Cypress Semiconductor Corporation Q2 2010 Earnings Call Transcript

| About: Cypress Semiconductor (CY)

Cypress Semiconductor Corporation (NASDAQ:CY)

Q2 2010 Earnings Call

July 22, 2010 11:30 AM ET

Executives

T.J. Rodgers – President and CEO

Chris Seams – EVP, Sales and Marketing

Brad Buss – EVP, Finance and Administration, and CFO

Shahin Sharifzadeh – EVP, Worldwide Manufacturing and Operations; President, China Operations

Dana Nazarian – EVP, Memory and Imaging Division

Norm Taffe – EVP, Consumer and Computation Division

Dinesh Ramanathan – EVP, Data Communications Division

Analysts

Ashish Rao – Credit Suisse

Gene – Citi

Adam Benjamin – Jefferies

Tim Luke – Barclays Capital

Doug Freedman – Gleacher & Company

Chris Danely – JP Morgan

Sandy Harrison – Signal Hill

Steven Eliscu – UBS

John Barton – Cowen

Jeff Schreiner – Capstone Investments

Raji Gill – Needham and Company

Vijay Rakesh – Sterne Agee

Charlie Anderson – Dougherty & Company

Srini Pajjuri – CLSA

Operator

Good morning. And welcome to Cypress Semiconductor’s Second Quarter Earnings Release Conference Call. Today’s conference is being recorded. If you have any objections, you may disconnect at this time.

I would now like to turn the call over to Mr. T.J. Rodgers, President and CEO of Cypress Semiconductor. Sir, you may begin.

T.J. Rodgers

Good morning. And we’re here to report second quarter of 2010. We’ll start with our CFO, Brad Buss.

Brad Buss

Thanks, T. J. Good morning, everybody. Thanks for attending our second quarter call. As usual, everything in our press release and on this call is based on our preliminary unaudited results and we encourage you to review out 10-K, which we’ll file in early August.

And, as usual, we make a lot of forward-looking statements. They entail a bunch of risk and we have no duty to update it so we encourage you again to look at the Risk Factors in our 10-Q. I’ll go through Q2 and give you a quick look at the guidance for Q3.

Q2 came in extremely well. I was very pleased with how we ended. We had better revenue gross margin, OpEx, net income and earnings per share than we originally expected. We exceeded my prior guidance and we also beat the average street consensus. And again, most of that was really driven by strong revenue and more importantly, the strong internal leverage in our business model that we’ve been talking about for quite a few quarters.

Revenue for Q2 was $223 million, an increase of 10% sequentially. It increased 40% on a year-over-year basis. And again, I was very pleased with that result considering that our normal Q2 seasonal growth is normally around up 2% to 5%.

We saw sequential growth in all major end-market segments led by communications and industrial military. And I know I’m going to get the question, so I just want to let you know, our PC segment was up sequentially as was our revenue in Europe, surprise, surprise, everybody.

We have finally returned to the pre-recession revenue levels that we last achieved in Q3 ‘08. However, we have substantially better financial results. So just to put that in perspective because I think it’s really important.

If you look at it in Q3 ‘08 we had relatively the same revenue levels, yet now in this quarter, our gross margin percent is 9 percentage points higher, our OpEx is 5 percentage points lower and the corresponding operating income is 14% higher.

And this isn’t really some one-off, right. This is a result of a lot of the strategic initiatives that we’ve been doing over the last couple of years, everything from the Flex Fab to the Sync SRAM conversions and a big focus on proprietary products, and a big focus on our operating expense structure. So we’re really pleased with where that’s gone. We don’t see it as a one-off and I think we’ll have continuous improvement overtime.

If you look at it by divisions, MID increased 14%, driven by strengthen our SRAM business due to market share gains and increase in communication and demand, mostly driven by wireless and wireline end customers like you’ve been seeing from the other FPGA guys. DCD increased 9%, again driven by growth in com and some end of life sales.

CCD increased 3%. Our flagship PSoC family, which is the largest revenue component of CCD had record revenue for any June quarter in its history. Our design activity there remains very strong and our current backlog for PSoC is at a record level. We expect record revenue for PSoC in TrueTouch in the third quarter and for the entire fiscal year 2010. Our PSoC based FingerNav sensor for cell phones began a shipment production late in the quarter and that helped drive our emerging tech division to 100% sequential revenue increase.

