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Intersil Corporation (NASDAQ:ISIL)

Q2 2006 Earnings Conference Call

July 19, 2006 4.45 pm EST

Executives:

David Zinsner, Vice President and Chief Financial Officer

Rich Beyer, Chief Executive Officer

Louis DiNardo, President and Chief Operating Officer

Analysts:

Michael Masdea, Credit Suisse First Boston

Bill Lewis, JP Morgan

Harsh Kumar, Morgan Keegan

Ross Seymour, Deutsche Bank North America

Craig Hettenbach, Wachovia Securities

Douglas Freedman, American Technology Research

Tore Svanberg, Piper Jaffray

Craig Ellis, Citigroup

Steve Smigie, Raymond James and Associates

Ahmie(?), Thomas Weisel Partners

Michelle Chen, Morgan Stanley

Romit Shah, Lehman Brothers

Han Lee, Global Crown Capital

Robert Burleson, ThinkEquity Partners

Presentation

Operator

Good day, ladies and gentlemen, thank you for your patience. Welcome to the Q2 2006 Intersil Corporation earnings conference call. My name is Cindy and I will be your coordinator for today. Operator instructions. I would now like to turn the call over to Mr. Dave Zinsner, Vice President and Chief Financial Officer.

David Zinsner, Vice President and Chief Financial Officer

Thank you, Cindy. Good afternoon and thank you for joining us today for Intersil’s Q2 2006 earnings conference call. We completed Q2 on June 30 2006. A press release was issued today at approximately 1.30pm Pacific Time. A copy of the press release is available on the investor relations section of our website at www.intersil.com. In addition, this call is being webcast live over the Internet and may also be accessed via the investor relations section of our website. A replay of the conference call and webcast will be available for two weeks through August 2nd. Joining me on today’s call is Rich Beyer, Intersil’s Chief Executive Officer, and Louis DiNardo, President and Chief Operating Officer. In a few moments, Rich, Louis and I will deliver remarks on Q2 2006 and provide a summary on our business outlook. After our prepared comments, we will open the line for questions.

Please note that some comments made during this conference call may contain forward-looking statements. I would like to remind you that while these statements reflect our best current judgment, they are subject to risks and uncertainties that could cause our actual results to vary. These risk factors are discussed in detail in our filings with the Securities and Exchange Commission. In addition, during this call we may refer to pro-forma or other financial measures that are not prepared according to GAAP. We use these non-GAAP measures because we believe they provide useful information about the performance of our business and should be considered by investors in conjunction with GAAP measures that we also provide.

You can find a reconciliation of non-GAAP to comparable GAAP measures on the investor relations section of our website. For those of you in interested in learning more about Intersil at an upcoming investor event, we will be presenting at the RBC Capital Markets North American Technology Conference on August 9th in San Francisco, the Citigroup Global Technology Conference on September 7th in New York and the CIBC Annual Semiconductor Conference on September 25th in London, England. I will now turn the call over to Rich.

Rich Beyer, Chief Executive Officer

AdvancedPost Status: Published Draft PrivateSend trackbacks to: Separate multiple URIs with spacesPost slug:Custom FieldsAdd a new custom field to this post:KeyValue - Select - votio enclosure or WordPress bookmarkletYou Thanks, Dave. Good afternoon and thanks again for joining us on this conference call. We are very pleased with out Q2 financial results. The company achieved net revenue of $187.6 million and GAAP and non-GAAP EPS of $0.30. This represents the seventh consecutive quarter of sequential growth in revenue, gross margins and earnings on a non-GAAP basis. In addition, our book to bill was once again above one. We have a very successful business model that diversifies our revenue stream across numerous vertical and general?purpose markets. As a result, we experienced sequential revenue growth from three of our four end markets in Q2. Revenues into the high-end consumer, industrial and communications markets all experienced strong sequential growth. We experienced a sequential decline in the computing market, as expected, due to seasonality and a weaker than expected environment in that space. Louis will provide more color about the end markets after Dave summarizes the financials.

Again in this quarter we grew revenues significantly over last year, 35% and we grew our EPS even faster – 100% over Q2 2005. We continued to show strong cash generation, delivering over $49 million in cash flow from operations during the quarter. We exited the quarter with approximately $733 million in cash and marketable securities and no debt. As a result of our strong positive cash flow and balance sheet, our board of directors again authorized and declared a quarterly dividend of $0.05 per share of common stock. At this time, I’d like to turn the call back to Dave Zinsner, our Vice President and CFO, who will provide a financial summary. After that, Louis will discuss the results from each of our end markets, and then I’ll provide some comments on our Q3 outlook. Dave?

David Zinsner, Vice President and Chief Financial Officer

Thanks, Rich. Let me begin with the income statement. As Rich stated, we reported $187.6 million in net revenue for Q2 2006, an increase of 35% from the same quarter last year and an increase of 5% sequentially. We were pleased to close the quarter at a book to bill that once again was above one. Based on the profile of our backlog, we require an order turns rate during Q3 of slightly less than 40%. On a GAAP basis, net income for the quarter was $43 million or $0.30 per diluted share, up 149% from $17.3 million or $0.12 per share for the same quarter last year and up 33% from net income of $32.4 million or $0.22 per share for Q1 2006. GAAP results included several one-time events that lowered our GAAP tax rate from approximately 25% to a benefit of 5% in Q2. On a non-GAAP basis, excluding the amortization of intangibles, stock-based compensation and other unusual items, net income for the quarter was $43.7 million or $0.30 per diluted share, up 100% from $21.4 million or $0.15 per share from the same quarter last year, and up 6% from net income of $41.3 million or $0.28 per share for Q1 2006.

