Microsemi Corporation F4Q09 (Qtr End 27/09/2009) Earnings Call Transcript

Nov.12.09 | About: Microsemi Corporation (MSCC)

Microsemi Corporation (NASDAQ:MSCC)

F4Q09 Earnings Call

November 12, 2009; 04:45 pm ET

Executives

Terri Donnelly - Coordinator

Jim Peterson - President & Chief Executive Officer

John Hohener - Vice President & Chief Financial Officer

Steven Litchfield - Executive Vice President - Analog Mixed Signal Group

Analysts

Craig Berger - FBR Capital Market

Tore Svanberg - Thomas Weisel Partners

Quinn Bolton - Needham & Co.

Rick Schafer - Oppenheimer

Harsh Kumar - Morgan Keegan

Romit Shah - Barclays Capital

Andrew Huang - GC Research

Steve Smigie - Raymond James

Nicholas Aberle - Caris & Co.

David Wong - Wells Fargo Securities

Christopher Longiaru - Sidoti & Co.

Craig Berger - FBR Capital Markets

Steve Smigie - Raymond James

Operator

Ladies and gentlemen, thank you for standing by and welcome to Microsemi fourth quarter and fiscal year end conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question-and-answer session. (Operator Instructions)

I’d now like to turn the call over to Terri Donnelly to begin.

Terry Donnelly

Good afternoon and welcome to Microsemi’s fourth quarter and fiscal year end 2009 conference call. I’m Terri Donnelly, Coordinator of this call. In a few moments you will hear from and have an opportunity to ask questions of Jim Peterson, our President and Chief Executive Officer; and of John Hohener, our Vice President and Chief Financial Officer.

A recording of the conference call will be available on the Microsemi website under the investor section. Our website is located at www.microsemi.com. Microsemi issued guidance in the Form of a limited business outlook, on our expectations for the next quarter.

This business outlook reflects our expectations as of November 12, 2009 and is continually subject to reassessment due to changing market conditions and other factors and therefore must be considered only as management’s present opinion and the actual results maybe materially different.

However, management undertakes no obligation to update these or any forward-looking statements, whether as a result of new information, future events, or otherwise. If an update to our business outlook is provided, the information will be in the Form of a news release. We wish to caution you that all of our statements, except the company’s past financial results are just our opinions, predictions and present expectations.

Actual future events or results may differ materially. For a review of risk factors, please refer to Microsemi’s report on Form 10-K for the fiscal year ended September 28, 2008, which was filed with the SEC on November 21, 2008 and our Form 10-Q for the quarter ended June 28, 2009, which was filed with the SEC on July 30, 2009.

That said, I’m going to turn the call over to John to discuss our financial results and then Jim will address our end markets and overall business strategy. Here is John Hohener.

John Hohener

Thank you, Terry. Net sales for the quarter ended September 27, 2009 were $109.7 million down 18.6% from $134.7 million reported in the year ago fourth quarter, but up 2.5% from $107 million in the third quarter of 2009. Net sales for the full fiscal year were $453 million, down 11.9% from yearly sales for fiscal 2008 of $514.1 million.

Non-GAAP gross margin for the quarter was 48.6% compared to 52.5% in the year ago fourth quarter, but up from 47.2% in the third quarter of 2009, an increase of 140 basis points. We continue to improve our factory utilization including improved cycle times and yields allowing us to permanently cut costs in the manufacturing area.

This quarter non-GAAP, selling general and administrative expenses were $18.1 million or 16.5% of sales, compared to$ 21.1 million or 15.7% of sales in the fourth quarter of last year and it compared to $19.1 million or 17.9% of sales in the third quarter, a reduction of $1 million primarily due to reduced legal expense.

Looking to the next quarter we expect SG&A to trend up approximately $500,000 as we return to more normalized prepaid practices for our workforce. Research and development costs were $10.4 million from 9.5% of sales for the quarter compared to $11.5 million or 8.6% of sales in the year ago fourth quarter and $10 million or 9.4% of sales in the third quarter of 2009. We expect R&D to trend up approximately $500,000 in the next quarter.

Our non-GAAP operating margin was 22.6% for the quarter compared to 28.3% in the prior year fourth quarter and up 260 basis points compared to 20% in the third quarter. Non-GAAP net income for the quarter was $19.3 million or $0.24 per diluted share compared to $29 million, and $0.36 per diluted share in the year ago fourth quarter and up $2.6 and $0.03 from the $16.7 million and $0.21 per diluted share reported in the third quarter.

For the fiscal of diluted earnings per share was $0.99 compared to$0.33 in fiscal 2008. Our non-GAAP effective tax rate was $19.6 in the fourth quarter compared to 21.5% in the third quarter. During the quarter we accrued reserves associated with the sale of our Colorado facility, the planned closure of Scottsdale facility as well as other headcount reductions.

GAAP gross margin was impacted by non-cash expenses of $7.3 million. Excluding the impact of these items our GAAP gross margin was 45.1% compared to 46.8% in the year ago fourth quarter and 42.2% in the third quarter, an increase of 290 basis points. GAAP gross margin in this quarter included $3.8 million for transitional idle capacity, a reduction of $1.5 million from the previous quarter.

In addition, operating income was affected by restructuring related items of $13 million, about 50% of which was non-cash. GAAP results in the fourth quarter also included non-cash charges of $6.3 million for stock-based compensation and $4.2 million in amortization of acquisition related intangibles and 800,000 of other expense.

