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Executives

Rick Crowley - CFO

Ted Tewksbury - President and CEO

Analysts

Sukhi Nagesh - Deutsche Bank

Peter Karazeris - Citi

John Barton - Cowen & Co.

JoAnne Feeney - FTN Midwest Securities

Sandy Harrison - Signal Hill Securities

Suji De Silva - Kaufman Brothers

Nicholas Aberle - Caris & Co.

Integrated Device Technology, Inc. (IDTI) F3Q09 (Qtr End 12/28/08) Earnings Call January 29, 2009 4:15 PM ET

Operator

Good afternoon, and welcome to the Integrated Device Technology Incorporated third quarter fiscal year 2009 financial results conference call. (Operator Instructions)

With that said, here with opening remarks is Integrated Device Technology's CFO, Mr. Rick Crowley. Please go ahead, sir.

Rick Crowley

Thank you, Kerry, and welcome to our fiscal third quarter 2009 Earnings Call. I'm Rick Crowley, IDT's Chief Financial Officer. Presenting with me on the call is Ted Tewksbury, our President and Chief Executive Officer. Also in attendance on the call are Brian White, our Vice President of Finance; Chad Taggard, our Vice President of Marketing; and Mike Knapp, our Manager of Investor Relations. We will all be available during the Q&A portion of this call.

Our call today will include remarks about future expectations, plans and prospects for IDT, which constitute forward-looking statements for purposes of the Safe Harbor provisions under applicable Federal Securities Laws. Actual results may differ materially from our forward-looking statements, as a result of various important factors, including certain risks which are detailed in IDT's most recent annual report on Form 10-K and quarterly report on 10-Q as filed with the SEC. IDT does not intend to update the information provided in today's call, and expressly disclaims any such duty except as required by law.

In addition, pursuant to Regulation G, any non-GAAP financial measures referenced during today's conference call can be found in our press release posted on our website at www.idt.com, including a complete reconciliation to the most directly comparable GAAP measures.

Please note we have made selected financial information available in webcast slides, which can be found in the Investor Relations section of our website.

Now, I'll turn the call over to Ted, who will report on the overall quarter and then I'll return to give you more specifics about our December quarter results and our outlook for the March quarter. Ted?

Ted Tewksbury

Thanks, Rick. Following two consecutive quarters of 6% growth, we finished our fiscal third quarter of 2009 with $167.1 million in revenue, which was in the range of our previously announced expectations and reflects the difficult economic climate.

Revenue was down 17% sequentially, while non-GAAP EPS of $0.18 was above the high end of the range we provided in our revised guidance released on December 8, 2008. The strong bottom line results were the result of significantly lower operating expenses, highlighting our disciplined cost management, variable expense structure, and resilient business model. In addition, we generated almost $38 million in free cash flow, which represented approximately 22% of our total revenue.

Now, let me describe some of the trends that we experienced in our end markets during Q3. As expected, revenue declined in all of our markets due to weak end user demand and inventory reductions in the channel. However, some of our sub segments held up better than we anticipated.

In computing, sales of memory interface devices for servers exceeded our prior expectations by being down only low single-digits sequentially. This was largely due to stronger sales of our low power, advanced memory buffers to customers whose mission critical applications require the highest performance and the lowest power consumption.

Sales of PCI Express switches declined low double digits as new product ramps and some customers were postponed. PC revenue, which includes both audio codecs and clocks was down approximately 25% sequentially, in line with the broader PC market. These declines were due to weaker demand from our OEM and ODM customers, as well as channel inventory reductions.

Our computing end market represented about 42% of our total revenue, up from 40% in the prior quarter. Our consumer end market was also weak in the December quarter, as double digit declines in gaming and other consumer sub segments were partially offset by growth in our display business. This resulted in a sequential decline in consumer-related revenue of just over 10%.

The consumer segment represented 16% of total revenue in Q3, up from 15% in the prior quarter. Total revenue from our communications end market decreased approximately 20% sequentially, as the wireline, wireless and enterprise sub segments all decreased by double digit percentages. These declines reflect weakened end customer demand, but market share in each segment remains stable. Our communications end market represented 42% of total revenue, down from 45% in the prior quarter. SRAM remains approximately 5% of total revenue.

Now I'd like to provide some more detail on new product introductions and design wins in the December quarter, as well as our outlook for the March quarter.

Let me start with the consumer segment, where we are seeing significant traction with our push into the display market. We recently announced our PanelPort family consisting of an embedded DisplayPort compliant receiver and timing controller device has been chosen by CPT for inclusion in its 14-inch flat-panel display for notebooks. This product was also included in EDN Magazine’s Hot 100 products list.

In addition, our integration of Silicon Optixs is proceeding ahead of plan. The HQV brand has been reestablished with well-attended demonstrations at the Consumer Electronics Show, several new design wins and the tape-out of the team’s first IDT product.

Also in the consumer segment, we introduced a new series of devises in the company’s industry-leading portfolio of low-power, asynchronous dual-ports for high-end handsets. We've seen increasing design win activity with our dual-port products, especially in Asia.