We saw an increase in our gross margins for Q2 from 57.3% to 57.8%. This 50bps improvement was driven by continued reduction in manufacturing costs and better product mix. Since Q4 2004 we have improved gross margins by more than 250bps. We expect to continue to improve gross margins in the second half of this year and in 2007. As a percent of revenue, Q2 R&D expenses were 14.6%, flat with Q1. In absolute dollars, R&D expenses were up $1.3 million from the prior quarter. You may remember that R&D was down in Q1 due to the timing of new product expenses. In Q2, we accelerated our new product development efforts and continued to add new engineers. R&D will continue to grow in absolute dollars in upcoming quarters, but will likely remain below our target of 17-18% of sales. As a percent of revenue, Q2 SG&A expenses were 15.6%, approximately flat with Q1. In absolute dollars, the increase of $1.7 million from the prior quarter was due to increased commission on higher revenue and several one-time expenses. SG&A expenses will be flat to slightly down for the next several quarters as we move to our target of 14-15% of sales.

In total, we expect overall operating expenses to be flat to slightly up in Q3, on increasing revenue. Our non-GAAP operating income in Q2 was 27.7% of revenue, up 30bps from Q1. We continue to move steadily toward the higher end of our target operating model of 27-30%. Our non-GAAP tax rate was 26% for Q2. Our estimate for Q3 is approximately 26%. This rate could be lower if Congress approves the R&D tax credit that expired on December 31 2005. In summary, we have made tremendous progress toward our long-term model over the last seven quarters. In that time frame, gross margins have improved by over 250bps and operating profits have grown by over 170%. We expect to continue to improve both gross margins and operating margins in the second half of this year and in 2007.

Now, moving to the balance sheet.

For Q2, we generated over $49 million in cash flow from operations and we exited the quarter with approximately $733 million in cash and marketable investments and no debt. On an absolute dollar basis, inventory increased by $3.7 million from Q1. Inventory turns improved from 3.5 to 3.6 turns, while DSO was 52 days, basically flat with 51 days in Q1. Distributor inventory increased but in our judgment, these levels are appropriate to support our projected growth in Q3. During Q2, we repurchased approximately $60 million or 2.1 million shares of our stock. Our weighted average share count increased by approximately 1 million shares in Q2. For the upcoming quarter, we expect our fully diluted total shares outstanding to remain basically flat with Q2. Now I will turn the call over to Louis DiNardo, Intersil’s President and Chief Operating Officer.

Louis DiNardo, President and Chief Operating Officer

Thanks, Dave. I’ll start with a few comments about high-end consumer. Revenue into the high-end consumer market represented approximately 28% of Q2 revenue. We experienced very strong sequential growth in this end market in Q2 due to our leadership position in handheld devices, display and optical storage products. We increased our content in a wide range of single cell lithium ion devices as well as in LCD and advanced TVs. We continue to focus on growing our existing businesses through execution and produce development, to expand our silicon footprint within consumer markets. For example, we’ve secured new design wins in MP3 players, cell phones and smart phones, with our ultra-low-noise audio data switches. These switches are the first commercially available advices in the industry to provide both low distortion audio and USB switching capabilities. Combining audio and data switching allows our customers to eliminate external connections on devices such as MP3 players and cellular phones, thereby providing overall cost savings. On an absolute dollar basis, revenue in the high-end consumer market increase 15% sequentially and increased 40% YoverY.

Turning to computing, revenues into the computing marked represented approximately 23% of Q2 revenue. On an absolute dollar basis, revenues into the computing market decreased 13% sequentially due to seasonality and some weakness in the PC space. We continue to be the leader in traditional power management solutions for desktop and server markets and now offer a complete product solution for the notebook market that includes core regulators, battery chargers, systems regulators, DDR, chipset and GPU power. If next generation platforms are deployed in desktop, servers and notebooks, we’re very well positioned for growth. Revenue into the computing market increased 40% YoverY on an absolute dollar basis. We’re confident in our position in the computing market, yet we remain cautious about the growth in this segment as our customers transition to new platform launches in both desktop and notebooks.

Moving to the industrial market, revenues into the industrial market represented approximately 25% of Q2 revenue. Nearly all of the industrial product families experienced solid growth. On an absolute dollar basis, revenues into the industrial market increased 6% sequentially and 26% year over year. The combination of strong seasonality and the focused investments that we’d made in our general purpose product portfolio have allowed us to see continued growth in the industrial end market. Design wins and applications such as point of load modules, industrial automation, CAT scan machines, security systems and voting machines have all contributed to our success. The majority of our products sold into the industrial market are general purpose products, which provide solid and steady revenue growth with very attractive gross margins.

Finally the communications market. Revenue into the communications market represented 24% of Q2 revenue. On an absolute dollar basis, revenues in the communications market increased 15% sequentially and 34% YoverY. The majority of our products into this market experienced very nice growth. We continue to see strong design win momentum in the communications market across a broad spectrum of product families. Applications include wireless point of sale systems, network routers, base stations and satellite equipment. Similar to the industrial market, the majority of our products that serve the communications market are general purpose products. We are extremely pleased to see the general purpose side of our business continue to grow as life cycles are long and gross margins tend to be above the corporate average.

Now I’ll turn the call back over to Rich.

Rich Beyer, Chief Executive Officer

Thanks, Louis. Let’s look at our outlook for Q3. We currently anticipate revenue to grow between 3-5% from our Q2 revenue of $187.6 million. We expect solid growth in our industrial and communication end markets. However, there is currently softness in the computing market and several consumer-related product areas, which is limiting our visibility into Q3. As a result, we remain cautious. We expect GAAP earnings per diluted share of approximately $0.25 and we expect non-GAAP EPS of approximately $0.32, up from $0.30 per share in Q2.

Before we open it up for questions, I’d like to summarize with these key points. This quarter, we grew revenues 35% over Q2 2005 and 5% sequentially. We expect this growth to continue as we expand our share of the available market through new general purpose and application-specific product families and by growing our silicon content within these families. In addition, we are very pleased that we are able to grow non-GAAP gross margins for the seventh consecutive quarter. In that timeframe, gross margins have improved over 250bps. We expect to continue this gross margin expansion through better wafer prices, new products developed on advanced geometries, improved back end prices, operational efficiencies, lower internal fab depreciation, and improved product mix.