In conjunction with worldwide operating strategy, which includes the previously announced closure of our Scottsdale facility, we recorded a non-cash valuation allowance on our deferred tax assets related to our U.S. operations and related income. Including the effects of these operational and valuation accruals we recorded a GAAP net loss of $31.3 million in the quarter. U.S. portion of our total income improves, the valuation allowance will be reduced and our GAAP tax rate will improve.

Capital spending was $2.5 million this quarter compared to $2.8 million in the third quarter. Depreciation and amortization expense for the quarter was $8.3 million compared to $9.1 million in the third quarter. Accounts receivable decreased by $12.5 million from last quarter, improving our DSO from 63 days to 57 days. Inventories also decreased by $16.8 million from last quarter, $7.3 million, which was due to the Scottsdale closure, but still a significant amount due to yield predictability, coupled with cost improvements at our manufacturing facilities.

Our days of inventory decreased 15 days to 168 days. Once again, cash generation was very strong. For the quarter, our operating cash flow was $30.7 million, and our free cash flow was $28.2 million. For the year, our operating cash flow was $105.6 million, up 15% from the prior year and free cash flow was $92.9 million up 39.5% from the prior year. Cash reached a record level of $216.7 million at the end of our fiscal year.

Our book-to-bill ratio was greater than one-to-one. Our best estimate of the end of market percentage breakout of net sales for the fourth quarter was approximately defense 40%, commercial air and satellite, 24% medical, 12% notebooks, LCD TVs and displays 7%, mobile connectivity including POV 11% and industrial semi-cap 6%.

Now for a business outlook, for the first quarter of fiscal year 2010, we expect our net sales will increase between a range of 1% and 4% sequentially. As a reminder, we sold SEMICOA last quarter and as such it will not contribute to this growth. On a non-GAAP basis we expect earnings for the first quarter of fiscal year 2010 to be $0.24 to $0.26 per diluted share.

With that, I’ll turn the call over to Jim Peterson.

Jim Peterson

Thank you, John for detailing our fourth quarter and year end results as well as updating everyone on the continued initiatives to improve profitability. As I do each quarter, I’d like to give all of you some detail on each of our reported end markets with some color as to our view of the current climate as well as long term objectives and opportunities. Microsemi has focused greatly on optimizing a business model and cost structure as designated for growth and improving profitability.

Going forward, we project our growth will come from continuing contribution of our core end markets and share gains as we entered new and adjacent markets through organic product introduction and accretive acquisitions. Our projected profitability will be realized from cost cutting and streamlining the organization as we executed on integrating acquisitions and realizing more operating efficiencies by moving efficiencies to lower cost regions as evidenced by the announced closure of our Scottsdale facility.

Now, let’s go to the results for the quarter, let’s start with commercial markets. We recorded strong results in our notebook, TV and display, end markets, with this market up 45% sequentially. In this market strong CCFL Backlight sales are driven by LCD TVs seasonally and market share gains offset somewhat by a slower notebook CCFL and automotive display revenues.

In addition to the focus, on LEDs, CCFL TV applications will be a growth market in 2010 and beyond for Microsemi as we’re encouraged by our growing market share, not just with Tier 1 suppliers, but also increasing with large manufacturers on the Chinese mainland. We see years of growth ahead and CCFL backlighting for TV. We’re also excited about LED Backlight opportunity that is recently the focus of our investors.

Having the broadest LED Backlight portfolio in the market today, we are engaged across the board in Tier 1, Tier 2, OEM and ODM is that all screen sizes and for all LED Backlight solutions, including edge lighting, scanning backlighting, direct backlighting and RGB backlighting.

In the September quarter, we’re please to have commenced volume shipments of LED backlight solutions for both TV and notebook applications. We look forward to reporting our progress in this emerging market in the quarters and years to come. Our mobile and connectivity end markets comprise of PoE and wireless LAN, continue their comeback in the fourth quarter growing 22% sequentially.

Enterprise drive PoE revenues while slower out of the box than a more consumer targeted products have begun to hit stride as a result of strong demand in the quarter for our midspan solutions and our IC products.

We expect continued near term strength in this business. High performance wireless LAN applications continue to drive demand for our products and we are growing through Reference Designs for wireless access points, netbooks and growing consumer applications. We are encouraged by improving trends, our industrial and semi cap markets. Our semi cap customers are to express some cautious optimism resulting us in cling in orders.

Moving on to higher liability markets, medical was down in this quarter as forecasted. We saw lower ICD revenues due to the fact that over the course of the last year, we supported a new platform launch for our largest medical customer by filling the product pipeline. We are pleased at this launch was successful and reporting our customer is consuming this product at a level such as the scheduled deliveries will be at a much higher rate within the next two quarters.

We’re aggressively engaging with other customers to drive Microsemi content into their applications. In conjunction with Scottsdale shutdown, we’re in the process of moving this product line to a lower cost structure location, in order to maximize our operational efficiencies.

Another component of our medical market is MRI. The market environment and the lack of capital continue to pressure the MRI market. We expect to see this ease in 2010, the medical market continues to be a focus for Microsemi and we believe at the strength of our new product roadmad and design win activity will contributed to good, long term growth in this market.