Turning to the profit line on a GAAP basis, we had another positive quarter. We had a net income of $20.6 million. That was $0.11 per diluted share. That was a 63% sequential increase versus the diluted earnings per share of $0.07 in Q1 and substantially better than the net loss per share in the year ago second quarter that was $0.32.

Our GAAP operating income increased 100% sequentially and I expect to be strongly GAAP profitable for the balance of the year. On a non-GAAP basis our net income was $48.1 million, an increase of 41% sequentially and that was the highest level since Q4 of 2000. That yielded earnings per diluted share of $0.24, which again was above my guidance of 19% to 21%.

Our operating income increased 47% sequentially and we hit a 23.4% PBT and that’s our highest non-GAAP PBT since end of Q4 of 2000. So, we’re really pleased with where that’s came in.

Another little record area was in margins. Our non-GAAP gross margin hit a record 59.3% and that’s up a full 3.7 percentage points from Q1 and up 15.1 percentage points from Q2 of 09. Our results here were above guidance as our factories and our foundry partners continue to execute very well. We had a favorable product mix. We continued on our 65-nanometer conversions and we also enjoyed lower inventory reserves.

Our core semiconductor gross margins, which excludes the impact from the emerging tech division again were another record and broke the 60% mark for the first time, it came in at 60.1%. Our utilization in our fab in Minnesota based on wafer starts for Q2 was 89%. That was up from 81% and we expect to see that move towards 92% in the third quarter.

As we’ve been discussing for the last couple years, our Flex Fab strategy continues to pay off and in Q2 we had approximately 30% of our wafers coming from our foundry partners and we see that number moving up closer to the 50-50 mix over the next year or so.

Our product margins increased nicely due to the SRAM conversion to 65-nanometers. Overall cost improvements in all of our product lines favorable yields out of our factories and we also had stable pricing and in some cases rising prices. You saw that our ASPs moved up again. We increased to $1.51 and that’s the highest in almost a decade and again, just further evidence of the move for us proprietary products that we’ve been enjoying for the last year or so.

Non-GAAP operating expenses increased $2.3 million sequentially. That totals $78 million and that included $1.8 million non-cash accounting benefit related to the deferred comp plan. As usual, my guidance does not include the deferred comp plan because it’s impossible to forecast. So if you look at it on an apples-to-apples basis, OpEx was $79.8 million up slightly from my guidance and really just due to higher revenues and profits driving a little higher variable comp expense and we also have increased travel to support our design activities.

Our headcount is being very tightly managed. We only increased in the quarter on a net basis by 24 people and most of that was offshore and it was focused on supporting our growing design wins and our emerging tech group.

Our headcount was around 3500 people and again, a decrease of 20% since our peak in Q3 ‘08 and the lowest in over a decade and more importantly our revenue per head is at the highest level in over a decade, and we’re managing OpEx extremely tightly and we will continue to do that into the foreseeable future.

The non-GAAP tax charge in Q2 was $4.4 million that was an effective tax rate of 8.4%, slightly better than my guidance of 10% due to some higher foreign tax credits.

If we look at the balance sheet it continues to remain very strong. Our cash, cash equivalents and investments totaled $278 million, decrease from Q1 due to the yield enhancement program that used a net $80.7 million of cash. If you include the $31 million of auction rates we have classified as long term we have $309 million in cash and investments, which approximates about $1.93 per outstanding share.

Over 0.3% of our assets are in cash and investments and we have no debt. We had really good cash flow performance in the quarter. In Q2 we had operating cash flow of $46 million and our free cash flow of $37.5 million increased 85% sequentially.

Inventory has gone over very well. The ops team here has done a great job. Our net inventory was $81.5 million, which decreased 3% from Q1. Our net inventory is actually down 35% since Q3 ‘08 when we actually have the same revenue level, just to put that in perspective. And more importantly, we’ve been increasing our on time delivery, which is helping us competitively.

The net days of inventory decreased of 85 in Q1 to 82 in Q2, and is down from historical average levels of around 100 plus days during 2008. If you exclude the $4.3 million related to the capitalized non-cash stock based comp and $7.5 million, due to the shutdown of our Texas fab in ‘08, the normalized inventory is down around just about $70 million or 70 days.

We finally saw our distributors start to increase. Their inventory in Q1 gets positioned to support the big backlog that we’ve got going. The DISD’s accounted for 64% of our revenue in Q1, a multi-year high and they grew 13% sequentially, which was higher than our 10% average growth rate and again, remember we don’t recognize revenue until the product is fully resold to the end customer.