With our continued intense focus on driving revenue growth and gross margin expansion, we are confident that we will be able to continue to demonstrate sustained, long-term progress as we position ourselves among the top tier high performance analog companies. With that, Lou, Dave and I will be happy to answer any of your questions. Operator?

Questions and Answers

Operator

Thank you, sir. Operator instructions. Your first question will come from the line of Michael Masdea of Credit Suisse. Please proceed.

Q - Michael Masdea, Credit Suisse First Boston

Thanks a lot. Clearly we have a little bit of a choppy environment macro there, everybody’s concerned, you talked about softness in PC and consumer and yet on the other hand you said the turns requirement sounds very similar to last quarter and you have decent forward guidance. Do we translate all that into saying that you’re assuming there’s going to be a weaker environment already in the PC and consumer, and that if it doesn’t turn out to be that way we could expect a little bit better? Or is this kind of middle of the road guidance?

A - Rich Beyer

Michael, this is Rich. The guidance is predicated on a little bit of uncertainty about the transition, as Louis pointed out, in both parts of the computing market and also there have been some indications about such segments as the LCD market and so forth, inventories. So we believe the guidance that we’ve given in fact represents a temporary lull in a couple of these markets. Obviously things could strengthen and that would represent upside, we believe.

Q - Michael Masdea, Credit Suisse First Boston

If you take a look at your growth this quarter and even in the next quarter, what do we really see going on in the underlying markets and customer base right now, because it seems like you have such product momentum in the new areas that it’s probably skewing your numbers relative to the group a little bit.

A - Louis DiNardo

I’m not sure I completely got the question. We’ve increased our share of the available market so dramatically over the past few years that our account base continues to expand QoverQ. We measure that by region every quarter as we meet for our quarterly business reviews. Our geographies are far more well penetrated with respect to design wins. Our design wins here in the first half of 2006 are putting us on a pace, which really outstrips even the great accomplishments we made in 2005. With respect to our competitors, they’ve got their own challenges. We’re introducing at a significant pace, new products into a wide range of new markets for consumer computing, industrial communications, military, just a wide range of products, wide range of end markets.

Q - Michael Masdea, Credit Suisse First Boston

I guess that makes sense, but what I’m trying to get at, if you look at actual underlying demand, setting aside all your market share gains and all that good stuff that’s going on, actual underlying demand and customer mentality right now, how would you characterize that?

A - Louis DiNardo

I think it varies from market to market. Probably the greatest hesitation – we all read the same newspaper – the greatest hesitation certainly seems to be in the computing space. Does that imply that there will be a weakness in demand? I don’t think anybody’s really clear on that. There are transitions in the notebook space from last generation to next generation platforms and in the desktop space from last generation to next generation. From our vantage point, as Rich said, we’ve baked that into and comprehended that in our guidance. The rest of the markets overall seem to be relatively healthy. Of course, as Rich said, there are comments about the display market and there’s a little bit of trepidation in the handset business, but overall demand is pretty solid across the wide range of industrial communications markets.

Q - Michael Masdea, Credit Suisse First Boston

Great, thanks a lot.

Operator

Your next question will come from the line of Bill Lewis of JP Morgan. Please proceed.

Q - Bill Lewis, JP Morgan

Great, thank you. I guess along the lines of what Michael was asking, when I look at the guidance say up 3-5% sequentially, that would seem to be in line with what you might expect in a normal seasonal pattern. Certainly you guys haven’t been around that long in the business and it’s changing, but kind of what I might call a normal, seasonal increase. So how do you kind of compare that normal seasonality with some of the uncertainty? It would seem like, you know, if anything you might be a little more optimistic this year than in other years. If you could just kind of talk about those seasonal trends versus your caution?

A - Rich Beyer

Sure, Bill. This is Rich. A year ago, we grew from Q2 to Q3, double digits. Our business is continuing to be more and more robust. The underlying design wins that Louis alluded to are very, very strong. So the guidance of 3-5% is taking into account what could be modest perturbations in the computing market in Q3, as Intel transitions its desktop and notebook platforms. It also takes into account that the toll on things like displays might be similarly affected, so seasonally as you said, we don’t have many years of experience as a pure high performance analog company. But we could and should have stronger growth than what we said in the guidance. What we said is we’re cautious about it for the reasons we just explained.

Q - Bill Lewis, JP Morgan

Okay. And then, could you elaborate on the comments you made about weakness in certain consumer product areas? Is there any more that you might be able to tell us? Certainly it sounds like displays but you know, anything else you could share about the state of the market?

A - Rich Beyer

Yes. The two areas are areas that are captured in consumer but they tend to overlap consumer and computing. Our optical storage business as well as our LCD monitor and notebook panels are the two areas. Handheld business looks good, looks solid, so those are the three major segments, two of the three have linkage to PCs and so we’re cautious on those as well.

Q - Bill Lewis, JP Morgan

Last if I could, for Dave, it appeared the FAS123 expenses were significantly higher this quarter. Could you talk about that, please?

A - David Zinsner

In prior years, we gave four quarterly grants and priced the options at the first of the month of every one of those quarters. This year we moved to one annual grant and so what that does is it causes a spike in expenses in the first quarter in which you do that, and then the expense trails off over the next three quarters. When we did the annual grant, it was on 1 April. That’s why you saw a spike in the expense in Q2.

Operator

Your next question will come from the line of Harsh Kumar of Morgan Keegan.

Q - Harsh Kumar, Morgan Keegan

Kind of following up slightly on the first two questions, are you actually seeing some issues in some of the areas you’re talking about? Are you kind of just anticipating but given the transition, maybe you could clarify that? Second question, real quickly, some simple question, can you just reiterate your long term gross margin goal as to when you think you might be able to get to 60%?

