Microsemi Corporation F1Q09 (Qtr End 12/28/08) Earnings Call Transcript

Jan.22.09 | About: Microsemi Corporation (MSCC)

Microsemi Corporation (NASDAQ:MSCC)

F1Q09 (Qtr End 12/28/08) Earnings Call Transcript

January 22, 2009 4:45 pm ET

Executives

Terri Donnelly – Conference Call Coordinator

Jim Peterson – President and CEO

John Hohener – VP, CFO, Secretary and Treasurer

Steve Litchfield – EVP and President of Analog Mixed Signal

Analysts

Rick Schafer – Oppenheimer

Tore Svanberg – Thomas Weisel Partners

Romit Shah – Barclays Capital

Steve Smigie – Raymond James

Patrick Wang – Wedbush Morgan Securities

Harsh Kumar – Morgan Keegan

Vernon Essi – Needham & Company

Adam Benjamin – Jefferies

Craig Berger – FBR Capital Markets

Nicholas Aberle – Caris & Company

Christopher Longiaru – Sidoti & Company

Operator

Good afternoon. My name is Lindsay and I will be your conference operator today. At this time I’d like to welcome everyone to the Microsemi’s First Quarter Earnings Conference Call. 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 will now turn the call over to Terri Donnelly, the conference call coordinator.

Terri Donnelly

Good afternoon. And welcome to Microsemi's first quarter 2009 earnings conference call. I am Terri Donnelly, coordinator of this call. In a few moments you will hear from and have an opportunity to ask questions of Jim Peterson, our President and Chief Executive Officer, of John Hohener, our Vice President and Chief Financial Officer, of Steve Litchfield, our Executive Vice President and President of the Analog Mixed Signal Group and of Rob Adams, our Vice President of Business Development.

A recording of this conference call will be available on the Microsemi Web site, under the Investor section. Our Web site is located at www.microsemi.com. Due to changes in public companies' abilities to communicate with analysts and investors brought about by the SEC rules on fair disclosure, Microsemi issues guidance in the form of a limited business outlook on our expectations for the next quarter.

This business outlook reflects our expectations as of January 22, 2009 and is continually subject to reassessment due to changing market condition and other factors, and, therefore, must be considered only as Managements present opinion. And actual results may differ materially.

However, management undertakes no obligation to update these or any forward-looking statement, whether as a result of new information, future events or otherwise. If an update to our business outlook is provided, the information will be in the form of a news release.

We wish to caution you that all of our statements except the company's past financial results are just our opinions, predictions and present expectations. Actual future events or results may differ materially. I refer you for some of the risks to see Microsemi's report on Form 10-K for the fiscal year ended September 28, 2008 which was filed with the SEC on November 21, 2008.

Information about Microsemi filed with the SEC is available free of charge at www.sec.gov. These reports identify important factors that could cause actual results to differ materially from our projection. That said, we can begin. Here is Jim Peterson.

Jim Peterson

Hey, thank you, Terri. I'd like to thank all of you for joining us this afternoon for Microsemi's first quarter, fiscal year 2009 earnings call. As you all know, this is a difficult macro-economic environment. But we are proactively managing our businesses as evidenced by our December performance, whereby the strength of our strategic diversity is again evident.

We finished our December quarter within our original guidance. Net sales totaled $130.6 million, up 5.7% from the $123.5 million reported in the year-ago first quarter and down 3% from the $134.7 million reported for the fourth quarter of fiscal 2008.

Earnings totaled $0.36 per diluted share on a non-GAAP basis, consistent with the September quarter. And up from $0.31 per diluted share in the year ago December quarter. Non-GAAP gross margins, for the quarter, were 51.8%, compared to 52.5% in the fourth quarter, and 51.3% in the first quarter of last year.

Our non-GAAP, operating margin, was 26.9%, compared to 28.3% in the fourth quarter and 26.2% in the prior year first quarter. We believe that Microsemi's performance due to our diversity and our focus in the high reliability markets which we expect to have limited exposure to the current economic conditions.

As we did last quarter, let's review all of our end markets from worst to first, so as to give you an idea of our unique positioning. As expected notebooks, LCD TVs, and displays was our worst performing end market in the quarter. We don't expect a quick return to growth and what is already a seasonally March quarter.

Our mobile and connectivity end markets were also weak. The products here and the PoE and the wireless LAN end markets, given the capital expense nature of PoE system build out and the ongoing consolidation of the financial end markets, which make up a large percentage of the PoE customer base. We expect continued declines in the mobile and connectivity end markets.

Our industrial semi cap end markets were a mixed bag. Although semi cap products remained depressed, we are pleased that this group will be able to grow sequentially due to a solid performance from some of our industrial products. However, going forward we expect these combined end markets to decline.

The economic environment is driving the analog mixed signal business down as a percentage of sales. However, we are very committed and well positioned to expand our position in this downturn. Our strength in differentiated product, roadmaps, application-specific products, design wins, customer engagements, R&D investments will allow us to come out in a much stronger position.

Now let's move to the high reliability end markets. These strategic markets provide us with stability, visibility, and strength as compared to our commercially targeted peers. Let's starts with the commercial air and satellite markets. After a big showing in September, this end market continued to grow as anticipated in our December quarter. Microsemi's positioned to grow in this market whether it's from new aircraft rolling off the assembly lines, from electronically refurbished planes or high reliable of radar and avionic solutions we provide.

In any scenario we see the commercial air as a long-term strategic market for Microsemi. Additionally, as we have said many times recently, we believe that the satellite remains one of our stronger end markets with continued visibility going forward. We expect the satellite market to be one of our better, long-term opportunities, and for our dollar content continue to increase through acquisitions such as Babcock and our own internal developments.

We believe that the medical market remains one of our strongest end markets driven by our continued dollar content penetration and implantable defibrillator market and a steady contribution from the MRI markets. Driven by strong ordering patterns from our customers, this end market is expected to grow.

Defense remains our largest end market. In the future we expect to succeed in the defense market as a result of our superior scale, our quality of manufacturing, and our focus on increasing our footprint through acquisitions and through internal development of product such as our new rad-tolerant and radiation hardened offerings and our award winning silicone carbon devices. We expect this end market to continue to grow.

