Semtech Corp (SMTC) 2010 Q3 法說會逐字稿

Good afternoon. My name is Courtney, and I will be your conference operator today. At this time I would like to welcome everyone to the Q3 FY '10 Semtech Corporation earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be question and answer session. (Operator Instructions) Thank you. Mr. Chris Rogers, you may begin your conference.

Thank you, Courtney. Welcome to our fiscal year 2010 third quarter conference call. We have just issued our press releases announcing our unaudited results for our third quarter ending October 25, 2009, and the acquisition of Sierra Monolithics Inc. A copy of our press releases are available on our website, www.semtech.com, as well as National News and financial market wires. A replay of this call will also be available on the Investor Relations section of our website through December 18.

During this call, Mohan Maheswaran, Semtech's President and Chief Executive Officer and Emeka Chukwu, our Chief Financial Officer will be discussing our news 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 releases as well as other risk factors noted in Semtech's most recent periodic reporting document on Forms 10-Q and 10-K filed with the SEC for more detailed discussion.

Also during this call, we may refer to pro forma or other financial measures that are not prepared according to Generally Accepted Accounting Principles. In conjunction, we have provided supplemental information in our third quarter results press release to help readers understand the Company's comparable financial performance between periods. Thanks for your attention to this important preliminary information. I will now turn the call over to Emeka Chukwu, Semtech CFO.

Thank you, Chris. Good afternoon, everyone. In my prepared remarks, I will discuss our Q3 financial performance, our Q4 outlook, and we conclude with more details on the Sierra Monolithics or SMI acquisition that was announced this afternoon. Revenues for the third quarter of fiscal 2010 were $75.1 million, a 13% sequential increase and down 6% from the same quarter last year. In the third quarter, 61% of our revenues were derived from customers in Asia, 23% from North America, and 16% from Europe. Direct sales represented approximately 51% of total revenues, while distribution made up 49% for total revenues. Our GAAP net loss for the quarter was $20.9 million, or $0.34 per share, down from net income of $11.5 million or $0.19 per share for the same quarter last year. And net income of $7.4 million or $0.12 per share for the second quarter of 2010.

It is important to note that GAAP net loss for the quarter incorporates a one-time tax expense of approximately $33 million, related to the decision to repatriate foreign-based cash for purposes of funding the SMI transaction. Although the SMI transaction has been announced now in our Q4, the transaction does result in a one-time tax expense that we retroactively incurred in Q3. Excluding these one-time tax expense, our GAAP net income would have been $11.9 million, or $0.19 per share.

Bookings were up sequentially in Q3, driving a positive book to bill for the quarter. We saw increases in all end markets. Net (inaudible) orders accounted for 41% of shipments during the quarter. In the third quarter, expenses related to equity based compensation were $4.1 million, or 5% of revenue. This is a decrease of approximately $900,000 from the second quarter of fiscal 2010. This sequential decrease was due to a revaluation of awards accounted for liabilities and the true up -- for future assumptions.

In Q3, due to an increase in activity related to our ongoing stock option matters, we incurred approximately $1.1 million of legal expenses compared to a net benefit of $327,000 in Q2. GAAP gross margin for the third quarter of fiscal 2010 was sequentially up by 60 basis points to 55.1% driven by increased revenue for higher gross margin products from our advanced communication and sensing and power management product groups. GAAP SG&A expenses were $18.5 million for the quarter, or 25% of revenue. An increase of $1.8 million from the second quarter of fiscal 2010. This increase was driven by the termination of the Company's mandatory time off, higher litigation expenses and higher selling costs, partially offset by lower equity compensation. GAAP research and development expenses were $10.5 million for the quarter, or 14% of revenue, down $100,000 from $10.6 million in Q2, due to lower equity compensation expense.

Interest and other income was $1.1 million in the third quarter compared to $300,000 in the second quarter of fiscal 2010, reflecting the receipt of $827,000 in settlement of our property insurance claim for the Reynosa fire incident, our business interruption claim related to the Reynosa fire remains outstanding. Our GAAP tax rate in the third quarter was 258%, compared to 15.7% in Q2, reflecting the tax impact on the use of our foreign cash to fund the acquisition of SMI. Excluding this one-time tax expense our tax rate in the third quarter would have been 9.6% because of a favorable reasonable mix of income. The diluted share count for Q3 was 61 million shares.