You saw our deferred income grow from $86 million to $108 million in Q2 and again, that’s a function of the increase in DISD inventory. The vast majority of that was unit growth, but we also had some growth in the deferred income due to DISD book pricing increases.

Most importantly the average weeks of inventory at the DISD’s remain constant with the last few quarters at eight -- six weeks, I should say, and remains at the lower end of historical levels between six and eight weeks.

CCD has a massive backlog led by PSoC, but a majority of the CCD revenue is shipped through DISD, so this is pretty much in line with where we’re at. Receivables were up again based on the increase in the deferred income, our aging remains extremely well and things are going very well with respect to our DISD relations. CapEx continues to remain low. It was $8.5 million for the quarter and our depreciation for the quarter $11.9 million.

Turning to the share count, our weighted basic shares came in at 161 million below my guidance. The fully diluted shares were roughly in line with guidance. Late in Q2, the yield enhancement program delivered 7 million shares to us. That didn’t have a big impact on the shares due to the weighted average nature in Q2 and we’ll see benefit of that in Q3.

And I’m going to now switch over to the guidance. So, as you saw in the press release, we have a very strong book-to-bill of 1.3, all divisions are north of 1.1 and CCD is growing the most led by record PSoC backlog. Our backlog is at a multi-year high and grew very strong sequentially, again led by CCD and DCD. We’re 92% booked entering the quarter, which is up fairly significantly from the prior quarters normal levels and kind of the high 60% to 70% range.

So, if I look at Q3, we’re looking at revenue in the range of $234 million to $240 million, which is up 5% to 8%. The vast majority of the growth will be driven by CCD and emerging tech. I’m looking at non-GAAP gross margins of 58% to 59%, which again will vary with product mix, manufacturing constraints, et cetera and that’s again based on the 91% utilization internally and assuming no major capacity issues internally or externally.

OpEx around the range of $80 to $82 million, if you look at OIE, I’d just plug in about 400 K and a minority interest benefit of about 200 K. Tax expense for Q3 should be around 9%. CapEx is $9 to $11 million, depreciation of around $11.5.

I think the basic shares will be around $157 to $160 million and fully diluted, somewhere around the $195 million level and obviously that will vary with the stock price a lot. You roll that together, it gets you a non-GAAP earnings per share in the range of 26% to 28%, which is 13% to 22% above the current Q3 consensus of 23%, and 160% to 180% higher than Q3.

I’ll now turn the question over -- the call over to Chris and he’ll take you through the market and sales trends.

Chris Seams

Thanks, Brad. Now, I’ll start off with some of the traditional indices that I give and then some flavor on the market that we’re still looking at. In terms of shifts of our revenue by geography relatively unchanged from last quarter. Asia Pacific again led the way at 50% of our shipments. North America was 23%, followed by Europe at 15% and Japan at 11%.

Obviously, with revenue going up faster than our ASP, units were up to $147 million in the quarter. Brad talked about our ASP increasing 3 pennies from $1.48 to $1.51. Again, it’s reflective of a continued supply constrained market environment and a richer mix of our newer products getting out to market and being designed in by our customers.

In terms of the end market segments, every one of our end markets grew sequentially in the second quarter and again in the third quarter almost every end market segment will grow. They will be lead by consumer in the handset segments will be the strongest in the third quarter.

Our lead times while not where we would like them to be internally still remain very competitive within the industry, with most of the products being between six and 12 weeks. Having said that, the industry having stretched lead times has led our customers to change their booking and order pattern behavior where they are extending their booking horizons.

That leads to the high book-to-bill of 1.3 where a lot of bookings frankly are coming in now even into the fourth quarter. Brad talked about being 92% booked to the current quarter and order patterns to hit the guidance that we’re giving give us confidence that’s the good guidance for this quarter.

With that sort of market environment, we are very diligent in monitoring for signs of order pattern changes or changes in behavior. Two other things, that we monitor internally besides going out with our customers and checking the channel for inventory where we don’t see any big signs of any build up.

Internally, we look at our customers request for expedite and I will say that their requests have not abated and they remain numerous. The other thing we look at are cancellations and push outs, and we actually went back in this sort of market we look at historical levels and we’re still unchanged on a cancellation and push out basis all the way back through 2009 as far as we can look. So, right now there’s no big signs of a big change in the market. So very strong market with a longer booking horizon is what we’re seeing right now.