In summary, in spite of the macro economic environment our bookings remain solid, with the book-to-bill coming in at one to one. While our first fiscal quarter was challenging, our results clearly reflect a more resilient model. And with that, let me turn the call over to John for the financial details for the first fiscal quarter of 2009 and the outlook for Microsemi's second fiscal quarter of 2009, ending in March.

John Hohener

Thank you, Jim. As Jim previously mentioned, net sales for the quarter ended December 28, 2008, were $130.6 million, up 5.7% from the $123.5 million reported in the year ago first quarter and down 3% from $134.7 million in the fourth quarter of 2008.

Non-GAAP gross margin for the quarter 51.8% compared to 52.5% in the fourth quarter and 51.3% in the first quarter of last year. This quarter non-GAAP selling, general, and administrative expenses were $21.7 million or 16.6% of sales as compared to $21.1 million or 15.7% of sales in the fourth quarter and $19.8 million or 16% of sales in the first quarter of last year.

Research and development costs were $10.8 million or 8.3% of sales compared to 11.5 million or 8.5% of sales in the fourth quarter, and $11.2 million or 9.1% of sales in the year ago first quarter. Our non-GAAP operating margin was 26.9% compared to 28.3% in the fourth quarter and 26.2% in the prior year first quarter.

For the first quarter, non-GAAP net income was 28.7 million or $0.36 per diluted share. This compares to $0.36 in the prior quarter and $0.31 cents per diluted share in the year ago first quarter, a 16.1% increase. Our non-GAAP effective tax rate was 19.8% in the first quarter compared to 25.1% in the fourth quarter and 26.9% in the year ago first quarter. This non-GAAP effective tax rate was favorably impacted by the reinstatement of the research and development tax credit retroactive to January 1, 2008, amounting to approximately $0.01 of diluted earnings per share.

Our first-quarter results included $6.9 million for transitional idle capacity, a reduction of $700,000 from the previous quarter, and $2.9 million in restructuring and other charges the majority of which is due to headcount reduction as we transition our manufacturing operations. Also included were non cash charges of $7.9 million related to stock-based compensation, $3.2 million in amortization of acquisition related intangibles and $200,000 for manufacturing profit and acquired inventory.

Our GAAP gross margin was 46.2% compared to 46.8% in the fourth quarter and 42.5% in the year ago first quarter. Our GAAP operating margin was 10.6% compared to 16.3% in the previous quarter and 8.9% in the year ago first quarter, an improvement of 170 basis points. For the first quarter, our GAAP net income was $13.2 million or $0.16 per diluted share as compared to $17.3 million or $0.21 per diluted share in the fourth quarter. And $8.6 million or $0.11 per diluted share in the year ago first quarter, a 45% increase.

Capital spending was $4.2 million this quarter, compared to $8.2 million in the fourth quarter. Depreciation and amortization expense for the quarter was $7.7 million, compared to $8 million in the fourth quarter. Accounts receivable were $100.5 million at the end of the first quarter, compared to $103.5 million at the end of the fourth quarter. We were able to keep our DSOs flat at 69 days even in these difficult market conditions.

Inventories at the end of the quarter were $128.9 million, compared to fourth quarter levels of $121.7 million. This increase is primarily due to our acquisition of Babcock and our Ireland expansion. Cash generation was strong again this quarter. Our operating cash flow was $21.8 million during the quarter. We were again able to fund our recent acquisition with cash flows primarily generated during one quarter.

Our best estimate of end market percentage breakout of net sales for the first quarter was approximately

defense, 34%; commercial air satellite, 26%; medical, 16%; notebooks, LCDs and displays, 6%; mobile connectivity including POE, 10%; industrial and semicap, 8%.

Now for our business outlook. Microsemi expects that for the second quarter of fiscal year 2009 our sales will decline within a range of 16% to 20% sequentially. On a non-GAAP basis, we expect earnings for the second quarter of fiscal year 2009 to be $0.15 to $0.20 per diluted share. With that, I'll turn the call back over to Jim.

Jim Peterson

Thanks, John. Normally we open up the conference call to questions from the analysts regarding the earnings release. One subject matter that I just want to jump on right now and address it right to the point. And this question is on everyone's mind, so let me get to it. And probably the best way to do is t is my fashion, and I'm going to ask a question, I'm going to answer it. And it goes like this; you know, I just got back from the road. So, probably the number one question is, hey, what's the status of the corporate governance committee review regarding Jim Peterson? And the answer is, the review is still in progress. It has not been concluded. And then, you know, the natural following question is, you know, hey Jim, when is the committee expected to complete this review? And the answer right to the point at this time is, I don't know when the issue will resolve. And I will not comment on this subject matter during the rest of this conference call. So to the short, it is a process. I respect the process. I understand the process. I have great confidence in my governance committee and I have tremendous confidence in my Board. So, I would ask that this conference call we focus on the earnings release and that you also respect the process that’s in hand. That having been said, let's open up this conference call to questions, guys.

Question-and-Answer Session

Operator

(Operator instructions) The first question is from the line of Rick Schafer from Oppenheimer.

Rick Schafer – Oppenheimer

Hey guys. I got a few questions here. So that’s alright. I think I'll start with the first and what gives you guys, Jim, what gives you confidence that the March quarter revs are only going to be down about 20% at the low end? And I guess, sort of what turns do you need to make that guide? And maybe the third thing on that question is, do you assume that this is the low watermark for revenues?

Jim Peterson

Yes. We have a lot of visibility obviously in the High-Rel business. When we have to go into a quarter we are pretty confident that – of our guidance range. This one here, I put full capitulation in guidance share.

Rick Schafer – Oppenheimer

Okay.

Jim Peterson

Let's see what's going on out there. Last quarter we said they had a lot of mixing, the week all set by Hi-Rel. And now I'm saying the analog mix signal is just part. And I could – our team wants me to say horrible three times. And somewhat offset by Hi-Rel. Things are a little different in Hi-Rel and I'll walk you through it. Let me get the turns rate. You hit the high end of the guidance, at this point my churn rate is on about 17%. So, this is probably the most cautious you'll ever see Peterson, but I realize stockers out there people saying take air out of the balloon, whatever it seems may be. Call it what you want, but my churns rate for the high end of the guidance is on about 17%. In the norm, probably 33% to 38% at this time. So, this is certainly capitulation in guidance. And let me just try to give you a couple more pieces of puzzle here. If you're that confident then you wind this down 16 to 20. Analog mixing, it's as bas as everybody says out there, right. We are not immune from it. All the market segments are horrible and getting uglier, and quite honestly, it's like flying an airplane without any gauges, right. I'm not sure how much fuel is in it. My distributors, they are pretty much closed for business, except for I'm trying to get low bids. And the end customers, they even closed since the first second week of December. I think they are going to close there through the Chinese New Year. Though, we don’t have a lot of visibility. You know I'm watching some of the larger guys out there and they are just not even going to give guidance. So, I'm pretty comfortable. So why the down tick on the road then, if you're so confident in the strength, backlog is up, right, a book of one-to-one, know that there is a horrible market, the analog mixing and there must be some good bookings in the Hi-Rel business than there is. But here is what it is. 50% of that business go through distribution shape and with couple of things going on distributors one, they have already said they are not sure how they can secure a lot of financing. Right.