Moving on to the balance sheet, in Q3, we generated approximately $23.3 million in cash from operations. Which is 31% of revenue, and ended the quarter with approximately $316 million of cash and investments. In Q3, no repurchases were made under the 2008 stock repurchase program. We have $15 million left under the 2008 stock repurchase program. The Company spent approximately $3.8 million on property, plant, and equipment in Q3. Depreciation and amortization was approximately $1.7 million, including $302,000 of intangible amortization. Accounts receivable was flat from Q2, and days sales outstanding decreased to 31 days from 34 last quarter. Net inventory decreased by $1.2 million or 5% in the third quarter as compared to Q2. And the days of inventory decreased to 70 days from 80 dance in Q2. We expect inventory to be approximately flat in Q4.

Inventory at our distribution partners declined approximately $900,000, or 3% from Q2. Channel days of inventory declined to 72 days from 79 days in Q2. We are pleased with both our internal and channel inventory positions. Now to our Q4 outlook. A quick reminder that our fourth quarter of fiscal 2010 will be a 14-week quarter. Also, this outlook excludes any financial results associated with the SMI acquisition. Typically, our Q4 demand is softer than Q3 demand.

Due to the strong bookings that we saw in Q3 which have continued into the fourth quarter, and also due to the impact of the extra week, we expect our fourth quarter revenue to be sequentially flat to up 4%. To achieve the midpoint of this guidance or up 2%, we needed net (inaudible) orders of approximately 39% at the beginning of the quarter. In the fourth quarter of fiscal 2010 we expect GAAP net income of $0.15 to $0.17 per diluted share. GAAP gross margin is expected to be sequentially flat to up 40 basis points due to projected favorable mix of higher communications revenue and lower computing revenue. We expect GAAP SG&A expenses of $20 million, an increase of $1.5 million because of the extra week and legal and accounting expenses associated with the SMI acquisition. GAAP R&D expenses are up $11.2 million higher than expected in the fourth quarter. This sequential increase of $700,000 is due primarily to the impact of the extra week and new product expenses.

Equity compensation expense is expected to be approximately $4.7 million, broken down as follows. $250,000 in manufacturing. $3.2 million in SG&A, and $1.2 million in R&D. The sequential increase of $600,000 is primarily due to the impact of the extra week. We expect stock option related legal expenses of approximately $800,000 in the fourth quarter of fiscal 2010, a decrease of $200,000 from Q3. We expect interest and other income of approximately $300,000 in Q4. Our GAAP tax rate is expected to be approximately 14% for the fourth quarter. As a reminder, these rates can be affected by several factors including the original mix of income, fluctuations in foreign exchange rates, and ability to utilize past credits. We expect diluted weighted average shares outstanding of 62.2 million shares in the fourth quarter of fiscal 2010. In the fourth quarter of fiscal 2010 we expect capital spending to be approximately $3 million to support a ramp-up of new products and various new process and package developments. Depreciation should be approximately $1.8 million and amortization of intangibles will be $302,000 in the fourth quarter of fiscal 2010.

Now turning to the details of the SMI acquisition, under terms of the agreement, Semtech will pay the stockholders of SMI $180 million in cash. Semtech will also assume the existing uninvested options of SMI employees valued at approximately $8 million, and grant additional equity incentives of up to $12 million to employees at closing. In order to meet any indemnifiable claims as specified in the definitive agreements, $18 million would be placed in escrow for 12 months. We expect to incur an additional $2.5 million in transaction fees upon close of the acquisition. We expect to fund the acquisition with our existing cash and investment reserves. In association with bringing back a portion of our overseas cash to fund the transaction, we took a one-time tax provision of approximately $33 million in Q3. In connection with this transaction, we explored a broad range of financing alternatives and concluded that even with this one-time tax expense, utilizing our existing cash represented the most attractive financial outcome for Semtech. After the transaction closing Semtech would return approximately $130 million of cash and investments.

Given the profitability and low capital intensity of our business, we are comfortable that this amount is sufficient to run our business going forward. We expect SMI to positively contribute to Semtech's financial profile in terms of revenue growth, gross margin and earnings per share. SMI, who has grown at a compounded rate of over 40% in the past five years expects to generate revenue of approximately $50 million in calendar year 2009. We expect the SMI business to grow 20 to 30% in calendar year 2010 largely driven by growth in demand for [40g] and 100g technology. The gross margin is currently in the mid to the high end of Semtech's gross margin targets of 55 to 60%.

