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Cypress Semiconductor Corporation (NASDAQ:CY)

Q2 2009 Earnings Call

July 16, 2009 11:30 am ET

Executives

T. J. Rodgers - President, Chief Executive Officer, Director

Brad W. Buss - Chief Financial Officer, Executive Vice President - Finance and Administration

Christopher A. Seams - Executive Vice President, Sales and Marketing

Norman P. Taffe - Executive Vice President - Consumer and Computation Division

Dana Nazarian - Executive Vice President, Memory and Imaging Division

Dinesh Ramanathan - Executive Vice President, Data Communications Division

Harry Sim - Chief Executive Officer of Cypress Envirosystems

Shahin Sharifzadeh - Executive Vice President - Worldwide Wafer Fabrication and Technology; President, China Operations

Analysts

Suji De Silva - Kaufman Brothers

Tim Luke - Barclays Capital

Uche Orji - UBS

John Pitzer - Credit Suisse

Doug Freedman - Broadpoint AmTech

Analyst for Glen Yeung - Citi

Sandy Harrison - Signal Hill

Sirini Pijirri - Analyst

John Barton - Cowen

Chris Danely - J.P. Morgan

Jeff Schreiner - Capstone Investments

Adam Benjamin - Jefferies

Operator

Good morning and welcome to Cypress Semiconductor’s second quarter earnings release conference call. (Operator Instructions) I would now like to turn the call over to Mr. T.J. Rodgers, President and CEO of Cypress Semiconductor. Sir, you may begin.

T. J. Rodgers

Good morning. We’re here to present the second quarter 2009 to investors. We’ll start out as usual with CFO Brad Buss and market comments by marketing VP Chris Seams. I’ll make a few comments and we’ll get quickly to questions. Brad.

Brad W. Buss

Thanks, T.J. I want to thank everybody for attending our second quarter call. Again, just a quick reminder that everything in our press release and on this call is based on preliminary unaudited results and we encourage you to go through our 10-Q once it’s filed in early August and as usual, we’re making a lot of forward-looking statements, obviously a ton of risk. Again, see our press release and our public filings for a discussion of all those risk factors.

We talked about non-GAAP and GAAP -- there’s full recons in the press release and we also have them available on our website as well.

So I’ll go through the Q2 results and then I’ll do a quick review of guidance and then turn it over to Chris.

So I was really pleased with where Q2 ended up. We ended up with better revenue, more importantly better gross margins and better or smaller loss, I should say, than we originally expected and it exceeded our guidance as well as the average street consensus.

Revenue for Q2 was $155.8 million, a 12% sequential increase and it was a decrease of 26% on a year-over-year basis. We exceeded the top end of guidance due to a steady business pick-up throughout the quarter, really across all of our product lines. It was led by strength in Asia and Japan, which offset continued weakness in Europe that, like other semiconductors, we continue to see as well.

If you look at it by division, MID was basically flat, which was consistent with what our guidance was. BCD increased 25% sequentially and benefited by certain end-of-life military related shipments and increased sales of Westbridge into the handset market. CCD, which has the most consumer PC and handset exposure increased 20% sequentially and it was driven by [PSOC], which just as a data point grew much faster than the CCD 20% average, and we also benefited from strong USB sales as PCs continue to perform well.

True touch, our new touch-screen product, continued to grow rapidly and we’ve more than doubled its revenue in Q2, as we added additional customers and handset models into volume production. We continue to see a very strong design win and many of the handset vendors and we expect to see a multi-year growth coming out of that. And we expect it again to probably be our fastest programmable product to hit $100 million in our history.

Turning to earnings, on a GAAP basis, we had a net loss of $45.3 million, which was $0.32 a share, and that was primarily driven by the 123R charges, a little bit of restructuring, and the impact of our operating loss. That was more than cut in half from the $0.66 loss in Q1.

Our non-GAAP net loss was $3.8 million and that led to a loss per basic share of $0.03, which is again far better than the $0.08 to $0.12 we originally guided and it was higher than the street estimate, that was around $0.10.

And more importantly the EPS strength all came from internal operating leverage. We had the higher revenue, we had better gross margin, and we continue to have very tight OpEx control. And again, that $0.03 loss was down significantly from the prior quarter where we clocked in at a $0.22 loss.

Non-GAAP gross margins were 44.2%. It was up 10 percentage points from the prior quarter and above guidance as our wafer starts activities and utilization all rebounded from an all-time low in Q1. The average utilization in Q2 was approximately 59%, which again was up 25 percentage points from our average of 34, and we expect to see our utilization move up in Q3 to probably the high 60s to low 70s.

And if you look at what we call our adjusted equipment capacity, i.e. where we’ve resized the fab from a variable cost structure, that will start bringing us up to a range of high 70s.

We’ve taken a lot of proactive steps to manage our cost structure and we’ve decreased our variable costs by over 25% in Q308 to Q309 and we still remain very committed to our Flex Fab strategy and I look for further margin improvement as we continue to load the fabs in the future.

One of the positive things that we’ve continued to see is that our product margins remain relatively stable, as almost 80% of our business is proprietary in nature. Our corporate average ASPs decreased slightly to $1.39, mostly due to mix. You have to remember in Q1, our ASPs cranked up 11% sequentially due to a higher mix of SRAM. If you look at it on a year-over-year basis, our ASPs have actually increased, which is very nice, especially in this economic time. And I think if we continue to look at where we are going with gross margins, we are very comfortable that we will hit our 50% target in the second half of this year.

Turning to expenses, our non-GAAP operating expenses decreased by $2.1 million sequentially, totaled $74.7 million, and included in that was a $2.3 million accounting charge related to our deferred comp plan, so I think as you all know and we showed in the press release, as that plan moves up or down, it goes through OpEx, you get the benefit or the hit in OIE and net net, it has no impact on EPS.

But just to put it in perspective, when I gave the guidance of 75 to 77, I always assume no movement in the plan because it’s very hard to predict. So we really came in at $72.4 million on an apples-to-apples basis versus my guidance. Again, you know, very tight cost controls. We’ve had lower selling expenses and we’ve had reduced take out in [mask] expenses.

From a restructuring standpoint, in Q2 our headcount continued to decrease. We hit approximately 3,700 people. That was a 5% sequential headcount decrease and approximately 16% since our peak in Q308. We’ll have a small reduction continuing into Q3 and then I think we’re finished from that perspective.

I expect the bonus plans to turn back on in Q3 and Q4, as we’ll be returning to profitability and we had tiered pay cuts that we talked about before that are still in place and we’re currently evaluating when we’ll turn those around. But needless to say, we are very committed to managing OpEx and a lot of our cost control actions are going to continue into 2010.

OIE came in at $2.6 million, which again that’s the other side of the deferred comp, which was $2.3 million. So if you take that out of the equation, it was pretty consistent with my guidance. Basically everything going through that is about $0.5 million in interest income and then there’s about $100,000 related to the bond that goes through there.

Our non-GAAP tax charge was within the guidance at 800K and the basic shares actually came in almost spot-on at 141 million.

If I look at the balance sheet, again another source of pride here at Cypress -- I think we have a very solid balance sheet. Our cash, cash equivalents and investments total $246 million. It increased $22 million or 10% from Q1. If you add in the $34.5 million of auction rate securities that we have classified as long-term, we have $280 million. We continue to remain a pretty conservative portfolio and we will see where rates take us going forward but I wouldn’t expect any big increases in OIE.

We generated positive non-GAAP EBITDA in Q2 of almost $10 million, which is really the highest level since this downturn began in Q4 of ’08. More importantly, we had positive operating and free cash flow, again sooner than we expected, and I expect to see increasing levels of operating and free cash flow into the second half and continuing into 2010.

Inventory management was another bright spot. Our net inventory was $90.6 million, which was down 10% from Q109 and is down $42 million or 32% from Q308. Q2 inventory levels are the lowest since Q306. And again, just to put some of that in perspective, of the $90.6 million in net inventory, there’s $7 million related to FAS-123R charges, which technically obviously is an operating inventory, and there’s $16.2 million for the last [build] that we did with the closure of Texas in that number as well.

