 is usually down. I would say this year is probably a little bit unusual in that industrial has been incredibly weak so far. And so we may see a little bit of a difference there. Com continues to be strong and I think consumer and computing are really the questions as to what happens in the end of Q3. And as we go into Q4 and how strong Christmas is. So I think it's a little bit of a question mark there but at this point we're fairly bullish on the situation.

Fair enough and then maybe a question for Emeka. Any change to your long term model? You're kind of making pretty good progress towards your 55 to 60% kind of gross margin goal and all the stuff that follows with that operating margins et cetera. At this point you still feel pretty comfortable with what you said before? Could you reiterate that maybe?

No, yes. At this time, we are very comfortable with it. There's no reason to change anything or the strategic investments that we've made. Continue to point to the fact that the model of 55 to 60% is definitely achievable and sustainable when we get there. And also the operating margin model of 20 to 25% on a GAAP basis. So at this point, we do feel very good about our model.

Great. Thanks. I'll get back in line, thank you.

Our next question is from the line of Terence Whalen with Citigroup. Please go ahead with your question.

Good afternoon and thanks for taking my question. Mohan, I think you concluded your discussion about ACS. But despite it declining about 5% sequentially, you said it was going to actually grow quite significantly. And I know you hit some details of that segment but if you were to point out one or two sub segments within ACS that are driving growth next quarter, what should we focus on?

Well, Com is obviously record bookings for the Com infrastructure probably means that we'll shift more Com in the following quarters. So I would expect Com to continue to be strong, and this is really driven by the emerging segments of 3G, 4G, IP, backhaul, WiMAX, multi-protocol type base stations.

So this stuff is going to go for a while. Time to revenue tends to be a little bit longer but now we're starting to see traction. I think it's going to be there for a while. So that's definitely driving growth.

I think there's going to be and we're seeing a little bit of signs that industrial is going to come back a little bit. I don't know how strong but that one I expect to see a little bit of a pick up versus what we've seen so far. And then in general, I think we have got very good design win momentum of some of the RF and sensing applications. Both in the industrial but also in the consumer space and that should drive some growth also.

Okay, great and then as my follow-up. You guys did a nice job at holding the line on gross margin despite the growth that you witnessed in computing and consumer. I guess my question is at what point over the next several quarters might we see an upward inflection in gross margin. And will that be driven more by a pick up in industrial or by a waning in the still below corporate gross margin computing power business?

Well, I think the main driver, Terence, is going to be the Power Management business as a whole. The new platform starting to get traction.

Even within computing, new Power Management platforms drive a higher gross margin for us. So I think that's one thing. I think the advanced common sensing, the more communications obviously drives a much higher gross margin for us. And that -- so that's a good sign.

The JANS products that we -- I talked about in our Power Discrete business drives a higher gross margin for us. So those are all positives for us. And there are still some yield improvements and things that will give us some benefit in the Power Discrete business. But it's really mix and new products.

In general, computing and consumer drive lower gross margin and industrial and Com drive higher gross margin. And if you look at our balance today we're quite nicely balanced. We would like to see probably a little bit more Com, a little bit more industrial, a little bit less consumer and then more new products driving the mix and that should help us to expand our gross margins.

That's helpful. Thanks and nice job.

Thank you.

Our next question is from the line of Steve Smigie with Raymond James. Please go ahead with your question.

Great. Thank you. I was hoping you could talk a little bit more about the Power Management business. It seems like you're getting some traction there which is pretty encouraging. I know you mentioned the categories generally for consumers are doing well. Within consumer, can you point to what applications you're actually showing up on?

Yes. We're doing quite well in Handheld, Steve. The smart phones, GPS, I'd say cameras, general. And also in the high end consumer; some of the TVs, displays we're doing quite well. Set top boxes started to get some traction, picture frames and things like that, if you want to break out some of the other areas.

