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Microsemi Corp. (NASDAQ:MSCC)

F3Q10 (Qtr End 06/27/2010) Earnings Call

July 22, 2010 4:45 pm ET

Executives

Terri Donnelly - Coordinator

Jim Peterson - President & CEO

John Hohener - VP & CFO

Analysts

Steve Smigie - Raymond James

Quinn Bolton - Needham & Company

Harsh Kumar - Morgan Keegan

Nicholas Aberle - Janney Capital Markets

Rick Schafer - Oppenheimer

Adam Benjamin - Jefferies

David Wong - Wells Fargo

Operator

At this time, I would like to welcome everyone to the Microsemi's third quarter earnings conference call. (Operator Instructions)

I would now like to turn the call over to Terri Donnelly.

Terri Donnelly

Good afternoon and welcome to Microsemi's third quarter 2010 earnings 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 this conference call will be available on the Microsemi website under the Investors 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 July 22, 2010 and is continually subject to reassessment due to changing market conditions and other factors, therefore must be considered only as management's present opinion, actual results may be 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 current opinions, predictions and 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 27, 2009, and our Form 10-Q for the fiscal quarter ended March 28, 2010, which were filed with the SEC on November 24, 2009 and April 30, 2010 respectively.

That said, I'm going to turn the call over to John to discuss our financial results and then to Jim, who will address our end market and overall business strategy.

Here is John Hohener.

John Hohener

Thank you, Terri. Net sales for the quarter ended June 27, 2010 were a record $136 million, up 15.1% from $118.2 million in the second quarter of 2010 and up 27.1% from $107 million reported in the year ago of third quarter. Gross margin in the third quarter was 48.4% up 100 basis points from $47.4 in the second quarter of 2010 and up 620 basis points from the 42.2% gross margin we reported in the year ago third quarter.

Approximately 50 basis points were $700,000 of the sequential improvement is related to cost savings associated with our Scottsdale transition. When we announced the closure of the Scottsdale facility, we stated the gross margin impact related to these saving would equate to between $20 million and $25 million on an annual basis or 400 to 500 basis points when applied to fiscal year 2009 consensus sales estimates.

As of today, our best estimates of the quarterly gross margin improvements relating to the Scottsdale closure are as follows. We expect an additional $350,000 from each of the next two quarter. We then expect to close away from fab operations at the end of November, a five month pull in, which should yield margin improvement of an additional $2 million from our March 2011 quarter.

We expect the complete closure of the facility, including the assembly and test areas to occur at the end of February 2011, another two months pull in. This is expected to result in margin improvement of an additional $2.5 million from our June 2011 quarter. All of these improvements results in an annualized savings of $23.6 million. This quarter, non-GAAP selling, general and administrations expenses were $21.6 million or 15.9% of sales compared to $18.2 million or 15.4% of sales in the second quarter of 2010, and compared to $19.1 million or 17.9% of sales in the third quarter of last year.

The increase is associated with the light division and increased costs to support higher sales as well as accelerating the planned closure of Scottsdale. We expect SG&A to trend up by $750,000 to $1 million next quarter, primarily due to having White for a full quarter.

Research and Development costs were $14.8 million or 10.9% of sales compared to $12.1 million or 10.2 % of sales in the second quarter of 2010, and compared to $10 million or 9.4% of sales in the year-ago third quarter. R&D costs trended higher due to increased new product development and White R&D expense. We expect R&D costs to trend up by $1 million to $1.5 million next quarter, primarily due to continued increased spending on product development and having White for a full quarter.

We have spoken numerous times about the increased breadth of products and increased SAM via our acquisitions strategy where we are increasing our product development effort to realize the benefits of these transactions.

Our non-GAAP operating income was $29.4 million or 21.6% compared to $25.8 million or 21.8% in the second quarter of 2010, and $16.2 million or 15.1% in the prior year third quarter. Non-GAAP net income was $24.7 million or $.030 per diluted share compared to $21.4 million or $0.26 per diluted share in the second quarter of 2010. And $12.6 million or $0.15 per diluted share in the diluted share in the year ago third quarter. A year-over-year improvement of 100%.

Our non-GAAP effective tax rate for the quarter was 15.6%. Our third quarter operating results include $3.6 million for restructuring acquisition and other charges. Also included were non-cash charges of $6 million related to stock based compensation and $5.9 million in amortization of acquisitions related to intangibles.

As a reminder, the new accounting standard ASC 805, which was formerly FAS 141R now dictates the acquisitions cost, the expense and the period occurred and not carried as part of the overall consideration of a purchase.