Disti inventory, another big part of our supply chain, again decreased by 9% from Q1. This is the third consecutive quarter that the distis have been draining their inventory and they are at their lowest level since 2005. So I think these levels are pretty low and I am hoping to see some of them increase in the back half of the year. There’s a lot of chatter out there on this inventory restocking cycle and I think from our perspective and as you see in our number and the conversations we have with our customers and supply chain partners, we have personally seen almost none to limited inventory restocking going on and we expect that that will have to pick up some time in the back half and/or as the economy increases.

If you look at our expected revenue increase and where we want to manage our inventory, I think we’ll see a slight increase of inventory by no more than $5 million in order to support the revenue we’re going to be talking about, as well as meet the profiles of some new products. But I still see another drop in days of inventory on hand, which is good.

Accounts receivable totaled $84.4 million. It was up $12 million from the prior quarter and that was really all just due to increase in revenue and the timing of shipments. DSO moved up by two days -- again, just due to timing of shipments. And more importantly, our ageing continues to be excellent. I think we’ve sailed through this downturn very well and have had no significant issues with any of our partners, so I am pleased to see that.

Just as a side not, remember disti is a big chunk of our business. It’s anywhere from 55% to 65% depending on the quarter. We ran it around 60%, 62% I believe in Q2. CapEx was in line at $4.9 million and depreciation was $13 million.

Turning on to the debt end of it, so we have $28 million base amount of the convert left. It has a conversion price of 564. The bond matures in September 15th of ’09, so we’ll be taking care of that this quarter. We have the option to settle the premium in cash and/or stock, and we also have a call spread remaining on the stub part of that convert [to put the] conversion price up to 637.

So you’ll see us put out some information on that, and then basically by the end of Q3 we’ll be debt free, most likely we’ll spend the cash to take that out, which again, depending on the stock price and where it’s trading during the averaging period, you know, it could be somewhere north of $40 million.

You’ll still see the convert and cost spread impact of fully diluted shares in Q3 on a weighted average basis and then you’ll see no impact for that for Q4 going forward.

Turning to the share count, we repurchased 700,000 shares in Q2 at an average cost of $6.82. And I think as most of you will remember, we bought another 1.5 million shares in Q1 at $4.60 and 24.5 million at a price of $4.03, so that’s obviously worked very well in our favor and we were glad to return that back to the shareholders.

So the weighted average basic shares for EPS for Q2 were $141 million and one of the things I think you guys need to keep in mind is going back to profitability, you’ve got to look at the fully diluted share count and you really need to take in the stock price movement and what’s going on, and I’ll give you some more guidance on that going forward.

From a GAAP perspective, if you are looking at GAAP earnings, you can just continue to use the basic share count for that.

Okay, so now turning to guidance -- I think as you saw in our press release, we talked about our overall book-to-bill being at 128, all of the division were above one. And we had a very nice strength in backlog going in, so we are looking at Q3 revenue to be in the range of $170 million to $175 million, which is up 9% to 12%. At the midpoint of that number, that’s double or normal average seasonal growth of 5 and it’s our highest Q3 growth rate in many years. This is significantly higher than the current street consensus of about $162 million.

CCD will grow very strongly, driven by True Touch and USB. MIB will grow based on SRAM market share and we expect DCD to be flattish, since the one-time military shipments are not repeating at the same level as they did in the prior quarter.

As well, we expect CCD to become our largest division by revenue in the second half of the year. We expect continued gross margin strength. I am pleased to announce that we are looking at gross margins of 49% to 50% and we expect all of our reportable divisions to increase their gross margins in Q3. And again, to my prior point, that’s assuming utilization up in the high to low 70s and again, I am very comfortable thinking that we hit 50 in Q3 or Q4, I think that’s a very strong possibility.

OpEx around $73 million to $75 million, and again that assumes no fluctuations in the deferred comp plan. OIE again at $300,000. A tax expense of 900K, CapEx of around $11 million, depreciation of about 13.

On the share count, I would assume the basic share count of around 150 to 153 and the fully diluted to be around 186 to 188, again driven by the higher average stock price that we’ve all been fortunate enough to see.

If you put all that together, it looks like non-GAAP earnings per share in the range of $0.05 to $0.07, which again is significantly higher than the current street consensus of approximately break-even.

So I’ll finish up there. I’ll turn it over to Chris and then T.J. will wrap up with a few comments. Thank you.

Christopher A. Seams

Thanks, Brad. Let me start out with a few of the normal indices and then give you some flavor on what we are seeing in the market.

Ship to revenue by geography -- Asia grew to 54% of sales, North America declined to 24, Europe declined to 12, and Japan remained at 10% of our sales.

Units increased to 112 million in the quarter and the pricing environment remained fairly stable. Our corporate ASP did decline $0.04 to $1.39, driven mostly by just a richer mix in the consumer oriented products that we sell.

In terms of end markets, our revenue grew in all of our end markets in the March quarter. We were led in handset, PC, and consumer end markets. All of our end markets for us are forecasted to grow again in the June quarter as well.

In our press release, we gave you the book-to-bill. Brad stated it’s 1.28, and our six-month backlog increased to $184 million, so we had a good book this quarter.

In terms of bookings patterns, we continued to see strength month by month throughout the quarter. That trend has continued into the first two weeks of this quarter so we are feeling fairly good about order patterns and we are actually starting to see the booking horizon from many of our customers start to stretch back out longer in time and book some into next quarter as well.

Let me turn the call back to T.J. now for details on the quarter.

T. J. Rodgers

Okay. First of all, a divisional breakdown -- BCD, which includes USB, which was very strong for the quarter, and PSOC, the same, was $62.3 million, with 48% gross margin. Data-com was $25.5 million, with 64.5% gross margin, and MID was $66.2 million, with 36.8% gross margin. We expect each of them to increase in gross margin in the coming quarter.

A few comments on technical announcements or product announcements and design wins. Our programmable and proprietary products, things that only we make, are now 79.2% of our revenue. That’s accounting for the stability or prices -- I’m going to walk over here to a graph.

We will put our ASP graph on the web for you today to take a look at but our ASP for the quarter is $1.39. It was down from $1.43 but if you look at the graph I’m looking at, there’s been pretty much a [monetonic] increase. We had a bottom of $1.02 in Q4 2005 and we’ve been, with a little bit of noise, going up since that time.

One of the factors that drives this up is the ASP of our new products. Last quarter was $1.63 and as you bring in those new products, that’s what brings up your ASP even when the market is weak.

We began selling development kits for our new PSOC 3 device. It’s in its early phases of introduction and these kits are what helped our customers designing the new product. PSOC 3 is in effect our second generation PSOC product. It has an 8051 microcontroller in it, an industry standard microcontroller. It’s 10 times more powerful than the [home brew] microcontroller in PSOC 1.

Based on our input from multiple design wins over the years in PSOC 1, we put in 10 times more programmable logic than PSOC 3, so people can put more into it. And we’ve also improved the analog dramatically. The analog in PSOC 3 is both 20 times faster and 20 times more accurate than the faster times accuracy. You can get either speed or more accuracy, 20 times more on PSOC 3.

The main event for us is that PSOC 1 only addresses about a $1.5 billion market at the low-end of the eight-bit microcontroller space and PSOC 3 takes our served available market, or SAM, to 6.2 billion.

We had several big design wins in [cap sense]. I’ll name the designs and then talk about the generalization -- Lucky Gold Star, W53 and W4, LCD monitors, Acer Aspire notebook computer model, and Whirlpool and -- washing machines. We’ve also gotten a [inaudible] design in Hewlett-Packard in their new all-in-one C4600 printer series.

The generalization of those data points is that buttons are going away. It’s happened in monitors, it’s happening in, of course, with water proofing in [inaudible] goods, and we are getting the benefit of that.

The second thing that is happening to us is what’s called true touch, or what we call true touch. True touch is nothing but cap sense with the ability to sense capacitors in a like your track pad on your little -- on your personal computer, on your laptop, except in the case of true touch, the capacitor array is made from [inaudible], which is the clear electrode, a clearer conducting material. And that electrode is on a foil which is laid over the top of a screen, so you can see through it.

So you think you are touching an image on a screen -- in reality, you are touching invisible electrodes that are overlaid over that and then True Touch senses the XY position of your finger and whatever device you have knows what image you are touching because it’s creating that image and that’s in effect how touch screens get created.

We’ve got a design in the Samsung mobile phone, so that’s a big line design win for us. We’ve had another design win in the Sharp waterproof mobile phone. So we are starting to see, and Norm can talk more about this later, the turn on of true touch as a touch-screen type controlling.