Computing we've historically done well in notebooks and desktops. I think we're doing quite well in netbooks. We're doing quite well in the peripheral space in computing, which is encouraging. Because computing today is I think now this quarter, last quarter was 15% of the Company. I think we could probably do with getting that up a little bit. It's a little bit low.

And then in the general, Com and industrial space I think we're doing quite well in the routers, base stations, some of the wireless LAN applications. So it's kind of a mix of it.

Before we had such a focus on the computing space that we were blind I think to the broader SAM that existed for us. And I think now with a lot of the new platforms we are attacking the broader SAM. And that's really our strategy in Power is to really go off to the rest of the SAM versus just the computing segment.

Great, and I appreciate that diversity there. I do have a computing question though. In the computing wins that you've gotten, I assume that those sockets you're chasing are not really the traditional sort of more commoditized IM VP sockets or VR11 or what have you sockets?

That's correct. We are going after within the computers themselves, displays. We're going after the peripherals stuff, some of the rail, just regulators that drive some of the other rails versus the core regulator. And so obviously some of the peripheral products we're doing quite well in servers and printers and that area.

Okay, and then turning to the wireless business, encouraging to see signs there as well. For the 4G stuff you talked about is that more on the WiMAX side where you're seeing orders versus LTE? Or is it pretty much spread across both those areas?

A little bit of both. I'd say it's more 3G/4G IP backhaul infrastructure. WiMAX is very small at this point in time. We are seeing a little bit of traction there, but it's more the multi-protocol base stations for IP backhaul.

Okay, and last question. I apologize. Just on the Power Discrete business, I think I saw some softness there. How did you get some mixed data points on some of the military aerospace, I heard some real strength and a couple points of weakness. Can you talk a little bit about why that was sort of soft in the military aerospace? Would have expected that to be a little bit stronger there.

Actually, the military and industrial and even the high end medical for Power Discrete was softer this quarter. There's no question about it. And it has come down. I mean the customers or the military side, for example, are waiting for in many cases budgets to be -- kind of get to the point where they actually can spend money on some areas.

And so while there's no risk I think of them canceling programs or anything like that, I think they are just soft. And we've seen that across-the-board in military and industrial. And it's not just with one customer it's a number of customers. So I think that's a common theme. I think military industrial is generally soft.

On the other side of that, I think the space area -- the space segment is quite strong, particularly military commercial satellites. And we are seeing increased demand for that. Now that's a new SAM for us so we just started to play in that. So it's a good sign but I think it's going to take us a while to get back to the Power Discrete growing again.

Okay, great. Thank you very much.

Okay.

Our next question is from the line of Sumit Dhanda with Banc of America/Merrill Lynch.

Yes, hi guys. A couple questions. Emeka for you first. First on the expense increases that you're seeing associated with the stoppage of the time out programs; the higher litigation, higher selling costs. Can you help us understand whether there's additional normalization of expenses that is yet to take place. Or especially as it may relate to variable comp or profit-sharing or is this sort of the extent of the normalization we should expect as your revenues have returned to not quite a normal run rate but something closer to it?

Sure. Sumit, I think if you go back and look at the history of our financials, our total operating expenses on a quarterly basis is usually $30 million to a $31 million run rate. And with the guidance that we have right now we're coming up to about $29.5 million or thereabouts.

During the prepared portion of my remarks, I did indicate that there was still some expenses that we have not brought back. We still have not brought back -- we've reduced the rates of expected pay outs on the bonus programs. And we're still not hiring unless it's absolutely necessary. We're still suspending our Company matching program. So yes, there are definitely some expenses that we have not brought back yet.

So is $31 million the right run rate to think about?

I would think so in the $30 million to $31 million run rate is the normalized level. But the other thing to point out on that subject though is that what we have said is that we would expect that level of expenditure of the $30 million to $31 million that would expect that to support revenues of $85 million to $90 million. So definitely there is a lot of sign in terms of leverage and EPS.