Despite all the positive momentum we've seen in design activity for our new products in the consumer space, we remain exposed to end market demand weakness, inventory drains and seasonality.

As such, we anticipate further declines in the March quarter, the seasonally weakest quarter for our consumer business. We are currently projecting declines of approximately 50% sequentially in our consumer end market in the fiscal fourth quarter, with the bulk of the weakness coming in the gaming sub segment.

Let me now turn to computing, which includes both servers and PCs. We continue to expand our industry-leading PCI Express product portfolio as we introduced two new generation two switches, optimized for computing and embedded applications.

In addition, we introduced several new PCI Express timing products, including fan-out buffers, zero-delay buffers, clocks and jitter attenuators in order to offer our customers a complete suite of application optimized solutions.

Customer design wins remain strong in this market. In fact, ASUS recently chose an IDT PCI Express switch for use on its newest high-end Intel processor-based motherboard. We also announced support for Intel Xeon processor based on Nehalem, which includes production-ready PCI Express switching, clocks and Intel-validated DDR3 registers.

As I mentioned earlier, we are still seeing strong interest from customers for our server memory interface products. However, coming off a relatively high Q3 base, we anticipate that revenue from our memory interface product lines will be down double digits sequentially in the March quarter.

Overall for the March quarter, we currently project declines of approximately 25% sequentially in our computing end market due to normal seasonality, exacerbated by lower end user demand and customer inventory reductions.

Within communications, the long awaited awards of 3G licenses to service providers in China has generated an increase in orders for some of our core wireless infrastructure products, and that will partially offset other near-term weakness.

We have one clock and serial rapid I/O switch sockets at all of the major equipment manufacturers in China and expect some of these to begin ramping in our fiscal 2010. We are also seeing design win traction with our network search engines, in RNC, media gateway platforms and some routing infrastructure equipment.

Near-term demand remains weak and visibility remains limited for all our communication sub-segments. Altogether for communications, we expect revenue to decline approximately 20% sequentially in the March quarter.

In total, in the March quarter, our fiscal Q4 of 2009, we are projecting that revenues will decline to approximately $120 million plus or minus $6 million. We estimate that approximately a third of the expected declines in the March quarter will be related to weak demand, another one-third to inventory drains and one-third to typical seasonality.

Rick will provide more details on our financials in a moment.

As the December quarter illustrated, IDT's flexible business model has the ability to deliver strong bottom line results despite lower revenue levels. However, we are not relying solely on our variable expense structure to maintain our solid cash flow and profitability.

We recently announced a 7% reduction in our global workforce across multiple divisions worldwide. This downsizing was the outcome of a deliberate and structured approach to increasing investment and strategic growth businesses while downsizing in non-core areas.

In addition to a one week shutdown taken at the beginning of the quarter, we have frozen all hiring, except for a small number of key technical staff and we're reducing discretionary expenses wherever possible.

Our manufacturing facilities are also taking additional time off throughout the March quarter, in order to reduce costs and align production output with lower demand levels. These steps are enabling us to reduce our overall cost, commensurate with revenue.

We are currently faced with an unprecedented demand driven downturn. In near term, we expect customers to remain cautious and visibility to remain limited. However, the execution of our new strategy aimed at providing comprehensive, system optimized mixed signal solutions for processing, transporting, and delivering digital media is proceeding on plan.

Our structured approach to downsizing enables us to continue to make critical investments in product definition, analog design, and applications expertise needed to implement our strategy.

Longer-term, we remain confident that a return to growth in our core businesses, combined with innovative new products currently in development, will position IDT to outgrow the industry when demand improves.

With that, I'll turn the call over to Rick to expand on our financial results and outlook.

Rick Crowley

Thanks, Ted. Let me start by reviewing the non-GAAP results for fiscal Q3. Revenue of $167.1 million was within the range we provided in our revised guidance released December 8, 2008.

As Ted indicated, the sequential decline in revenue was the result of weaker demand in each of our end markets, combined with attempts by our end customers and distributors to reduce inventory levels.

Despite the sudden drop in demand in the December quarter, distribution channel inventory did decrease quarter-to-quarter in absolute dollars, while days of distributor channel inventory rose slightly.

Fiscal Q3 gross margin was 50.4%, down from 51.3% in Q2. The decline was driven primarily by revenue mix and inventory reserves. Fab utilization declined to approximately 70% from 79% in the prior quarter.

Overall, operating expenses in Q3 decreased $6.4 million from the previous quarter, demonstrating the benefits of our variable expense structure and our focus on cutting costs. This decrease was the result of lower compensation expenses, losses in the deferred compensation plan, lower sales commissions and lower payroll expenses from the holiday shutdown.

R&D expenses during the fiscal third quarter were about $32 million, down from approximately $36 million in Q2, while SG&A expenses were about $22 million, down from approximately $24 million in the prior quarter.