Our satellite and commercial aerospace and end markets grew sequentially, notwithstanding our disposition of the semi business. Satellite continues to grow for Microsemi, as a result of organic plus acquisition formula for increasing our footprint. Our new Rad Hard mass ware devices have generated substantial interest and we’re seeing revenues from this Rad Hard introduced in the current. Expect a long list of space level product successes from Microsemi over the next several years.

We continue to believe in the commercial aerospace markets are bottoming and are poised for resumption of growth in 2010. Recent IATA data shows improving trends for passenger and cargo traffic and rising seat capacity numbers suggesting stronger refurbish from revenue, going forward, as well. Commercial aerospace is a cyclical market and our revenues have been affected as much as anybody else’s, but our diversity helped us manage this downturn.

Our defense end markets continue their steady contribution again this quarter. We’re benefiting from our footprint and stable environment for our customers now that the 2010 budget has passed and our focus on the changing nature of Electronic Warfare, which we plan to exploit through organic product development and select accretive acquisition.

We strive to double our SAM in the next several years. We’re confident, but we continue to outpace the market growth. To the sharp our balance growth model served us well by design our business model has continue helped us outperform our competitors. Before we turn to your questions, let’s just review the highlights for the quarter.

Revenue was up, gross operating and margins continue to strengthen both GAAP and non-GAAP. We continue to reduce our transitional idle capacity with another reduction of $1.5 million. Our DSO materially improved, our inventory level continues to drop. We had a positive book-to-bill. Last but not least cash flows were $92.9 million up 39.5% year-over-year.

We thank you for your interest and support now we’ll turned over to questions from our analyst.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Craig Berger - FBR Capital Market.

Craig Berger - FBR Capital Market

I guess first of all, we still on track for next quarter to be the last quarter of transitional idle capacity charges?

John Hohener

Yes, that is the case.

Craig Berger - FBR Capital Market

Then as part of the Scottsdale fab closure, you just help us understand the timing of that and I guess what resources are being expended in order to re-qualify those products and how far along into that process we are?

John Hohener

As we announced in our press release from a few weeks ago, one thing that’s going to happen is we’re going to see expected savings in the neighborhood of $20 million to $25 million on an annualized basis. At that point in time, which is expected to be completed in an 18 month timeframe that will effectively increase our gross margins somewhere in the neighborhood of 400 to 500 basis points and, as you know that translates somewhere in the neighborhood of $0.20 EPS improvement.

From a cost standpoint we have been transitioning up to this point and taking some cost out and that’s one reason you’ve seen a material improvement in our gross margin this quarter, as well as the last several quarters, our GAAP gross margin up 290 basis points going from $42.2 to $45.1 and our non-GAAP up 140 basis points going from $47.2 to $48.6.

Craig Berger - FBR Capital Market

In terms of re-qualifying the products, how far along in that process are we?

John Hohener

At this point in time we have talked to customers. They’re obviously aware of what we’re doing, and we’re in the process of re-qualifying the products and it will happen over the next 18 months.

Craig Berger - FBR Capital Market

Then I guess the other question I had is the high role business is sold out 75% of overall revenues?

Jim Peterson

Exactly, and in fact pretty close to 75%, 25% at this point.

Craig Berger - FBR Capital Market

So my question is that the new mix that’s about 10 points higher than you guys used to run.

Jim Peterson

Just like most of the market realize there is great strength in our Analog Mixed Signal business. I like the trend the way it’s going, 70:30 doesn’t bother me as well. I mean the ultimate solution is both of the groups are making money and growing and profitable. I’m okay with 70:25, or 70:30, I mean 60:40 mix, my friend.

Operator

Your next question comes from Tore Svanberg - Thomas Weisel Partners.

Tore Svanberg - Thomas Weisel Partners

First of all, was the SEMICOA contribution to the September quarter?

John Hohener

There was very modest because we sold them early in the quarter.

Tore Svanberg - Thomas Weisel Partners

Could you just qualitatively talk a little bit about the guidance as far as visibility and backlog coverage is concerned?

John Hohener

Can tell you right now the backlog is word for use given internally robust. Let’s talk turns, give me the quarter we’re about 33% which is pretty common with us, historically. You don’t mind if I throw in lead times in there at the same time in this one, because it’s pretty much falls in the same bucket, our lead times, for analog mixed signal, mobilize usually on 12 or 14 weeks. Last quarter our lead times were six to eight weeks.

So I think in all the side same thing this quarter, overall pretty much normalized 20 to 30 weeks. Last quarter they were up 15 to 26 weeks and most of that efficiency is because of our improvement in cycle times or lead manufacturing. So Hi-Rel probably 15 to 26 weeks, satellite, normal backlog, 36 weeks and you’ll see that again on or about 36 weeks.

Tore Svanberg - Thomas Weisel Partners

A question on gross margin, if I do the math correctly here on revenues and EPS, is it safe to say that gross margin could be up potentially another 100, 150 basis points next quarter?

John Hohener

No, I mean right now I would factor in somewhere in the neighborhood of 20 or 30. We took a big step this quarter, most of that surrounding our Colorado closure, as well as the first step in Scottsdale. Right now we’ll see improvements more in terms of the traditional yield enhancement and so on, until we take the next step in Scottsdale over the next 18 months.

Tore Svanberg - Thomas Weisel Partners

Then last question, Jim, you mentioned you already had production volumes for LED and notebooks and TVs, are these Tier 1 customers you’re shipping to already?