Factoring in SMI's current quarterly operating expense run rate of $6 million to $7 million, and our expectations of 22 to 25% non-GAAP tax rate we expect the transaction to be immediately accretive to Semtech's non-GAAP earnings per share. Based on an expected GAAP tax rate of 18 to 21%, we expect the transaction to be accretive to our GAAP earnings per share within 12 months. In summary, we had an excellent Q3. We grew revenue 13% sequentially. We expanded GAAP gross margin 60 basis points sequentially and 160 basis points on a year over year basis. We've continued to demonstrate the leverage in our model by growing operating income 42% sequentially. We generated $19.5 million or 26% of revenue in free cash flow. With our demonstrated ability to grow organically we are excited about the future with the acquisition of Sierra Monolithics. I will now hand the call over to Mohan.

Thank you, Emeka. Good afternoon everyone. I will discuss our Q3 fiscal year 2010 performance by end market and by product group, and then discuss our acquisition of Sierra Monolithics, which we announced today shortly before our Q3 earnings results. Q3 of fiscal year 2010 was another really strong quarter for Semtech. We achieved net revenues of $75.1 million, this is above the high end of our revenue guidance and represents a 13% sequential increase versus Q2 of fiscal year 2010. We also increased our GAAP gross margins to 55.1%. In Q3, revenues from communications increased and represented approximately 21% of revenues. High end consumer revenues increased and represented 43% of revenues.

Industrial revenues were down and represented approximately 20% of revenues, while computing revenues increased and represented approximately 16% 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 softer in Q3 due mostly to softness from the military and aerospace segments within our power discrete business in North America.

Now let me discuss the performance of each of our product groups in Q3. In Q3 our power management revenues increased sequentially by 20%. Strength in our power management business was driven by all end markets, with computing and high-end consumer segments exhibiting the strongest growth. We continue to make very good progress in reinventing our power management business, to become a more diverse business with the revenue contributions from all major market segments and with higher overall gross margins. We are very encouraged by the quality of some of our new product platforms and the attraction of these new platforms at customers in all geographies. For example, we recently announced a new tiny LED back lighting driver platform for handheld backlighting systems. We already have good design win traction from this new platform. We also announced a new synchronous buck regulator platform targeted at high efficiency low EMI applications. This new platform is also doing quite well from a design win standpoint, in the computer peripheral and communication segments. We expect our power management revenues to be approximately flat in Q4.

In Q3, our protection revenues increased sequentially by 16%. Demand for our protection products remained 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, future unprotected systems. Our protection business unit continues to execute quite superbly, and we are really encouraged by the design win momentum of our protection products across all our target end markets in all regions. In Q3 we extended our high performance protection platform targeted at 2.5 volt systems. These new proprietary protection devices are designed for high-end smartphones using 65-nanometer base chip sets. In Q3, we also released our next-generation proprietary high-end protection process technology. This new process enables us to design and build ultra small form factor protection devices with extremely low capacitance and extremely low leakage. We will begin volume shipments of products based on this advanced process in Q4. In Q4 we expect our protection revenues to increase modestly.

Our power discrete revenues were down approximately 31% sequentially in Q3 as the military and aerospace segment continue to remain very soft. This result was disappointing as we had anticipated some modest recovery in these markets. In Q3 while revenues were disappointing we started to see a modest improvement in orders. Our high reliability power discrete business is driven by demand from the aerospace, military, industrial, and high-end medical markets. Our main focus areas in the power discrete business are accelerating the release of new products that expand our SAM, indeed improving on supply throughput of our Janus space products as we improve our fab yields. Our fab yields are improving nicely, and should be back to optimum levels by the end of this quarter. In Q4 we expect our power discrete revenues to be approximately flat. Revenue for the advanced communication and sensing business increased 27% sequentially. Strength in this business was driven by both the communications segment and the industrial segment. Specifically, revenues from our new top sync timing synchronization platform reached a new record and revenues from new industrial wireless platforms and existing medical platforms resulted in a very strong quarter for our advanced calm and sensing business. Our advanced communications and sensing business continues to do very well from a new platform execution, design win and booking standpoint.