Interest income and other income expense decreased by $1.5 million sequentially to a net expense of $1.2 million in the December quarter. This decrease was driven by declines in the investment portfolios of our deferred compensation program and less interest income due to lower average cash balances.

We recorded a tax benefit of $400,000 in the December quarter. This benefit was related to a tax holiday in a foreign jurisdiction, and new R&D refundable tax credits in the U.S. created under the Housing Assistance Tax Act of 2008.

Net income for the December quarter was $30.1 million or 18% of revenues, while EPS was $0.18, down from $0.26 in the prior quarter. Our EPS was above the high end of our prior forecast, primarily due to lower operating expenses.

Now, let me summarize our results on a GAAP basis. We reported a GAAP loss of approximately $345 million or $2.06 per share in the December quarter. The difference between our GAAP and non-GAAP results nets out to about $375 million or about $2.24 per diluted share.

As a result of the current economic environment and decline in the market value of the company, we conducted an interim goodwill and intangible impairment analysis, which will result in an estimated non-cash charge of $339 million for the quarter.

Fiscal third quarter 2009 GAAP results also include $19.7 million in amortization of acquisition-related intangibles, $9 million of stock-based compensation expense, $5.6 million of in-process R&D related to the Silicon Optix transaction and a $3 million asset impairment charge.

For further information including a detailed reconciliation of non-GAAP to GAAP results, please refer to the financial tables of today’s press release, which can also be found on our website at www.idt.com.

Now, turning to our balance sheet. Cash and investments totaled approximately $302 million at the end of the December quarter. We continue to maintain a conservative cash management strategy and invest primarily in a diversified portfolio of high quality money market agency and government instruments.

We generated approximately $38 million in free cash flow during the quarter and approximately $2 million from the share purchases under our employee stock purchase program. We were active again in our share repurchase program during Q3.

During the quarter, we spent approximately $25 million to repurchase 4.8 million shares of IDT common stock. Over the past several years, we've purchased approximately 48 million shares and we currently have about $78 million available for additional repurchases under our existing program.

Given the sharp decline in our revenues, the recessionary economic conditions and uncertainty of near-term demand, we are temporarily suspending our share repurchase program in order to preserve cash.

Net inventory increased slightly to about $77 million in December from $76 million in the prior quarter. Days of inventory increased to 85 days from 71 days in the prior quarter, driven by lower cost of goods sold on relatively flat net inventory.

Our trade accounts receivable decreased by $23 million to $65 million in December, primarily due to lower revenue in the quarter, while DSO decreased to 35 days from 40 days in the prior quarter.

I will now turn to our forecast for the March quarter. As Ted indicated, we currently project revenue for our fiscal fourth quarter of 2009 will be in the range of $120 million plus or minus $6 million. We experienced weak bookings throughout the December quarter with particular slowness in the second half of the period. This resulted in a book-to-bill ratio significantly below one.

Given customer efforts to reduce inventory and the timing of Chinese New Year, we estimate that demand will be stronger in the back half of the March quarter than it has been thus far in January.

On a non-GAAP basis, we currently project gross margin to be in the range of 47.5% plus or minus 50 basis points, depending primarily on the revenue range and product mix. We anticipate Q4 fab utilization will be approximately 50%. We currently project operating expenses in the March quarter to be approximately $54.5 million plus or minus a $1 million.

This sequential increase of approximately $1 million is driven primarily by the calendar year reset of U.S. payroll taxes, increased employee benefit costs and an assumption that there will be zero benefit to operating expenses from the deferred compensation plan.

These items are projected to increase operating expenses sequentially by a total of $3.9 million over the December quarter, and are mostly offset by lower estimated variable compensation and a partial realization of savings from the reduction in force announced this week.

R&D is expected to be approximately $32.5 million and SG&A is projected to be approximately $22 million. We currently project non-GAAP operating margins to be about 2% plus or minus a percentage point, primarily dependent on the revenue range.

We anticipate interest and other income to be about $1.3 million, and we expect our taxes during fiscal Q4 to be about $300,000 as we continue to benefit from tax credits accumulated in previous years.

We project share count to be about $165 million on a diluted basis. We currently project EPS on a non-GAAP basis to be about $0.02 per share plus or minus $0.02, depending primarily on the actual revenue range and product mix.

On the balance sheet, we expect to generate approximately $11 million in cash during the March quarter and project a quarter ending cash balance of roughly $313 million. This projected balance excludes the impacts of any additional M&A activity.

We currently project our GAAP EPS to be lower than our non-GAAP EPS by about $0.20 plus or minus $0.01. Most of the difference between GAAP and non-GAAP projections or about $0.12 per share is related to the amortization of the intangibles primarily as a result of the ICS merger. We currently project stock option expenses to be about $.04 per share in the fiscal fourth quarter. Severance expenses are projected to be an additional $.04 per share.

IDT, along with the rest of the semiconductor industry, is in the midst of a perfect storm. The projections for our fiscal fourth quarter of 2009, reflect a confluence of weak end demand, channel inventory reductions and unfavorable seasonality.