Our GAAP operating income was $13.9 million compared to $14.7 million in the second quarter of 2010 and $3.8 million in the prior year third quarter. Our GAAP net income was $33 million compared to $11.5 million in the second quarter of 2010 and $7.8 million in the prior year third quarter. For the third quarter of 2010, we evaluated our deferred tax assets and liabilities subsequent to the acquisition of White and reverse non-cash evaluation allowances of $22.8 million. This results in a net GAAP effective tax benefit for the quarter of $19.3 million. Our GAAP earnings per share were $0.40 compared to $0.14 per diluted share in the second quarter of 2010. And $0.10 in the year ago third quarter.

Capital spending was $3 million compared to $3.1 million in the second quarter. Depreciation and amortization expense was $10.4 million compared to $8.6 million in the second quarter, with the increase primarily due to the White acquisition. Compared to the second quarter, accounts receivable increased $4.8 million with the increase due to the White acquisition. Our DSO decreased from 54 days to 50 days.

Our inventories increased by $20.2 million compared to the second quarter, the majority of which was related to the White acquisition and the rest was to support business growth, including growth in our SecureWave products for the whole body scanners, customized GPS modules for defense application, and as well as preparing for our facility consolidation. On a GAAP basis, our days of inventory decreased to 138 days. As a reminder this is an improvement of 48 days or 26% from the year ago third quarter.

The next few quarters should show moderating increases in inventory levels to support continued business growth as well as managing the overall consolidation of the facility. Once again, cash generation was very strong. For the quarter, our operation has generated cash flow of $36.4 million and a net of $33.6 million after acquisition cost. Our free-cash flow was a record $30.6 million. We entered the quarter with a cash balance of $188.2 million. Reflecting a continued strong growth trend, our book-to-bill ratio was greater than 1:1.

Our best estimate of the end market percentage breakout of net sales for the third quarter was approximately: Defense & Homeland Security 40%, Commercial Air & Satellite 20%, Medical 6%, LCD TV Displays 7%, Mobile Connectivity including POE 16%, and Industrial Semi-Cap 11%.

Now for our business outlook, for the fourth quarter of fiscal year 2010 we expect our net sales will increase between a range of 7% and 9% sequentially. On a non-GAAP basis, we expect earnings for the fourth quarter of fiscal year 2010 to be between $0.33 and $0.35 per diluted share.

With that I will turn the call over to Jim Peterson.

Jim Peterson

Okay. Thank you, John. Our Defense and Homeland Security end markets were among the star performers in the quarter, with revenues growing 24% sequentially. White's first quarter contribution was clearly a factor in the growth and was strengthened by ramping production shipments of our SecureWave millimeter wave scanning subsystems as well as our growth from the rest of the Defense and homeland security product lines. We expect continued growth from this end market over the next 12 months. Let me give you just three examples driving that conviction.

First, we expect to continue to ramp shipments of SecureWave RF subsystems in Q4 and beyond, benefiting from growing order flow from these solutions. The homeland security research group has estimated that the global whole body scanning whole body scanning systems sales will total $2.1 billion over the period from 2010 through 2014. Looking at our content within, this implies a TAM of approximately $275 million from Microsemi over this period. Second, we expect strong contributions from our anti-tamper GPS module platforms.

Our announcement last week of a $22 million in order for our military GPS modules is clear evidence from the administration's focus on reduction in collateral damage, but also a focus on protecting our troops while at the same time maintaining information integrity and rationalizing defense expenditures. All these goals are achieved with growth in electronic content. Simply put, electronic content growth within the department of defense budget saves lives and saves money.

Third, our growing footprint in hard value product offering opens greater revenue opportunity. Over the last number of years, Microsemi has transformed itself and our product portfolio is larger than it's ever been. We've leveraged our core competencies in power, power management and RF to expand our product offering to include a growing number of discrete, integrated circuit component solutions, as well as having moved upstream in converting captive to merchant subsystems and in system solutions.

This significantly expands our SAM, but also increasingly positions us as one stop shop for aerospace defense suppliers looking at speed product development while lowering overall system cost. Seeing a bright opportunity for new, higher value added solutions, we have begun to invest more aggressively in our product roadmaps ensuring our ability to continue to outgrow the greater aerospace and defense markets.

Now let's turn to our industrial end markets, which continue to benefit from semiconductor capital equipment as well as energy production and measurement initiatives, growing about 40% sequentially in dollar terms. At this pint, we continue to expect our semiconductor capital equipment business to perform nicely. Driven by a rebound in our traditional applications, our growing customer base and a richer product mix.

While semiconductor capital equipment has been the headliner over industrial end market, it is not the only application that has us excited. Energy applications are a growing opportunity for us and Microsemi is gaining momentum. While solar, wind, oil or battery driven energy technologies have been an ongoing focus for us, we're excited to expand our industrial energy technologies into the smart grid market.

Shipping product last quarter to one of the leading intelligent metering solution providers in the marketplace today. Our TV and end markets also grew up approximately 11% sequentially. We continue to expect a strong second half for our LCD TV business, as well as gain market share and tier one suppliers such as Samsung, Sony and Sharp, as well as tier two OEMs and ODMs.