In Q3, bookings of our advanced communication infrastructure products reached another record high driven by momentum in the 3G, 4G, LTE and WiMAX infrastructure segments. We are seeing very good momentum at all major infrastructure OEMs as they deploy new IP back haul and multi standard access base station solutions. Also in Q3 we continue to see very good design win traction of our new RF platforms in the energy harvesting, security and home automation subsegments. As well as some new emerging applications in consumer segments. We also recently announced our first consumer analog touch screen sensing platform targeted at consumer and industrial resisted touch controller applications. Semtech's new touch screen platform is an ultra low power small form factor high ESD platform that leverages several of the competencies we have in the Company. We believe the addition of touch-screen platforms to our portfolio will enhance our portfolio sell at both our consumer, computing and our industrial customers. We already have design wins for our touch screen platform that should generate revenues early in fiscal year 2011. In Q4 we expect revenues from our advanced communications and sensing business to increase modestly.

From a distribution POS standpoint in Q3, we saw total POS increase by approximately 6% driven mostly by Asia. Distributor inventory was down again in Q2 from 79 days to 72 days. We believe that our channel inventory is at the levels necessary to appropriately support our customers as we entered Q4 with a positive book to bill and a positive demand outlook. Moving onto new products and design wins, in Q2 we released nine new products and recorded over 668 new design wins. We were pleased with both these results. We believe that we are uniquely positioned to benefit from 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 leadership platforms in Q4.

Now let me comment on our acquisition of Sierra Monolithics. Today we entered into a definitive agreement to acquire Sierra Monolithics. Like all my colleagues on Semtech's Board and Semtech's Senior Management team, I am extremely pleased to be entering into this important and exciting transaction for many reasons. Some of which I will discuss on this call. Sierra Monolithics, or SMI as I shall refer to for the rest of this call is the leader in 40-gigabit per second and 100 gigabit per second (inaudible) devices sold into the communications infrastructure market and is a recognized leader in the design and development of RF, microwave and new meter wave communications technologies of multiple emerging applications. Headquartered in Irvine, Southern California with design centers in Irvine and Redondo Beach, California, we believe that SMI is an extremely good fit, strategically, culturally, geographically and financially with Semtech. We are very excited by both the short term and long-term opportunities that the acquisition brings to Semtech.

SMI's 40 gigabit per second [CERTES] product portfolio includes multiple chipsets which address all the major 40-gigabit per second modulation schemes currently being deployed worldwide. These leadership products have enabled Sierra Monolithics to become a key supplier to almost all of the major telecom OEMs and optical module customers offering 40 gigabit per second solutions. Following up on its success in the 40 gigabits per second [CERTES] arena, SMI was also the first semiconductor company to provide both client side as well as line side 100 gigabit per second [CERTES] chipsets for the emerging 100 gigabit per second telecom and datacom markets. In addition, SMI leverages its expertise in high frequency wireless technologies and protocols to deliver wireless solutions for high performance military and wireless networking applications.

We believe that the market for 40 gigabit per second and 100 gigabit per second devices will continue to grow at a very rapid rate as both public and private networks look to increase their bandwidth to accommodate more voice, video, and data traffic in both long haul and short reach applications. SMI has experienced significant growth over the past few years fueled by rapid growth in traffic over both wireline and wireless telecom networks. Future market growth drivers include grind video traffic over the Internet, competition between cable operators and telecom carriers, emergence of data centers, cloud computing, and wireless data services. Semtech will become one of the few Semiconductor companies that operate portfolio technologies and platforms to span the sub 1 gigahertz ultra low power industrial wireless segment. Through the 1 gigahertz to 20 gigahertz RF and microwave communication segments, and through the 20 gigahertz to 110 gigahertz millimeter wave communication segments. The acquisition of Sierra Monolithics also brings to Semtech a treasure chest of intellectual property for microwave products targeted at the industrial segment and the communications segment. More specifically, the military communication segment, the industrial sensing segment and the communications infrastructure segment. All these markets are attractive markets and fit well with Semtech's current strategy.