A - Louis DiNardo

I’ll just answer the first part of the question, and Rich can talk to the gross margin growth. It’s a bit of a mixed bag. As we take it into Q2, optical storage set a very strong and robust pace. I think there is hesitation in the buying patterns that are coming out of optical storage and to some extent, that’s not unusual. Q2 tends to be a strong quarter for the subsystems that get sold into the PC space. Then there’s a little wait and see during the cooler Q3, whether there’s incremental demand. On the display side, again it’s a bit of a mixed bag. We have strength in certain parts of our display business and we do see signs that there’s a bit of hesitation in other parts. That varies from power to analog products that are used in displays. I think, as Rich said and I think I’ve reiterated, we’ve comprehended that in our thinking about guidance for Q3, with respect to the second question, seasonally we would expect a stronger Q3. A little bit of caution I think is prudent given the somewhat mixed bag that we’re seeing within the consumer segments that we’ve touched on here, the display and optical storage businesses as well as the PC space. We do expect all of those businesses – computing, consumer, industrial, as well as the communication business, to demonstrate growth in Q3 and that growth is really predicated now on what the momentum in some of the consumer and PC businesses can really achieve.

Q - Harsh Kumar, Morgan Keegan

Louis, also about gross margins, what are your long-term goals?

A - Rich Beyer

58-62%. We’ve made seven quarters in a row of steady progress towards it. We ended up this quarter at 57.8%. We’re just about to knock on the door of the low end of that model. We indicated, I think, in both of the two previous conference calls we had that we anticipated that we would achieve the 58% low end of the target some time in 2006 and we remain confident that that’s the case.

Operator

Your next question comes from the line of Ross Seymour of Deutsche Bank. Please proceed.

Q - Ross Seymour, Deutsche Bank North America

Two quick questions. First on the balance sheet, Dave, on the inventory side of things. In the channel, you said it was up a little bit. Can you describe either what products the inventory increased in and then would you care to quantify what ‘up a little’ really means?

A - David Zinsner

We’re not going to go into that level of detail, Ross.

Q - Ross Seymour, Deutsche Bank North America

Okay, in general, just the idea of your guiding relatively cautiously and inventory in the channel rising. Is there any disconnect there we should be concerned about?

A - David Zinsner

No, the fact that the inventory in the channel rose a bit, that was factored into our guidance of 3-5%.

Q - Ross Seymour, Deutsche Bank North America

Okay. Switching gears over onto the PC side of things and revenues, Louis, you’ve talked in the past about some of those transitions that are happening both in notebook and in desktop. Can you give us just a little bit of an update on how those are going right now? Are people just waiting to see what sells through? Or is it a matter of waiting until some of these price cuts come? Any sort of update would be helpful.

A - Louis DiNardo

I think both the comments that are part of your question are true. People are waiting to see price cuts and people are certainly in the midst of the transition. From my perspective, now I think it’s clear that the broad water launch that’s in play, that we will see that transition from last generation that we would in the power space call VR10 or 10.1, to VR11 solutions. We’re extremely well positioned on VR11, maybe even better positioned, frankly, than we were on VR10.1, where we had significant market share. In the notebook space, I’ve seen Core Duo labels on PCs and notebooks being carried around at conferences that we all see each other at. We’re better positioned in the Core Duo space than we were in the last generation of notebooks. So the transition is underway. Has it really hit in earnest? I don’t think so. Is it imminent? It certainly feels like it and I think the outcome will lead to successes with VR11 for Intersil as well as successes in the Core Duo space in the notebook arena.

Operator

As a reminder, ladies and gentlemen, please limit your question to one and to one follow up. Your next question will come from the line of Craig Hettenbach of Wachovia. Please proceed.

Q - Craig Hettenbach, Wachovia Securities

can drag the following link to your links bar or add it to your bookmarks and when you "Press it" it will open up a popup window with information and a link to the site Thank you. Could you discuss the industrial end market where you’re expecting continued growth into Q3? Can you talk about whether that’s the end markets? I know you’ve had increased design activity re a general?purpose product portfolio, if you could just decipher between your own product momentum versus what you’re seeing in that overall industrial end market please?

A - Louis DiNardo

It’s interesting, I think this is maybe the second or third time here that the question has been posed, maybe in a different fashion and it’s a legitimate question – how much of what we’re seeing is end market demand growing versus how much of it is us expanding our portfolio into new served available markets? We do talk in our investor presentation about our five points of leverage and frankly those are two of the best points of leverage we have. That we’re playing into markets that are growth markets, as well as getting served available opportunities within those markets. It’s really hard to separate. If you take an example in the point of load space, where module suppliers supply the down converters, if you could call it that, from 48 volts to 12, or 12 to five. There seems to be robust demand in that space. It serves the communications infrastructure space, both for wired and wireless applications, fiber and copper and it covers the whole gamut of infrastructure for point of load solutions after the isolation conversion of high power to lower power. There’s good growth in the end markets and we have a wide range of products and a far greater focus in that marketplace. Looking at it from the stand point of numerically where the split is, it’s really hard to say. We’re seeing both in the industrial and in the communications space. We’re seeing good end market demand and we have more products to sell and very, very capable people in applications and field sales that are penetrating new and different accounts for us every day.

Q - Craig Hettenbach, Wachovia Securities

Just a follow up, companies are more aggressive in buying back stock in the last couple of quarters as an operating cash flow has increased. Can you just give us an update on where you stand on what the optimum cash level is to hold in your view on buybacks versus dividend increases on a go forward basis?

A - Louis DiNardo

Well first of all on the share repurchase program, we announced a new program in the middle of the quarter, a new $150 million program. We have repurchased $8 million into that program, so $52 million of our repurchase this quarter related to the prior program. We expect to be continued active buyers in the stock with $142 million of available share repurchase that we have available to us. Cash positions right now, at $733 million, most of that we don’t necessarily need to obviously run our business, so it’s there for strategic acquisitions or the like, that we might want to do. So we’re comfortable with our cash position, we’re certainly not looking for it to grow significantly over time though.

Operator

Your next question will come from the line of Doug Freedman of AmTech Research. Please proceed.

Q - Douglas Freedman, American Technology Research

Thanks, guys. Nice report. If you could comment on the bookings trends that you’ve seen in the first few weeks of the September quarter, or would you characterize them as seasonal?