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

T.J. Rodgers

A few bullets and then questions. We had two major milestones from our emerging technology division. In the annual report I said that there were four new business ventures that we were hoping to get to a $1 million quarter in revenue. The first significant quarter was growth hopefully thereafter.

Two of them made the milestone this quarter, emerging, the China business unit had actually a $2 million quarter and our optical navigation systems business, this is the FingerNav, think of the little FingerNav on the RIM Blackberry phones, the new ones, the optical ones, it achieved its first $1 million quarter.

We have two companies who we hope to achieve $1 million quarter yet this year that Cypress and Viro Systems on that we talked about before, and a GiGa Technology, which is the storage -- non-volatile storage place.

We introduced our -- in production our PSoC 5 chip. PSoC 5 is the 32-bit microcontroller with ARM Core -- Cortex-M3. It’s their first foray into 32-bit. We have had customers having that product for about a year now but only seven customers in effect are off the customers debugging it. We’ve now gone through general release. Along with the general release, we’ve released with what we call the FirstTouch Starter Kit and a Processor Module Kit, so we’ve basically begun broad sampling and design wins on PSoC 5.

Lucky Gold Star put our CapSense into their new flat-panel TV. That’s a big trend right now. When you have a sleek black flat-panel TV, you don’t want ordinary knobs and buttons sticking out of the bottom. So we’re getting a lot of CapSense business on that.

In addition, we’ve gotten automotive qualified PSoC is capable of doing can and win, PSoC 3 can and rest are the win, which are the automotive bus standards, and that means that we allow quick integration of touchscreens into automobiles. We’ve been qualified, automotively qualified and our biggest win is the Chevrolet Volt, the new electric car where we are in the center panel of the car.

We added a board member, J. D. Sherman, he is the CFO of Akamai Technologies and he’s also held financial management positions at the semiconductor group at IBM and understands their business.

In the event related to what we do but not directly to our business, we announced on the 2nd of July we had an event called the Independence of the Grid near the 4th of July, the Friday before the 4th and we announced that we are now 75% powered by power generated on our site, we only buy 25% of our electricity from the grid.

We have two sources of power, everybody knows about the solar cells that was SunPower that we started working with in 2003 and the newest one we just turned on, which triggered the event, was Bloom Energy that is a private company, Kleiner Perkins get all investment. They make fuel cells and we put 300,000 watts of Bloom -- so-called Bloom Boxes on site. They are 51% efficient. That is they turn the chemical energy and natural gas from methane 51% into electrical AC energy.

That’s more efficient than a power plant for PG&E, even a giant power plant that produces a gigawatt of power. And they are also local. I can see them from here. And therefore there are no transmission losses running the power across the state of California from SunPower plant on the coast.

We use the Bloom Boxes to power our base load that is the lowest power draw we have in the middle of the night and then we use their 300-kilowatts -- we also use 300-kilowatts of solar and we use the 300-kilowatts of solar to power during the day, so we have a peak power generation and a peak load during the day.

We announced that we were going to become 100% energy independent in 2015. Fact is, if we bought another Bloom Box and put solar cells in the parking lot we can’t put anymore, on our roofs are pretty much covered, we could become 100% self-generating today.

We aren’t doing that and we set a longer time frame because we’re still looking for another technology. I absolutely believe the fuel cell technology is going to be important, that it will be the next SunPower. We’re looking for a third technology, point one.

Point two, we’re looking for storage. Right now I don’t see a good way to store energy and point three, we’re looking for true independence meaning that we can power ourselves when the grid goes off, as opposed to just generating our own power and paying a lower bill.

Our wafer fab in Bloomington, Minnesota, Fab 4, has been named a trusted foundry. A trusted foundry is a Department of Defense term and it means that you can make highly classified integrated circuits that require background checks on the officers of the company and et cetera. It’s a notch up from just making a military product.

And finally Cypress Envirosystems, which is nearing its $1 million -- first $1 million quarter was named one of the top innovative green companies by the California Public Facilities Commission. Normally, I don’t house government awards but in this field, that award leads to customer knowledge and downstream business so we put it in our reports.