This acquisition will be the largest in Semtech's history and will significantly expand our competencies, our portfolio, our engineering talent and our SAM. The acquisition of Sierra Monolithics will create the uniquely differentiated company that has leadership position in several product categories with the opportunity to develop leadership positions in several more categories. Once the transaction is closed Semtech will be a technology leader in high end protection platforms, in timing synchronization platforms, in 40 gigabits and 100-gigabit-per-second platforms, in hand held white LED backlighting power management platforms, in ultra low power small form factor medical platforms, in ultra low power industrial wireless platforms, in high bandwidth wireless solutions to the defense industry and in higher liability power discreet devices to military space, industrial and medical markets. I believe these leadership technology platforms in addition to Semtech's overall growth portfolio of high performance analog products position us well to outperform the market in the future.

The acquisition will also help us to achieve the following objectives. Provide further top line revenue growth with another high performance growth engine and accelerate that journey to $500 million and beyond. Add a product line which will be immediately accretive to Semtech's non-GAAP gross margins and accretive to Semtech's non-GAAP earnings per share and that fits well with our current financial model. As the product line targeted at communications core infrastructure, high end routers, datacom, and microwave communications, commercial and military applications, increasing our overall communications and industrial content.

Strengthen Semtech's strategic value proposition to major OEMs in the communications infrastructure and industrial markets by offering our customers a broader range of products and a broader array of competencies we believe that cross-technology selling opportunities will exist in addition to cross marketing opportunities. Finally, brings into Semtech a team of highly talented engineers and executives. In total, Sierra Monolithics will add approximately 60 engineers to the Company. Chairman of Sierra Monolithics, Charles Harper and the President and CEO, Javed Patel will both join the Semtech leadership team reporting to me. Both executives are very strong additions to our management team and I am personally delighted to have them both join us, as well as the rest of their team.

As I have stated on previous conference calls, it is my belief that Semtech is executing very well as a Company and so I believe the timing of this acquisition is very good for us. I also believe that due to the location, strategic fit and the cultural fit between the two companies that integration should be manageable, and relatively fast, and that we would drive solid execution of the combined Company in a relatively short time frame. Finally, the combined company will have an even better end market balance than we have had previously with 27% of revenues coming from communications, 27% from industrial, 13% from computing, and 33% from high-end consumer. We believe this mix will allow us to continue to grow faster than our peers while continuing to expand gross and operating margins. I will now hand the call back to the operator, and Chris, Emeka and I will be happy to answer questions. Operator.

Operator? Operator, are you there?

Sorry about that. Slight technical difficulty. Ready for questions?

Yes, we are.

All right, your first question comes from the line of Harsh Kumar from Morgan Keegan. Your line is open.

First of all, congratulations. Sounds like a good deal. Two questions here. First of all, Mohan, from what I understand about your Company, I think your OpEx structure is geared for, I'll call it $95 million to $110 million in revenues. What does this deal do for you from a leverage standpoint outside of the margin structure that Sierra Monolithic brings?

It adds about $50 million of top line revenue, Harsh. I think the main thing that it does for us is it gives us access to a whole new set of spaces that we haven't participated in before. So it's really a SAM expansion strategy, then obviously with the leadership position they have in 40-gig and 100-gig which are both very fast growing markets, enables us really to drive further top-line growth. That said, I think there are opportunities to continue to expand gross margins. I think there's a fit for both companies is very good. I think with the balance of comm and industrial increasing that will help us from a portfolio standpoint as well. So all of those should give us a little bit more opportunity to grow our earnings.

Got it. Just one more follow-up. Your guidance, Mohan, at the midpoint of up 2%, you've got an extra week, which roughly is about, call it 7 to 8, 7.5%, something like that if I back out the extra week, if I back out the extra week, you're somewhat cautious or worse than seasonal this time around, down about 5 to 6%, call it. Is it just -- when I look at your call, business seems to be very good. What's the reason for some sort of hold-back, call it, on guidance?

Well, I would say Q4 is seasonally down for us, Harsh. Consumer and computing are seasonally down. We do have the extra week, but from a standpoint of seasonality, I think the fact that we are guiding up tells you that actually our businesses are holding up quite well. We expect consumer probably to be flat to slightly up. Computing to be probably slightly down. Communications to be up, and industrial to be up. So depending on how those play out, I think our guidance is still fairly positive.

Okay, fair enough. I'll get back in line. Thanks, Mohan.

Your next question comes from the line of Rick Schafer from Oppenheimer. Your line is open.

Hey guys. I will add my congratulations. A quick follow-up on the SMI deal. Can you give an idea of expected timing, when the deal ought to close, and maybe back to Harsh's question a little bit, but how accretive? Can you give us order of magnitude or an idea how accretive deal ought to and how much of it depends on cost reductions and efficiencies?