Looking specifically at our LED TV and backlight business, we continue to expect that 2010 will be dominated by lower cost, lower performance Edge-lit solutions, while our advanced Edge-lit solutions is sampling in the marketplace today, and we could see some revenue in the coming quarters.

Conversations with our tier one customers confirm our belief that the direct backlit solutions will be the technology that stands the test of time. Microsemi is focused on increasing our content within this high growth market and we're pleased to report that we've just received our first design in for DC/DC product with a major Korean manufacturer.

We'll work hard to make this trend with all our display customers. Our enterprise, the mobile connectivity end markets continues to grow up over 12% sequentially in June in dollar terms. We've high expectations for this business and we believe that is not only just now hitting critical mass in terms of adoption by our estimate PoE enabled port penetration will come close to 20% of the total switching port market in 2010.

The market is moving beyond early adopters and into a period of high growth. We are engaged with all players in this market. The higher powered AT standard along with share gains continue to drive strength.

In the June quarter, we entered into an important IP patent transfer, licensing agreement with Cisco covering PoE patents. Microsemi is really focused on PoE opportunity. And our agreement wit Cisco can accelerate or expand into applications such as network cameras, access controlled devices, laptop computers, PDAs, fire sensors and alarms, audio and video remote monitoring systems and residential gateways.

Our medical end markets were mixed in the June quarter and were down approximately 16% sequentially, while all major ICD customers took product in the quarter, product mix was not as rich as the prior quarter resulting in lower revenue.

MRI however, is at a record high benefiting from new customer relationships and increasing content as a result of our growing footprint of new product.

Our aerospace end market performed well in the quarter growing about 6% over the March quarter. We are pleased with the continuing bounce back in our commercial aerospace markets.

As air traffic continues to improve, while fuel prices are on the rise, carriers are looking to acquire newer more fuel efficient planes to service the rebounding demand. At Farnborough International Air Show in England, new plane orders through Wednesday morning totaled over 600 commercial passenger aircraft with the largest demand from Asia, Middle Eastern and North American carriers. Both, the President of Boeing's commercial airplane's division, "It's amazing how quickly the market is coming back."

We remain pleased with our satellite end markets and we expect the rally to continue for the foreseeable future. The space and satellite markets remain an area of intense focus for Microsemi as a result of their economically resistant cycles and significant barriers to entry. Already a leader, we're investing in R&D more aggressively than ever to capture this large and growing market opportunity.

For example, in leveraging the DC to DC power conversion technology, we acquired with the backpack acquisition, we can attack the space level of DC to DC converter market that we estimate to total approximately $220 million annually. Leveraging our existing position in the market to attack the SAM, we expect to deliver strong growth results in this end market well into the future.

We're extremely pleased with our third quarter results with meaningful contributions from multiple product lines that should continue to strengthen over the next several quarters. Our gross margins showed significant improvement, which included initial contribution from our Scottsdale transition.

This is a good indicator of things to come, with continued profitability improvements from our core businesses and further contribution from our Scottsdale facility. In addition, we are on plan with our White acquisition integration. As previously stated, it will meet and or exceed our corporate gross margins target.

Before we turn to your question, let's just review the highlights of the quarter.

Record revenue growth, accelerated Scottsdale closure timeline, margin expansion occurring as planned and a continued success of our M&A strategy. We thank you for interest and support and now we'll take questions from our analysts.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Patrick Wang with Wedbush Securities.

Patrick Wang - Wedbush Securities

A lot of moving parts in gross margin going forward. I just wanted to get a better sense of how we should think about margins just in the next I guess four quarters, I know you are only guiding for one. But you can just kind of help us, give a little information of what to expect here?

John Hohener

Actually in the quarter, we guided much longer than that as it related to Scottsdale. So let me just take this opportunity to provide a little more color on that. In Q3, we did see savings related to Scottsdale about $700,000. In Q4, we're saying we're going to have another $350,000, which on a cume basis, that becomes a little over $1 million in Q4.

In Q1, we talked about another $350,000, which takes us up to a cume basis now of $1.4 million, Q2 of 11, $2 million which now on a cume basis of 3.4 contributing to that quarter. Q3 of 11, it was 2.5, so now; we're contributing $5.9 million to that quarter. When you take that $5.9 million, which is the end point, and you annualize that times four, that's how we get our 23.6, which is right in the middle of that range we have previously guided.

Patrick Wang - Wedbush Securities

Okay, got you. No doubt, that was extremely helpful. It looks like some pretty good stuff ahead with gross margin. Hey, Jim, can you talk, I guess help us understand the growth of the end market here, could you maybe rank order then top to bottom?