A - Rich Beyer

Yes, Doug, we saw a little bit of softness in the month of June and the first several weeks of this quarter have been more or less what we anticipate happening in the first several weeks of any quarter. They’re at a level slightly below the May level, which is part of why we’re cautious about our guidance. But it has been baked in, as someone asked earlier – the turns that we require are certainly in line with the turns that we’ve been achieving in probably the last four quarters or so at the slightly below 40% range.

Q - Douglas Freedman, American Technology Research

And then if I could, just one other question on what you’re seeing as far as pricing in the marketplace when you go out to win new designs. Is the analog market becoming more price sensitive or more price competitive, as you’re no longer sort of flying under the radar?

A - Rich Beyer

I don’t think across the board there’s a statement we could make that suggests that it’s getting more competitive. Obviously there are individual product families or segments of the market that might experience a little bit more price pressure at different times, but by and large they tend to be short term in nature. They’re not a sort of wholesale change. I’ll give you an example. When any one of the vertical markets we’re in is in a transition, and clearly optical storage is in a transition from the end of the live of DVD Red optical drives to DVD Blue optical drives, there tends to be a little bit less innovation and a little bit more price pressure. So we expect to see unit growth in optical storage, but there’ll be continued price pressure. That sort of thing happens in a number of different areas, but then in comes the next cycle and the price pressure alleviates. That’s what I say. We see isolated examples of price pressure, but we’re not seeing anything dramatic. I think there’s an opportunity to differentiate products, very few of the products we have lend themselves to immediate replacement by somebody who drops the price and so I don’t think there’s anything systemic about the price situation for us.

Q - Douglas Freedman, American Technology Research

Since you mentioned it, Rich, could you compare your share expectation in DVD Blue versus what you controlled in the DVD Red market?

A - Rich Beyer

We think we’ll continue to be a major supplier in the DVD Blue market, just as we have been in the TV market and in the DVD Red market. We obviously have such a base of experience, talent, application and system skills that allowed us to begin investing in Blue about four years ago with some of the early developers of products and we think all of that is positioning us very, very well again in this market. So we think we’ll continue to be this strong player in Blue as we have been in DVD Red.

Operator

Your next question will come from the line of Tore Svanberg of Piper Jaffray. Please proceed.

Q - Tore Svanberg, Piper Jaffray

Good afternoon, nice quarter. First of all, Louis, I think you mentioned some initial success in the lithium ion market. Could you elaborate a little bit more on that please?

A - Louis DiNardo

Tore, we’ve had good success as we’ve spoken to in several conference calls on the battery charging side. We continue to have strong momentum in the cellular handsets business and you know, we’ve spoken to five of the top six manufacturers in the world and that continues to be chased. Frankly, our handheld business is seeing strength as we’ve now introduced safety circuits for over voltage, over current protection, display drivers for small panels, in handsets, MP3 players and other single cell lithium ion devices as well as DC/DC converters and I tend to try not to be power-centric, given that was the business that I ran for a couple of years here, but we’re also having great success with our analogue switches in the handheld space for the data and audio switch, which is really a unique position. It’s an innovative product which allows data and audio to be switched over the same connector and brings a lot of added value to these small devices, where the less connectors, the lower the bottom cost and the greater ability to miniaturize. By and large the single cell lithium space for us is a catchall not just for the charging element but for the power management playing overall as well as the analog opportunities in anything that requires very good performance at low power.

Q - Tore Svanberg, Piper Jaffray

Thanks. I realize there’s a transition going on in the notebook market, but as we do see the transition to Core Duo, what does that really do to your business or maybe what does that do to your content per system?

A - Louis DiNardo

It’s a significant increase in our content per system. As we look back to the last generation platform, particularly the launch several years ago of the last generation Centrino, we didn’t have a whole lot beyond the core regulator. Today we have the core, we have the system reg, we have the battery charger, we have DDRs, GPU as well as peripheral power management devices. We’re having success in a variety of places with a variety of those components and in some places we sweep the board, and in some places we get pieces of that opportunity. So our opportunity in the notebook business I think is far brighter during this launch of innovation out of the notebook space than it was in the last launch. Our content is up significantly, our branding and position in the marketplace is far wider recognized.

Q - Tore Svanberg, Piper Jaffray

Just one final question, if we strip out the PC part of optical storage, would you still be conservative on your consumer guidance for the September quarter?

A - Louis DiNardo

That’s a tricky question. That’s really hard to say. I do want to add one thing to Rich’s comment about our position in the Blue versus the Red space, which is that we have now sampled our first photo diode IC, which gives us incremental content in the optical storage space as we go forward. Traditionally we’ve been the leading supplier of laser diode drivers. Today in the HD or Blue arena, we have the opportunity to take significant content or significant share in the reader, as well as in the writing mechanism. The readers tend to be a significant part of the total available market on the leading edge of new optical storage introductions, but whether or not we’d have that same cautiousness about our guidance without optical is a little bit more granularity than we’d like to give our competitors.

Operator

Your next question comes from the line of Craig Ellis of Citigroup. Please proceed.

Q – Craig Ellis, Citigroup

Thank you. A lot of the questions have been asked and answered here, but I wanted to step back and just ask a question about the portfolio. I think in the first question, Louis, you mentioned that the company was on track to outstrip 2005’s successes. I think that was on new customer and new market penetration and new products. How should we think about the growth in the portfolio as we look out over the next year? Are we going to see communications and industrial start to grow at a faster rate relative to your application-specific markets, or should we continue to expect that application specific will outpace industrial and communications longer term?