In the static RAM arena, we introduced a 72-megabit [cross] data rates SRAM. What is that? It is the high performance SRAM that performs the memory in the guts of most routers in most companies. The thing that makes it good for Cypress is that it’s a 65-nanometer product, it’s the next generation and during the last crash, many, many static RAM companies were [out] and that left us not alone but with a few companies in the static RAM market. And this is the most advanced product in the market, just being introduced. We actually [shipped] revenue last quarter on it.

So this says going forward we will have the Moore’s Law advantage, if you will, although we make this at a foundry at UMC but we’ll have the Moore’s Law advantage in the static RAM space.

We have a new subsidiary. We haven’t talked about it before. It’s called Gigatech. It’s a startup. It’s an internal startup and they are in San Diego. The team is a bunch of Cypress people plus one guy who ran a company called Anchor Chips that we acquired that was part of our USB portfolio that we acquired about 10 years ago.

They make a product that -- a non-volatile dynamic RAM, non-volatile dynamic RAM access memory. And what that means is it’s a system product. It has the dynamic RAM in it that looks exactly like a dynamic RAM to the user but on a small board, in addition to having the dynamic RAM, it’s got a system controller chip, some super capacitors to store energy, and NAND Flash. So what happens when the system powers down, and this could be a black-out or brown-out position, not a deliberate turn-off, there’s enough energy stored in the capacitors to allow transfer of the data error free from the dynamic RAM to the NAND Flash and on returning power, it transfers the data back from the NAND Flash back to dynamic RAM.

We already make what are called non-volatile static RAMs. We do about $22 million a year on them and they do exactly the same function I just described and they do it without batteries. The big deal, this function is done in almost every machine in the world that has to be reliable and hold data, and it’s done now by having a memory system that’s power to the battery and the battery is able to keep the memory alive. People don’t like the batteries because they are unreliable, they have to be replaced every year and they are expensive. So for a long time the industry searched for a way to have a non-volatile memory, non-volatile static RAM and/or a non-volatile DRAM, that doesn’t need a battery. We’ve been shipping that in small form, whether non-volatile or static RAMs, for a few years. This is now a non-volatile dynamic RAM. It’s a system product. We make some of the chips in it but it’s more of a system play than a chip play.

So we got our first revenue from that -- that start-up last quarter. We haven’t talked about it because there has been revenue. We acquired the thing last year, it turns up when we acquired [Simtech], a small company in Colorado that was in the non-volatile static RAM business. They had this thing going as an internal start-up. And after we evaluated it, we thought it was a great idea and we continued it.

Finally, we named [Etoshio Shizowa] as our Japan country manager. He has a PHD. He joined Cypress in 2008 and he was formerly the President of [Siloc] Japan.

Those are the most important things in products and customers that happened in the last quarter. We’re ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Suji De Silva, you may go ahead and please state your company name.

Suji De Silva - Kaufman Brothers

Nice job on the quarter, guys. Can you guys talk about the backlog? I know you are talking about companies giving you more visibility here. Is it the sense that perhaps some companies are trying to get ahead of potential second half demand and putting, increasing backlog just to make sure they get supply here or does it still feel like companies are tight with the backlog and this extension is a very real indication of demand? What’s your thoughts there?

Christopher A. Seams

My comment was the backlog trend and the bookings trend frankly to me has returned to normal say after about a year of people booking very late and to what they finally got a purchase order from their end customer for. So for me, I see it returning to normal patterns. I don’t see any frenzy yet.

Suji De Silva - Kaufman Brothers

Okay, good. And then secondly on true touch, I know you made a comment there, this will be the fasted product to $100 million in your history. What is that timeframe implied by that, looking at past products? And also if you could talk about the top five handset guys, how -- if you expect to penetrate all five over time? Thanks.

Brad W. Buss

On the 100, again, we’re just trying to give a data point where we are not looking to say it’s going to happen in X period or X year. I think it will happen quicker than normal and we’ll just leave it at that, put the burden on sales and Norm to continue delivering those big design wins.

T. J. Rodgers

Well, when do you expect the touch screen will pass $10 million per quarter?

Norman P. Taffe

Very soon. Very soon.

Suji De Silva - Kaufman Brothers

Thanks, T.J.

T. J. Rodgers

It’s like Cap Sense, another big deal for us and it’s bigger than Cap Sense because it looks like all interfaces are going that way. It points out, and let me stop for a short advertisement here, it points out that the benefit of PSOC, because we can -- we’ve got this chip and we can internally take our best experts and we can mobilize them to make these chips do functions that we didn’t know were going to be problems that we would need to solve when we invented PSOC. We might have to modify chips a little bit and get to market very very quickly with a product, and once the product is out there, we are competing with a flexible product that will be programmed to add buttons and do other things, versus competitors who are working in hardware design to bring in a fixed function product.

So this is a great opportunity and we are able to jump on it faster than the other guys because we have PSOC technology to bring to bear on it.

Suji De Silva - Kaufman Brothers

Very good. Thanks, guys.

Operator

Thank you. Tim Luke, you may ask your question and please state your company name.

Tim Luke - Barclays Capital

Just with respect to the outlook as you see the shape of the year, Brad, maybe you could give us some sense as to how you perceive the normal seasonality as you go into the fourth calendar quarter, sometimes given the consumer bits having shipped in the third quarter, it’s a little lower. What should we be broadly thinking?

And then, with your very strong gross margin guidance to now to the 49%, 50% range for the calendar third quarter, how do you see that shaping and what sort of ranges are you beginning to target, either sort of longer term as you move through calendar 2010? Thanks.

T. J. Rodgers

Let me take the gross margin one. We’ve guided 49 to 50, so obviously with decent mix, the fabs continuing to move, and the right product mix, you know, we could obviously hit the 50 now. And I think we have a very good chance, assuming booking patterns and the [work] continues to definitely hit it in Q4.

You know, part of it is the inventory levels are very low, right, so we have to continue to build some inventory, we’re absorbing more of the fixed costs and our manufacturing facilities have done a fantastic job of taking costs down. So I think we are back to the 50s like we were in 2008, right? We were at a 50% level until the downturn in Q4.

I think longer term, I don’t see any reason we can’t start looking at the low 50s to even 55. It’s not something you guys should start modeling in Q4 or Q1 of next year. I think with the mix and where we are going with our manufacturing strategy, it’s definitely in our favor because as T.J.’s pointed out, more and more of growth in new products are more proprietary in nature and we’re enjoying better ASPs and margins with that.

So I think we are going to definitely be in the low 50s and mid 50s over the next two years.

Tim Luke - Barclays Capital

And just with respect to the seasonality for December?

Christopher A. Seams

Obviously Brad is not going to let me give any guidance on the call. What we are hoping for is normally we do have seasonality because of the consumer segment. We are pretty excited about penetrations that we are having into the true touch markets in handsets specifically, although we do have designs going on in many other end markets with true touch as well. And we are hoping that that plus share gains in static ram will help offset that normal seasonality.

Tim Luke - Barclays Capital

Okay, so you will be at least flat?

Christopher A. Seams

Like I said, Brad won’t allow me to give guidance on this call.

Brad W. Buss

Just to put it in perspective, normally in Q4, we could be flat to down a few points. I think if we were flat to slightly up, we’d be real happy with that and you should be too.

Tim Luke - Barclays Capital

And then just the shape of OpEx, Brad, do you think it can edge lower as you move through the next few quarters? Or how should we think about that?

Brad W. Buss

No, I don’t think you’ll see it go much lower. I mean, that’s why I made the [comments] -- we’ve got the bonus plans coming back, we’re going to reverse the pay cuts. We’ll be working hard to offset cost to bring those back in and not take off [inaudible] substantially. You know, as the revenue moves, we get higher selling costs. The back half of the year, you are going to see a -- you know, the big public launch of PSOC 3 and Vibe and [inaudible] higher costs there but I don’t think you will see it move up substantially. It’s not -- you know, I don’t see it going up $4 million or $5 million at all in the short run. We’re working pretty hard to [inaudible] that and we are reallocating dollars between some of our slower growing divisions to the higher growth divisions.

Tim Luke - Barclays Capital

Chris, could you possibly give the book-to-bill for the different segments and within the segments, it looks like the memory division has been fairly stable the last couple of quarters. Should we think about that continuing to be stable or do you think there’s room for that to see some seasonal improvement?