The deal should close by the end of the year. So I think before the end of the calendar year is our expectation.

Rick, so with regards to the accretion what we have stated is that on a non-GAAP basis, excluding stock-based compensation and cost of intangibles, that we expect the deal to be immediately accretive. We don't have an exact number yet, but it should be immediately accretive. With regards to any sort of cost synergies is at this point we have not really baked in any synergies. SMI is an organization that runs pretty lean. Any cost synergies that we would expect to see from an integration probably would be offset by spending to pursue additional revenue opportunities. So at this point we expect it to be accretive immediately on a non-GAAP basis without a lot of cost synergies.

Okay. And then the second question, just on the military defense side of the business seems to be weighing on the industrial segment. I guess you gave some color, said orders had started to pick up there. Can you give any more color exactly what's happening there? Maybe describe what you see in the channel there? I know the channel seems awful lean everywhere except maybe in the defense piece.

I think that is most of it, Rick. Channel is still pretty heavy with military. I think with the change of administration, there's a little bit of -- it's not clear which programs are getting funded and which ones are not, and some of the, maybe the legacy programs are not -- are being funded the same way as they were, so a little bit of uncertainty there. But I think the good news is that we still see opportunity to expand our SAM. So regardless of what goes on in the marketplace, I think that once we start to get the JANUS space products out and start to get some of the new products out we should start to see -- get back on a growth curve independent of the market.

Okay. All right, thanks a lot, guys.

Your next question comes from the line of Li-Wen Zhang from Pacific Crest. Your line is open.

Congratulations. My question is how are the order lead times compared to historical? Is there any changes there?

The order lead times are similar. Nothing really unusual there. Supply lead times, I would say are pretty consistent as well, Li-Wen. I don't think there's anything very different.

And also, are there any changes in foundry outsourcing strategies?

No, our strategy is still the same. We continue to use multiple foundry partners. We don't have our own manufacturing fab outside our power discrete business, as you know, and that continues to be the strategy. So we work very closely with our foundry partners, and then develop leadership process technologies and continue to rely on them to support us through the ups and downs of the semiconductor industry. Next question.

Your next question comes from the line of Steve Smigie from Raymond James. Your line is open.

Great. Thank you. Mohan, you guys have put up several nice quarters in the power management business. How sustainable is that kind of growth? Can you talk a little bit about any new platforms you might be have coming out in that area?

Yes. Power management business is doing quite well. The strategy has been to come out with lots more new product platforms, try to balance the business from being historically more computing-centric to a little bit more diverse. And we are seeing good traction there. I'm pleased with the progress in the handheld space, I'm pleased with the progress in the computer peripheral space. I think consumer is doing quite well. So we have more and more platforms coming out. And I think we'll continue to see that as you watch the releases come out. You will see more and more products that are really differentiated power products for us, and I think we'll continue to do quite well.

Great. And then, also, in terms of overall communications and how you go to the market, obviously you had the product and some other product. How does that fit in with the selling of the new comms product? How does the sales force work look? You talked about -- can you talk about that?

Yes, it's one of the beauties of this deal, really. It really strengthens our portfolio to the type of customers that we've been seeing quite good traction on, with our timing synchronization platform. But also, even power and protection, where we go into some of the major OEMs and we're protecting 10 gig and gigabit ethernet ports and providing the power solutions for some of these OEMs, to be able to also provide 40 gig and 100 gig service devices I think is a real win for us. Then the other opportunity, as we start to talk with these OEM direct customers, in terms of their strategies, and where the biggest integration opportunities, I think the wireless play for us, the very high end microwave wireless integration becomes a real key strategy for us.

Okay, great, thank you.

Your next question comes from the line of Douglas Freedman from Broadpoint AmTech. Your line is open.

Hi, it's Ian Ing for Doug Freedman. Congrats on the results and the SMI announcement. SMI related question. Could you talk a little bit more about the customers that they're attracting now and also the potential customers they could gain once they become part of Semtech and perhaps more like a tier 1 supplier?