So, those are the main, well actually there’s a couple more. Gross margin 59.3%, I got out a record this morning and the last time we had gross margin exceeding 59.3% was in 1990, so it’s been 19 years. 59.3% is a little bit better than we did during the peak of 2000, 59.2% and the peak of 1996, which is 54.8%, so we’re happy about our gross margin.

Our price to sales ratio at the end of the quarter, the price at the end of the quarter was $10.89 and our price to sales ratio was $2.41, which is very near the median of $2.27 so our share price based on multiples is right near the middle of the pack for our history.

A reminder, when I talk about price to sales ratio, I calculate market cap for the companies in fully diluted shares from the prior quarter that we report. The share price at the end of the quarter and then I calculate revenue price on sales as the last quarter’s reported revenue times four, so it’s annualized, it’s fully diluted market cap divided by annualized sales and the median for Cypress, this is on our website you can look it up, we’ve got history going back to our inception is $2.27.

That’s it. We’re ready for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) John Pitzer, your line is open. Please state your company name.

Ashish Rao – Credit Suisse

This is Ashish Rao for John. Could you update us on where the TrueTouch revenues were for the quarter and if you’ve gone past the customer pick up that you saw in the March quarter and also as you look ahead to 2011, how do you view the tablet opportunity versus the predominantly handset smartphones today?

Brad Buss

Ashish, it’s Brad. You know, as you guys know, we’re not going down every product line revenue, Norm will take you through some of the good things that are going on there but business is very strong there and Norm can take you through a lot of the detail.

Norm Taffe

Hi, Ashish. This is Norm. So, I think the second part of your question was related to what kind of momentum we’re seeing in terms in the March quarter and going forward on touch. My answer to that is we continue to see great momentum there. In fact, we said another design win record in Q2 as far as wins in the touch space.

And I think importantly that was the biggest driver for on extraordinary bookings in PSoC, actual PSoC book-to-bill was above 1.7 in Q2 and we will be growing substantially in the back half of this year driven by a lot of that such success. I think the second part of your question or maybe the third part was related to the tablet space.

That is an important new space for us and as I said previously, we have been working with some lead customers actually over the next month or so, you’ll have a couple important announcements specifically about both medium and large touch solutions. We are developing solutions all the way up through 14 inches right now with several customers and it will actually a first revenue for us this quarter, but significant revenue, we see for that is in 2011.

Ashish Rao – Credit Suisse

Okay. Cool. Very helpful. Secondly, on SRAM. SRAM was like 50% of revenue this quarter, well above like 40% you had in late 2008. Clearly, this is being driven by the wireless networking strength and also by share gains. I mean, do you guys have a target mix in mind as you look at these different segments and how they might continue to grow later this year and into 2011?

Brad Buss

Well, let me answer that. First of all, MID’s memory and imaging division that also includes a revenue from our image sensor business, it is in Belgium. We had, you’re right, we had a very strong quarter in SRAM and the really driving strengthen that is the data communications, all of the broader companies we go in very strong and they use our highest technology, most advanced Sync Static RAM, high performance Sync RAM, which has an ASP in the $10 plus range and that’s been driving revenue.

In the longer -- so that’s the short-term driving force that put us where we were at 50% MID of revenue. In the longer haul, the SRAM market is about $1.2 billion, may be up to $1.4 billion this quarter based on the strength and the communications. But in the long haul, the SRAM market is not growing that fast. It takes an occasional excursion to $3 or $4 billion based on something taking off.

For example, in 1996, it was cash RAM and personal computers and in 2000 it was RAM and routers and the dot-com boom we’re having a little bit of micro dot-com boom right now. But that market is in the long haul is going to be limited in its growth and therefore, the play there is profitability and market share.

So we expect in the longer haul CCD, specifically PSoC, which is the primary component of CCD to become the largest part of revenue. That’s where we’re investing our R&D dollars. So if you want to ask where we are in two to three year timeframe, the CCD number will be 50% plus.

Ashish Rao – Credit Suisse

Okay. Cool. Very helpful. And then lastly, any, you talked about the 65-nanometer transition and the FPGA guys have been talking about supply constraints at 65- and 90-nanometers this week. Just wondering if you guys are supply constrained and are you still on track to get to like the 50-50 mix by mid next year, Brad?

Brad Buss

Yeah. I’m very comfortable on the 50-50 and I’ll let Shahin give you some commentary on the foundry since he runs all of that.