While the headwinds of seasonality will abate after the first calendar quarter of 2009, it is unclear at this point what the level of customer demand will be for the remainder of 2009. However, the keen focus by our customers and channel partners to reduce inventory is encouraging and leaves us to believe that inventory levels exiting the March quarter will be better aligned with end market consumption.

As Ted pointed out earlier, IDT is fortunate to have a very resilient business model which enables us to weather temporary economic downturns. We strengthened this model through specific cost cutting measures that are projected to reduce IDT's quarterly spending by over $4 million by the first quarter of fiscal 2010, which ends in June.

As a result of these actions, we estimate that our cash flow break-even will be approximately $100 million in quarterly revenue, with non-GAAP EPS break-even at approximately $110 million of revenue. We believe these discrete cost reduction actions combined with continued tight expense control and solid free cash flow generation will enable IDT to emerge from this economic slowdown as a stronger and more competitive company.

In addition, our continued investment in the key growth areas is allowing us to build solid platforms that we believe will provide future growth as the economy recovers.

With that summary, I'll turn the call over to Kerry for the question-and-answer portion of the call. Kerry?

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Sukhi Nagesh from Deutsche Bank. Please go ahead.

Sukhi Nagesh - Deutsche Bank

Thank you. One question I had was, could you give us the split between your OEM distribution and consignment in the quarter and just talk a little bit about what the current inventory situation is at each of those places?

Ted Tewksbury

Yeah, in terms of the split of revenue, direct OEM customers and contract manufacturers were 28% of revenue, while revenues through consignment channels were approximately 10% and revenue to distributors was 62%, including 16% recognized on a sell-through basis and 46% recognized on a sell-in basis.

Sukhi Nagesh - Deutsche Bank

Thanks for that. If you were talking about inventory levels, how would you characterize inventory levels across those three categories today, sell-in versus sell-out?

Rick Crowley

Sukhi, this is Rick. If you look at the inventory, it actually, in aggregate, from September to December both sell-in and sell-through went down just under 10%, standing at about nine weeks in aggregate. The sell-through is a little bit higher than that average and the sell-in is lower on a week's basis.

So I think that from a channel basis, we started to see progress in the December quarter. We anticipate further declines again in aggregate dollars in the March quarter and hopefully also in weeks of inventory obviously depending on the sell-through that we see.

Sukhi Nagesh - Deutsche Bank

Okay. Thanks, Rick. You're talking about some kind of, hoping it is back-off of March will be slightly better. What gives you confidence at this point to say that we will be better off in the second half of March?

Rick Crowley

I think if you look at the behavior in January particularly out of Asia with the Chinese New Year this week, seeing booking patterns similar, maybe slightly lower than what we saw in the third fiscal quarter. And the reports we get out of Asia are basically saying that, it's pretty heavy pull down on inventory and that post-Chinese New Year that we expect to see things pick up a bit.

Sukhi Nagesh - Deutsche Bank

Would you feel comfortable with calendar Q1 being at the bottom for you guys, or would you not comment on that at this point?

Ted Tewksbury

We have no visibility.

Sukhi Nagesh - Deutsche Bank

Okay. One quick question for you, Ted. As you look across your product portfolios right now, you've talked in the past about trying to increase footprint in the consumer side. But given what we are seeing as a significant retrenchment across every consumer segment, do you still see this as an opportunity for IDTI?

Ted Tewksbury

I definitely do, Sukhi. Were you at CES, Sukhi?

Sukhi Nagesh - Deutsche Bank

I was.

Ted Tewksbury

Did you see our demo?

Sukhi Nagesh - Deutsche Bank

I did come by. Yes.

Ted Tewksbury

Okay. If you saw our demo, then you've seen what the IDT HQV technology can do. We can take a YouTube video and clean it up, so it won't look like high definition, but it looks pretty darn good. You can take a Blu-ray video and make it look better than high-definition, so there's some really exciting technology there.

We believe that demand will continue to be strong for products and technologies that really make a truly noticeable improvement in the way that people experience visual media, and anybody who saw those demos at CES, I think would be a believer that we have those kinds of technologies and we continue to see strong demand from our customers and customers’ customers.

Sukhi Nagesh - Deutsche Bank

Okay. I think you mentioned briefly that the display business grew in the last quarter.

Ted Tewksbury

It did. It grew significantly off of a small base.

Sukhi Nagesh - Deutsche Bank

Right.

Ted Tewksbury

But, it did grow significantly primarily because of the contribution of the Silicon Optix revenue.

Sukhi Nagesh - Deutsche Bank

Okay. Got it. So, it's not the DisplayPort yet?

Ted Tewksbury

DisplayPort as we've talked about in the past is primarily tied to the Capella ramp. We talked about design wins in the past. We actually had seven confirmed design wins this past quarter on DisplayPort. We can't name those customers, but those were very significant design wins. And as soon as we see Capella notebooks start to ramp, we will enjoy that revenue.