Rick Schafer – Oppenheimer

Right.

Jim Peterson

Two I know the fact right they are going to have a party out there right now. They are already calling people up the one that are working, those were Chinese New Year and they already starting with, hey, we will give you an order but we want 25 degradation in ASP. And what that means to me is that's going to take away from my margins and I am not sacrificing the future margins of this Company. So what we are going to do, we have a pretty good strategies we are going to lessen all dependents, all distributors in the Hi-Rel market space and that’s dance we want to dance this quarter we are going to sit back and watch it. We’ll be the better for it over the next few quarters. Also I can’t call the bottom to Schafer because no one really can but I tell you what I think we are going to start next quarter we’d like to drive about it.

Rick Schafer – Oppenheimer

And couple of questions I want to follow up on that stuff you didn’t want just to Hi-Rel the in market demand for high reliability are you basically saying that this it sounds like Hi-Rel is going to be down sequentially I mean it sounds like that’s not a demand issue, its more of a just the sort of de-stocking issue or something

Jim Peterson

I just want to load some of my dependents on it. I mean strategically right when you (inaudible) meeting and we want to strategically hit the chance right that all that predominantly sole source product or two source product we don’t believe really should be go through all distribution be going as well yet. So there is still being flown on, we are going to lessen dependence on the distributors mainly could large on this product by the way. And then it’s also going to give us an opportunity strategically against closer to some of our larger customers and may be increase our socket opportunities with those end customers by directly touching within so the answer, yes, you are right. Hi-Rel’s backlog is stronger, Hi-Rel business is rock solid. We are just taking an opportunity in a crisis market to strengthen our future.

Rick Schafer – Oppenheimer

So, you haven’t seen, just the way I am hearing it you are not seeing any cancellations in the Hi-Rel or any of the stuff we are seeing in the rest of the lot of the other got spaces here?

Jim Peterson

Look, I've read some report that people said that?

Rick Schafer – Oppenheimer

Yes.

Jim Peterson

Absolutely incorrect.

Rick Schafer – Oppenheimer

Okay. And then Jim just how much did you think Litchfield’s business is going to be down in 2Q?

Jim Peterson

I may just call it ugly, horrible and then I am going to say you read a report everyone else out there, and here we got a report of last quarter mid-point out of our 30%.

Rick Schafer – Oppenheimer

Yes.

Jim Peterson

And again this quarter down about 30%, which would be 60% downtick. Litchfield aim much after that? You might even deal it a little. You might be good at that.

Rick Schafer – Oppenheimer

Okay, and then just one last question. You mentioned margins, I messing up my model here to get to that $0.15 to $0.20, it seems like I have got it to assume margins in the mid-40's range, it might sort of on the mark John or Jim?

Jim Peterson

It's actually not and you got to John to answer this. But this is probably the highlight of the whole conference call. Let's go for our margins our GAAP margins were 46.8 and went down to this quarter to 46.2. Right? Non GAAP was 42.5 went down to 61.8, next quarter, right? Even with those guidance, our model is at gross margins of 50%. So even with this segregation, because what we're doing with the distribution in the like right. The high point of this whole thing is we are margining, we got it miles in that at 50% gross margins next quarter. And I think the best step is that just anybody would ask.

Rick Schafer – Oppenheimer

Okay, so you must be planning an uptake in operation system somewhere or?

Jim Peterson

Just the name of the game? But you got to make sure your cost controls are in place and controlling your expenses and we've got that down. Believe me.

Rick Schafer – Oppenheimer

Okay, thanks guys.

Operator

Your next question comes from the line of Tore Svanberg from Thomas Weisel Partners.

Jim Peterson

Hey, Tore.

Tore Svanberg – Thomas Weisel Partners

Hi. Maybe I could just follow-up on Rick's question about the model and gross margin, because if we do use the 50% gross margin, it would assume that OpEx would be up sequentially. So can you just elaborate a little more, please?

Jim Peterson

Here's where the finance sections in charge.

Steve Litchfield

Yes. Well certainly our OpEx is going to go up. You know, slightly. SG&A primarily due to legal, although those litigation costs are bottled into our guidance. In addition on R&D, you know, it will rise even though it did drop slightly this quarter compared to last quarter. And right now, we are investing to succeed. When we come out this thing we want to be there.

Tore Svanberg – Thomas Weisel Partners

Okay. And on the inventories being up this quarter, can you just give us what the organic inventory was without the Babcock?

Steve Litchfield

No. I think right now I'd like to just say that the combination of Ireland and Babcock contributed to the increase.

Tore Svanberg – Thomas Weisel Partners

Fair enough and if we look at the March quarter, what are you anticipating inventories to do?

Steve Litchfield

In real dollars it will go down. I can't say it in terms of days because of the guidance that we've given being a decline. I don't want to comment on or try to forecast that.

Tore Svanberg – Thomas Weisel Partners

Very good. And then, you know, back to Jim. This strategy to maybe rely less on distributors is that going to be, you know, just this quarter or is that going to be more sort of a 2009 strategy?

Jim Peterson

No, I think it's going to taste pretty good, when we start doing this. So I'm looking at it more of a 2009 strategy. You know, realize you know first let me do to speak right, distributors logistically are best in class, right. This has nothing to do with the strength of the logistics of a distributor. This has to do with an opportunity in an ugly macro-economic situation, right, to take Microsemi a little direction and maybe keep some of the margins for us. So I think what you are going to find is that we're going to lessen the dependence, and I think you're going to find us going toward that certainly for 2009 quarter with respect to distis [ph] but I think it will strengthen our models.