Shahin Sharifzadeh

In terms of, this is Shahin, in terms of the 65-nanometer capacity and supporting our SRAM, we don’t have any capacity issues from our foundry partners and we expect to be able to achieve the conversion rate that MID required for next year.

Brad Buss

Yeah. One of the things that I think is unique with us is we have more strategic and even development relationships with both of our major foundries, so we’re not just the typical buy resale kind of customer guy and that’s one of the things that Shahin and our technology group, they are working very closely with both of them.

Ashish Rao – Credit Suisse

Okay. Perfect. Thanks.

Brad Buss

You got it.

Operator

Our next question comes from Glen Yeung. Please state your company name.

Gene – Citi

Citi. Hi, this is [Gene] for Glen Yeung. Nice job on the quarter. Chris, you had talked about lead times about six to 12 weeks for most products and that you were looking to bring those in a little bit. Where are your target lead times?

Chris Seams

Targets for us are between four and eight weeks depending on the product set and the customer set.

Gene – Citi

Okay. Thank you. And Brad, you had talked about, earlier about potentially re-instating the share buyback once again once you reach the year mark. Any update there?

Brad Buss

Yeah. So, I mean, the time when we can do it is spec and (inaudible), right, it’s a two year anniversary of the spin so that would put you in the end of September of 2010, then we’ll be in the quiet period for Q3 earnings, so I’d expect post Q3 earnings that we’re able to do stuff and with the pathetic stock prices that the market is giving right now, I think you could expect that we would take the full advantage of that. I mean, we’re very confident in the economy and more importantly I think the new products and the new big end markets that we’re going into. So we kind of like it in a way, but we don’t like it in a way but we’re definitely going to take advantage of it.

Gene – Citi

Okay. Great. Thank you.

Operator

Our next question comes from Adam Benjamin. Please State your company name.

Adam Benjamin – Jefferies

Jefferies. Thanks, guys. I think I ask this every quarter. In terms of the SRAM, what was the percentage that you’ve – you’re now shipping 65-nanometer at this point?

Dana Nazarian

This is Dana. On the synchronous product line it’s about 20% and it’s headed to 40%from by the end of this year.

Adam Benjamin – Jefferies

And then, just in terms of following up with that, Dana, in terms of the market share gains and the pricing environment, obviously, it’s been pretty good for you guys. How should we be thinking about that playing out going forward and how you’re able to hopefully sustain that pricing advantage?

Dana Nazarian

A couple things on pricing, Adam. Just in general, the trend is pretty stable right now, so I’d classify it as stable pricing. In general, we’re shipping more and more performance content for units shipped and so when I say performance low power, high speed, high density and those command higher and higher ASPs. And there’s -- in the long-term there’s fewer and fewer suppliers that can deliver those performance goals. So I expect fairly stable pricing for the long-term.

Adam Benjamin – Jefferies

Got you. And then Norm, a question for you on TrueTouch. You’ve kind of talked about $100 million as a number for this year. Based on what you’re seeing now plus or minus what do you think?

Norm Taffe

Based on what we’re doing right now, we’re still on track to more than double what we did last year. It’s not clear yet whether we’ll look to get all the way up to the $100 number but we’re certainly on our plan more for than double this year.

T.J. Rodgers

So a lot of its Adam like we talked about is in the back half and I think the key thing from our end, the design activity has been great. We just need the guidance to come into market and ship well and all of you guys to upgrade those old fashion phones quicker.

Adam Benjamin – Jefferies

And then Norm just a follow-up to your tablet comment. Clearly, outside of one tablet the rest of the market remains uncertain. Can you just talk a little bit about what you’re seeing from design activity from customers that are features or other things that could potentially suggest that there could be some material volume there for you guys outside of that one large customer?

Norm Taffe

Yeah. I’m not quite sure how to answer your question. I mean, in general, there is an AMP you could say of customers both frankly in the handset and the PC space for a true convergence market all clamoring to produce their answer to that one product and so, I think you’re going to see that.

I do believe Cypress is very well positioned because the solutions are out in the market today are one and two finger touch and all of the direction is to our multi-touch all point solution and five or even 10 finger solutions, and that’s really the technology of course we brought into the handset space, so there’s plenty of pull.

I think it’s still what I would call an immature market where a bunch of people kind of trying to put something together to get something in the space and I think it’s very unclear how big the demand will be in the end and that’s why I think most material revenue will be next year, but I’d also remind you that this is not a single chip solution we provide, so the ASP per unit is substantially higher. So I do think it’s a great opportunity for us and I think we’re well positioned but I think it’s still early outside the one main guy.