Christopher A. Seams

Let me give it to you by division -- CCD was 1.5; BCD was 1.25; and MID was 1.05. And [inaudible] memory, while that’s stable, 1.05 is not a bad book-to-bill. It indicates growth, you know, a fairly good quarterly growth rate so I think we feel like we are going to continue to take share on the SRAM market, even though that overall market isn’t going to grow very much.

T. J. Rodgers

And Tim, I know that is your favorite question, and we should probably just start dealing with it up front but you guys also have to remember a lot of our stuff gets through distribution, so distis don’t book like a normal OEM. So book-to-bill, it’s a good indicator, you know, it’s something like -- sometimes you have to take it with a grain of salt. It could be a lot higher, it could be a lot lower. I think the biggest point, like Chris said, is we continue to see the booking increase kind of quarter to date.

Tim Luke - Barclays Capital

Very helpful. Thank you very much, guys.

Operator

Thank you. Our next question comes from Uche Orji.

Uche Orji - UBS

Let me start by asking you about where SRAM revenues should go in the second half, how should we think about that, given that there is still some restocking to go within SRAM?

Dana Nazarian

I think we are going to continue to gain share in the SRAM market. We are cautiously optimistic and that’s basically being fueled by our technology advantage. In addition, we are just starting to ramp up revenue on our 65-nanometer line, so that will also be incremental revenue for us. So in general, slow steady progress.

Uche Orji - UBS

Okay. Just a different question, I just have a couple of questions on some other areas. If I look at West Bridge, can you just give us some updates on some of the momentums, some of the momentum on some of the wins you have and how should we think about West Bridge momentum going into the second half of 2009? There’s been a lot of design activity you’ve talked about in the past. How should we think about how much that will contribute coming into the second half of ’09?

Unidentified Participant

A lot of the design activity that we have been working on will probably not contribute into the second half of 2009. It will contribute in 2010, so that’s where we are expecting most of the existing design activities to go. We are seeing a fair bit of momentum, pushed by the value proposition that we are bringing to the table and we think that it is good positive momentum going forward.

Uche Orji - UBS

And Brad, within BCD, I mean, the non West Bridge revenue, what are your expectations for recovery within that? I mean, it looks like the momentum so far has been focused mostly around West Bridge. I mean, what should we look at for the other non-West Bridge type revenues within BCD?

Brad W. Buss

Well, let me let Dinesh, who runs the division, answer that one.

Dinesh Ramanathan

So the next thing that we have been working on, which T.J. has basically talked about earlier, is power PSOC. This is taking our PSOC franchise and adding power electronics to the device so that we can drive small motors and LEDs in that space, so we think that that’s the next growth engine that we are basically going to come out with going forward. The revenue from that will basically start impacting our numbers in 2010.

Uche Orji - UBS

Okay. And lastly, let me just ask T.J., I mean, with the tightness with the recession, a lot of expenses and bonuses were cut but as things start to improve, should we expect some of the -- on the expense line to start to increase again? And how should we think about your operating leverage for the company as you start to reinstate some of the expenses that have been squeezed with what happened in the last six months?

T. J. Rodgers

We’ve been in a head long rush to reduce our costs for a while. The turning back on of the bonus plan, we don’t reduce our bonuses. We have a policy. It’s real simple. When EPS has brackets on it, bonuses equal zero for everybody, no questions asked. That’s our policy.

So that will be a speed bump for us as we turn it back on in the third and fourth quarter. But we don’t expect to be raising our costs. There are really two driving forces for it. One is we are going outside for incremental capacity. So right now we make about -- if you look at wafer starts, not what we shipped for the quarter but what we will ship 90 days from now, we make about 70% of our stuff inside but yet what we make outside, it’s now grown to 30% and that’s in low cost Chinese foundries, the [inaudible], for example.

The 72-megabit SRAM I talked about is made at UMC, so as we expand outside, we are going to forego buying the capital equipment in our fabs that we would have done in past up-turns and that is a major driving factor. [No more], we’ve talked about it for a couple of years.

The other driving factor is that we -- once we decided PSOC was our winner and we were basically a RAM company and we had some other winners but once we decided -- and it’s very difficult to cut costs on a company by cutting 5% at the bottom of every group. It’s not very effective and it also harms your good groups.

So that kind of cost-cutting, reorganizing to focus on your winners, is what we are doing and I believe those two forms of cost cutting will balance out the turning back on of the bonus plans in the third and fourth quarters and we will not see a significant increase in expense. We are expense hawks, right now.

I’ll give you one example -- the way we manage headcount, even today, even with the up-turn, is we have what’s called a “[rec auction]” [inaudible], and every week the VP of HR comes in and lists people that have terminated for one reason or another and that is a budget and last week was a big one. We had about a couple hundred thousand bucks of the annualized salary that went away because people in various groups for whatever reason left.

You do not get guaranteed to get back the person that left. There is no replacement rec in the corporation. Each VP comes in with a list of two or three of the most critical people in that VP’s organization to re-hire, and then the $200,000 is applied, sometimes with a little jawboning, sometimes with a little arguing, to the most critical positions in the company. We’ve been running that way now for a couple of years.

So we’re not even allowing hiring that isn’t justified, pre-justified by somebody leaving the company. We’ve got equivalent kind of systems and expense control, capital control as well. We won’t go into them but we are cutting costs at Cypress and we do not expect our costs to go up.

Uche Orji - UBS

Okay, that’s great. Thank you very much, T.J.

Operator

John Pitzer.

John Pitzer - Credit Suisse

I guess, Brad, on the True Touch part, can you help us understand the gross margin evolution we should expect on that part? And I guess T.J., as you think about the evolution of just the touch screen market, clearly handsets, big uptake coming. When do you see PCs coming and how are you positioned there? And if you could walk through the different competing technologies and how you think True Touch lines up, that would be great.

T. J. Rodgers

Those are all True Touch questions. Norm is best to answer them. Norm.

Norman P. Taffe

I’ll start I guess with your last question about the competing technologies -- the competing technologies, historically the market for touch screen has been a resistive market. One of the biggest growth factors which is helping everybody in this space that we are seeing a fairly rapid transition from resistive technologies, which you would be familiar historically on things like ATMs, et cetera, that have touch screens towards capacitive. Capacitive is much better in terms of the clarity of a screen, therefore it’s much more useful in handsets. We’re seeing handsets move from resistant to capacitive very rapidly and drive the growth. It also is more durable because you don’t physically compress the screen to it touch.

That’s the biggest driver. Within the touch screen itself, within the capacitive touch screen state, there’s been different types of implementation. Part of the reason we are having such great success on the design end is we are the leader in what was called multi-touch all points, which is a mutual capacitive approach to touch screens which allows you to recognize independent fingers on a screen.

Most previous solutions in the market have suffered from -- they may be able to recognize two fingers but actually not independently, and therefore there is something called ghosting, which has affected literally almost any touch screen you see out there.

I can’t name the customer but a recent very well-reviewed phone that uses our first generation touch controller technology has really gotten a lot of reviews, rave reviews on its touch screen capability because it eliminates that and it uses a multi-touch all point capability.

That capability is putting us in a very strong position and allowing us to get a lot of wins, very few of which that we are really showing any revenue from yet, but will significantly impact the back half of this year and then throughout next year.

Another comment, I think another part of your question was what about beyond the handset space, some of the other market places. I’m glad you brought that up because we do believe touch screen is significantly more impactful than the capacitive market, even though we had and built a very strong business [in capacitive] [inaudible], we expect touch to be quite a bit bigger. And part of that is because it’s one, being adopted even more broadly in handsets but it’s also being adopted in all kinds of other markets, like gaming devices, netbooks, notebooks, printers, even automotive is an area we are seeing quite a bit of early design-ins.

So I think there’s a big opportunity and we are participating in all the segments, not just the handset segment.

John Pitzer - Credit Suisse

And then guys, longer term when you look at the PSOC market segment, there’s clearly a couple of distinct selling channels, you can sell the PSOC and let them develop their own application, or you can do as you’ve done with certain applications, develop it yourself. As you look at this market unfold, what percent do you think will be the former versus the latter? And then Brad, maybe the margin implication as you start developing your own applications on the PSOC foundation.