Okay, great. The foreign exchange losses you talked about associated to the weaker dollar. Could you just walk us through the mechanics of that and what do you need to think about from a currency perspective to model that appropriately going forward?

Well, I don't know how you model that but what is going on is that we do have some of our foreign subsidiaries that have the U.S. dollar as their functional currency. So we have to at the end of every period we value, the balance sheet items that are denominated in foreign currency to reflect the changes in the exchange rate.

So typically the rule of thumb is that when the dollar strengthens against the foreign currency that is a benefit to our P&L. And when it gets weaker it's a downside to our P&L. And just to give you a little bit more detail, the three currencies that actually really drives this is the British pound, the Swiss franc and the Mexican peso.

Okay, and maybe last question for me for now. On the advanced Com and sensing group and the expectations you clearly talk about a rebound in Com infrastructure. Anything more you could share with us on your traction with new sensing platforms? I know you talked about that almost a year ago and the fact that the second half of this year might see that ramp come to fruition?

Yes, Sumit, we had very good design wins with our wireless and sensing products; really, really good design wins, good applications, good customers. They just haven't turned to revenue. And I think there's a time issue with that. I think the time to revenue is a little bit longer than we would like.

Part of it is the industrial sector is a little bit behind the rest in picking up here. But I think we are very hopeful and very excited by some of the applications because they are in new areas that I do think will -- I've been driven by the whole energy push and by green standards and by a number of initiatives in both the home automation and industrial automation markets that I think will transpire. It's just a timing question.

Thank you very much.

Okay.

Our next question is from the line of Doug Freedman with AmTech.

Great. Thanks guys. Congratulations on a good quarter. Can you give us a little insight into the way we should think about the 14 week January quarter? It's a little tough to model given the fact that it is going to run over sort of a holiday period. Are there any sort of actions you might be taking on the expense lines? How much of an increase are you expecting to see? I know it's 5% to 7% increase in days. Is that the way we should think about it; 5% to 7% both in the revenue capture and 5% to 7% increase in expenses?

Doug, let me take the expense portion and Mohan can answer the revenue portion. So on the expenses, our overall goal is to try to keep expenses in Q4 flat to Q3 or just with a slight increase. Obviously we're not guiding to Q4 at this point. So we'll work out the details as we get closer to Q4 but our goal will be to try to keep expenses flat to Q3.

Revenue, Doug, it's kind of tough. We haven't looked out that far really. Obviously we have a Q4 demand forecast and a view today, but I'm not sure that it really takes into account that extra week. My own sense is Q4 typically is down for us seasonally. And this quarter, this year might be a little bit of an anomaly. But that's about all I can comment on. You know what I expect at this point.

All right, great. And moving on I guess, if you could, you're in the range in terms of gross margin at the low end 55%. Traditionally in the past the Power Management segment has brought sort of higher gross margins. Is there anything that you're seeing as far as price pressure in the marketplace that sort of is changing your gross margin outlook of any of your segments?

Well, so there's -- you got to look at it both from a vertical market segment and a product segment. So from a market segment, obviously computing and consumer tend to be lower gross margin, industrial Com tend to be higher, as you know. And I think the mix for us if I look at that Power Management business has historically been, a majority of it is being computing and consumer driven. And we're now starting to get a little bit more Com, a little bit more general purpose, a little bit more industrial, a little bit more balance in that business. So that's one of the reasons why gross margins in that business should expand.

But I think the other thing is new product platforms. So the price pressure that we see in the normal consumer environment and the normal computing environment is offset somewhat by cost reductions and then we see the new products that we bring out should give us the expansion. The gross margin play for us is definitely new power platforms, new ACS platforms, more Com, more JANS, high yields in our discrete fab. And then just generally, trying to maintain the kind of cost road maps that we have in our normal product strategies.