Jim Peterson

Yes, most certainly Tier 1 customers’.

Operator

Your next question comes from Quinn Bolton - Needham & Co.

Quinn Bolton - Needham & Co.

You guys took a lot of charges this quarter. It looks like for both Colorado and Scottsdale. So I’m wondering going forward are we going to see much smaller charges for Scottsdale or do you think you’re going to see continued charges for Scottsdale over the next year as you shutdown that facility?

Jim Peterson

As we said in our press release of Scottsdale, a couple of weeks ago I think the number was $3 million that we will expect to see over the next 18 months, as we incur those and then the final days, when we actually do close them out at 18 months there maybe some incremental charges as well.

Quinn Bolton - Needham & Co.

The seven or so million dollar charge associated with inventory out of Scottsdale, are we going to see something like that again next quarter or is that a onetime hit?

Jim Peterson

That’s a onetime hit.

Quinn Bolton - Needham & Co.

So really the only additional charge from Scottsdale would be in the $3 million range going forward and that maybe spread out over the next four quarters?

Jim Peterson

Yes, exactly.

Quinn Bolton - Needham & Co.

So really the only difference between GAAP and non-GAAP going forward, amortization, deferred stock, little bit from Scottsdale and no other real differences?

Jim Peterson

Yes, after December there will actually be imparity.

Quinn Bolton - Needham & Co.

Second question John, you talked about the evaluation reverse against deferred tax assets in the U.S. I think typically when you do that that has the effect of lowering the tax rate. I noticed the tack rate was 19.6% this quarter. Wondering if you could give us any tax rate guidance for fiscal 2010? Do you still think it is in the low 20’s or are you trending lower than that now because of some of these changes in the tax structure?

John Hohener

On a non-GAAP basis we will trend lower. I’ll use around 18% for next year.

Quinn Bolton - Needham & Co.

Then lastly for Jim, just any color you can give us on end market strengths, heading into the December quarter, in which end markets maybe weaker?

Jim Peterson

Let me just touch on the Analog Mixed Signal. The Analog Mixed Signal, there’s tremendous string in the TV and CCFL, and our new LED lighting, PoE, we want to put that, my guys don’t like to work, but its way hot on fire. It’s real strong in the channels now. The one that’s going to be kind of flattish would be the medical and the implantable medical market. The other one if you’re looking for that might be a little light, we call them pretty much, and we call that bottom to the commercial aerospace market. So that could be flattish maybe off note maybe slightly down. That’s about it.

Operator

Your next question comes from Rick Schafer - Oppenheimer.

Rick Schafer - Oppenheimer

I got a couple of quick questions. Just on current refs going through Ireland, I’m curious what they are now versus current capacity and how big could Ireland get for you guys, I guess over the next year or so in terms of percent of refs. I guess this part of the question is how much of that tax rate reduction on 18%, is related kind of this moving a lot of this Scottsdale stuff over to Ireland?

Jim Peterson

Right now Ireland is in the neighborhood of $100 million to $120 million depending on the timing of certain transfers, and so forth. We certainly see the potential to have upside there and we continue to analyze that and that’s part of what will happen commensurate with the Scottsdale closure. There will certainly be some more benefit coming to Ireland. I’m sorry, I lost the second.

John Hohener

Taxes.

Rick Schafer - Oppenheimer

I was just curious how much of that 18%, which obviously a great tax rate for you guys, how much of that’s really Ireland…?

Jim Peterson

Certainly this last year, as a significant portion of our improvement was due to Ireland. Next year we’ll continue to see improvement with Ireland as well as some of other tax strategies we have going.

Rick Schafer - Oppenheimer

It sounds to me, and I don’t want to get too far ahead on you, but it almost sounds like we’re going to have further tax benefit even in calendar ‘11, moving the stuff over to Ireland.

John Hohener

Yes, that is true.

Jim Peterson

There’s another, we’re closing down Scottsdale and in addition to Ireland we’re actually moving the medical products with the help of our 3M customers over to a site in the Philippines.

Rick Schafer - Oppenheimer

What’s tax rate in Philippines, you guys?

John Hohener

Right now we have a zero % tax holiday that has been awarded to us.

Rick Schafer - Oppenheimer

How long does that last, you guys said, is that a…?

Jim Peterson

On or about eight years is what we’re understanding.

Rick Schafer - Oppenheimer

Then just one more follow-up on that other stuff, can any updates you can give us on the strategy there? I mean, I guess to SEMICOA experienced slow you down at all, or change your attitude? I guess do you have a target number on tuck-in, tie-back Hi-Rel acquisitions or the targets over the next year or two? I know even looking outside of Hi-Rel, now are you looking anything bigger potentially?

Jim Peterson

Yes, yes. The end side of acquisition did not slow down. As we adapt to the situation what would SEMICOA like, as you know we completed three acquisitions. We started to look at vertically integrating up so vertical and horizontal integrations was pretty important to us that continues. We increased our SAM by about 40% with the last couple of acquisitions.

As you noticed, last quarter we tucked in Analog Mixed Signal acquisition for the fact that market started to normalize and is truly producing strength going forward. We’re in a acquire of companies, if you look historically last five years, I think we grew 19% or 20% year-over-year over the last five years and we’ve done that as a combination of organic and certainly our acquisitions. So I’m very active in the M&A area.