Norman P. Taffe

My colleague reminded me I missed one of your questions related to gross margin, so let me answer that as part of the answer to the question you just asked, because I think they are related.

It is an evolution. We in the long-term, and one of the benefits of PSOC is it has a tremendous advantage to the consumer of being able to own their own design, add IP, and make modifications to that IP in their application.

What happens as brand new markets come out, most of the design activity is stuff where we help the customer use it and then we produce additional products kind of in the family, like True Touch is really a family that has PSOC capability.

So I think initially there’s more where we are working with the customer. Over time, it’s another benefit we provide that customer as far as adding IP to his own designs and it really allows us to differentiate with software. You know, when we announce our next generation product, perhaps the most compelling aspect in addition to the performance that T.J. talked about is going to be the software tools that support it and allow customers to differentiate their product very, very quickly.

That on a long-term scale gives us a very stable base with better and better gross margins.

I think in general to answer your question about the gross margin of this business, because we add value in things like True Touch to the product, we expect -- you can expect those gross margins to be higher than the average and we expect that trend to continue as we add more and more value through software capability on the silicon base.

John Pitzer - Credit Suisse

And then my last question is maybe for Brad -- Brad, clearly a lot of new market opportunities you guys are getting into. To date you’ve had kind of a fairly normal downturn/recovery relative to your sequential growth rates with your peers. When would you expect to see these new markets kick in and actually allow you to start to outgrow kind of the industry recovery?

Brad W. Buss

I think we are seeing some of it now and I expect it to continue really into next year and beyond. I mean, the new market expansion that just the PSOC 3 and 5 that we will publicly launch later this year and go through pretty heavily at the analyst day meeting, I mean, that is a multi, multi-year TAM expansion and I think more importantly, where I think you were going on, you know, we kind of go up in Q3, consumer seasonal, go down, go back up. I think we’ll see some of that start to modulate as we get more and more into industrial and medical areas and again, more into higher end handsets and I think where Norm was talking, white goods, et cetera, automotive. You know, we’re getting into non-traditional areas that will reduce that cyclical flow.

But I think you are going to start seeing some of it really every quarter but I would still expect to see a seasonal downturn in Q1 through this year, maybe it modulates a little more the next year and then I’m hoping it’s gone after that. It’s a little early to tell.

John Pitzer - Credit Suisse

Perfect. Thanks, guys, appreciate it.

Operator

Doug Freedman.

Doug Freedman - Broadpoint AmTech

Thanks for taking my calls, guys, and congratulations on the good execution in the quarter. Brad, can you just remind us what percentage of your distribution is sell-out versus sell-in? I know we made some changes about a year ago.

Brad W. Buss

Yeah, 100% is sell-through.

Doug Freedman - Broadpoint AmTech

Okay, I just wanted to confirm that, thank you.

Brad W. Buss

Yeah, we don’t have any of that weird sell-in and that’s to my point on the restocking, you know, I think there’s still a lot of opportunities to drive revenue growth as we get the weeks of inventory back up. It’s way too low.

Doug Freedman - Broadpoint AmTech

Can you talk a little bit about what you are seeing as far as are there any delinquencies in the quarter and what your lead times have done? Has that contributed to your normalcy commentary regarding orders, if you could describe normalcy for us?

Christopher A. Seams

In terms of lead times, most of our lead times remain in the four to eight week range. We have seen a couple of our products go above that four to 10 week range but we are getting those back shortly under control, so a few things blip up every now and then with some short lead time orders but we get them back under control. So overall, we are handling it fairly well.

In terms of normalcy, typically at this point in the quarter for next quarter, I am typically between 15% and 20% booked on the day I talk to you guys for the fourth quarter, let’s say. And today that’s about where I’m at for what we are projecting internally.

If it were this call last quarter, that number would have been half that number, so when I say normalcy in terms of the horizon, that’s what I mean.

Doug Freedman - Broadpoint AmTech

Great, thanks, and a question for you, Norm, on the -- in the annual report, you guys showed a great chart showing PSOC design kit downloads. Can you talk about how that is tracking, what you are seeing there? And any commentary you can offer regarding if you are measuring conversion of design kit shipments to design wins.

Norman P. Taffe

As far as the metrics you mentioned, we don’t actually track that directly so I’ll have to get back to you afterwards with a specific answer. We are seeing continued growth in development kit downloads. That’s been continuing for really ever since we introduced PSOC so that continues to be strong.

Doug Freedman - Broadpoint AmTech

All right. And then lastly, West Bridge, we tried to get into what you guys are seeing as far as West Bridge opportunity -- what percentage of the opportunity for West Bridge do you feel you presently maybe secured versus what percentage do you think you are presently seeing design orders and shipments for?

Dinesh Ramanathan

Can you elaborate that question a little bit more, in terms of design wins to which we are shipping, to where the design wins are located?

Doug Freedman - Broadpoint AmTech

So if you were to consider your West Bridge TAM to be 100, you’ve secured what percentage of that 100 in design wins? And then what percentage of that 100 are you presently, do you think you are presently shipping?

Dinesh Ramanathan

I don’t have -- so you have to bear with me, I don’t have exact numbers the way you have broken it up but we think that it’s a very small percentage of what the overall TAM is that we have secured design wins in right now and of the ones that we have secured design wins in, we are shipping to a very low percentage as well. So I say it’s about 50-50 design wins to what we are shipping.

Doug Freedman - Broadpoint AmTech

Terrific. Thank you.

Operator

Glen Yeung.

Analyst for Glen Yeung - Citi

Hi, this is [Ji] for Glen Yeung. I know that Cypress participates in the China wireless builds through SRAM. I was just wondering how you see that end market in the third quarter and if Cypress is benefiting there from penetration, increasing market share, sorry.

Brad W. Buss

-- half the accounts in Mainland China for the build-out, we are slightly increasing our market share as time goes on. Obviously there was a big build-out in the first half of the year. We are seeing though great decline in the second half and actually we’ve got desires we think as other cities, if you will, build out that we are going to see an actual rise probably over the next few quarters back up again. It’s stable right now.

Analyst for Glen Yeung - Citi

Okay, and you might have mentioned this earlier but can you remind us of the total TAM for PSOC 3 and 5?

Norman P. Taffe

The total TAM is around $12 billion for PSOC 3 and 5. The 6 represents just PSOC 1 and 3 TAM, which we currently service.

T. J. Rodgers

So PSOC 1, we currently ship into, was $1.5 billion. PSOC 3, which adds the rest of the 8-bit TAM to it and the low-end of the 16-bit, takes us from 1.5 to 6.2. PSOC 5, which is the 32-bit [arm quartex] base device, same peripheral PSOC technology, different processor, takes us from 6 to 12.

So PSOC 5 is actually in our fab right now and it will be our next big product introduction. So we are working on increasing our TAM as fast as we can.

Analyst for Glen Yeung - Citi

Okay, great. Thank you.

T. J. Rodgers

And then again, you’ve got a whole different True Touch TAM, the power PSOC, et cetera, et cetera, that aren’t part of those and like you guys, we’re trying to get our arms around kind of the touch screen TAM and I think Norm hit it best. I mean, it’s growing faster and quicker than we think and you’ll probably see more units outside of handsets than in handsets over the next few years, so something multi-billion dollar opportunity longer term.

Operator

Sandy Harrison.

Sandy Harrison - Signal Hill

Thanks for taking my calls, guys. A quick question on enviro systems -- you talked about a lot of the other initiatives here. Could you talk a little bit about sort of where things are in enviro systems and how that’s progressing and some of the other issues associated with the environment and green movement and how this plays into that?

Harry Sim

In terms of the progress, we are seeing good demand and good interest in two of our products right now that are specifically getting the interest. The wireless schematic thermostat, which saves energy and has a good play in the whole smart grid development right now, and I’ll explain that a little bit more. Also, the wireless gauge reader, where we’ve just formed a partnership with Honeywell. They started selling our product last quarter, and that’s through to different industries that they serve in 100 countries worldwide.

So first with the wireless schematic thermostat, what we found is a lot of interest right now in smart grid and when you have smart grid, you need smart buildings to connect to them and unfortunately, what we see is a lot of buildings right now are dumb. They are old buildings that have no communicating thermostats, no ability to be controlled, even if a utility, electric utility sends a signal out.