Tore Svanberg – Thomas Weisel Partners

Okay. Fair enough. And then if… if that leads to more direct working relationship with your customers, should we also assume, you know, R&D will be steadily increasing then?

Jim Peterson

Yes, we're investing in R&D. Here's a chance. We're… the strong come out stronger. So, you know our R&D number's going up. Litchfield's got a tremendous analog mixed signal they have a tremendous roadmap of products. And we're winning design wins. We're doing application specific products. We're right with the end customers. We're in the lines [ph] where we should be. And while others are trimming their R&D, right, I'm going heavy on it because when this thing does turn it at will, right, my product portfolio is going to be bullet proof. That's our intent. We believe it will be bullet proof.

Tore Svanberg – Thomas Weisel Partners

Very well. Lastly, on the tax rate, you got the… the reinstatement of the credit. Should we now model a gross margin for the rest of the year to be around 15% to 20%?

Jim Peterson

No. No… you mean tax rate?

Tore Svanberg – Thomas Weisel Partners

Sorry, I meant the tax rate, sorry.

Jim Peterson

No problem. The 19.8% did include an effect of about $0.01 for the R&D tax credit, as you just said. If you kind of back that out in terms of real dollars and equate it to a percentage, it came out more as a normalized 22%. I would say that's probably a good number for your models moving forward.

Tore Svanberg – Thomas Weisel Partners

Very good. Thank you very much.

Jim Peterson

Thanks, Tore.

Operator

The next question comes from the line of Romit Shah with Barclays Capital.

Romit Shah – Barclays Capital

Hey guys, thanks for taking my question. Jim, so I understand you correctly, you did things than Hi-Rel that you had expected the satellite, medical, and… and defense to grow in the March quarter?

Jim Peterson

Yes. I said the strengthening in those markets. We see strengthening in those markets, exactly.

Romit Shah – Barclays Capital

Okay. So then, but the overall Hi-Rel business will be down in the quarter?

Jim Peterson

Yes. You know, we're guiding it down with real capitulation in our guidance. You know, the real point is I want the churns rates, what, about 17%. The message here is kind of shifting, so rather than work through distis, I'm probably going to get lighter by not working through the distis. It's just a strategy and will show up this quarter as a downtick overall, but for the benefit of the margins of the company.

Romit Shah – Barclays Capital

Okay. And then this is probably a naive question but just with respect to the Hi-Rel business, you are moving to more of a direct model because your distis are hammering you on pricing. But you guys are sole sourced on most of your products. From what I understand there's a long qualification process, long product life cycles. How is it that your distis have any sort of pricing leverage here?

Jim Peterson

That's a good question. There's a lot of pricing leverage with me. Okay. But I'm not sure what kind of financing they're going to get in the forefront just to take any product. I want to be real cautious there. And across the board I guarantee the margin… guys that are running disti companies, if they're not marching to their truth right now until they start telling them to push in for degradation of price in any product area I would be surprised. Once again, I'm being extremely cautious in a very difficult macro economic environment and I think that's the right thing to do for our company.

Romit Shah – Barclays Capital

Okay and then just last question for you or Steve. You know, there's… there's some speculation or just looking at the numbers that, your analog customers have overcorrected in terms of reducing inventories and if I could just get your perspective on that? Thank you.

Jim Peterson

You know what I don’t see such a (inaudible). There might be some overcorrection in the inventories, right. What we don't know is what… how much product and end product is sitting in warehouses on ships. But I'm here to tell you right now, the distributors in the Pacific Rim, they're already starting off with a 25 degradation ASP for any product that's out there. So even if the inventories have hit a point of capitulation, expect for multi-source products and expect the game to be played this way, that they'll give you a purchase order, they'll promise you a 100%, and they get a lot of degradation of 25% ASP. So even if we complete it right. You'll face a degradation of 20% to 25% just by playing this dance in the front end. Litch?

Steve Litchfield

I guess the only thing I had… I mean hopefully they are overcorrecting. Our real focus right now is focus on the product roadmap and make sure that we're well positioned as we do come out of this. And so we're not as concerned. We want to minimize the inventory that we have on ourselves and we're watching the channels very closely. But our real focus is how we position ourselves with our products going forward.

Jim Peterson

Thank you, Litch.

Romit Shah – Barclays Capital

And Jim, just back to your, back to your point. Are you saying that, you know, so the analog business is down… down close to, let's say, 30% in December, and… and maybe around the same in March? The majority of that has been driven by units and then I guess going forward, as units come back, we're going to have an ASP headwind?

Jim Peterson

I think a lion's share of that was demand. But I do think, you know, and… you know, I might be wrong on this one. But, you know, I played the Pacific Rim for a lot of years, right. I expect them to… if they can't get financing or you know if they do, they're going to come out of the gate, and they're… it's going to be tremendous price pressure. I mean they themselves have come out already and the low end of some products coming out by 40%, right. So I would expect that the gamesmanship between after Chinese New Year all the way through the last day of March that those companies that have multiple competitors in their product lines are going to get themselves into a negotiation battle that they've never seen before. And I think those that have high churns rates that are seeing $0.50 $0.60, and $0.70 churns rate to make their number, I would expect that they' might be really get their numbers and giving you some bad news in a couple of weeks. That's my – that's my take on this.

Romit Shah – Barclays Capital

Alright, good luck. Thank you.

Jim Peterson

Thank you.

Operator

The next question comes from the line of Steve Smigie with Raymond James.

Jim Peterson

Hey, Steve. How are you doing? You are there, Steve?

Steve Smigie – Raymond James

Yes. Can you hear me okay?

Jim Peterson

Okay, okay.

Steve Smigie – Raymond James

Cool, thanks. I just wanted – you said one of the items, the expenses would be legal expense. I'm just wondering if you could comment on how much that might be?

Jim Peterson

It was priced in the model, but it's going to go up. And let me just leave it at that, and as the quarters roll on, I'll let you know.

Steve Smigie – Raymond James

Okay. And overall, operating expense in the quarter, roughly what percentage should that be up on the dollars?

John Hohener

Well, again, I'm going to just say from – in terms of real dollars, it's going to go up. Certainly as a percentage of revenue it's going to go up as well, because we are guiding beyond in our revenue. I don't want to give you a percent because then you'll try and dial in on my guidance range.