SMI has actually done a very good job in the communications infrastructure space. They really have, very good penetration of a lot of the leading players there, and also the module providers into that space. I think that actually they are going to benefit Semtech from that standpoint. The penetration of those customers. I think where we, Semtech, are going to bring a lot of value to Sierra Monolithics is really on the broader wireless play and also in the defense area. So specifically the wireless area, we have a pretty good traction there with our top synchronization product, for example, and the ability to parlay some of the Sierra technology into those customers I think is a good opportunity. Obviously I can't mention any customers at this point.

Great. And moving on to gross margin expansion opportunities, I see that SMI is fabless in using the SiGe process, so should I assume there's fairly limited manufacturing leverage there, that these are going to remain separate tracks?

Well, they have similar operations to us in that they are a fabless company. I think the opportunity is to bring some of the know-how and knowledge of building complex analog high volume products to Sierra Monolithics and to try to minimize costs, from that standpoint, there is opportunity, I think, but their gross margins are actually better than ours. So I think at this point in time, I would say that the margin profile is probably the right profile for us going forward.

Great. Thanks a lot.

Your next question comes from the line of James Schneider from Goldman Sachs. Your line is open.

Good afternoon. Thanks for taking my question, and congratulations. Mohan, maybe you could talk about what you're seeing in the industrial end market ex the military and aerospace section of that? Are you seeing that being strong again in Q4, and would you expect your distributors to again deplete inventory in the quarter?

So, Jim, the industrial is strengthening outside the military space is definitely getting stronger, and we do expect it to increase in Q4 also. And then the other part of the question was?

Whether you expect to see deplete inventory again in the quarter.

Yes, POS was strong in Q3. I think POS is going to continue to be quite strong in Q4. But the days are kind of in line. 72 days I think is our days of inventory, is about right. If POS continues to increase, then obviously they'll probably have to start replenishing.

Fair enough. Maybe just a follow-up. Just the detail on the OpEx for SMI. That $6 million of OpEx, would you expect that to -- how is that split between SG&A and R&D and would you expect any efficiencies there?

Jim this is Emeka. I think I'm not quite sure of the split between SG&A and R&D, but like I said before, we do expect some efficiencies. However, SMI offers us a lot of revenue opportunities, and we will be looking to have some discretionary spending in areas that will allow us to pursue higher revenues. So what we're looking at at this point is that we're not really expecting that much cost synergies from this transaction.

Fair enough. Thanks very much.

Thank you.

Your next question comes from the line of Craig Ellis from Caris & Company. Your line is open.

Thanks for taking the questions, and echo the congratulations on the deal. Mohan, can you provide some context on the deal? How long have you guys known SMI? Were you looking at other potential candidates in addition to SMI? Fill out the picture a little bit for us?

Yes. So for some time, I think I've been talking about how Semtech has gradually been improving its execution organically, and I was comfortable that as an organic engine we were doing very well focussed now on the scale side, how do we grow the business and try to expand our SAM. And that was really kind of the beginning of the process, probably about 12, 18 months ago. We set a very rigid, very tough framework. Has to be a Company that has unique competencies, fast growing markets, extremely difficult products to develop. They differentiate on process and analog design and packaging has to be a cultural fit. Customer oriented, fast moving, who value the people assets. Has to be able to fit our gross margin model and our operating margin model. Has to be accretive on a non-GAAP basis fairly quickly. On a GAAP basis, within a reasonable time frame six to twelve months. Has to be able to strengthen our portfolio. Location was important.

Then really, just end market balance, bringing us a little bit more industrial and consumer. Sorry, industrial and communications. So I've been talking to SMI well over a year. We knew that they have been looking at potentially going IPO, but I think they got very comfortable with us as a partnership. Obviously they had to look at other alternatives, but when we started to really talk about the opportunities, I think they felt and we felt that it was a very good fit for both companies.

Okay, that's real helpful. Emeka, on your end, it seems like there's quite a few tail winds sequentially with gross margins at least a number on the mix side. Are there any head winds given that the low end of the gross margin guidance is flat? What could cause gross margins to be flat sequentially since mix should get better?

Although we expect the mix to get better, you really never really know. We see continued strength in the consumer business, and maybe even the computer business. Taking all that into account, the basis of your question is that if the mix gets better as we would expect, our expectation would be that we should come out at the higher end of the gross margin guidance.

That's clear. And then one last detail. On the cash balance, how much of that now is in the US versus outside the US?

End of our Q3, probably 25 to 30% was in the US, and the balance is overseas. What we've reported is that outside the transaction we expect to have about $130 million left, and my estimation would be that 40% of that would probably be in the US.