Jim Peterson

Yes, first let's just kind of call to fact that right now it's a growth revenue story going forward for Microsemi. We see certainly 20%, maybe as high and strong as 30% for the next four quarters. So it's a revenue story. So let me do the stack ranking. Let's go first to Defense and Homeland security. Lot of design wins, lot of traction. Last quarter we accelerated about 24%, I expect that to continue.

Second, let me call out Industrial, small in dollar content grew 40% last year. A lot of movement in our Solar, lot in our Energy and we've made some entry into some metering business.

Third, mobile connectivity, certainly PoE is strong and the wireless LAN continues to ramp and I think you know that from the old market. End market grew about 12.7% last quarter.

Next, certainly commercial satellite, we call the bottom to commercial air two quarters ago. I think what you're seeing from Boeing in the light and the market space, I think we called that one dead on. So let's put forth the commercial and satellite we mentioned in the prepared statement, extremely strong.

Fifth, display. CCFL is doing quite well. LED is starting to emerge. We're confident in the backlit technology going forward. And then last but not least, we got the step right, the last would be medical. Last quarter I mentioned that ITB was turbulent, and it is, but the MRI business is strengthening.

So defense and homeland security, industrial, mobile connectivity, commercial satellite, TV display and then medical.

Patrick Wang - Wedbush Securities

Okay, terrific. And just one last question, great announcement in terms of the bilateral agreement with Cisco, can you talk about when we can start to expect some of that contribution to show up as well?

Jim Peterson

Yes, we're starting to see a bit of that, Cisco has always been a customer, certainly themselves and more importantly Linksys, right? I'm not at liberty again to detail the agreement, because of the terms of the confidentiality. But let me tell you what it does, right? It opens the major door for our system engineering group to work with their system engineering group.

We're both wide open now in communications. The internal strategy within is Cisco, let's just say, I think they are ranked from an OEM customer on about number nine or 10. And I'm pretty convinced that my strategy, well, I'll you my strategy; my strategy is that over the next 18 to 24 months they become a top three customer.

And it's not just PoE, Patrick, it's PoE, it's DC to DC, it's certainly the RF products, a number of standard products and hopefully some custom products going forward.

Operator

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

Craig Berger – FBR Capital Markets

Just wanted to dig in a little bit to the industrial and mobile connectivity businesses because they're shipping a lot higher than they have been recently. And so I'm just wondering how should we think about sustainability of current shipment levels for those businesses?

Jim Peterson

Let me touch the industrial, you're absolutely right, I mean semi-cap is on fire. Advanced Semi just came out with some interesting news on the strength of that market. What I've seen in that is it could be three or four quarters of strength. Having a hard time getting some of the products out there, right, it supply constraint. But I think we're on a run, our top customers are AES, MKS, Teradyne's become a new customer for us.

Smart grid business, they start to ship now from Microsemi. And we throw in there a bid that is for some of the body scanners for the passive manufacturer Brijot down in Florida.

So I think industrial is going to be strong three or four quarters and maybe beyond. But I see a good solid three. Mobile connectivity, it's a good solid opportunity for us. I mean PoE is now shifting from early adopters to solid market share growing customers.

And last, but not least, the wireless LAN and then the mobile connectivity. And if you look at what's going on with Atheros and Broadcom and 802.11n and the strength of the Wi-Fi, with the applications going forward, I think we once again got some strength two, three quarters out.

Little sparkling strength on the wireless LAN for us, and I think we've pushed it over that up next quarter.

Craig Berger – FBR Capital Markets

And then I guess just a follow up, how else should we thinking about gross margins next quarter? I know you said 350 of incremental contribution. Beyond that should we expect further utilization or White benefits?

John Hohener

Yes including the Scottsdale benefit that I mentioned, we're guiding somewhere in the range of 40 or 70 basis points.

Craig Berger – FBR Capital Markets

Great, and then last one, can you just talk about any plans for price positioning as we move into the fall of 2010?

Jim Peterson

You know the interesting part is price positioning, when we just a discrete company was a bold aggressive move for Microsemi. We pretty much now price it as we introduce our next generation product, you'll see the benefit from there.

Operator

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

Steve Smigie - Raymond James

I guess I was just wondering if you could talk a little bit about how we should think about seasonality post the September quarter, obviously you had some benefit of White here with return to normal seasonality after that, which for you it is not a seasonality, but I guess my question is, is the big bump from White over, and we just expect normal results after this?

Jim Peterson

I think what I'm starting to see from my team and the new markets that we are in and the new products and gaining market share going forward, I think the one to three, maybe two to four story might be the old Microsemi. We might be the flipping the page with the system business and the like. And I think we're going to see strengthening in the revenue, and that's why I'm talking 20 and not hitting the 30 because I'll get the look from (Rob and Lich), but we're certainly looking way beyond that for Microsemi.

I think this quarter is a nice home run. I think we're looking for a grand slam next year.