So we have a very low cost, very non-disruptive way to upgrade old buildings. That’s really our specialty, so we are seeing a very nice play to enable smart grid in that area and with the stimulus funding coming from the administration, Department of Energy, I think some of that will come into play probably at the end of this year, early next year.

And then the wireless gauge reader with Honeywell, that we’re seeing in new applications. Those are channels that we didn’t have access to before in areas like power generation. We’re finding pulp and paper and so on, so we see a larger TAM that we can now reach.

So really the focus for us is building channels, get touch points to market, and get the product out.

Sandy Harrison - Signal Hill

Thanks for that update. Just a quick clarification on a prior question on the True Touch and I guess T.J., you had asked when they could get to 10 million a quarter. Was that Q3 of this year or Q3 of next year?

Norman P. Taffe

This year.

Sandy Harrison - Signal Hill

Okay, gotcha. And then --

T. J. Rodgers

True Touch is a cell phone device. I mean, it will be in everything eventually but right now it is taking off in cell phones and all you need is a couple of design wins and the numbers get pretty big, pretty fast.

Sandy Harrison - Signal Hill

And then as we see greater economic recovery, and you look at sort of the SRAM market with the competitive landscape changing, what do you think the ASPs on that are going to be? Any change from in the past that should be able to provide some stability versus prior cycles, or has your position on that changed at all?

Dana Nazarian

It’s pretty stable and don’t expect any significant changes. The thing in memory though is more and more requirement for higher and higher densities, so the aggregate ASP for the ASPs are in general going up in our division because we are delivering more and more bits per unit shipped.

Sandy Harrison - Signal Hill

Okay, and then last, if I could, on the internal manufacturing or the flex fab strategy, T.J., you had mentioned that you thought you would be around 70% through the second half of this year. Where do you see six months from now, a year from now, a year-and-a-half from now -- ultimately your fab internal versus external mix going to?

Shahin Sharifzadeh

We expect this year to be about 70-30 internal versus external. Our long-term vision is to be about 50-50 internal versus external in the next couple of years, so we are executing on that.

Sandy Harrison - Signal Hill

Okay. Thanks for taking my questions.

Operator

[Sirini Pijirri], you may go ahead and please state your company name.

Sirini Pijirri - Analyst

Thank you. Brad, it looks like you have a lot of [payables] as you enter 2010 on the gross margin front. Obviously utilization is still 70% and a lot of new products have better gross margins. I’m just wondering, I mean, why wouldn’t you expect the 50 to 55 [inaudible], why are you kind of taking a little bit of a cautious stance there?

Brad W. Buss

It’s just the type of guy I am -- you know that.

Sirini Pijirri - Analyst

Yeah, yeah, right.

Brad W. Buss

Again, we feel very comfortable. I mean, I’ve been pushing up to 50, saying we could do low 50s to mid 50s. It’s just -- you know, the economic times, mix, you know -- who knows? I think it’s going to happen. I am very confident. We are modeling towards it. We are moving towards it. We are talking to our own board about it.

It’s just a little far out right now to be saying for absolute certainty. I think by the end of the year, going into next year, we’ll be able to give a lot more clarity on that. But I am comfortable in you guys starting to move up north of 50, no problems. And again, especially with the opportunities in Norm’s area, to his point, the value add that we’re bringing in our PSOC products and with more of a software sell, is very big and it’s very competitive. And as we move more to the fab, like Shahin said, that’s going to continue to grow. You know, if we didn’t have the flex fab in this quarter, we would have been in a little bit of a pickle trying to meet all that demand, so we are very committed and you’ll see that continuing and driving further cost savings as well.

Sirini Pijirri - Analyst

Okay, and just for modeling purposes, Brad, as we enter 2010 first half, you know, obviously utilization probably will come down a bit. Should we model gross margin down or do you expect it to be kind of flattish and then go up from there?

Brad W. Buss

Again, it’s a little hard right now but I would say if I looked at Q1, I’d say flattish. I don’t expect any material swings between now and then.

Sirini Pijirri - Analyst

Okay, got it. And then just a couple of questions on the True Touch -- obviously you guys have had a lot of success and a lot of buzz about the touch market. My question is, I mean, what do you worry most about in this market? Are you seeing any new competitors out there or you know, some of the issues that you can talk about for the next couple of years?

Norman P. Taffe

As far as competition in this space, it’s a very exciting market. There’s going to be lots of competitors, no doubt about that. I think the broad growth of the market and the move from resistant to capacitive is going to make a lot of room for a lot of people to succeed. We are very confident in our position. We’ve gotten very good technology. It’s very flexible and we are right now, we are quite sure we’re gaining significant market share in terms of design sockets and we intend to keep doing that. But it’s definitely going to be very competitive. Any market that has grown this fast attracts a lot of people trying to get into it.

T. J. Rodgers

Let me give a little color to that, talk about Cap Sense -- we got in the cap sense market by taking actually a PSOC chip, running [out a sense capacitant] and getting early market share. That was a big market, it attracted a lot of attention, primarily microcontroller companies. They came in later, design custom microcontrollers with the right kind of peripherals to sense capacitors.

The third wave after the microcontroller guys are the Taiwanese guys who typically come in super cheap on the very low end. So for example today, if you want to buy a two-button capacitor sensing chip for a rice cooker, how much is it?

Unidentified Participant

$0.25, $0.30.

T. J. Rodgers

Thirty cents -- so the name of the game is to get in first, to hold the high ground, and then of course we are as good as anybody at cost reduction. You know, we’re a RAM company -- we understand that and we have now got some super low cost Chinese foundries so that we’ve got all the capability to do it.

So right now, we’re at the front end of that. We’re just being able to do it, is all that matters. Being able to give somebody the capability to get touch screen in the marketplace is a big deal and this market, it will get more competitive over time.

The advantage of PSOC, if you get there first is that there’s always other stuff that you train your customers, or they come to know that they can do. They can go change their hardware and they can do it in a day and they can come out with a new product. They can -- but they don’t have to change the manufacturing, they don’t have to buy the chip, they don’t have to prototype something else, learn a new operating system, none of that.

So when you get in first, you are pretty difficult to dislodge as long as you provide them the cost curve that they are looking for. So we got in early in the cap sense. We are still I believe dominant -- is that true? Number one in cap sense. We are expecting a lot of them to come after us and obviously we are not going to be standing still.

Sirini Pijirri - Analyst

Got it, and Brad, finally back to you, on the OpEx front, you talked about some of the bonus and pay plans maybe reverting in the next few quarters -- how should we think about it, assuming that you bring back all the pay cuts that you have done in the last six months? What’s going to be the magnitude of that, just assuming that it just comes back to previous levels?

Brad W. Buss

It depends on the size of the pay increase T.J. gives me, but I would say to my earlier comment though, I mean, we are reducing costs and reallocating dollars in other areas, so I don’t expect a full reversal to come hit us. It will be some proportion of it.

You know, as business keeps trending up, do we move up a million-ish or two million-ish maybe a quarter is probably all I would see in the short-run. I don’t see us zooming back up to an $80 million non-GAAP number anytime soon, if that’s where you are going and concerned about.

I mean, we are looking internally trying to make sure that we could take 70%, 75% of the incremental GP and drop it right through to the bottom. That is how we are trying to manage to, at a max.

Sirini Pijirri - Analyst

Thank you.

Operator

John Barton.

John Barton - Cowen

Thank you very much. If I could go back to the comments about touch screen and the competitive dynamics, I don’t know, T.J., Chris, whoever, or Norm -- but what are the current dynamics when customers are looking at silicon solutions versus sub assemblies? How much engineering expertise is out there in the customer base? How much do customers really want to have control of the firmware so they can make changes, et cetera? I mean, how do you see that today and how do you see that playing out over the next year or so?

Norman P. Taffe

Good question. As far as the evolution of that space, certainly one of the things I think driving our success right now is we’ve definitely seen it move from a -- the large suppliers looking for a silicon based solution as far as versus maybe the very early market, more module based. So they do want more control over the supply chain. I will tell you that one of the things that allows us to differentiate and keep the real players fairly small at this point is there’s a ton of expertise required, not just in terms of the product itself but in terms of understanding the whole stack-up in terms of the screen itself, the IPO material -- that it is not a simple market from that standpoint and still all of the largest handset players do rely on the touch screen solution providers to have significant investment in terms of supporting them and helping them design these touch screens. They are not -- it is a much more difficult problem to solve than the cap sense problem, even though it’s based on similar technology. [I’d say that’s a good thing.] It allows us to differentiate.