A - Rich Beyer

Let me comment and Louis can add some color. Again this quarter, we grew the general purpose portfolio of products at a nice clip and so the breakdown turned out to be 40% general purpose and 60%. What we’re seeing, Craig, is exactly what we wanted. We’re continuing to introduce more new products, expanding the families, we’re getting significantly more design wins. Louis alluded to that – the design win activity in the first half of the year across all of our markets has been up quite significantly in numerical terms and much of that can be explained by the number of smaller general purpose opportunities that we’ve closed. We envision that the general purpose part of our business in absolute dollar terms is going to continue to grow quite steadily. The dilemma for us is to say is it going to ever outstrip the rate of growth of the vertical markets. That’s a tough call. We’re obviously investing in more and more vertical markets as well so we just want to be sure that the general purpose continues to grow, because as you know there’s very little fall off in sales and design of general purpose products so it’s a tremendous flywheel effect on the business and its very, very high gross margin. All I can say to you is it’s growing, it’s grown every quarter now for several years and as we look at the projections going out we expect it to continue to grow.

Q – Craig Ellis, Citigroup

That’s helpful, Rich. Just cycling back to gross margins, I know we can’t expect gross margins to increase steadily forever, but it sounds like you guys have a number of vectors at work on the gross margin line. You had a very steady pace in terms of increasing your gross margins. We’re in a somewhat uncertain period, but would it be fair to expect that you could increase gross margins at a similar pace going forward as you have over the last seven quarters?

A - Rich Beyer

If we do, obviously we’ll be up above the 60% range. Our model is 58-62% so clearly 60% is the sweet spot of getting there. Obviously we can’t do it in a systematic fashion that has us improving the same number of basis points on a constant basis, because there are so many factors that go into it. But the fact of the matter is, as we look at the mix of products and the operational activities we have talked about in the past as to why we’re improving on the overall cost structure, we’re confident that we still have room to continue to expand our gross margins and again we’ll reiterate, we anticipate moving above the 58% threshold of the model some time in the second half of this year. And Dave said, we think we can move steadily forward through the second half of this year and again into 2007.

Operator

Your next question will come from the line of Steve Smigie of Raymond James. Please proceed.

Q - Steve Smigie, Raymond James and Associates

Great, thank you. I was hoping you could comment a little bit on correct capacity utilization and then how would you react in an environment where it appears GDP is slowing. Do you take capacity offline? Or how would that happen? I realize it’s a sort of a theoretical question, I’m just curious how one would react to that.

A - Louis DiNardo

Internal utilization for our fabs is 85%. That’s consistent with what it’s been for the last two quarters.

A - Rich Beyer

This is Rich. What would we do in the event that demand for our internal fabs slowed down? First of all, let me say that’s not happening, which is a good thing. But if it does, the major lever or cost that we have is actually the labor cost. This is in our Palm Bay facility. Much of the equipment is depreciated and what we do in our facility is we have a group of very, very talented long-term employees, but we augment that group with some people that work for us on a temporary basis. So if in fact things slow down significantly we would slow down in the employment of some of those workers who are on a part time or temporary basis. We think we can modulate the overall cost structure if in fact we found that the demand was going down. But I’d like to reiterate, that’s not the case. We develop new processes in our own fabs, we’ve enhanced existing processes and we’ve actually introduced new product families and new and enhanced products to existing product families that are really effectively utilizing that fab and we think that’s going to be the case for us for many years to come.

A - Louis DiNardo

The other thing, Steve, is that our revenue is about 45% internally manufactured and 55% externally manufactured. So more than half of our revenue actually comes from external foundries, where the ability to modulate what we produce is a lot better.

Q - Steve Smigie, Raymond James and Associates

Just as my follow up, if you could comment on how you perceive industry-wide capacity in general?

A - Rich Beyer

Industry-wide capacity as it relates to our needs is quite adequate.

Q - Steve Smigie, Raymond James and Associates

I guess it was more, do you see your competitors adding too much capacity, not enough, that sort of thing?

A - Louis DiNardo

That’s hard to say. Their models are significantly different than ours. As Dave said, we’re buying outside a significant percentage of our wafers, where what we view as our major competitors tend to be internal fab usage. Your question probably really begs an answer from them, relative to if there was a significant change in the GDP which impacted end market demand, what do they do about depreciating significant capacity that’s been brought online. Are there shortages caused by capacity? I don’t think so. Are there upsides? I don’t know. We have a very nice, flexible, fab light model. Two of the other things we talk about in our five points of leverage are our fab light model, where we get to pick the best process and use other people’s money when it comes to investing in fabs – you know, those are the kinds of things that separate our strategy.

Operator

Your next question will come from the line of Joe Osha of Merrill Lynch. Please proceed.

Q - Joseph Osha, Merrill Lynch

My first question on margins has already been answered. I did have a question on the cash, though. You guys have been buying back lots of stock, which is great, your share count from the beginning of 2005 is down by about a billion shares. Which is not a lot, so I guess my question is why, given this impressive cash balance, are we not seeing, you know, a much more dramatic dividend? It seems to me like that would be a great way to show some leadership.

A - Rich Beyer

Joe, we revisit the subject of dividends typically with our board of directors on an annual basis. The last several years we’ve increased the dividend when we’ve had that review, which typically takes place in September/October/November. We clearly will have that discussion yet again. We are generating significant cash, there’s no question about it. We increased the rate of buyback over the last six months or so. If you recall, we authorized 150 million back in September and we utilized the majority of that by May and so now we’ve authorized another 150 million and so we’re spending at a higher rate to buy back the stock as we speak and we will unquestionably revisit dividends in several months with our directors.

Q - Joseph Osha, Merrill Lynch

Thanks. Then a products question, very quickly, Louis, I presume that the notebook wins you’re referring to all fall under the rubric of the IMBP 4.5(?) cycle. Is that pretty much what we’re talking about? On the notebook side?

A - Louis DiNardo

For new wins, that’s the case. We do expect to continue to see some of the last generation stuff as well.

Q - Joseph Osha, Merrill Lynch

But your share went up in IMBP 4.5, right?

A - Louis DiNardo

Yes.

Operator

Your next question will come from the line of Eric Gomberg of Thomas Weisel. Please proceed.

Q – Ahmie(?), Thomas Weisel Partners

Hey guys, Ahmie(?) in for Eric. How you doing. Just quickly, following some of the hiccups that you can see in the computing market in Q3, do you see normal seasonality, you know, from your conversations with your customers, do you see normal seasonality returning for Q4?