Steve Smigie - Raymond James

Okay, great. And then I was hoping to just to get some how house keeping items, I don't think you specifically said what you thought the tax rate would be in this September quarter except the adjustments you made this quarter for example. And share count it looks like it's been moving up here a little bit over time. Is it just through acquisition stuff or is it some sort of consistent option grade program?

John Hohener

Yes, the share count is just the nature of people who actually have five options, you know, they've have had granted to them over the years, and we moved up modestly just a 100,000 this last quarter and it's going to go up. We guide typically in the 400,000 range. So used 83 for next quarter, and then from a tax standpoint I would use the same amount for Q4 which somewhere in the neighborhood of 15.5, 15.6.

For next year I think it's safe to go down to 15%.

Steve Smigie - Raymond James

And do you have all the stuff in there like Macau that has since come in, in like 0% and all that stuff? Are we still waiting for some of that?

John Hohener

Actually Macau has started kicking in much greater than it did in previous years, but next year is actually a big year for Macau that they will have paid for their initial payments for the R&D cost share that they were responsible for.

Jim Peterson

I want to touch on M&A, predominantly our M&As have been on cash that we've generated, and as a quick mention, accretive.

Operator

Your next question comes from the line of Quinn Bolton with Needham & Company.

Quinn Bolton - Needham & Company

You talked about accelerating the traditional one to three, two to four kind of growth rate. You got it seven to nine, could you kind of give us a sense what do you think is organic growth in the September quarter, how much of it is just a full quarter contribution from White?

Jim Peterson

Let me do one better. Let me just touch on last quarter. We guided 3 or 5 with Microsemi proper by itself, and I think we are more like the 7% to 8% from Microsemi proper organic kind of growth balanced with the White acquisition. If feel it's certainly then 50-50, I mean for revenue growth and organic and acquisition. I don't know, depends on the time for acquisitions is strong. John, you want to touch a bit?

John Hohener

Yes, the only thing I would fill in there is that again, we had White for two months this quarter, and we'll have them for three months next quarter.

Quinn Bolton - Needham & Company

And then you guys had mentioned that you continue to think that edge backlit systems will be most of the LED TV market this year, direct backlighting kicking in more 2011. Do you have any sense what kind of percent market share direct backlighting might have in 2011 at this point?

Jim Peterson

Obviously we just end up banging these number around, right? Overall, we think that LED penetration for TV in 2011 will be on or about 30%. And my hope is that 5% of our sale is direct backlit. But I wouldn't be surprised if it was only 2%.

Quinn Bolton - Needham & Company

Okay, that's next year?

Jim Peterson

Yes, 2011, yes.

Quinn Bolton - Needham & Company

Okay. And then as part of the OpEx it looks like you guys are accelerating some R&D investments. Is that Jim, just generally across the board or are there particular product lines or say subsystems and systems? Is there any, sort of overall theme where you're investing more heavily, given that acceleration in R&D spending over the past quarter or two?

Jim Peterson

Well, John knows some specifics. But as you reflect on the question, I am looking at putting in a little strong report in R&D, more certainly in the high-rel, certainly in some of the White activities, certainly in the Rad Hard activity and giving them a fair shot at taking market share away from some of the other leaders. And we are in the system business, and it’s new to us. And so why not throw a little bit there. John?

John Hohener

Yes. And I will tag that in terms of, again just to make sure we've got the math right. We did acquire White this quarter. We did have two months of their cost as it relates to both SG&A and R&D. Obviously, next quarter we have that third month. What we are guiding for SG&A is, it will probably be up in the neighborhood of $750,000 to $1 million; R&D up $1 million to $1.5 million.

Quinn Bolton - Needham & Company

And then just lastly, a clarification John, that discussed our contribution where you walked through the cumulative savings. Is that all coming out of the cost of goods line or is there any split that hits the SG&A line over the next four quarters?

John Hohener

That's a good question. The numbers that I gave you were cost of sales. At the tail end, we will have contribution from their operating as well. And at the point in time that we are now, I think was about $2 million a quarter.

Quinn Bolton - Needham & Company

Just to clarify though, when we get out to fiscal second quarter and third quarter of next year, a portion of the cumulative or the $2 million contribution in the second quarter and 2.5, there will be a little bit of that falling in the SG&A?

John Hohener

No, we are going to have the increment on comp of that investment.

Quinn Bolton - Needham & Company

Oh, on comp of it. Okay, perfect. Thank you.

Operator

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

Harsh Kumar - Morgan Keegan

Congratulations first of all. Great quarter, even better guidance. Let me start off with I think some of what the previous person was asking about. Just listening to your commentary, it's pretty obvious you are very, very extremely bullish about your near term future, next four months or so. Is it fair to say that the new normal would be higher than your typical guidance range in the past?