All right, great and my last one just, Emeka. On your tax rate planning, anything that you see happening as far as legislation, what type of impact if you have taken any look at that should we think could occur next year?

I mean, we're definitely aware of all of the proposals that is coming out of the government. But at this point, we're not really concerned about anything that we've heard. So there is nothing that we are really worried about as of now. So we expect our tax rate to just behave normally.

Do you have a number for us maybe for next year? Are we thinking that that comes back up to 20 to 23?

I don't have a number at this point, Doug. All I have looked at is just what the tax rate is going to be for the rest of the year. But I have not looked that far out in 2011, but I wouldn't expect it to be anything out of the ordinary.

Great. Thanks again and congratulations on a solid quarter.

Thank you.

Our next question is from the line of James Schneider with Goldman Sachs. Please go ahead with your question.

Good afternoon and thanks for taking my question. I guess first of all, Mohan, if you could address the industrial segment for a minute. Some of your competitors have talked about a bounce back in industrial and some signs of life both there and in automotive. Seems maybe not quite what you're seeing at least yet. Could you talk about some of your end market exposure there and whether you're seeing balance both in the broader OEM industrial space as well as the broader distribution base of smaller customers?

So, we've seen industrial at least for the first half particularly in North America and Europe as being very, very weak. In Q2 we found North American distribution, European distribution was very weak and just broad industrial customers not ordering as much.

There has been signs of a little bit of -- I don't know if bounce back is the right word but improvement. And so that's encouraging going forward. But I don't know if I can say that it's back to the robust levels of the past. So that would be the thing that I would caution. And I think also distribution is still both in North America and Europe from what I've seen so far is not as healthy as we would like it to be.

Fair enough and then maybe one for Emeka. Just following up on your earlier question on OpEx you talked about the normalized run rate being 30 million to $31 million. Is there something you have to see for you to release that kind of extra million or two of OpEx? Is it sort of a revenue level or is it a certain cash flow level or should we just think about it drifting slowly up towards that level over the next couple quarters?

I think what's going to happen is that we're just going to keep an eye on the top line and see what the top line is doing. I cannot determine how quickly we bring these things back. But I think it's probably going to take revenues of about $75 million to $80 million a quarter for us to really get back to the normalized run rate. But there isn't really anything that we're looking at but the hope here is that the revenue will continue to see a nice increase in the top line. And that would allow us to gradually bring back the spending to normal levels.

One of the important takeaways is that we'll manage the OpEx according to what we see both in the current quarter and future quarters. If we don't see the demand coming in strong, we may be more aggressive in how we manage the OpEx downwards. There's also a couple of factors a little bit out of our control. One of them is litigation expense. And then obviously equity expense is driven also by to some extent the stock price and things like that.

Fair enough and then maybe one last one for you Mohan. Talking about the Power Discrete business and some of your new products you're trying to ramp there. If you look out a couple years what do you think the market opportunity would be for your business in Power Discretes incremental to what you're already doing?

From a SAM standpoint?

Yes.

I think the good thing about the Power Discrete space for us is we are coming back into it. So I look at this as $100 million, $150 million SAM of which we play a very small percentage today. And the driving force behind expansion of our growth of our revenue is going to be bringing out new products and going after one competitor. And that's Microsemi, who has a much larger revenue base.

So the JANS is a good example of that, as we come out with more JANS products I'm quite confident we can get more business in the military and commercial satellite space. We'll start to focus on some other new product areas as well and gradually expand into that SAM. And one of the constraints we have today is our fab, which is now starting to get back on track. And I think the supply throughput as we get more products out, we'll be able to expand our revenue.

Great. Thanks very much.

Thank you.

Our next question is a follow-up question from the line of Harsh Kumar with Morgan Keegan. Please go ahead with your question.

Do you have some idea of what can be the benefit as Reynosa gets back to sort of a normalized level? Perhaps you can quantify it Emeka on gross margins? And then also, as far as your long term model is concerned, what kind of revenue number should we be thinking of to get to that 55 to 60% gross margin number?