Rick Schafer - Oppenheimer

Just to clarify is it a goal to kind of keep cash around this sort of $200 million level and maybe use cash flow to kind of fund tuck-ins or do you guys have a target level at cash or anything like that?

Jim Peterson

One of the rules of thumb, which is not in concrete, is I like to buy things at a good price, that we can turn into a great market. I historically prefer tuck-ins and integratable acquisitions. I always wanted to do things that are accretive and I believe that companies our size should take sizeable bites and not try to do something that’s way out of what they can actually bring down to the mat. So, normalized, I like, most likely won’t buy anything with over $100 million in revenue. That would be odd for us to do that.

Operator

Your next question comes from Harsh Kumar - Morgan Keegan.

Harsh Kumar - Morgan Keegan

Let me start out with the other income lines, $716,000 charge versus possibly what should have been a positive number. Is there anything going on there that you can talk about, John?

John Hohener

Yes, that was actually just some incremental legal costs that we had as it related to our AMI settlements of a quarter ago.

Harsh Kumar - Morgan Keegan

So that’s a one-time deal and one should not repeat it self?

John Hohener

Yes.

Harsh Kumar - Morgan Keegan

Then let me think about Scottsdale closure, is there a point in time next year, perhaps, where you get a pretty significant bump as we think about modeling for gross margins?

John Hohener

We certainly haven’t announced that, yet. We’re studying the whole thing, but over 18 months we definitely will see some improvements, probably closer to 12 months.

Harsh Kumar - Morgan Keegan

I guess, Jim, if I can ask, you talked a little bit about signs pointing to the bottom or the chains pointing to the bottom or the turn in aerospace. Can you talk about what you are seeing perhaps the tangible. Is it content or something else?

Jim Peterson

Basically just one of the point that IATA right, I mean passenger up, cargos up, seat capacity is rising, a lot of refurbishment, a lot of our product being put into provision market space and just to share a fact that the international market is once again started to grow and gain from some of the stimulus packages that they have there and it’s always good to read customers say and most of them are calling pretty much a bottom to it with growth coming back in 2010.

Harsh Kumar - Morgan Keegan

Last question, guys, can we get breakdown for options within SG&A and R&D?

John Hohener

Yes, actually what we do is we do about 10% in cost of sales and we do about 90% in OpEx. We really don’t breakout between SG&A and R&D.

Operator

Your next question comes from Romit Shah - Barclays Capital.

Romit Shah - Barclays Capital

Q3 turned out to be better than expected quarter for most companies in the space, and I noticed you guys came in right inline with the midpoint of your guidance and, Jim you mentioned that medical was down in the quarter. Was it down a little bit more than you expected?

Jim Peterson

Not really, I think we came in pretty much what we guided to, midpoint of our guidance. I was comfortable with it, but back to the medical, no not necessarily. We knew we had, two quarters ago strong bill for Boston Scientific you member we kept Scottsdale facility open two or three quarters to do that.

So I think all in all for the medical market, ICDs to continue to grow. Our dollar content continues to excel and to grow and be in customers. So I think it was pretty much on target and so was our quarter. We focused on a lot of operations efficiency, including a real strong position in our cash flow.

Romit Shah - Barclays Capital

You did a great job on the cash flow just going back to medical for a second. If my numbers are correct, this business has been hovering at around 15 million per quarter for the last, few years. Is this still a growth market for the company?

Jim Peterson

Most certainly a growth market, we also had a settled down tick in the MRI, which is, maybe 15% of that total business with us and as long as people find themselves in the unfortunate situation of being unemployed and the lack of capital out there, you going find just being a drag on the market space as well.

Let us get more dollar content right; I will out of our facilities and dollars content, dollar per widget and widgets that better there, but it’s a real strong market for Microsemi. The next move for us with the three largest customers in the flammable, we’ll work with them shoulder to shoulder in moving manufacturing overseas which is more cost effective going forward and which should strengthen us panel for the growth there and certainly in the financial contribution in that market space.

Romit Shah - Barclays Capital

So the content story is still intact, we’re just waiting to see better units.

Jim Peterson

No, I think the units are going well. It was pretty much the build for the front Tier platform for Boston Scientific that has brought it down a little bit, but it’s a strong growth market. I mean, I would reenter that market if I weren’t in it.

Romit Shah - Barclays Capital

My last question is on stock option expense for the December quarter, is the 6.3, we should we expect that number to increase along with the rest of OpEx, or how are you thinking about DSO in the fiscal first quarter?

John Hohener

Yes, our first fiscal quarter does have a little pop-up in stock comp, little normally and then it will drop in the second quarter. So I would go up about 400.

Operator

Your next question comes from Andrew Huang - GC Research.

Andrew Huang - GC Research

A lot of your competitors with more consumer exposure are guidance before down line 10% to 15% or 20% sequential and I was wondering if you give us a sense of expectations for your commercial side of the business for Q4?

Jim Peterson

I am really comfortable with growth in that area for a couple of reasons a lot of new product introductions and the fact that our product, we kind of keep away from this high-end consumer, market space and if you look at our component, we have a strong component in most certainly in PoE, the mid span is the inventory is real low and customer demand is very, very high.

I’m getting great, great response and design in for that back lighting market. In fact the matter is backlighting some of the numbers that we have is 2009 is 109 million TVs worldwide and 98.5% of CCFL, 2010 might go up to about 130 million units and 90 plus to CCFL and we gain a lot of market share there. So our product mix is a lot different from our competitors and peers in that market space. I usually go for the higher margin less multiple competitor spaces and it has proven to be successful.