Jim Peterson

Yes, that's what we are talking about Harsh, right? I mean it usually, one to three things are good, two to four things are great, right? We might be a step beyond that, right? I don't want to guide beyond one quarter, it not what we do. But we certainly see strength in the business we bought, obviously a longer lead time, longer cycle time businesses. So we're a bit more confident that we might be going to a different level over the next four quarters, yes.

Harsh Kumar - Morgan Keegan

And then through rough maths, maybe a question for John. Coming up with third quarter 2011 gross margin of about 54% to 55%, does that sound more or less accurate from a margin standpoint just figuring in the savings of Scottsdale?

John Hohener

I don't exactly remember what the starting point is in your model specifically, but what we said is, the midpoint of 50 to 55 we are comfortable with exiting June of next year.

Jim Peterson

Let me help you with Scottsdale. It's a pretty question at Scottsdale. We had told our investors, our stakeholders that the closing of Scottsdale would give us a benefit of on or about 400 to 500 total basis points contribution. We saw a touch of that this last quarter; it came in a little bit. Now, we are actually accelerating Scottsdale in to John's newest model that we just put out there.

In addition, we said we'd be generating cash of roundabout 20 to 25, and I think we will be right about the midpoint of that as well.

Harsh Kumar - Morgan Keegan

That's pretty helpful. And then guys, if you can remind me of what White's operating model was like, and what you think you can add on to that from just the efficient way that you guys do business? Just any color would be helpful.

Jim Peterson

They were a public company right? So it's public information, right? When we bought them, their gross margins were 38%, which talks to the strength of Microsemi's core business. So this quarter, the gross margins were up, you know, total. And the plan is to get White just like every other business to our corporate target of 50 to 55, and operating of, you know, a great target of 30%.

And we believe we have visibility, and more importantly we have a plan to get them there.

Operator

Your next question comes from the line of Nicholas Aberle with Janney Capital Markets.

Nicholas Aberle - Janney Capital Markets

Just to follow on the previous caller with respect to White. You talked about the gross margin expectations there. Can you talk about OpEx? I mean, we get another month's worth of contribution here this quarter. Do you guys have the scope to actually pull some incremental OpEx out of that going forward? Is there synergies there on that front?

John Hohener

Yes. And certainly, we hit that pretty hard right when we acquired them and there's more to come. And that is built-in to the guidance that I provided, next quarter going up $750,000 to $1 million, remembering that that is an incremental one month for White.

Nicholas Aberle - Janney Capital Markets

So it's already built into the last quarter, and then your guidance for this quarter?

John Hohener

Yes.

Nicholas Aberle - Janney Capital Markets

Okay, got you. And then on gross margin, I mean you guys have a fantastic performance in gross margin this quarter. Some of that was from Scottsdale. It looks like 40 to 50 basis points in addition to Scottsdale. Was that mix or what exactly also drove up gross margin for the core business?

Jim Peterson

Yes. Certainly, it was mix, and certainly it was the fact that we are selling products that are satellite strong as well as a significant contribution from Ireland as an example.

Nicholas Aberle - Janney Capital Markets

Got you. Medical is kind of the only headwind during the quarter. Are we at a bottom there, or do you expect that to continue to kind of deteriorate here in the near term and bottom out some time later in the second half of the year?

Jim Peterson

Yes, I think the word deteriorate was a good example for last quarter. I think slightly down in absolute dollars, and then I think it starts building from there.

Nicholas Aberle - Janney Capital Markets

So slightly down in the September quarter and that's the base to move higher. And I mean, do we see a recovery to previous peak run rates there at some point in the future, or we kind of passed the prime for that business?

Jim Peterson

Certainly not. I was hoping for double digit organic growth, we all were. So I don't think we're going to get back to the high double-digit growth (inaudible) particularly is for a period of time.

Nicholas Aberle - Janney Capital Markets

Got you. And then you referred to the mix being unfavorable within the medical segment as well. Can you just give a little more color as to what exactly that means?

Jim Peterson

Yes, that's the good news. The good news is, we're in the MRI business, and that's extremely strong, 3 Tesla or 3 Tesla going to 7 Tesla. And more importantly, it's more in the apparatus than the large mainframe MRIs themselves. And that was extremely strong; a lot of new customers, a lot of design-ins, lot of new product.

Nicholas Aberle - Janney Capital Markets

Perfect. Obviously, bullish on the top-line and gross prospects going forward. I think, clearly the body scan opportunity and then the GPS module opportunities are two big ones that will help drive that. Any way you guys can quantify how you think those two opportunities layer into the top-line here in the near-to-medium term?

Jim Peterson

They are certainly accretive. I mean, let's just say, very important spokes of the hub.

Nicholas Aberle - Janney Capital Markets

Are we talking like $5 million to $10 million of incremental revenues in the next couple of quarters, bigger, lesser?