Sukhi Nagesh - Deutsche Bank

Got it. One last question from me was on the pricing front, in typical downturns as I see you probably come out and somebody, maybe not IDTI, but one of your competitors may start cutting prices. How are you managing or how will you manage pricing in this tough environment in the next couple of months?

Ted Tewksbury

We haven't seen to-date any anomalies in ASPs. We haven't seen any dramatic reductions by our competitors. On the other hand, we have to prepare for the fact that that could happen, and one of the ways that we're doing that is by providing a complete portfolio of solutions for our target markets, that's really the essence of our strategy.

If you take a look at the display market, for example, we have DisplayPort devices today and timing controllers, we have the Silicon Optixs post-processors and we're working on a range of other products so that we can provide a complete portfolio of products for behind the glass and notebook computers and LCD TV's. So that gives us a lot of advantage over our competitors who are just offering isolated products.

Sukhi Nagesh - Deutsche Bank

Thank you.

Operator

Thank you. Our next question comes from Glen Yeung of Citi. Please go ahead.

Peter Karazeris - Citi

Hi, this is Peter Karazeris for Glen Yeung. I wanted to ask about gross margin growth going from December to March quarter, we're losing about three points of margin. Could you help us understand how much of that is coming out due to lower factory utilization and how much is due to, say, product mix?

Ted Tewksbury

The bulk of it is coming out from lower utilization, that's the biggest impact.

Peter Karazeris - Citi

All right. And then you're talking also about March quarter as it progresses. You have some feel that your bookings will start picking up. When is it you would start to expect to have your utilization or when do you feel like the balance of orders picking up and inventory having come down enough you'll start taking your factory utilization backup?

Ted Tewksbury

We really have no visibility beyond the current quarter on that. It's all linked to demand.

Peter Karazeris - Citi

Do you see a case, where you would actually bring your utilization down from here?

Ted Tewksbury

We just don't know.

Peter Karazeris - Citi

Okay. And then are there any end markets that are drivers within the pickup that you're seeing in the back half? In other words, I took the point that it's some of the inventory pulldown and pickup from Chinese New Year or around Chinese New Year, but are there any end markets you can give us color on. And can you give us some sense of what that product mix would do to margins as well?

Ted Tewksbury

Well, as I talked about in the prepared remarks, we are seeing declines across most of our businesses. There are some bright spots, however. PCI Express, for example, is an area that continues to grow. We expect to see double-digit growth during the quarter. We continue to win the majority of new sockets that become available, so there is some uplift from PCI Express.

We're also getting some ASP up lift in our PC audio business as a result of new Montevina Refreshes that are using our higher ASP PC audio products that have integrated headphone and speaker amplifiers. However, that probably won't contribute a lot of uplifting in this quarter. The rest of the businesses are, they will all be down fairly significantly, but we do expect to see some more pickup in our PC and consumer areas towards the end of the quarter.

Peter Karazeris - Citi

And then lastly, can you give me any other feel for the wireless infrastructure build? I think you talked about those coming out of China. Just what that demand looks like, and how that could progress through the quarter as well?

Ted Tewksbury

Yes. So, as I think you know, we have several different kinds of products in wireless infrastructures, including clocks and our serial rapid I/O switches. Most of the short-term uplift that we'll see as a result of 3G license grants will be clock design wins.

And then next year and towards the end of this year, we'll see some growth due to the serial rapid I/O pre-processing switches and central packaging switches that we talked about in the past. Those tend to be mostly in the long-term evolution base stations.

Peter Karazeris - Citi

All right, great. Thanks.

Ted Tewksbury

Near-term growth will be clocks.

Peter Karazeris - Citi

Perfect. Thanks. I appreciate it.

Operator

Our next question comes from John Barton of Cowen. Please go ahead.

John Barton - Cowen & Co.

Thank you very much. And Rick I think you touched on this. I don't believe I got all the data, but the 7% headcount reduction, did you say it would account to about a total of $4 million in savings, and if so, what was the time frame for reaping all those benefits, please?

Rick Crowley

You're right. It was 7%, $4 million, we expect to realize the full savings beginning in our fiscal Q1 ending in June.

John Barton - Cowen & Co.

And, then what percentage are you already seeing them in the March quarter?

Rick Crowley

Pretty modest impact from that, about $0.5 million or just something like that I think.

John Barton - Cowen & Co.

Okay. And, then on the fab side, by cutting utilization back to 50% in the March quarter, if you hit kind of the mid-point of your revenue range, what are your expectations for change in inventory over the quarter?

Rick Crowley

I believe the inventory will be relatively flat, but the days will go up somewhere in the range of 105 to 115 days.

John Barton - Cowen & Co.

Okay. And, if you look at the inventory that you have from a customer production life cycle, I mean how much of it is at risk, the potential write down, how much of it is really long production life comp stuff that you will eventually sell regardless, etcetera?