Yes, so I'll take the second one first. To get to the mid point of the 55 to 60%, I think what we've articulated in the past is that we would need revenues of $85 million to $90 million a quarter. And also we would need that revenue to come in the right mix, as Mohan has indicated, a little bit more from the communications and industrial side. I think that would help us to get to that (inaudible). So in terms of revenue, $85 million to $90 million is probably the revenue side that I would expect to see us get to the mid point of the gross margin model.

With regards to Reynosa coming back on line with (inaudible) improving, there's probably two aspects to it. There's going to be just a (inaudible) improvement and driving better throughputs. So absorption would be better. And what I'm hoping is that with the improved yields too and the demand coming back that the revenue from our Power Discrete business will start to grow again.

So it's probably going to be two drivers pushing our gross margin upwards. I don't know that I can really quantify right now exactly how much of improvement that would be to gross margin but rest assured it will be very helpful.

That's fair thanks, Emeka, thanks, Mohan.

Thank you.

Our next question is a follow-up from the line of Terence Whalen from Citi. Please go ahead with your question.

Hi thanks, a couple administrative ones. You'd mentioned that cash flow operations and CapEx number. Can you repeat those, Emeka?

The cash flow from operations was $19.2 million, and in Q2 we spent $2 million on CapEx. The forecast is that we're going to spend $5 million in Q3. And the increases are driven by a whole lot of new product and new process and packaging developments.

Okay, great. And then the other question I had, I think you said you expect $1 million in legal expense, so that would be about $0.013 out of your earnings but that's included in the $0.12 to $0.14 guidance, correct?

Yes, that is included in the guidance.

Okay wonderful. Thank you.

Our next question is from the line of Rick Schaefer with Oppenheimer Funds.

This is [Ryan Berkman] on behalf of Rick. I just wanted to get a quick follow-up with regard to Power Discrete. What proportion of sales are made up from that segment as well as how many products and design wins did you get in the most recent quarter from that segment?

Well, we don't talk about design wins on a product by product basis, or product line by product line basis. Chris, do you have the Power Discrete? Power Discrete is 11% of our Q2 revenue.

Okay and that's from -- what was it in the prior quarter?

It was 13% in the prior quarter.

Okay. Thank you.

Our next question is a follow-up question from the line of Doug Freedman with AmTech Broadpoint. Please go ahead with your question.

Thanks again, guys. Just a quick one, Emeka. You were able to benefit from some insurance claims. Are there any outstanding or has all of the insurance stuff being cleaned up now?

So the insurance reform that we benefited from was just a refund of the legal expenses associated with the stock options matter. That was just a one-time thing. I think you're probably thinking about the [importation] insurance benefits from the Reynosa fire. We did not see any benefit in the past quarter. We continued to work with insurance Companies to close out on the outstanding claims that we had.

And what were the damages there that you're seeking to -- what size can that potentially be?

We're still negotiating with the insurance company. We don't have an amount yet, but I can give you a range. It's probably somewhere in the range of $1.5 million to $3 million.

Great. Thank you so much.

Our next question comes from the line of Craig Ellis with Caris & Company. Please go ahead with your question.

Thanks for taking the question. Mohan, just returning to the Power Management business a little bit. As you look at the mix of that business right now, it seems very PC and wireless centric but you've talked about a number of new design ins. Can you give us a bit of a timeline when you think that the non-PC and wireless part of the business would be greater than 50%? And is that really the inflection point for when we're going to see gross margins really start to take off in that business?

Well, let me answer the second one first, Craig, because the new products we're getting that we have out in the handheld and the computing space that are getting designed in -- they aren't getting designed into the same, necessarily the same systems that were being designed in before. All of the same sockets like core regulator, they might be peripheral power or they may be feature rich handheld products or something like that. So they will drive higher gross margin in those segments.