T.J. Rodgers

Let me comment there. Since 2007, Apple brought out the iPhone and there was a land rush to turn to touch cell phones. The iPad has created a similar land rush to go to tablet PCs or tablet format anyway.

In 2007, we had a chip called Radon we brought up and we programmed it to do the touch function equivalent of the iPhone. We’re in the same position and it reflects I think the reason we’re doing PSoC.

PSoC 3 turns out one PSoC 3 and one chip we call EDN which is our cell phone touch chip, so one cell phone touch chip plus PSoC traffic will do touch screen for an iPad size tablet computer, so we already have the silicon out. We’re already sampling. We’re already prototyping and we will simply solve the problem by putting software chips in that are already in manufacturing and are ready to ramp. And that will be our response to the iPad introduction for the people who want that format.

Adam Benjamin – Jefferies

Got you. And the just one last question. As it relates to the smartphone maker in Canada, you guys have got good traction there with several designs that are coming in different form factors there. I know you had some hiccups with that customer in terms of maybe your product roadmap didn’t match up. I was wondering if you can talk a little bit about what’s changed that relationship and why the things are going in the right direction there?

Chris Seams

Yeah. Adam, this is Chris. You know our style. We generally won’t name customers so we won’t name customers on this, but Brad has convinced me that Canada has a very good hockey team.

Brad Buss

Yeah. I…

Chris Seams

We feel good about North America handset customers.

T.J. Rodgers

Yeah. I don’t want to mention RIM, but the one thing both of you talked about…

Adam Benjamin – Jefferies

I didn’t mention it intentionally, T.J.

T.J. Rodgers

I know. The whole story is about et cetera, et cetera. I know that there is certain place what I remember, I meet with them high level people pretty much on a quarterly basis and we’ve had an ongoing good relationship with them and we’re doing our best to serve them and we’ve got products that they are interested in.

Adam Benjamin – Jefferies

All right guys. That’s all I have. Thanks.

Operator

Our next question comes from Tim Luke. Your line is open. Please state your company.

Tim Luke – Barclays Capital

Thanks so much, from Barclays Capital. First time I’ve heard someone refer to pathetic stock prices on a conference call I think, it’s never a dull moment on this call, but anyway, Brad…

T.J. Rodgers

That’s why you all turn into Cypress.

Tim Luke – Barclays Capital

Just with respect to the gross margin, an elevated level. How do you obviously you’re guiding it again to be fairly firm. How are you thinking about the shape of that, Brad, as you move through the balance of this year, how are you thinking about sustainability of that margin level.

And I was also just wondering perhaps for T.J., as you look at the business and you’re going into this quarter with a big book-to-bill and low turns. Do you feel there’s a degree of visibility that should enable you to deliver fairly normal seasonality for the December period or how should we think about that?

T.J. Rodgers

So, let me take the gross margin one. I mean obviously, we’ve done better in kind of our model and what I’ve been thinking we’ve been doing and part of it, a transition thing. I mean moves to the foundry, moves to 65, those are all going very well and in some cases better than we probably expected. And again, I think with the focus on the proprietary products that we have and the extreme value-added solutions we’re bringing out in all of the PSoC families which includes power PSoC and our FingerNav, and even PSoC 3 and 5 which you’ll start to see come in nicely next year, are putting us in a whole different gross margin range.

So I think the levels we’re at are probably attainable. I mean there is probably noise give or take a point or so, depending on mix and manufacturing issues. But I’m fairly confident we could probably stay at these levels. I’m not at a point where I think I want to push it up yet but I think as we go through these next couple of quarters and see a lot of the new PSoC stuff ramp we’ll evaluate that.

Net-net I’d probably see more upward bias than downward but I don’t think there’s anything we could commit to right now. So, if I were an investor and asking the question at 60% gross margin which is a record for 19 years, are we in a peak period if this is the new 2000 and what might happen to the company going forward. Going forward for the next couple quarters, you ask that question you can look at your backlog.

The only question there is do you have double booking in your backlog. We may have a little double booking in areas that are traditionally to that and that would be, for example, USB that has a tendency to do that. We’re all over it. We’re actually allocating to channels where we think that they are made up of book and we’re actually looking at consumption rather than just orders.