Steve Smigie – Raymond James

Yes, it's okay, I understand. And I guess the question should have been asked in different ways, but as we look out to March, obviously, in – excuse me, in the June quarter, Jim, you have been even pretty costing in the picture rating here. What kind of opportunity is there for recovery or how long does it take you to get more direct and sort of if you're going around the distributors selling, sort did you get the business flowing potentially?

Jim Peterson

You know, I'm not going around. I'm just lessening dependence. I don't want to upset my distributors. We are going to have a lot of meetings with them over the next month and a half. You know, I only guide one quarter.

Steve Smigie – Raymond James

Okay.

Jim Peterson

You got to respect that. And I did mentioned to Schafer, I think we are going to start with some dry product next quarter or so.

Steve Smigie – Raymond James

Alright. Cool. Alright, thank you.

Operator

The next question comes from the line of Patrick Wang from Wedbush Morgan Securities.

Patrick Wang – Wedbush Morgan Securities

Yes, hey, guys, thanks.

Jim Peterson

How you doing?

Patrick Wang – Wedbush Morgan Securities

Good. How you doing? So first off, I just want to ask you about, you know, any potential risk you might see with this shift in strategy with the distributors there.

Jim Peterson

You know what, it always the only – to the upside, better relationship and more direct with our end customers. To the downside, not a lot. And I got to just a deputy manager, he's best in class, alright. And so – I don't think, and like I said, they might be happy knowing that they can look and battle elsewhere for the next quarter or so.

Patrick Wang – Wedbush Morgan Securities

That's fair. Okay. And then I also want to talk about – I know you talked about hitting the high upper portion of guidance at the churns here, but at the lower end of guidance, what kind of churns are you guys taking to that expectation?

John Hohener

Yes, much lower than 17%, I'm here to tell you.

Patrick Wang – Wedbush Morgan Securities

Okay. So does that mean that – would it be fair to say that you guys are, you know, largely booked for that low end of guidance, or…

Jim Peterson

I don't have the hard number with me, but at the high end of 70%, where the norm is 32% – 38%, you can – you can always do the math yourself, kid.

Patrick Wang – Wedbush Morgan Securities

Okay. Now that's helpful. Okay, and then also just in terms of margins here, I know you said that 50% is what you guys are dialing in for the quarter here. If you could just talk a little bit about, you know, maybe – maybe the shift in margins as we go beyond the March quarter and obviously not giving guidance here. But just directionally, what are some of the things that we should see that should benefit there some of the moving parts?

Jim Peterson

From the 50% in the worst of times, right. I mean, my team, myself can go the direction called upwards in strengthening. You know, we do a lot of things. We could have a lot of new product, right. You know we always do sizing, we focus on factory utilization enhancement program, we are watching our operating expenses or controls. You know, we're shifting some products, more products over to Ireland. You know, we are doing more than what we've done in the last three years. So it's – strangely enough, it's more business as usual. But maybe a little more attention to detail, which doesn't hurt.

Patrick Wang – Wedbush Morgan Securities

Is utilization a point or part in your margins there?

Jim Peterson

Yes. It does. Let me give you utilization rate because that will come up. Utilization for the analog mixing is all established, I mean, there is no real utilization there. For the Hi-Rel, our utilization's on or about 80%. So I asked my operations guy, what do you think it will be next quarter? And he said, 70%. I was like, oh! My God, what's happening? And he said, Jim, we're getting more efficient. When you get more efficient, and you get better yields, utilization is going down a little bit. So utilization is about 80%. Maybe next quarter, it will down to 70% – 75%, just for the fact that it's strengthening.

Patrick Wang – Wedbush Morgan Securities

Okay. And compared to the December quarter, what was utilization there?

Jim Peterson

About 50%, I'm sorry..

Patrick Wang – Wedbush Morgan Securities

Got you. Okay, and then lastly, just a quick one on Ireland here. How is that ramping and can you remind us the benefit to taxes that we should think about here?

Jim Peterson

Now let's go through over the whole thing. First of all, it's an operational efficiency strategy, right. We are moving manufacturing overseas, right. Probably the most important part of it is and the fact is that we gained about 20% better efficiencies. And that's how much that we were getting in the other facilities. We've got an educated work force, and a stable work force, right, and nationalized medicine. I'm not a big fan of it, but it certainly helps. And at present the tax rate over in Ireland is about 10%. Those are some of the reasons.

Patrick Wang – Wedbush Morgan Securities

And I mean, just in terms of how that moves the tax rate here. Any color here in terms of where it could go exiting the year?

Jim Peterson

Yes. You know – John, do you want to give…

John Hohener

Yes. I mean, certainly what I said is, 22% is where we're forecasting it based on the mix, and Ireland's proportion of that mix moving forward.

Jim Peterson

Thank you, John.

Patrick Wang – Wedbush Morgan Securities

Great, thanks so much.

Jim Peterson

Okay.

Operator

The next question comes from the line of Harsh Kumar from Morgan Keegan.

Harsh Kumar – Morgan Keegan

All of my questions have been asked, But outside of legal and R&D maybe on the OpEx side, can you talk about any steps that have been taken for cost control or anything that – that you guys can do in the future?

Steve Litchfield

Hey you don't realize that OpEx is going to be, last year it was about $25 million. It should be less than $20 million, right, going to into this? A lot it, we were putting a lot of back-end equipment into Ireland. And we think we are pretty much covered in that spot. So, total OpEx for a company our size of less than $20 million down from $25 million, I think that's pretty good.

Harsh Kumar – Morgan Keegan

Okay. And that's pretty fair. And then Jim, maybe, it takes a little bit of time to build maybe the relationships to the direct OEMs. Can you give me some confidence of how we’re going back to growth more past the March quarter?

Steve Litchfield

Yes. It's not going to be a major shift in strategy. We've gone through allocation meetings with every one of our Hi-Rel customers for the last two and half, three years. We know them extremely well. They know us extremely well. Not a difficult transition. Once again, we're still – direct is going to be a very strong component. Because logistically, a lot of the Hi-Rel customers really depend on distribution now logistics experts where lot of the Hi-Rel customers of last 7 to 10 years have transferred logistics to the distributors. So there is not a takeaway or run away from distributors. This is just a strategy to make some hay in bad weather.

Harsh Kumar – Morgan Keegan

Fair enough. And then last question, maybe just looking back and in turn I'll put the pieces together. A lot of the other semiconductor companies are showing a steep decline in the December quarter in the analog space. You guys said okay in analog. Is it because you guys are just shipping in the inventory and didn't see the revenues fall off or was it just offset by standing the front any clarity would be helpful?