But we have moved into the phase where we see the predominant design [inaudible], silicon based, looking for us to provide the silicon while they choose the partners. And our early on strategy of partnering with every major ITO supplier, we think is starting to pay significant dividends in terms of design-ins.

I think that will still play out for the next year-and-a-half or so, where the complexity will drive us this way. Over time, you know, the benefits we bring in software in terms of the -- adding features, you know, a good example, just the immersion announcement we made in this press release where it’s another capability that because we have a programmable solution, they can now add that [inaudible] capability on a touch device that’s programmable, and now gives that [inaudible] in the same location as the touch but also improves the performance of [inaudible]. It’s not just run by a different processor. Again, that is another key thing and as we continue to add those kinds of features, it makes it harder and harder for other people to get designed in. That’s key to the strategy.

T. J. Rodgers

On your specific question of module versus chip, in the beginning you have a strange new thing like a touch screen and all you want to do is get in the market and have your touch screen be competitive, you are tempted to go to a module. What happens though is very shortly thereafter with cell phone manufacturers, you want to disaggregate the supply chain. You do not want to be paying a module manufacturer mark-up for an LCD screen, for example, you could buy yourself probably cheaper than the module manufacturer could.

So we’ve focused on what we do, which is silicon, and getting that right and partnering in the module side as opposed to trying to make modules.

John Barton - Cowen

Great, and if I could also, Norm, go back to a response you gave about tracking development kit sales -- any interesting trends with respect to now that you have the PSOC 3 development kit out there, as far as initial ramp, how it compares to the initial ramp of previous generations? Any trends that you are seeing as far is it primarily existing customers upgrading to the next family or is it truly getting into those other verticals already?

Norman P. Taffe

One thing I’ll state on the PSOC 3 -- we had tremendous traction right away, although I will tell you that we didn’t broadly introduce it. Actually, we will broadly introduce PSOC 3 and 5 -- so that’s when we do kind of the public launch. So while we brought the product out, we only brought it out to a subset of the customers.

I will tell you the hit rate on those customers and active designs is much higher than we had in the PSOC 1 generation. I think part of that is because it’s more well-known technology. I think also part of it is frankly the software and silicon is just way better.

So we have a lot of traction but I will tell you the numbers aren’t the same because we have introduced it to a minimized base at this point. We just now have opened up to essentially all of our direct OEM base just two weeks ago and then we will do broad public launch at the end of the quarter. At that time, I’ll be able to give you more kind of apples-to-apples numbers but I expect them to be far higher.

T. J. Rodgers

I think one of the things you guys need to keep in mind, right, with this is moving us more higher end motor control, industrial, medical, the design win cycles are going to be longer and with it not being a consumer focused product, you are not going to go from zero to $10 million in some company in nine months or a year, like we had some early big hits in PSOC that allows you to accelerate. This is going to be a constant, growing, you know, design win laying in revenue for again multiple, multiple years. I don’t think you are going to see one design win being a $20 million opportunity, like we could see in the other areas. But that could happen.

And the thing like I said that I’m excited is opening up beyond the TAM dollars at end markets and customers we’ve never touched. So we now have the ability, you know, to cross-sell other parts that PSOC hasn’t sucked up already into that BOM.

John Barton - Cowen

Last question, if I could -- Chris, you talked about lead times going out a little bit, trying to keep things in the four to eight week range, when you look out across the industry, and obviously we are trying to turn capacities back on, how far are we from having the real challenges associated with that? So as an example, obviously Xilinx talked publicly about the fact they had some supply constraints. Are we getting anywhere near the point where customers are not going to be able to get specific products and whether company A is a given cause of the problem, it doesn’t matter because the customer isn’t bringing them the [BOM] until they can get all the parts and where do you think we are in that kind of continuum?

T. J. Rodgers

I can only give you my own personnel anecdotes from all the travels I did the past quarter. I actually had a guy at one of our major accounts tell me in a meeting he’s never scrambled so hard to get so many parts, even in this downturn. So I think there are going to be spot shortages.

Now, the counter to that is there is a lot of capacity that was idle and I think we are a good example of that. We’ve reinvigorated our capital or capacity and put it back online and others are having to do that.

So I think we are going to see momentary shortages all along the line but until we get back to those run-rates that we were at, 12 months or more ago, that’s when we are really going to challenge the capacity in the industry and most of the press releases of late have been on the advanced technology nodes and that’s when people were marching down the technology curve and that’s why they are having those problems.

John Barton - Cowen

Thank you.

T. J. Rodgers

I think the industry has -- I won’t say overreacted but reacted very rapidly to the downturn in the economy. You know, our own inventory down 10%, more disconcerting to me is distribution inventory down 9%. And we are basically making them as they use them, and I won’t say there’s a problem yet but let’s just say I personally go to meetings every single week where I watch this thing because as a proprietary product company, we can’t tell them okay, you know, [inaudible] is from Samsung or anything like that anymore. We have to ship on time 100% and I am working on that problem right now.

John Barton - Cowen

Thank you.

Operator

Chris Danely.

Chris Danely - J.P. Morgan

A question for T.J. or Chris -- can you guys just give us your sense or take on the end markets, you know, which you think are stronger, which you think are weaker and what you expect for the second half of the year?

Christopher A. Seams

I gave some flavor to it. For us, we are seeing end market growth. You could call it recovery from last year but most of that is happening in the consumer and PC space. In the wireline and wireless infrastructure markets, we are seeing stability. I talked about us gaining share there. And in the handset market, there’s been some recovery in terms of units there but frankly, it’s a penetration play for us with True Touch, with cap sense, and with West Bridge. So that’s a big, big market and we just continue to penetrate it.

Chris Danely - J.P. Morgan

And then how about the industrial market? There’s been a lot of chatter that it might be bottoming. Are you guys seeing any stability or any up-tick there?

Christopher A. Seams

No, we are not seeing an up-tick. It’s one of our slower markets. Frankly we’ve benefited from -- we lump military and industrial together when I look at my numbers and frankly, we’ve done a great job in the military sales reinvigorating that and frankly the end markets wanting more units in that front lately.

Chris Danely - J.P. Morgan

Okay, and then Brad, when you talk about gross margins recovering to 50 or 50 plus next year, by segment, do you expect all of your different operating segments to get back or above their peak gross margins or will some do better than the others?

Brad W. Buss

I think they all will. The only caveat is like BCD -- it could flop around by quarter, depending on end of life stuff and TLVs or military. But yeah, I would say they all will and I think you will see CCD and then really MID benefiting more really than BCD and part of it is just their size, right? You know, they are a bigger chunk of the company and Norm has more and more of his stuff going to the foundries quicker, so the good thing is they are growing in the area that we want them to and they are going to be driving a lot of the incremental profit that we are talking about.

Chris Danely - J.P. Morgan

Sure. And then last question, I guess on the MID or the SRAM market, you know, it bounced nicely. It seems like it’s going towards a more normal growth pace. We all know it’s kind of tough, it has some commodity aspects there. I mean, how do you guys expect to gain share and maintain margins there?

Dana Nazarian

The same old fashioned way -- we simply have the broadest portfolio, we have the best technology and we have the best customer service, so we’ve been winning share consistently and there’s no change to that formula. We’re bringing out our 65-nanometer product. Shortly thereafter we are going to have another high density product and slowly and surely, the end customers are lining up with us because they we are going to win in the end.

Chris Danely - J.P. Morgan

Got it. Okay, thanks, guys.

T. J. Rodgers

Chris, we look at the SRAM market -- it’s really got a couple of parts to it. The commodity SRAMs are [asychronisthetic] RAMS and micro power [asychronisthetic] RAMs. And a couple of years ago, we moved the entire business unit, including the business unit managers, to Bangalore. So we now can make a profit, even in the mid-30s for gross margin, make a nice profit, even in mid-30s on gross margin in that group.

The other kind of SRAMs are the 65-nanometer [synchronisthetic] RAMs that go into routers, and that’s more of a high-tech play that is run here out of San Jose. So that’s our strategy for maintaining market and gaining share in the static RAMs. We’ve been doing static RAMs, our first product in 1983.