Andrew Huang - GC Research

Then I have follow-on on the balance sheet. Looks like actually receivables and inventory have been coming down the past three quarters. So will they continue to go down or maybe give us a sense for your targets in days and inventory?

Jim Peterson

Certainly we worked hard in terms of total balance sheet management and we’ve gotten the DSO as I mentioned to 57 days. Being an international company, we’re in striking distance of where that’s considered a very good number. I’d like to see a few more days shaved off and certainly the transition we’re doing with Scottsdale and transitioning to some of the other locations, our inventory may level off at this point in time and in the long term it will continue to trend down.

Operator

Your next question comes from Steve Smigie - Raymond James.

Steve Smigie - Raymond James

Some of you guys talk a little bit with regards to Scottsdale deal cost that’s coming out, is that something that you guys will, I mean obviously you’ve get that full amount, but is that something where I can take today’s gross margin and percentage and throw 4 to 500 basis points on it or should I assume that maybe there’s, you may chase growth more aggressively and so you may give away some of those cost savings in terms of pricing and things like that?

Jim Peterson

I don’t expect to give anything away as far as pricing goes. My game is continuing to strengthening. Let me move real short to the Scottsdale. First of all, just write-down the fact that we’re talking $20 million to $25 million annual saving every year. We’re talking about 4 to 500 basis points. I’m not going to chasing more as business to cover that. We’re talking $0.20 of share, all these complete in 18 months. So that should be the takeaway of Scottsdale.

Steve Smigie - Raymond James

Then with regard to the 2010 budget, I was wondering if you could talk a little bit how you think that impacts you, do you feel like you get stronger growth this year versus last year than probably increasing electronics content, and maybe tie to that you talked about a doubling in SAM, is that doubling in SAM coming from addition of market set or is it just because of the new program that the SIMs doubling?

Jim Peterson

Three points, one is our acquisitions, accretive acquisition. We increase our stand by 40%. I expect to continue to do that to grow our SAM. Two, which people don’t understand is vertical integration. We’ve been buying companies with subsystems that are actually growing organically themselves, but more importantly using Microsemi content. The real meat of this thing is the product to other company as going to be successful. Rad Hard, DC:DC regulator, Silicon Powered Thyristor, LED, Solar, POL, these are all now moving into revenue for Microsemi. We’ve been investing in it and start to go bear fruit.

Steve Smigie - Raymond James

Then just turning to the LED Backlight business, could you talk about what your content looks like, say, in white LED versus RGB and then does it matter if it is Edge-lit versus some other type of scheme there in terms of how your dollar content…?

Jim Peterson

I’ve Steven Litchfield, here. Litch.

Steven Litchfield

I think just to reiterate Jim comments. I mean, we really do have the most comprehensive product offering out there and maybe a little color on the market. What everybody is talking about is lighting market. The earliest stage we’ll move into the Scanning Backlight market, we’ll moving. There’s own domain and color management, I mean those are new areas. We have the best product portfolio out there and it’s a nice product roadmap that a lot of our peers don’t have. So as far as content itself, the early stages you’re talking anywhere from $2 to $4, on the D2 and D3 solutions you’re talking $15 to $20.

Steve Smigie - Raymond James

Can you talk a little bit about your product in general, in that market? I guess typically if you talk about white LED drivers that people tend to think about that as a commoditized market maybe that’s more isolated to something like driving white LEDs and handsets or something like that. Can you talk about is your product just an LED driver or is there some extra functionality to help the resolution of the screen, etc., that makes you differentiate a product to make it more difficult for somebody to displace after you get a design win.

Jim Peterson

It is more of an integrated solution. Again, it is not just a standard LED driver that you’ve seen within the handset space, where you are just driving a blue or white LED. There’s a lot more intelligence involved and then I think as you go up into the color management, there’s much, much more capabilities, digital content, frankly that end up having the offer to compliment the entire solution.

Operator

Your next question comes from Nicholas Aberle - Caris & Co.

Nicholas Aberle - Caris & Co.

On the CCFL side you talked about market share gains. Can you just put some color around where you’re gaining share, on the LCD TV side, notebook side, where the share has been, where it is now and where you think it is going…?

Jim Peterson

I think a lot of platforms in the TV, CCFL. We used to focus on 40 inch and above. Now we’re going 17 inch. We’re seeing a lot of growth out of mainland China, which we didn’t have. The beauty of all the LEDs, is not many more people have entered the CCFL space and that’s the way I like it. We got a good relationship with Samsung. Our engineers are welcome it within their walls and we’re set to go.

Nicholas Aberle - Caris & Co.

So anymore incremental core on exactly what your share is on the LCD TV space and then also in the notebook space?

Steven Litchfield

On the CCFL side, I mean I guess it’s a broad range, but I mean I’d say 35% to 45%. On the LED side, I mean, it’s such a small, it’s really an emerging market and 1.5% of total TVs shipped today is using LEDs, I mean that could go up to eight or 10 next year, but it is such a small market it is really hard to tell what that particular share is.

Maybe just a quick follow-on, something I mentioned to Steve a little bit earlier. If you look at progression from Edge Lighting, Edge Lighting is moving into this zoned application and you’ve seen the largest U.S. manufacturer today, Visio come out with a D2 solution and that really tells you where the market is going and the importance of having that follow-on product offering.