Rick Crowley

I think it's a pretty mixed bag, you’re right in the comp stuff already tends to have pretty good long life in the PC space and consumer space, that's kind of semi-custom depending on certain programs. So, I think it's quite a portfolio mix there.

But ultimately, I think that the risk is probably reasonably well balanced. And we're obviously trying to take steps to curtail and hold the dollars where we are today and hopefully bleed it down over time. But given the short lead times, we do anticipate that as we do book orders they will have short lead times. So, we do need the inventory on hand to be able to respond to that.

John Barton - Cowen & Co.

Last question I could and then maybe for you, Ted. On the competitive dynamics for network search engines really kind of a three horserace so to speak, are you seeing changes from a marginal player deemphasizing that with the weakness in the market or things that could potentially help you as you go forward?

Ted Tewksbury

No, we really haven't seen any material changes in share this quarter. As I mentioned earlier, we did see a double digit decline in our search engine business due to reduced demand in all of the sub segments there, as well as an inventory correction at our largest customer and then we expect to see a similar kind of reduction in the fourth quarter.

John Barton - Cowen & Co.

And then no major changes either on the design end front from a competitive dynamic?

Ted Tewksbury

On the design end front, well we've got our merchant business and then we've got the North American business is our largest customer. We've got a couple of new platform ramps that are going right now at our largest customers and those new ramps are always a little bit dicey and there could be puts and takes in share as that occurs.

As far as our merchant business is concerned, that is ramping very nicely over the past year. We've secured about 10 new design wins, which are ramping up for our search accelerator products that we talked about before. So we expect share of the merchant businesses.

John Barton - Cowen & Co.

Thank you.

Operator

Thank you. And our next question comes from JoAnne Feeney of FTN. Please go ahead.

JoAnne Feeney - FTN Midwest Securities

Yes. Hi, folks. Thanks. I'm wondering, if you could elaborate a little bit on, if there's any new competition that's emerging that you're seeing on the horizon for some of these new products, PCI Express and DisplayPort, you seem to be getting some good design wins and I'm wondering if you're seeing anything new on the competitive front?

Ted Tewksbury

Not really, JoAnne. On the DisplayPort side, it's all the usual suspects: Analogics, array and so forth. But really the key advantage that we have there other than the advantages of the product itself, which are low-power and high performance and integration are really that the advantages that we have, the whole portfolio of solutions for behind the glass in notebook computers and LCD display. So that gives us, I think, a very strong competitive position there.

As far as PCI Express is concerned as I mentioned, we continue to win the majority of sockets that open up for design and I expect to see our share continue to increase there. So, I think we're clearly in the lead.

JoAnne Feeney - FTN Midwest Securities

And would you say that these products will have gross margins that are higher than your corporate average?

Ted Tewksbury

In DisplayPort, the gross margins will start off towards the lower end and then as we start to integrate more and realize the complete solution strategy that I talked about, that combined margin will start to grow. But in the early days, it will be towards the lower end. Our PCI Express switch margins are about in the middle of the range or slightly higher than the middle of the range.

JoAnne Feeney - FTN Midwest Securities

Okay. And then on the server front with respect to the older memory buffer products and the newer ones that you're working on, can you describe a little bit what you see happening with the rollout of the new platforms and how much of a presence you have on the new Xeon's coming out later this year and on the AMB platform?

Ted Tewksbury

Sure. Well, AMB is the gift that keeps on giving. As we mentioned, it was down single digits this quarter. We actually expected it to be down double digits, so we continue to get a lot of sales for the low-power AMB in those high performance server applications.

Now, we've talked about the transition, the Tylersburg transition, the transition from fully buffered DIMM to register DIMM many times in the past and that is happening. There's no question that we will see AMB revenues start to monotonically roll off during the year, but at the same time, DDR3 will be ramping up.

And, as for the timing of those transitions, it really depends on the OEM calls that are going on right now and it depends on Intel's schedule. But, our product, our DDR3 register product is ready to go. We believe that we're in the lead, our product is undergoing OEM calls right now. So, when the market does start to ramp, we believe that we will have a leadership share.

JoAnne Feeney - FTN Midwest Securities

And, how would the gross margin on these compare with the AMB, the older one and then also just relative to your corporate average?

Ted Tewksbury

It's about the same.

JoAnne Feeney - FTN Midwest Securities

Okay, great. Thanks.

Operator

Thank you. And our next question comes from Tim Luke from Barclays Capital. Please go ahead. Mr. Luke, your line is open.

Ted Tewksbury

Tim?

Operator

Is your phone on mute?

Ted Tewksbury

You can go ahead and take the next question.

Operator

All right. We will move along to Sandy Harrison of Signal Hill. Please go ahead.

Sandy Harrison - Signal Hill Securities

Yes. Thanks for taking my calls guys. Ted, we've talked a lot about sort of the near-term stuff and I certainly understand visibility and all those issues associated with it. It's a similar thing we've heard across the board. But, as we sort of look at how we come out of this, there's a couple of different ways.