But I think in general as we kind of broaden our power presence, I would expect that we are getting traction now. But I would expect by probably this time next year, we'll have a very different makeup of our power business that will be significantly different from a calm and industrial as well as computing and consumer products.

Okay that's helpful, Mohan. And then Emeka, I know it's always hard to look into the future with any legal expense. But at $1 million a quarter, is there any color you can provide at all in terms of how long we should keep that in the model?

Craig, what we've had before, the historical run rates has been about $0.5 million a quarter. But last quarter, it picked up to about $1 million. Although the last quarters numbers were offset by an insurance recovery. But last quarter it picked up to $1 million and this quarter we are also expecting to be at $1 million level.

It depends on the level of the activity right. My expectation is that as we hopefully go into Q4, Q1 that it will come back down to the normal run rate until we get this cleaned up.

Okay, thanks guys.

Okay.

(Operator Instructions). Our next question is from the line of David Wu with PC Research. Please go ahead with your question.

Yes, I missed the comment on the Power Discrete business. Is the decline in the second quarter as a result of the weakness in the military, aerospace and high end medical industrial markets?

Yes, yes, David. The decline is largely -- we have seen softness in the military, we've seen softness in the high end industrial and the high end medical, Power Discrete business, yes.

I was wondering what level of revenues do you need to see to bring all these temporary cost cutting measures back to normal? In other words, we're at about a $70 million run rate in Q3, and hopefully there's some improvement in Q4, particularly given it's a 14 week quarter. But I was wondering at what revenue level do you need to bring the OpEx back to "normal"?

Well, David, we already answered that question. It is just to say the normalized run rate is about $30 million to $31 million.

Right.

And when we had those level of spending, we've seen revenues in the $75 million to $80 million run rate, so hopefully we can get back to that level pretty quickly. But I think the key point to focus on there is that we're going to manage our expenses in relation to what our top line is doing. And I think we've done a very good job of that in the past and we'll continue to do that.

Okay. If I were to look at the variables and what is going to give your gross margin a lift. I guess it sounded like product mix, when we get a recovery in industrial markets, that's the biggest driver on high gross margin, right?

Well, it's that plus new power platforms. So even if industrial doesn't come back, let's assume industrial doesn't come back, I'm confident we'll increase our gross margins with our new Power Management platforms in all of our segments.

So just getting new products out and making sure that we get design win traction on those new products in the multiple markets. Obviously, we get more gross margin if they come from industrial and Com, versus computing and consumer. But I think even the new power products in consumer and computing are going to drive higher gross margin for us.

The same is true of our advanced common sensing platforms. The new Com platforms we have that are gaining traction as I mentioned with the record bookings and in those areas are very high gross margin for us. I think that will continue to drive gross margin expansion. The more JANS products we get out and the more penetration we get there, I think we'll get gross margin expansion.

So we've got a lot of things that could help us expand our gross margins. Obviously if they all come to tuition, then we're going to be in good shape.

Okay. Thank you very much.

At this time, there are no other questions in queue. Gentlemen, do you have any closing remarks you'd like to make?

Okay, let me summarize by saying that Q2 of fiscal year 2010 was a very good quarter for Semtech. Revenues increased sequentially by 10% and GAAP earnings per share increased by 50% to $0.12 per share. We were able to generate 26% of revenues and free cash flow and increase our cash balance by $21 million to $291 million or approximately $4.77 per share.

Our end market balance and diversified platform portfolio, broad customer penetration and balanced geographical presence enabled us to protect against negative macro forces in the first half. And now our new product platforms and our focus on fast growth markets and SAM expansion combined with solid execution will help us to grow in the second half.

As overall demand increases, we believe we are very well positioned to take advantage of end market trends such that we will out perform the market and maintain the very resilient profit and cash generation model we have.

With that, I'd like to thank everyone for participating in our second quarter conference call and look forward to updating you all next quarter. Thank you.

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