Steve Litchfield

Yes sure. We were quite bold last conference call will tell you analog mixed signal down. Offset by the strength of high rep. Now we're telling you analog mixed signal uglier and offset by Hi-Rel.

Harsh Kumar – Morgan Keegan

That’s so funny.

Steve Litchfield

I told you.

Harsh Kumar – Morgan Keegan

Thanks. Thank you.

Steve Litchfield

Thanks.

Operator

The next question comes from the line of Vernon Essi from Needham & Company.

Vernon Essi – Needham & Company

Thank you. Just on that last comment, I guess one of my questions that I – it looks as though your analog mixed signal is actually down worse than your peers, I mean I've got 30% and 40% for both of those buckets in the fourth quarter?

Steve Litchfield

Because of the strength of the Hi-Rel, right, I've got – we've got the ability to shift things around a little bit. So, you know, hard numbers, you know, break out the way you want. But we don't have to be as aggressive in some of those areas as the other guys.

Vernon Essi – Needham & Company

Okay. So your point here is that you didn't opt to ship as much in at a disadvantaged price?

Steve Litchfield

My point is that, that would be a smart strategic move, wouldn't it?

Vernon Essi – Needham & Company

I'm not arguing whether it's not, I just want to know if that's what happened

Steve Litchfield

I'll give you a yes.

Vernon Essi – Needham & Company

Okay. And then on the SG&A, I just lost some of that commentary. Obviously it spiked up a lot could you walk through that again, John?

John Hohener

Yes, our expenses on SG&A will go up in real dollars as we move forward. The primary contribution of that is going to be some of our legal expenses. You know, but we have built that into our guidance. On the R&D side, it's also going to go up in real dollars because we're going to continue to invest in new products so that when we do come out of this, we're going to be well positioned.

Vernon Essi – Needham & Company

But for the actual December quarter, it went up $4 million sequentially. We do assume the bulk of that delta is legal?

John Hohener

I'm not sure where you're getting your $4 million. Vernon I'm sorry. You're looking at GAAP results versus non-GAAP results. Okay. The biggest contribution from a GAAP perspective has to do with our stock comp expense. And let me try and walk through that. I think I've done this with you before. You know, three years ago, we adopted FAS 123R, and ahead of adopting that, we accelerated…

Vernon Essi – Needham & Company

John, I apologize. Am I mistaken here that December SG&A was $30.6 million. And your SG&A in September was what?

John Hohener

26.2 million on a GAAP basis.

Vernon Essi – Needham & Company

Okay. So that's a 4 million… I'm trying to understand the $4 million.

John Hohener

Vernon I'm trying to explain it.

Vernon Essi – Needham & Company

Okay.

John Hohener

Okay. The increase… remember on a non-GAAP basis we tracked out are our stock comp expense. So all of the discussion up to this point we've been talking non-GAAP. You're asking me a GAAP question. The entire… the major portion of that increase deals with stock comp. It has to do with FAS 123R. It has to do with the fact that after we accelerated all of our option expense a few years back like every company did. You've now start taking your – your expense on a vesting schedule as you moved forward. Each year, you add one more year's worth of expense. We have a three-year vesting cycle. We're now at the point where we're hitting three thirds of our total expense. So there is $7 million numbers now kind of a normalized number moving forward.

Vernon Essi – Needham & Company

Okay. Sorry about that misunderstanding there.

John Hohener

Okay, are you okay with that now Vernon?

Vernon Essi – Needham & Company

I am. And let's… one other question here on your customer base. Do you have any customers larger than 5% in the quarter?

Steve Litchfield

I would guess no. John?

John Hohener

Now from a – from an SEC perspective we're support to report 10%, we certainly don’t fit that threshold and it's our belief we don’t have any...

Steve Litchfield

Wait a minute. I might have one touching over, it might be Boston Scientific.

Vernon Essi – Needham & Company

Okay.

Steve Litchfield

Okay, and I'm not sure. But I don't… I want to pose that if I did have one. Last quarter it would be Boston in slightly above the sky. Okay?

Vernon Essi – Needham & Company

All right. Thank you.

Steve Litchfield

Hey, thank you.

Operator

Thanks, next question comes from the line of Adam Benjamin from Jefferies.

Adam Benjamin – Jefferies

Thanks. Just want to follow up, Jim, on the comment, you know, just on the Hi-Rel business you usually have six month lead times. Obviously you're got to reeling that back in, you know, can you talk about the dynamic of what's getting real back in? I mean, did… did you push out to your customers, or did they push out on you? Or, you know, just… just go into more detail into what was going on there. Is there inventory that they're seeing? I mean obviously six months ago when they were ordering product, they were expecting much more significant demand environment than where we are today. So just trying to get a better understanding as to the dynamics there?

Jim Peterson

That's a good question. Let me answer it. Try to answer it beginning but I'll just go over lead times for you. Yes. You might get a feel for it. In the Hi-Rel, right, the normal lead times historically have been 20 to 30 weeks, okay. The lead times we're seeing now in Hi-Rel are between 15 and 26 weeks. All right, so we're just… you know, we're seeing a little bit of shortening of the lead times. All right now the satellite business, you know, is historically normally been 36 weeks and is still currently greater than 36 weeks, all right. So there's that base and in addition it's just a pittance because of the lead times is I'm not sure, and I'm not comfortable that I'm going to get all of my supply from Hi-Rel products. I mean, some of the components, whether it be the gases, whether it be the tin cans, whether it be some of the components we actually buy from the same suppliers as the commercial guys and I'm not sure of the strength and of (inaudible) some of those suppliers. I'm actually counting [ph] at Hi-Rel a bit more because of that as well. Not a lot, maybe 3%. So I think with the shortening of the lead times from the normalized 20 to 30 weeks now 15 to 26 weeks, you can see where the crossover might be.

Adam Benjamin – Jefferies

But with respect to inventory levels, do you think your end customers have excess inventory?

Jim Peterson

In Hi-Rel?

Adam Benjamin – Jefferies

Yes.