Could you talk as to how you feel that you think IDT is going to come out of this, is it more market-driven, more product-driven, a combination of both, which one would do it, but just what should we be watching for other than simply waiting for the economy to improve?

Ted Tewksbury

Yeah, good question, Sandy. Perhaps, I should just reiterate our strategy a little bit. I mean we talked about it in the past that every earnings call we talk about the same segments, we talk about wireless infrastructure, handsets, servers, video and display. And today, in each one of these boxes, IDT has several components.

Most of those components are digital. Most of those components are connectivity and timing. Very important devices in that they are integral to the customers’ architectures. They give us visibility into the customers’ applications. They've enabled us to develop very strong relationships with our customers. And so if you'll look at the boards that those products are on, there's a great deal of adjacent mixed signal opportunities.

Some of that is digital, but the majority of it is analog and mixed signal. And so our strategy simply put is to approach our customers’ applications from the system viewpoint and start to populate their boards and integrate more of this analog and mixed signal content. So it's really a whole system solutions kind of approach.

In order to do that, of course we have to have world-class analog design skills as well as product definers and application and systems experts. So over the past nine months, we've been hiring those individuals, and we will continue to do that. I talked about how we are lowering our overall OpEx, but we're doing it in a very deliberate and structured way, such that we can downsize in our non-core areas and make the investments that we need to make in these strategic areas so that we can grow.

If you look at what's going on right now, I'm perhaps a little bit of a contrarian. It's like somebody pressed the reset button on the whole economy and while the rest of the industry is in this holding pattern, companies that are smart about the way they invest have a chance to really change the competitive landscape. And so that's what we're doing.

We are really focused on new product development, making those investments that I talked about, so that we can come out of this downturn as a transformed company, a complete solutions provider with a heavier emphasis on analog and mixed signal.

Obviously, Sandy I can't disclose. I wouldn't be doing IDT a favor or any of the investors on this call a favor, if I were to disclose the details of what those products are. But to give you a glimpse into what the future might look like, you only need to look at our video and display business. Where, as we talked about, we have a complete portfolio of solutions for that application. And if you did see the demo at CES, these solutions really enrich the digital media experience in a very real way. So, that's the direction we're headed in.

Sandy Harrison - Signal Hill Securities

Got you. And just some housekeeping items, Rick. Any 10% customers this quarter?

Rick Crowley

I think Cisco is the only one.

Sandy Harrison - Signal Hill Securities

Okay. And then the sell-in, sell-out, the difference there is, unless I'm wrong, the U.S. or North American distributors are sell-out and your Asian guys are sell-in?

Rick Crowley

North America and Europe is sell-out and Asia is sell-in, that's right.

Sandy Harrison - Signal Hill Securities

Okay. All right, great. Thanks for taking my questions.

Operator

Thank you. Our next question comes from Suji De Silva from Kaufman Brothers. Please go ahead.

Suji De Silva - Kaufman Brothers

Hi guys, how are you doing? So, maybe a few housekeeping questions for Rick. Rick, how much was the gross margin impacted by inventory reserve and do you expect that to recur in the March quarter at this point?

Rick Crowley

It was about half and half between mix and inventory reserves, if you go Q2 to Q3.

Suji De Silva - Kaufman Brothers

The sequential, okay.

Rick Crowley

Yes. And I don't know, it's kind of getting a little granular. I think we answered the question earlier the biggest impact, the predominant impact going from Q3 to the projected mid-point of Q4 is volume reduction, fixed cost there.

Suji De Silva - Kaufman Brothers

Okay. And then on the headcount reduction, was that intended to be sort of the last step or was that something you see further opportunity in, going forward, perhaps?

Rick Crowley

We obviously are trying to take prudent cost reductions to get our break-even down, that's our ultimate goal. But, given the economy, one can't tell. It's our intent to take targeted steps as both Ted and I mentioned to get our costs down, but you can't say whether it's a final, final. We believe that we took prudent action.

Suji De Silva - Kaufman Brothers

Sure, fair enough. On the visibility you guys talked that it's very limited, but can I understand if you have some sort of sense of turns versus backlog in your guidance? Is it more turns than the typical 50% given itself like back-end loaded at this point?

Rick Crowley

I think the best way to describe it, is that the turns required to hit the mid-point of the guidance dollar-wise are about the same amount of turns that we had to do in November and December that we actually achieved in the face of a declining demand environment.

Suji De Silva - Kaufman Brothers

Okay. So, no larger expectation. Two last questions. One is, I think I believe I heard you say Ted, you mentioned non-core areas you're de-emphasizing even though the cuts were broad-based. Can you talk to us about which areas you consider non-core that you perhaps de-emphasize there?

Ted Tewksbury

Yes. Well, I don't think it's a secret to anybody that we've been deemphasizing SRAM for some time. And going forward, we continue to evaluate all of our businesses with respect to the performance and ability to deliver value to shareholders.

Suji De Silva - Kaufman Brothers

SRAM is the only one you point out at this point Ted?

Ted Tewksbury

Yes.