Jim Peterson

Let me give a little color. That's a good point, right? We get that question a lot of time. So let's address it. I think for the security business, for the scanners, we should order about slightly above maybe $2.5 million this quarter, which is what we had expected to do, and strengthening thereafter.

The GPS, we announced a $22 million purchase order. Sort of the question is, hey, my Gosh, when did that ship? And the answer is simple; we expect to ship that entire purchase order within the next 15 months or so.

Nicholas Aberle - Janney Capital Markets

Now it will be pretty linear over the next year and a half basically.

Jim Peterson

Yes, I think linear is a pretty good word.

Nicholas Aberle - Janney Capital Markets

Okay. GPS module, which segment is that baked into.

Jim Peterson

Now as we look at that Bob, where do you have that baked into?

Unidentified Company Representative

That's in the defense area.

Nicholas Aberle - Janney Capital Markets

Got you. And then just one last question. Can you kind of touch on visibility in the business, backlog coverage and churns requirements?

Jim Peterson

Churn last quarter? Churns were on or about 30%. The good news now is that churns for this quarter are on or about 20%, which kind of reflects our confidence in our strong guidance.

Operator

Your next question comes from the line of Rick Schafer with Oppenheimer.

Rick Schafer - Oppenheimer

I just had a couple of questions. One, just back on the GPS module, just real quick, how much of that $22 million contract was actually incremental to that sort of $60 million we talked about in terms of White contribution when you guys first made the acquisition.

Jim Peterson

Let's see. That might save you from $60 million to the upside beyond $60 million, Schafer.

Rick Schafer - Oppenheimer

So some of it maybe was baked in, but there's a decent portion that's incremental, is that kind of what you're saying?

Jim Peterson

I'd go $10 million of it's kind of (shorter) than I was talking.

Rick Schafer - Oppenheimer

Okay. That's great. And then just back on the scanner stuff, it sounds like you think about $2.5 million. How much did you ship in the June quarter?

Jim Peterson

1418 I think. I wish I got it, but it will be less in the next quarter, the following quarter.

Rick Schafer - Oppenheimer

I mean nobody knows what the $10 million orders shippable this year. It sounds like you'd probably get about 7 or 8 of that kind of recognized this year, and the rest I would seem just kind of gets you a headstart on calendar 2011.

Jim Peterson

Actually like any growing business, right, you get the one purchase order and you lap in the others. And that's the plan; that's what's happening.

Rick Schafer - Oppenheimer

And so you had follow-on orders now I assume. Is that what you're saying?

Jim Peterson

Yes we have, my friend.

Rick Schafer - Oppenheimer

Okay. Do you quantify those at all and talk about it?

Jim Peterson

No I don't, not at this time, because I don't quantum my orders. There's got to be a bit of secrets out here, Schafer.

Rick Schafer - Oppenheimer

I guess I have asked this before, but sort of what's the biggest choke point there for you guys in terms of getting your capacity up? Is it just simply starting more shifts off, add more heads, or is there actually equipment you're having to buy to get this ramped up?

Jim Peterson

Second shift, right? The second shift, and then reallocating our space for efficiencies, right. I mean, the name of the game is, they were doing x and now we're doing x-plus. And we have the team in place and it's just a matter of adding the second line in, and then what do you look for as the orders keep rolling in? But it's nothing that's not under our control, there's nothing that we're not executing on.

Rick Schafer - Oppenheimer

And then the last one is just PoEs. You guys have been selling PoE, any supply constraints there for you guys on the front-end, backend or anything like that?

Jim Peterson

Yes. Our team's right on this one, right? We saw it coming, we established good relationships, and I think we got this one, this is the layout for us; stronger, that is.

Operator

Your next question comes from the line of Adam Benjamin with Jefferies.

Adam Benjamin - Jefferies

You talked about the wireless LAN business and some constraints there. I think you previously talked about that not being so core to you. Can you just talk to, is that a change, where do you stand with that business going forward in terms of a commitment level and what you're thinking about the business in terms of growth going forward.

Jim Peterson

I don't think I've ever declared that was important to me. About four to five quarters ago, it was slowing down a bit. We're looking at it saying, okay, hey, where is this market going? That's changed, right? That was in Broadcom, and others have proved that this is a heck of a market.

It's so strong for us that it is of (vital) strength. I think we should get over it next quarter. But by all means, we are introducing new product, we have R&D dollars behind it. And we're a big supporter of wireless LAN at this point.

Adam Benjamin - Jefferies

So in terms of strategy, where do you plan to go after in terms of trying to grow that revenue and that share?

Jim Peterson

Yes, you know what? Certainly, stage show but a show without Broadcom. Look who might be trying to take their market share and then have my guys look at what the next-generation module approach might be and just focus on what we do best. We're great at 2.4. We're much better at 5.8 and the like and better. And just to make sure that we can capture market share and the major customers there.