A - Louis DiNardo

It’s difficult to say. That is our expectation. A lot of what we’re seeing we believe in the PC space for example is the transition from the last generation to next generation for both desktops and notebooks. Our belief is that we’ll flush out here in Q3 and that by the time Q4 rolls around, the platforms will have been launched, there’ll be some stability in the thinking about what the run rates and demands really are. Internally, we don’t see any reason that the computing business shouldn’t be a healthy second half and those transitions really should have unfolded and you know, the cards will fall where they will relative to who builds what you know, for desktops and notebooks, last generation versus next.

Q – Ahmie(?), Thomas Weisel Partners

Just to pick up on that last comment, is part of the visibility problem related to how your design wins will translate into actual shipments? Or is this just purely an industry transition issue?

A - Louis DiNardo

I think it’s much more an industry transition issue. We have a very, very good grasp of the account base, where we’ve won and what we’ve won and what volume of those particular design wins will run at. It really is an industry transition from one platform to the next. My experience in the computing space is not as deep as many at the company here, but I don’t think it’s typical that there are two significant transitions going on at exactly the same point in time, at least at the magnitude that we have here, with on the power plane we call it VR10 through VR11 and in the notebook space, from last generation to the Core Duo, which is a significant change in the notebook power plane. I think that’s really what the overhang is.

Q – Ahmie(?), Thomas Weisel Partners

In the transition from VR10 to VR11, you noted share gains. Am I understanding that correctly?

A - Louis DiNardo

I believe we will. I think we have better solutions and we’re more well positioned with a wider range of customers for the initial launch of VR11 than we were with the initial launch of VR10 or 10.1, depending on what snapshot in time you’d like to take. Our presence at major OEMs and well as ODMs and channel suppliers in Asia is widespread and deep at this juncture.

Q – Ahmie(?), Thomas Weisel Partners

So it sounds like a greater sale penetration? Or do you feel like your product refresh for the VR11 excelled versus competitors?

A - Louis DiNardo

I think it’s both. I think we have better products that are on time and we have an excellent sales force. I wouldn’t diminish the effort by our engineering team nor our sales force. I think they both have really performed exceptionally well in delivering for what is an important platform for us to participate in.

Q – Ahmie(?), Thomas Weisel Partners

Last question and then I’ll go away. On the digital power side, things like Intersil’s de-emphasized the focus there, maybe owing to better than expected performance out of your analog products. Could you maybe elaborate on that and give us kind of a sense of how much you’re leaning on the digital power portfolio and how much is sort of still the traditional analog business?

A - Louis DiNardo

Sure, I’ll tell you what our thinking really is and it’s no different than a power panel that I sat on about a year ago or so with some of our peers that are major players in the power management business. I don’t think customers really care whether it’s analog or digital. They care about transient response, power dissipation, thermal management issues and flexibility and programmability. From our vantage point, at least at this juncture, the idea of having a digitally controlled – some sort of digital bus interface with a controller that can deliver optimum performance for the loop or power loop itself is really what our play is at this point. We don’t see significant advantages being brought to customers by digital versus analog as it comes to the loop control itself as much as flexibility and programmability that goes with being able to hang controllers on a bus, talk to controllers and set margining, set voltages. We’re kind of splitting the goalposts, we’re taking the best of our analog products, we’re leveraging the fact that with a fabloid strategy we can use dense, reasonably fine line MOS process technologies to deliver high gate count bus interface power management IPs, and really get the best of both worlds. We’re an analog company, we’re going to be an analog company, the idea that we can talk to parts over a bus – okay, let’s call it digital, but we’re still an analog company.

Operator

Your next question will come from the line of Michelle Chen of Morgan Stanley. Please proceed.

Q – Michelle Chen, Morgan Stanley

Just a quick question regarding linearity. Could you comment on the linearity during Q2 and what you expect for Q3?

A - Rich Beyer

The sales were, generally speaking, linear. They were a little bit higher in the June months. It’s normal that we have higher shipments in the third month of the quarter. This particular quarter was not abnormal in that respect. From where we sit at the moment, we anticipate that it will be relatively linear again in this quarter. You know, the backlog has been laid in in a way that suggests there’s nothing unusual from that standpoint.

Q – Michelle Chen, Morgan Stanley

Great. Just to follow up on your commentary regarding the distributors’ inventory, during the past quarter, you talked about the distributors’ inventory increase and here, this quarter, you talked about it up slightly. Could you talk about whether that’s also consistent with the mean projections from distributors for the year?

A - Louis DiNardo

As I said, inventory was up in Q2, it was up slightly in Q1. That was consistent with what we would expect in terms of shipments out for the rest of the year.

Q – Michelle Chen, Morgan Stanley

Great. If I may, could I ask what the lead times currently are across the different segments?

A - Rich Beyer

We don’t break it out by segment, but lead times across the board were about four to six weeks. Generally they don’t deviate much from market to market. That’s consistent with what it’s been for the last couple of quarters.

Operator

Your next question comes from the line of Romit Shah of Lehman Brothers. Please proceed.

Q - Romit Shah, Lehman Brothers

Thanks. Rich, with respect to the communication and industrial markets, could you just give me a better feel for your confidence in those two segments continuing growth in the second half, in light of I guess a couple of OEMs indicating that demand has softened. Is the confidence coming from the order rates over the last couple of months, or is it more… Like, you guys have expanded your product base and your customer base, so even if demand is low, Intersil should be fine in those two segments.

A - Rich Beyer

We think that we can perform at a minimum a little bit better than the overall analog industry in the industrial and in the communications space for several reasons. One is, this is an area where we have invested significant money in new product development. Over the last several years, we have introduced quite a number of new products. As I indicated and Louis indicated a little bit earlier, we have very, very solid design win momentum in these markets, particularly with our general?purpose products. Our confidence that these two markets are going to perform well for us in the second half of the year is based upon the new products, the traction we’re getting with the new products, the forecast that we have associated with those design wins, combined with the backlog that we have. These are markets where we do tend to get, as some of our competitors do tend to get better insight, better backlog coverage out further into the future because the customers have a little bit better insight. Their product cycles are longer product cycles, it’s design wins, it’s backlog and that’s what gives us confidence that we’re going to do okay in Q3 and Q4 in those two segments.