Nicholas Aberle - Caris & Co.

I guess there’s probably another good question for you, Steve, but we’ve seen in analog bounce back pretty nicely in the September quarter. Sounds like you guys are comfortable with it growing again in the December quarter. When you guys are talking to the supply chain customers, is the strength, a demand snapback, is it inventory replenishment, and how sustainable do you think that momentum is early into 2010?

Steven Litchfield

I think very much like our peers, I think everyone is out there scrambling. The demand is strong and it continues to be. So we’re working through our supply chain issues like everyone else, but we’re confident that we can overcome them. I’m slightly ahead on that because something brought up earlier in our call, our analog mid signal business was up some like 40%.

So there was a question earlier about, peers and competition and how we’re doing against the competition. I don’t see a lot of our peers that have grown 40% sequentially this quarter. So I think we’re very confident in our performance against our peers in this market.

Nicholas Aberle - Caris & Co.

Just kind of go back to Scottsdale real quick as well. So $20 million to $25 million in save, that’s the big takeaway, anyway to breakdown what the split is between what you guys are benefiting from an OpEx side versus what you are benefiting from on the cost of goods sold side?

John Hohener

Significant portion of that’s cost of sales, hence we have the 4 or 500 basis points improvement, but a couple million of that is in the OpEx area.

Nicholas Aberle - Caris & Co.

Then you guys alluded to this early, I know basically it sounds like medical, ICD gross margins have been a bit of a headwind versus the corporate average…?

Jim Peterson

No, that’s the gross margins. Gross margin haves very significant in that area. That’s a wonderful, wonderful gross margin business. What we alluded to and talked to is the fact that we helped Boston Scientific build enough product, so they could be successful in their Frontier platform. That was the message.

Nicholas Aberle - Caris & Co.

So the net-net there is the gross margin should stay the same, the medical we’re hopefully troughing right around $13 million mark and hopefully growing…?

Jim Peterson

I think the gross margins are attractive, most would want it and what we’re doing is actually trying to bring more to our bottom line by looking at some better manufacturing efficiencies and we see that with a move overseas, which is new.

Nicholas Aberle - Caris & Co.

Then just lastly on the high reliability side of the business, it’s been pretty stagnant here in last couple of quarters and medicals been headwind there. Analogs come snapping back. I mean, do you see a similar phenomenon happening in Hi-Rel here in some point in the next couple of quarters, or is that going to be a slow linear recovery do you believe?

Jim Peterson

I think it’s anything Hi-Rel subs in the large for its steady. If things go one to three, things are good, things go two to four things are great. Name of our game is to increase our margins and get cash generated around that market segment and electric content is always a little bit higher than the organic growth rate of it.

Operator

Your next question comes from David Wong - Wells Fargo Securities.

David Wong - Wells Fargo Securities

Few clarifications on what you said about the earnings model. So the 500,000 increase in both SG&A and R&D in the December quarter, that’s pro forma. Is that correct? So we need to add to $200,000 to $300,000 to each everyone to do full gap?

John Hohener

Yes, the expenses that we talked about is, $500,000, each in R&D and SG&A and the earlier question dealing with stock comp, David, for you would be incremental.

David Wong - Wells Fargo Securities

You also quoted in your press release 45.1% gross margin in the September quarter excluding special charges, or one-timely charge or something and then if I understand correctly, there’s still a couple of special things still in the December quarter that drops from the 45% in the December quarter on a GAAP basis. Is that right?

John Hohener

No, it’s not necessarily December. Over the next 18 months, we’re going to incur an incremental $3 million to $4 million that we technically can’t accrue for when we announce the shutdown, so they will get expensed as we go.

David Wong - Wells Fargo Securities

As you also said the December would be the last quarter of transitional idle capacity. There will be some transitional idle capacity charges is this correct?

John Hohener

That’s true. That will be the last quarter where that adjustment occurs between our GAAP and non-GAAP. In the March quarter, GAAP and non-GAAP will be at parity.

David Wong - Wells Fargo Securities

Because you start putting those charges into non-GAAP you’re saying. You said that the residual charges go over several quarters?

John Hohener

These are two different topics we’re having a discussion on, David. The charges are unrelated to the transitional idle capacity that you’ve seen in our P&L presentation to-date.

David Wong - Wells Fargo Securities

The last thing is, what are you seeing in your under commercial aerospace side of things? I think one of your competitors talked about weakness in commercial aerospace, and have you got a different dynamic, because of your particular positioning?

Jim Peterson

I think the message for us is, we think it is bottomed. Its points are growth in 2010, and will not my differentiate us is our strength in refurbishment market rather than just the organic growth or new product. The aircraft as you know are going from hydraulic to fly by wire. That demand is little like your content be moreover our TVS module or TVS product. So it could be differentiate in the product, certainly not a barn-burner, but it’s poised are growth in 2010.

Operator

Your next question comes from Christopher Longiaru - Sidoti & Co.

Christopher Longiaru - Sidoti & Co.

I just want a few thing get a little more clarification that happened, and most of my questions have been answered, first what happened with the tax rate this quarter and why it jumped up as much as it did and if you just give me a little more meat on that, I’d appreciate it.

John Hohener

It’s the tax rate actually went down on a non-GAAP basis, if that’s what you’re referring to.