Adam Benjamin - Jefferies

Okay. That's helpful, Jimmy. John, on the OpEx, can you just go through that again, just in terms of where you see the trajectory of that going beyond the system recorder, once you factored in fully for White?

John Hohener

Well, we guided the September quarter as to be up $750,000 to $1 million. And I might as well do R&D $1 to $1.5 million in the September quarter. We didn't technically give a guide after that. But White will be baked in for a full quarter in September.

Adam Benjamin - Jefferies

And then maybe just directionally, can you give us some perspective as to how we should be thinking about the OpEx once White is in there? I mean, obviously it's an acquisition, so beyond that is it sort of more moderate growth from here, or would you expect moderate?

John Hohener

It will be moderate growth, but we have a goal to always, as a percentage of revenue have it declining. And after September, we see that we should be able to accomplish that.

Operator

(Operator Instructions) Your next question comes from the line of David Wong with Wells Fargo.

David Wong - Wells Fargo

Will you be having any restructuring charges in the coming quarter associated with White?

John Hohener

No. The answer to that is, no.

David Wong - Wells Fargo

Outside White, are there any restructuring charges that are coming up associated with what you're doing?

John Hohener

What I was about to answer, thinking of your question ahead of it was related to Scottsdale. And I was going to remind everybody that we did an accrual for the Scottsdale acquisition back when we announced it. When we actually closed Scottsdale, we threw up what our estimates were versus what actually happened. And there could be some restructuring at that point in time, a nominal amount from here on as those (people) depart.

David Wong - Wells Fargo

Right. And then amortizations starting in the September quarter, presumably all of White will be in there. In the September quarter, what would your amortization number be?

John Hohener

The amortization this last quarter, inclusive of White, it will be an incremental pick up of about 500k.

David Wong - Wells Fargo

Now, you gave the sequential increases in SG&A and R&D numbers, so that's presumably pro forma. Is it roughly the same if we do in GAAP or does the option expenses or other considerations push those numbers up higher?

John Hohener

Well, it will be roughly the same in terms of increment, because we're forecasting our stock comp to be flat.

David Wong - Wells Fargo

And just to clarify something I think you said just now. You said, about half of the sequential growth was acquisition related for the June quarter. So your 79% sequential revenue guidance for September, about 4 percentage points would be incremental White revenue so your organic growth expected for September is something like 3% to 5%. Is that about right?

John Hohener

You got it about right. What we said is the company is going to grow at 7% to 9%. White is Microsemi.

David Wong - Wells Fargo

Yes. But some of that is incremental acquisition related revenues.

John Hohener

I really don't have it broken out when I put it here. Well, I don't break up, you know as well as I do. Day one, right? Parts are moving, right? It's integrated. So I don't have the break out for you my friend, but I'm dialing in growth for the company, 79% next quarter.

Operator

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

Steve Smigie - Raymond James

Thanks for giving me the follow-up. Back to a gross margin question. If you get to sort of a mid-50s or something like that, just on the Scottsdale loan, would moving White up to the corporate margin add something beyond that so you can hit the high end of the range? Do we think about it that way? Or is it just White plus Scottsdale equals (inaudible)?

Jim Peterson

Well, (NYSE:DL) is one big stew, right? So White is part of it. We probably could just put in that White with just the Scottsdale closure. But it's all a close-up.

John Hohener

I mean, White, as we've mentioned, our goal is to get them to 50% is what we said in September, before we expect to accomplish that. What I said was, the Scottsdale was complete, we are going to be somewhere in the middle of 50% to 55% depending on where your models are at.

You can add in the numbers that we gave you before the Scottsdale closure. So we're comfortable that White's not going to be a drag; White's going to be right in there with everybody else.

Jim Peterson

Exactly, right.

Steve Smigie - Raymond James

And as a part of getting there, are you guys walking away from White business? So as I just look at what my assumptions were on White beforehand and then afterwards, I…

John Hohener

You know, the intent was to walk away. I think last time we said we walked away from 20% of that business, maybe only 18%. But yes, there is some (untolerable) business and if it makes sense for us we think we will do it, but we intend to walk away from some business if it doesn't meet our models.

Steve Smigie - Raymond James

And then just on PoE with the Cisco agreement, at this point pretty much your Cisco revenue's all Linksys, and anything that would come after this would be incremental, would be sort of in the non-Linksys type businesses there.

Jim Peterson

It was predominantly Linksys, yes. But going forward, right, the name of the company is Cisco. We're going to find out what the driver is, up to a top three customer, that's the strategy.

Operator

And at this time, there are no further questions.

Jim Peterson

Thank you for joining us today, and for your questions. Have a great day.

Operator

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

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Source: Microsemi Corp. F3Q10 (Qtr End 06/27/2010) Earnings Call Transcript
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