Jim Peterson

Not a lot. Not a lot. But, you know, I think… I think as we start sitting more face-to-face with them rather than have the distributor do it for us in all cases, I'll get a clearer picture on it. But I'm guessing not a lot. I mean we've been handing them out, a lot of product for a long time as you…

Adam Benjamin – Jefferies

Right. Right, So I guess that's what I was getting to. You've been handing them out for a bunch of products for some time. Do you worry about putting yourself in a problem of… of being unable to deliver products as you move throughout '09?

Jim Peterson

Not… not with those cycle times and lead times again. We have pretty good cycle times, pretty good lead times. You know, we know most of the programs because they are… these things go into systems and there are multiple customers in each of the systems. You know, we… we got this market… we have it nailed pretty tight. So I –

Adam Benjamin – Jefferies

Okay. Maybe one last way to ask this question. I mean, if you could throw out percentages as to is this, you know, a decision by Microsemi percentage wise our your customers percentage wise for why you're making this decision to reel back the March quarter on the Hi-Rel business?

Jim Peterson

Look it's certainly me… unless you are my dependents. That's our strategy. We want to get close to the customers. Our General Managers meeting that we just concluded, we have a lot of new, fresh eyes from some of the acquisitions. And they're saying, hey guys, you know, there's some more socket opportunities here by getting a little closer to your customer. You ought to give it a shot. And we are. Plus, once again, distributors have a difficult time getting financing. And I would rather… I think the end customers are still making a lot of money. And I think they'd be better payers at this point.

Adam Benjamin – Jefferies

Got you. Just one last question on the mixed signal business. You talked about a lot of designs and a lot of activity there. I mean, the business has kind of struggled here irrespective of the downturn. You know, be curious to hear you kind of elaborate on what end markets and what specific products you think can drive some growth in 2009, you know, assuming we get back to a normalized market here?

Jim Peterson

That's a good question. You know, one thing is a fact, right. In a downturn in… in a bad mark, right, what usually happens is downturns really accelerate a lot of innovation. And… and that having being said, I think you are going to see acceleration in the LED products. Which in notebooks and TVs. And… and if we work diligently then we're going to be there. We have strong offering of next generation LED products. We have a real strong product roadmaps and we're funding our R&D programs. You know, we're hitting it shoulder to shoulder, aptly [ph] specific with the customers. So I think this is where, you know, our strategy, even in this macro-economic downturn, I think it… if Steve had one slogan for his team, and we just can't meet with them all, let's go take some market share. This is…

Adam Benjamin – Jefferies

Got you. Just one follow-up on that LED, you know, comment. Design cycles for TVs are quite long. Do we assume you already have design wins, we'll see TVs in late '09 for the holiday season or is that more of a design year in '09 for revenue in 2010?

Jim Peterson

Good question. Let's show –

John Hohener

I think we'll be shipping some. But it will be very small volumes. In '09. And really there's not a huge market shift yet. I mean, I think that's really more of a 10, 11 timeframe that you see more of the market share converting.

Adam Benjamin – Jefferies

Right. Until I have guidance. Thanks. All right thank you.

Operator

The next question comes from the line of Craig Berger from FBR Capital Markets.

Jim Peterson

Hey, how you doing?

Craig Berger – FBR Capital Markets

Good. Thanks for taking the question. Can we start with transitional idle capacity? You've cut about $4 million out of that line in the last year. I think you've got two no more than four quarters remaining to make it disappear. Is that… are we still on track for that?

Jim Peterson

Hey good question… as a matter of fact, Yes. Since we started, a little more than $4 million dead-on [ph], $2 million in the last quarters. Last quarter I said I would close it in three to five quarters, and now I'm telling you flat out, we are going to close in two to four quarters right on track with my team. A lot of it has to do with the closing of Colorado. I'll touch more on that in a minute. What we do in sizing, what we're doing in Ireland and mix. So let's talk about Colorado, because that's probably a follow-up question. We've stopped wafer starts if that makes sense, okay. We're ahead of plan. We thought we were going to stop in April, but we stopped wafer starts already. We're ramping down that site. We're going to shut it down on plan into the next two quarters. And the building is listed for sale, and we own that building.

Craig Berger – FBR Capital Markets

So it sounds like it's going more like four quarters until?

Jim Peterson

No, I said between two and four.

Craig Berger – FBR Capital Markets

Okay. And…

Jim Peterson

Closed down Colorado? Yes. Ours shut down, we told you last five or three quarters it's going to be closed down in the next two quarters. I'm sorry.

Craig Berger – FBR Capital Markets

Okay. And I know you don't want us to get into the process. But I think more broadly, you know, if there is a lot of upset investors out there that perceive Microsemi as being less ethical than you guys should be. Whether or not that's actually the case isn't really for me to say, but the perception out there is that it's true which is why your stock is trading at eight times on your numbers. What actions are you guys taking and/or the Board taking to shore up investors' perceptions of your ethical behavior?

Jim Peterson

Yes. The question – John?

John Hohener

Yes. First of all, in our press release we issued you GAAP results. We have total transparency in our results. We take you through an exercise where we come down to our non-GAAP results. But certainly there's nothing there that isn't in our press release.

Craig Berger – FBR Capital Markets

Is that it?

John Hohener

Yes. Yes. I'm not sure, I don't know how to ….

Jim Peterson

I'm assuming you – when I went over the status of the corporate governance committee contract?

Craig Berger – FBR Capital Markets

I did, and that's why I'm not asking specifics on, whether when the board is going to come out with whatever relating to your credentials, etcetera. But I think more broadly, whether it's the diplomagate thing, whether it's buying up competition and potentially consolidating the market too much, whether it's taking recurring pro forma cash charges, these things are impacting the stock.

Jim Peterson

Yes. I understand. I read your reports. And, I respect your position on it. And you have to respect ours.

John Hohener

Yes. I guess one thing that I'll say, from an operating cash flow standpoint; we had a strong quarter at $22 million. If you look at that a year ago, that was $8 million. So I think we're making a lot of great improvements that are translating into hard cash. And we have no debt. I'm not quite sure the consternation in your tone.

Jim Peterson

No, that's okay. Lets get on, Next question, anyone? Any more questions?

Craig Berger – FBR Capital Markets

Do you guys have any plans to do share repurchases with the stock below 10?

Jim Peterson

You know, (inaudible). We do strategic accretive acquisitions, but next board meeting you can certainly believe we'll be discussing it.

Craig Berger – FBR Capital Markets

Okay. Thanks guys.

Jim Peterson

Alright. Thank you, Frank.