Okay, thanks, guys. Thank you.

Your next question comes from the line of David Wu from GC Research.

Great quarter. Just wanted to get a little bit more color on SMI. Can you tell us what -- who their top competitors are in the market, and I also am a little curious about once the accounting thing is over, in terms of -- when do you think we could get accretive contribution from SMI, and the last thing I have was, I'm a little confused, because, Mohan, you talked about the mix of the end market. I assume SMI is all in communications, and the 27, 27, 13, 33 doesn't show that SMI is only in (inaudible) maybe you could help me on that?

Let me start with that, David. So SMI is both industrial and communications. So they have both communications products but also products that go into the military. We categorize those as industrial products.

So the end market balance will be communications will be approximately 27%, industrial will be approximately 27%, high-end consumer will be approximately 33% and computing will be approximately 13%. So then on -- from a competition standpoint, on the optical side, it's mostly internal ASICs, mostly the OEMs who choose to have their own internal developments is really the competition. Some module manufacturers also have their own chipsets, so that's mostly the competition in the 40-gig and 100 gig space. In the wireless RS space, it's Maxim and Hittite. In the microwave space I would say it's Hittite.

So, David, with your questions as to when we expect to get accretive, I think I can lay it out this way, on a non-GAAP basis we expect the deal to be accretive upon closing. Now, if you exclude the cost of intangibles, our expectation is that the deal should be accretive within three to six months. Now, on a full GAAP basis, the expectation is that it should be accretive within six to 12 months.

I see. Full GAAP--?

Within six to 12 months.

Okay. I was wondering whether there's -- other than not going public, would there be any competing bidders for SMI? It looks like the numbers ought to be pretty attractive from a financial standpoint, and they seem to be serving top growing market. I was curious whether there were other competing bids in this spot.

Yes, I'm sure they had to weigh out the transaction with others versus Semtech. We know we weren't involved in a broad formal auction. They did tell us that. But I've been in dialogue with SMI for quite some time, and from the outset, we kind of built a good understanding of where the opportunities were with each other, and I think that was really important. But to answer your question, I'm pretty sure they had to weigh up some opportunities with other companies as part of the process that they would use, but we weren't part of a formal broader auction, if you like.

Okay. I was curious, because they're down in Orange County, and around there, there's one big company with billions of dollars, and they make a lot of acquisitions.

Okay.

I was curious how the $180 million came about?

Well, I mean, essentially, it's -- we have bankers, and they have bankers, and bankers talk, and that's how we came on the value.

All right. Thank you.

(Operator Instructions). Your next question comes from the line of Harsh Kumar from Morgan Keegan. Your line is open.

Can you just give us some idea about a tax rate for the out year, particularly with the two companies combining?

Thanks, Harsh. During my prepared remarks, I did indicate that on a non-GAAP basis, we do expect the tax rate to be somewhere between 22 and 25%, and on a GAAP basis, we expect it to be somewhere between 18 and 21%.

Fair enough. Thank you.

Your next question comes from the line of David Wu at GC Research. Your line is open.

On a GAAP basis, do you assume the R&D tax credit in the US continues, or do you assume that it expires?

We assume that it continues. There's no reason to assume otherwise at this point. Obviously that is an issue that is taken up every year, but at this point, we assume that it continues.

Okay. And the SMI would not change the tax rate for the Company, right?

I don't think SMI would change that significantly. One of the benefits that SMI business is going to have from the integration with us is that they will be able to enjoy the benefits of tax planning and structure. In as much as the mix of the revenue might be a little bit more on the domestic side, but we don't expect the revenues to really impact our tax rate that much.

Okay. Thank you.

You have no further questions at this time.

Let me summarize by saying that Q3 of FY '10 was a very good quarter for Semtech. Revenues increased sequentially by 13%. We were able to generate approximately 26% of revenues and free cash flow and increase our cash balance by $25 million to $316 million. Our end market balance and traction from our new product platforms and all end markets are enabling us to continue to outperform our peer group and maintain the very resilient profit cash generation model we have.

We are very excited with the Sierra Monolithics acquisition and strongly believe that the additional product breadth and technology capability that this acquisition brings will enable us to continue on our growth journey to $500 million and beyond. With that way like to thank everyone for participating in our third quarter conference call and look forward to updating you all next quarter. Thank you.

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