Brad W. Buss

I know a lot of people still have this memory bias and they lump all the memories together but even this quarter and in Q1, the money that Dana made in SRAM has been quite nice. I mean, he will be well north of 20% on a normalized basis going forward, which is something pretty darn nice.

Operator

Jeff Schreiner.

Jeff Schreiner - Capstone Investments

Thank you very much for taking my call, gentlemen. One comment I think you guys touched on a little bit that I would like to get a better grip to get my hands around a little bit better is understanding the growth of the touch screen handset market relative to who is taking share and is that share taking from current competitors already in the market or is the market growing enough at this point, do you believe, that all parties are actually winners?

Norman P. Taffe

I think that it’s a difficult question to answer. I think there’s some share taking from others. I think most of it though is that there’s very broad growth. I think the number of phones, you know, two benefits in the phone space -- one is there is more phones going into kind of that smartphone feature set that wants it and then we are seeing touch screens actually start to slip right down into more of the feature phone level. So even within the handset space, touch is going to become a much more common technology and therefore really drive significant volumes. At the same time, I think we are taking share as far as new design sockets but I think there is plenty of room for multiple companies to grow in the near-term.

Jeff Schreiner - Capstone Investments

Okay, just another question kind of staying around touch and looking at cap sense and the momentum, it seems you guys have been gaining across several markets, more importantly I’m trying to focus on and get an idea of maybe what’s the opportunity here in the next few years in the white goods and industrial market? And is that an opportunity that could be quite larger than the consumer opportunity?

Norman P. Taffe

Good question. I think the opportunity for stable consistently growing business is higher in those spaces. I don’t think the volumes will quite hit it but I believe that will be a foundation which will continue to grow for literally 10 years, and we are seeing that in the white goods space become the direction. But it does grow much, much slower, so from a magnitude standpoint, it will be interesting how big it gets. But I’ll tell you, it’s going to be long, stable growth and a core business which isn’t quite as dramatic ups and downs as we see in the consumer space.

Jeff Schreiner - Capstone Investments

Okay. Final question, just wondering kind of within the West Bridge market, kind of a state of the union maybe amongst competitive solutions or alternatives and maybe how West Bridge sticks out or stands out amongst those offerings.

Dinesh Ramanathan

So one of the things that we have been doing in order to make sure that our value proposition is actually very clearly articulated is we have been talking to our customers’ customers, so this happened to be some of the carriers that are out there, to make sure that they are able to understand and articulate the value of what we are bringing to the table. And we’ve seen a fair bit of up-takes there, primarily because the carriers understand the value of what we bring to the table.

Carriers are fundamentally moving away, or moving from music to being able to put video onto the handsets and primarily in smartphones and in feature phones, as they call them, and that is basically causing a lot of data that needs to be moved from your lap top into your handset. And this was where the West Bridge part actually makes a significant contribution in reducing the amount of time it takes to move a large amount of data.

So that value proposition, we are seeing acknowledged by the people that we end up selling our part to and the people that they end up selling their part to as well. So overall, we are seeing good traction in that marketplace and we hope to convert a lot of the traction into revenue as we go forward.

And as I mentioned before, we have design wins and design activities that are going on at our customers. We need to take advantage of that and bring them to revenue in the next few quarters.

Jeff Schreiner - Capstone Investments

Thank you very much.

Operator

Thank you. And our last question comes from Adam Benjamin.

Adam Benjamin - Jefferies

Thanks, guys. Nice job. Just a couple more follow-ups on the touch side -- I think last call, you talked about having design wins norm with all five of the tier ones. You announced the LG KS360 back in February and you announced the Omni HD today. If you look out to the back half of this year, on top of those that you are already shipping, can you talk about how many other tier ones you expect to ship this year and roughly how many models you are looking at?

Norman P. Taffe

It completely depends on the end customer but I will tell you we are shipping in some where they just don’t want us to announce that, even if it’s publicly known, so there’s additional ones that we are already shipping in.

I think what I can say is we do have wins, and design wins at six of the top eight and we are quite active on a seventh of the top eight suppliers, so that momentum continues to kind of what we described earlier.

As far as shipping before the end of this year, looking over at Chris I believe I guess the answer is --

Christopher A. Seams

We’ll ship at five or six of those -- probably seven [inaudible].

Norman P. Taffe

Yeah, I would say that, so there will be first shipments there. Now, whether we announce them or not, it really highly depends on how open they are in terms of disclosing what technology -- I mean, we do whatever the customer’s preference is there and a lot of the customers are very sensitive about that but we are getting -- having quite a bit of success at all the top guys, really.

T. J. Rodgers

And the other thing too is we’re finding you are getting more design wins, the attach rate is far greater at each of these than we expected going in, so --

Norman P. Taffe

Yeah, I think it’s safe to assume that if we get a win, we get more than one win and in some cases, we literally at some of the top tiers got double-digit wins, and in most -- very few of those are shipping as yet.

T. J. Rodgers

So I think the way to look at it too is the number of design wins in individual handsets, which we are not going to get into a practice of going down to the number or which ones, and I know you guys like to track them but as Norm said, from a customer standpoint, we just cannot do that and we are not going to go down that level. But we are shipping on a very small number of the wins right now. That’s why we have a fairly high confidence on that $100 million mark that we talked about.

Adam Benjamin - Jefferies

That’s fair enough. I appreciate the color. With respect to the economics, Norm, you talked a little bit about the chip and various module solutions. Can you get a little bit into the more detail there as you -- you looking at a handset OEM and the economics that they are looking at as they decide or evaluate a chip solution from you or a module solution from a competitor?

Norman P. Taffe

Well, I’ll try to add some color but I think that most of the direction we are seeing is that they are moving a little more toward owning, disaggregating that value chain, as T.J. said earlier, so we see most of the pull there. They often want to tell us exactly who those partners are and then when there is a partnership that’s required, it’s not a -- there’s still a custom side to the business in terms of matching up glass to device to software. So I’m kind of not sure exactly what you are asking but we definitely think the model that we are approaching is the approach that’s winning right now and expect that to continue for the foreseeable future.

Adam Benjamin - Jefferies

I was just looking, Norm, if you could give some way of analyzing how they are approaching a chip versus module solution in terms of, as you said, disaggregating the supply chain and what the economics could be in terms of savings potentially that you go in and pitch as a chip solution versus module?

Norman P. Taffe

You know, from our perspective, we mostly pitch the capabilities to bring on the device and then what they tend to do is they tend to -- they are able to essentially get competition not just on total solution, given only by one supplier, but they can get competition on the glass supplier, on the IPO supplier and for that way, they can offer a better one.

You know, we don’t go in there saying hey, you go with our chip solution, we’re this much, we’re less expensive. Frankly, right now we go in saying if you go our solution, our technology, the performance of your phone is better because you get multi-touch all point, you get much better response. That’s really the center of what we focus on. The economic case I think is quite a bit -- is obvious to them and they have control over that because they know where they can get their glass and their overall module suppliers sales down to, or prices down to.

Adam Benjamin - Jefferies

Brad, just one last question for you -- I apologize if you’ve already answered this but SRAM and 65-nanometer, what’s the percentage or rough percentage of mix today and where do you expect that to go as you go or finish next year?

Dana Nazarian

It’s just ramping up now, so we’re just ramping initial mass production this past quarter and we are going to convert essentially our entire synchronous product line over to 65-nanometers over the next year-and-a-half, so it will ramp linearly from zero to 100% over the next few years.

Adam Benjamin - Jefferies

Thanks a lot. That’s all I have.

Dana Nazarian

Just to be clear, that’s about a little bit more than half of the total SRAM volume.

T. J. Rodgers

And it’s important that you guys understand the synchronous part of it, not the [inaudible] thing.

Dana Nazarian

Right, the lower end, legacy SRAM that T.J. discussed running out of Bangalore, those will remain on the current technology nodes.

Adam Benjamin - Jefferies

That’s all I have, guys. Thanks.

Operator

At this time, I’m showing no further questions. Sir, I’ll turn the call over to you for any closing comments.

T. J. Rodgers

Thank you very much for calling in. We reported a quarter with a significant up-tick and good projections for the next quarter. Thank you very much.

Operator

Thank you. You may go ahead and disconnect at this time. This does conclude today’s Cypress Semiconductor conference call. Have a nice day.

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Source: Cypress Semiconductor Q2 2009 Earnings Call Transcript
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