Christopher Longiaru - Sidoti & Co.

On a GAAP basis.

John Hohener

On a GAAP basis we recorded evaluation allowance on our deferred tax assets. Let me just describe what that means. What it really means as we’ve been really successful in terms of employing our worldwide operating strategy, which we talked about with Ireland in the past, and so forth. That’s essentially let us take our tax rate down from 33% to 20% overall which is a true bottom line and cash saving.

So as such, our U.S. income has decreased as a percentage of our total, and which case we go through a calculation and you have to set up what’s called a non-cash valuation allowance on these deferred tax items. When that U.S. income starts to increase as a proportion of the total, we’ll be able to release some of that allowance in our gap tax rate will be ultimately benefited.

Operator

Your next question comes from Craig Berger - FBR Capital Markets.

Craig Berger - FBR Capital Markets

How shall we be thinking about OpEx over the next year?

John Hohener

OpEx over the next year will like you said this next quarter or this next quarter is kind of going to go up by $1 million dollars between SG&A and R&D. We’ll see probably a continued trend slightly up, but reduced as a percentage of revenue.

Craig Berger - FBR Capital Markets

I know it’s still early for March, but what’s typical seasonality there and how might this year look?

John Hohener

No real seasonality in our CapEx. It’s probably the lowest in the industry. Hope you looking at the find seasonality or any kind of cyclical...

Craig Berger - FBR Capital Markets

No, I’m sorry, I was asking about March revenues or demands?

John Hohener

I only guided one quarter. So I mean, when we have this earnings release call I’ll be glad to tell you everything.

Craig Berger - FBR Capital Markets

How are you guys usually, what’s typical seasonality for you?

Jim Peterson

We don’t have a lot of cycles. We’re usually one, three, two to four kind of guy quarter-after-quarter. I think I don’t want to call it steady Eddie I think that kind of label, but that’s historically what we’ve done from a historical point, not a guidance point.

Craig Berger - FBR Capital Markets

Looking your defense line item, it’s almost $44 million this quarter, or thereabouts, which is up versus what you guys would have done say a couple years ago and certainly versus a few years ago. Is there any risk to that number over the next year for the new defense budget, or should we continue to expect growth? Kind of what’s your intermediate term outlook in defense?

John Hohener

I think defense is a nice solid market for Microsemi, the new budget is passed. Electronic content is up. Electronic warfare and fencing and screening is up. Demand for high end greater than, 2 gigahertz and we’re playing up to 100 gigahertz and the RF of the defense space. That is certainly up. We have a real strong on new product funnel and product roadmap. We’ll be doing some accretive acquisitions in the space. I think defense is going to fare out to be very nice for us going forward, my friend.

Craig Berger - FBR Capital Markets

Last question, what are your customers telling you about their inventory position, particularly your Hi-Rel customers, do they need more, or there shortages, do they have enough, any insight there?

John Hohener

What we tell bubble, I think we caught that bubble. I think they’re pretty much, I don’t think they’re ahead of the game. I think it’s just kind of a take as they need and we’re ready for that. The Analog Mixed Signal, let me just touch on that. Inventories are down, there lean, much less than I would have thought in the pipeline, especially in the PoE. I think things look good in both markets are markets for us in the customers are not screaming for a tremendous amount of product. They’re not saying woe in anyway, shape or form.

Operator

Your final question comes from Steve Smigie - Raymond James.

Steve Smigie - Raymond James

I was wondering if you could talk a little bit about your international content might look like in the defense business. Few years back I think it was APTI you got some exposure to China. So I was wondering how much do you guys do hit direct to China and other international locations, or is it more maybe sell something to Lockheed and Lockheed sells something to China or something like that just if you would just walk through that dynamic?

John Hohener

First of all it’s a big deal. We all believe, the international foot printing opportunity for the international market is the Hi-Rel has more than doubled year-over-year. I think it was $75 billion from a year ago and I think, next year it will certainly be well over $100 billion.

China yet small, I mean you might see four to five ex growth in the market over in China for the Hi-Rel business. Satellite business is growing. A lot of the larger end customers were concerned with the budget and, the budget is not going to be very strong. So they moved over to let’s partner with international customers. So the international content is continued to strengthen and grow for Microsemi and Europe is always been a strong international component for Micro and that continues to strengthen.

Steve Smigie - Raymond James

Is it still relatively modest our position as we could see a lot of expansion or is it already done a decent chunk?

John Hohener

It’s relatively modest and we’re starting to go gain market share. No doubt.

Steve Smigie - Raymond James

One question is as we look forward to the on the other income, interest income, etc, I know you said this is a one time issue here in September, but what should we be thinking dollar wise for that line item going into December and going forward?

Jim Peterson

We have cash and our goal is to preserve the principal of that. So we’re not investing in anything other than money market funds, of a prime nature and if you look at your own money market accounts, you will know you’re not earning very much interest on those. So, it going be a modest level of income there and we also have a bank line that we do have a certain expense in order to have the line. So it’s going to be less than $100,000.

Steve Smigie - Raymond James

What would that I mean, I guys if we start to see interest rates pickup…?

Jim Peterson

Then it will go up.

Operator

We have no further questions or comments at this time.

Jim Peterson

Okay. Thank you for joining us today and for your questions and have a great day.

Operator

Thanks all for joining. You may now disconnect.

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