Suji De Silva - Kaufman Brothers

Okay, great. And last question, I know you guys don't want to pay your hand on new areas, but will you have something that your unique skills bring to, say netbooks and MIDS, if that market starts to turn up or will it be some similar products where you are selling now in the PC market?

Ted Tewksbury

Well, in netbooks, we have the same clock content that we have in higher end notebook computers, and obviously netbooks is one of the bright spots in the PC market. It's pretty rapidly growing, and we have well over 70% share right now in clocks for netbooks.

Suji De Silva - Kaufman Brothers

Great. Thanks guys.

Operator

Thank you. (Operator Instructions). Our next question comes from Nicholas Aberle from Caris & Co. Please go ahead.

Nicholas Aberle - Caris & Co.

Thanks for taking my questions. Just on the turns requirement follow-up, there's no specific quantification there for what type of percentage turns rate you'd need to hit the mid-point for the March quarter?

Rick Crowley

Well Nick, I think you can look at it from a percentage basis, given the delta change in revenue, the percentage kind of becomes misleading, so that's why I've expressed it in dollar terms, right. I think it's easier to grasp. I realize you can do the math on the percent but given the fact you're looking percentage turns on a big change in revenue, the percentage I think is less meaningful than the pure dollars.

Nicholas Aberle - Caris & Co.

Got you. So did you provide an absolute dollar number for the turns required?

Rick Crowley

No, we just said it was basically about the same dollar requirement in turns for the last nine weeks for the quarter, is what we actually experienced in the third fiscal quarter ending in December.

Nicholas Aberle - Caris & Co.

Got you. So I could assume that it's probably a pretty small number?

Rick Crowley

No. I wouldn't assume it's necessarily a small number.

Nicholas Aberle - Caris & Co.

Okay. On gross margin, I understand you're bringing utilization down, I mean, is there going to be a lag effect on the gross margin going into the June quarter because of that, the utilization drop?

Rick Crowley

To the extent that we would change inventory levels, might if we pull inventory down, you might see that.

Nicholas Aberle - Caris & Co.

Okay.

Rick Crowley

But if we run steady state, you wouldn't see that effect, I don't think.

Nicholas Aberle - Caris & Co.

Okay, got you.

Rick Crowley

I think for April, I guess.

Nicholas Aberle - Caris & Co.

Got you. On the PC clock and then the consumer clock business, any changes in market share, any competitive dynamics changing in those markets?

Ted Tewksbury

No change in market share or dynamics other than the fact that both are obviously down due to lower end market demand as well as burning off of inventory at the disties. But no, no change in market share.

Nicholas Aberle - Caris & Co.

Got you. We've kind of been waiting for thoroughly the launch and I mean, I think it is going to be a little bit of a headwind for you guys. Is the timing of that, still that's going to happen here in the near-term and the quantification of that is still, what like $20 million a quarter or something like that?

Ted Tewksbury

I don't want to comment on Intel's schedule. When it thoroughly ramps, obviously, it helps our DDR3 business and it hurts our AMB business. The PCI Express business also benefits, so there is puts and takes both ways.

Nicholas Aberle - Caris & Co.

Got you. Last question, you said you're suspending your share buyback, I mean your balance sheet is strong. It looks like you guys are going to generate a good amount of cash flow despite your top line being pretty muted. I mean, is that action more to leave some cash there for potential M&A to get aggressive in this market? Is that the right way to think about it?

Ted Tewksbury

Yeah. Obviously, our share price right now is very attractive from a buyback point of view, but we're in an unprecedented situation here. Like every other company in our industry, we've seen our revenue drop off precipitously. We are in illiquid credit markets and I think it's safe to assume that we can't rely on external sources of credit for the foreseeable future.

We are sitting on over $300 million in cash, but we don't know how long or how dark this tunnel is going to be. At the same time, as you alluded to, we are looking or we are constantly screening opportunities to do some M&A that would be strategically aligned with our business.

So, we need enough cash to get through this abyss and also to provide that option. So, we believe that at this particular time, we just don't have the luxury of buying back shares. When the economy recovers, we will resume.

Nicholas Aberle - Caris & Co.

Perfect. Good luck, guys.

Ted Tewksbury

Thank you.

Operator

Thank you. We have no more questions in queue. Please continue.

Rick Crowley

We appreciate your interest in IDT and look forward to meeting with you on our marketing trips this quarter and on our next call. We will also be attending the Deutsche Bank conference in February and look forward to seeing some of you then. Thank you. Good-bye.

Operator

Thank you. And ladies and gentlemen, this conference will be available for replay after 3:15 PM Pacific Time today through midnight February 5, 2009. You may access the AT&T replay system at any time by dialing 1-800-475-6701 and entering the access code 980637. International participants may dial 320-365-3844.

Again those numbers are 1800-475-6701 and 320-365-3844, access code 980637. And that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.

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Source: Integrated Device Technology F3Q09 (Qtr End 12/28/08) Earnings Call Transcript
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