Operator

Your next question comes from the line of Nicholas Aberle with Caris and Company

Jim Peterson

Hey, Nick.

Nicholas Aberle – Caris & Company

Good going guys. Can you give us an update if you can on the status of the lawsuit with the Department of Justice?

Jim Peterson

Yes, sure. Just a fact right, we believe they really don't have a great command on all the facts. We are and we've set some data as they are multiple viable suppliers and ways of entry into that market. Really the fact is that it's really immaterial in dollars and as things go on, I'll give – I'll continue to give you updates.

Nicholas Aberle – Caris & Company

How would you characterize a worst-case scenario for you guys and the outcome of that?

Jim Peterson

No, it's its all material. You know, I don’t have a worst case on it. I think we said the dollar range or worst case would be around $8 million. So, I'm pretty confident that we are right here.

Nicholas Aberle – Caris & Company

And I mean, just playing devil's advocate, I mean is there – are you guys worried that this could potentially set a precedent for additional lawsuits and/or hurt pricing, your ability to raise pricing in that marketplace going forward?

Jim Peterson

No, I mean understand our price positioning programs. It's totally unrelated to this action. So I'm pretty comfortable there. And no, I don’t think that – I think this is pretty much on this one subject matter we'll deal with.

Nicholas Aberle – Caris & Company

Got you. So, gross margins can be down about 180 basis points sequentially in the March quarter. I mean, I would guess that mix is actual strengthening. As analog comes back, do you guys – is there a possibility that analog actually, gross margins are headwind for your gross margin expansion in the next couple of quarter?

Jim Peterson

You know, yes. If you look at the product mix and the product roadmap that Litch and his team put together, yes. It could and should go up. If you, you know, if the data's correct. And we believe it is. That's a good question.

Nicholas Aberle – Caris & Company

And then just lastly, I mean what type of visibility do you have into your distribution channel in terms of inventory? Was it up sequentially, and what are you guys seeing here through the first couple weeks of January in terms of that inventory?

Jim Peterson

I think it was down in dollars and percentage of sales. John?

John Hohener

Yes.

Jim Peterson

Yes.

Nicholas Aberle – Caris & Company

What level – I mean, how much more burn do they have to do for you guys to feel comfortable that they might be nearing a trough level for inventory?

Jim Peterson

I don't have the POE and all the data in front of me, so I really don’t know, I can't tell you. But we're watching it close. I've got my sales guy nodding. I think we're in good shape there.

Nicholas Aberle – Caris & Company

Got you. Thanks, guys.

Operator

Your next question comes from the line of Christopher Longiaru with Sidoti and Company.

Christopher Longiaru – Sidoti & Company

Can you hear me?

Jim Peterson

Yes I can. Go ahead please.

Christopher Longiaru – Sidoti & Company

Okay. Most of my questions have been answered. I want to piggyback on a couple. Just going back to the Boston Scientific maybe being 5% is that something that’s going to continue to be around that range or is that due to large purchase order and exchange for keeping Colorado open a little longer?

Jim Peterson

Hey, Good catch. It has due to the large part or keeping Colorado open a bit longer. It ramped up nicely. And it continues certainly next quarter. And then I’ll work with them on quarter after that next during this quarter.

Christopher Longiaru – Sidoti & Company

Okay. Great. All right. So then, so nobody is probably going to be even near 5% after that.

Jim Peterson

You know, they might be near it. I mean, you always really the company is as you know, I think into (inaudible) you got a good handle on it. It is the diversity of the market and diversity end customers. So, I think we’ve shown a presentation none greater than 10. But I think we spotted out, you know, you with the acquisition to none greater than about, you know, five or six. If it goes to six, that wouldn't concern me when I go to I make that kind of clause.

Christopher Longiaru – Sidoti & Company

Okay. Let's see. What else do we have here. Just on semico [ph] situation it seems like this kind of came up right, you had the acquisition done, then all of the sudden is there do you think this could be a perception that the raising of your prices in October had something to do with the acquisition? Or –

Jim Peterson

No, no. Let me think. We’ve been price positioning for last five years in this market.

Christopher Longiaru – Sidoti & Company

Right.

Jim Peterson

So this is a real declining market. A lot of this product was designed 30, 50 years ago. So our cost of supply and the suppliers in it are minimal, right. A lot of it we have sole source suppliers. You know at a year ago I bought about $10 million worth of glass.

Christopher Longiaru – Sidoti & Company

Right.

Jim Peterson

And I bought, I couldn't get away for because is this I think, so if our guys bought all the way first so we had to buy as many as many wafers as we could we sold the two and three inch wafers and forged wafers. We actually If I'm not mistaken my operations guy actually bought some sand to guarantee supply. So the pricing is apples and oranges. And we are up-front with the customers. Here we go and say, 'Listen, the cost of us – of these products, right, and the cost of we have to build a whole run for whole stock, our wafers were sometime you know they want 30 widgets. And we can't price its based on those 30 widgets. So we've been doing it for five years. And the prices, the program is unrelated. Right?

Christopher Longiaru – Sidoti & Company

Okay. Got it. I think just the last thing was just on a – John, on the majority of the, I think you have the cash flow increase was, operating cash flow was above 182% over, it was sequentially I believe, was that pretty much all the transition idle capacity costs?

Jim Peterson

Certainly reducing the transitioning idle capacity cost is the cash component. So we are by reducing that we are generating cash. It's also the management of our balance sheet, inventory and receivables. And we just have a lot of programs in place where we are maximizing our balance sheet management.

Christopher Longiaru – Sidoti & Company

From a GAAP cash flow perspective, I guess I think at the point where we are comparing to you were looking at about I think $12 million now we are down to about seven if my history is right? I mean when we get down to seven, are we going to see pretty much another double in operating cash flow? Is that possible?

Jim Peterson

Are you talking about transitional idle capacity?

Christopher Longiaru – Sidoti & Company

Yes. Once the transitional idle capacity cost goes the rest goes away.

Jim Peterson

Yes. It's approximately 70% to 80% cash component of that.

Christopher Longiaru – Sidoti & Company

Okay. That's good enough. All right. Thank you, guys.

Jim Peterson

All right. Thanks for your time.

Operator

There are no further questions at this time. Do you have any closing remarks?

Jim Peterson

Just thanks for joining us today and for your questions. And have a great day.

Operator

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

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