Q - Romit Shah, Lehman Brothers

Okay. One last question. One of – I guess you could call the incumbent in the high performance analog space, has been more vocal over the last year about strategy to grow market share by providing highly integrated solutions in high volume consumer-related markets and in segments that you guys have done very well in. Their value proposition is that highly integrated ICs will drive down system costs, you know, create more board space. Could you guys give your perspective on that strategy? I just perceive Intersil more as a supplier of standalone building blocks, rather than of highly integrated ICs.

A - Louis DiNardo

This is Louis, I’ll comment on that. Yes, we are, as you said, a building block company. That’s really the meat of our opportunity. It’s the strength of our broad line general purpose business. Frankly even in our ASSP businesses, we tend to have innovative solutions, but they are really a very tailored function within a larger system environment. On the other hand, we do have a strategy and we’re very careful about that strategy. You can easily squander resources. The idea that an analog company throws 5, 10, 15, 20, or 25 engineers at a single project swinging for the senses and an opportunity that looks tremendous because of the levels of integration that you could sweep up for example all of the power management requirements in a cell phone, those are high risk projects. We do some of them and we do them very well. We have the capacity to do that both with our design skills, our design flow, the processes that are available to us but that’s something we measure every day. The fact that others are a big vocal about it, success shows up in the numbers. We’re building a general purpose, application specific, functional building block business and we do have products that are highly integrated. We’ve got our bases covered and I think we’re quite comfortable that our strategy as we move into 2007, 2008, 2009 and into the balance of the decade, even, is really laid out quite nicely.

A - Rich Beyer

I’ll just add a little bit to that. This has been part of our strategy for quite a number of years. When we think about integration, we think about integrating numerous parts of the analog signal path, conceivable the analog signal path with power management and we’ve done it, to just point to a couple of environments. In optical storage, we have what we refer to as the right strategy, laser diode driver. That is a highly integrated function, it has amplification conversion, modulation and so forth that all were, five or six years ago, separate components on the pick up unit and have now been integrated by us. In displays we have integrated power functionality with amplification functionality so this is a natural part of high performance analog and it’s something we’re capable of doing and it’s something if customers are going down that path, if the architecture of these systems that we’re participating in can benefit from that, we do it. We do it well and so we don’t think this is a strategy which is a differentiated strategy in the high performance analog space.

Operator

Your next question comes from the line of David Wu of Global Crown Capital. Please proceed.

Q - Han Lee, Global Crown Capital

Hi, this is Han Lee for David Wu. Most of my questions have been answered. But just one last thing, about the communication business; it was up 15% last quarter. Could you please tell me about which specific area are you seeing the strengths from?

A - Louis DiNardo

We’ve seen it really quite broadly. As you’re probably aware, we have communications products that go into DSL DSLAMs, we have communications products that go into IP telephony, we have products that go into 3G base stations and then we have general purpose products that are broadly used in routers and telecom switching equipment. The fact of the matter is virtually all of the product families, as Louis indicated, saw nice growth in the quarter. It’s very broad based and it appears to be continuing.

Operator

Your last question will come from the line of Robert Burleson from ThinkEquity. Please proceed.

Q - Robert Burleson, ThinkEquity Partners

Good afternoon. Can you talk a little bit about how much of the weakness in PCs has to do with continued share of single core notebooks representing a pretty big share of OEM notebook offerings right now?

A - Louis DiNardo

It’s hard to say. To put a number on it, it’s hard to say. Certainly, that is what has the channels in a state of pause. Should they continue to buy for what’s been a successful platform, some of the activities that are going on with a major supplier or suppliers of CPUs have been paused as well. It’s a really difficult question to put a number on, but it certainly is on our view the basis for the hesitation. The idea that notebook demand is not going to grow in the second half of the year, I think is remote. It really comes down to when and at what rate do the new launches of Core Duo take off. I don’t think we’re in a position to put a percentage or a number on that as it relates to Q3.

Q - Robert Burleson, ThinkEquity Partners

Just a quick follow up on assembly and test, are you guys seeing any capacity free up on assembly and test and what’s the impact on lead times?

A - Louis DiNardo

That’s difficult to say because we never really saw a constriction of capacity. We’ve had a pretty steady flow of products through our back end assembly and test operations without any interruption with the exception of the oddball case here or there. Without any real constriction in capacity, over the past several quarters, it’s difficult for us to be a barometer of whether capacity has freed up.

Operator

Thank you. Ladies and gentlemen, this does conclude the Q&A portion of the call. I will now turn it back to Mr. Beyer for any closing remarks.

A - Rich Beyer

Thank you. Our strategic objectives are to grow Intersil at a faster rate than the overall high performance analog sector and the majority, if not all, of our high performance analog competitors and to actually grow our earnings at an even faster rate than our revenue growth. Q2 was yet another excellent quarter in that respect. We grew the revenue 35% year on year. We expanded gross margins. We expanded operating margins again. We expanded EPS at 100% rate, so 35% revenue growth, 100% improvement in the profitability of the corporation. We think this is because we have a very, very solid set of product families. We have a very talented group of engineers, sales and applications people and we are very, very pleased with how we performed in this quarter, despite the uncertainties and various soft areas. We think going forward, we have a very solid perspective on Q3 and Q4 and into 2007 and believe we can continue to grow top line and bottom line at a rate that exceeds that of the sector in general. Thanks very much for your interest, and we look forward to seeing you either at a conference or on the Q3 call in 90 days. Good afternoon.

Operator

Thank you for your participation in today’s conference. This does conclude the presentation and you may now disconnect your lines. Have a wonderful day.

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Source: Intersil Corporation Q2 2006 Earnings Conference Call Transcript (ISIL)
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