In the other areas, once you get into the proprietary products, we make a point of having PSoC available in a reasonable time. We actually sacrificed turns business in the RAM area for example, in order to make sure we have PSoC so all the time and therefore our customers aren’t apprehensive, so they aren’t ordering extras store-up in case we can’t deliver but we have pretty good visibility.

The only other place where you could look for a downturn would be in static RAM and there, the dynamics would change. The old static RAM is so-called asynchronous static RAM, we now make and run the business out of India is the commodity business. And we watch it carefully but it’s only for the SRAM business. The high-tech static RAMs, the ones that are currently running at 500 megahertz and on their way to gigaHertz and a half. Those static RAMs are high-tech products and two people are doing the sophisticated customers, for example Cisco, and they have consignment programs.

So we actually are watching on a daily basis when they take out of consignment. So we know precisely what the inventory is in the channel and we don’t play games and they don’t play games.

So, if I look at -- can this, could 2001 be ahead of us? It may be. I don’t know. Nobody knows. But I do know that if I remember the cowboy days of 2001, people filling up warehouses with extra routers that took a couple years to burn off. I don’t see that and in general with proprietary products, which is now the bulk of what we ship, you just have better control. So what would happen if we went over the hill? What would happen in 2011 as opposed to 2001?

I don’t think our gross margins would crash. Actually 2001, our gross margins went down to 35% and during that crash and then that’s a typical number 25% to 35% during a hard crash. I don’t think they would go that low because I don’t think we’re going to see price erosion in static RAMs and the very high performance static RAMs, the way we did. That was when Samsung was flooding the market back in 2001, the price of static RAMs, the commodity type static RAMs literally got cut in half and the volume got cut in half, the business got cut by a factor of four.

And PSoC, we control price. So we have a choice of making the price more attractive and stimulating design wins or taking the design wins we’ve got and holding price limiting future growth and maintaining margins because we’ll balance that off in the interest of shareholders when we get there. So Cypress has always been good in downturns. We’re a pretty tough company and I’m feeling pretty good going forward. We haven’t bulked up. We haven’t added a lot of people. We managed passing every week, every person extent to the company 20 minutes in the beginning of the executive staff meeting we talk about bodies who we can hire.

We’ve held our head kind of flat and we’re ready if something goes wrong. I’m not projecting anything is going to go wrong. Certainly, if you look at our backlog, certainly, for the rest of this year, I don’t see anything going wrong. But we are in a state of being ready for something to go wrong and are going to maintain that State.

Tim Luke – Barclays Capital

Thank you. Just, if I may, lastly just for Norm, maybe would the book-to-bill and CCD at 1.7, what was the dynamic there that takes it from what it was last quarter? I don’t remember the exact thing but up so much and is it that it’s just a lot of constraint or can you just talk through that and how you’d expect that to look a bit going forward? Thanks.

Brad Buss

Yeah, Tim. It’s definitely not an issue of constraint. T.J. mentioned earlier, we are -- if we come upon a constraint, we make sure the PSoC lead time is well supported so the availability is there. Honestly, it’s a point of significant ramps to the customers we’ve been selling to. And I think importantly, we added, we received the first significant orders from two more of the top eight handset suppliers this quarter, which are going to ramp for us in Q3 and Q4. So now we are shipping volume in Q3 at five of the top eight handset suppliers on touch and so the backlog is really starting to ramp for us.

I will also point out what Chris said earlier. I do think our customer behavior has changed. I don’t think it’s related to our lead times which have been kept quite good on PSoC. But, I think, in general, they are seeing shortages so I do see longer bookings. Our bookings in PSoC are also very good for Q4 already, which is unusual that it’s that far out. So it’s a combination of those two things mostly driven by real demand increase.

Tim Luke – Barclays Capital

Why wouldn’t the hundred million be higher than you advertised in TrueTouch, if you got all of that order strength?

Brad Buss

Because it was already a very aggressive growth target, I guess, it is what I would answer that. And again, it’s not all TrueTouch too, Tim.

Tim Luke – Barclays Capital

Sure.

Brad Buss

Remember the core PSoC business, which is the core plus all of our cap spend which again, you know, is user interface oriented is that’s the big quarter when it ramps in Q3 as well. So you’re getting it, hitting on all areas. You are starting to get a little bit of PSoC 3 will come in late in the year and then all of those, we expect to continue very heavily next year. I mean, I think you’re going to see growth rates in the PSoC family that are unrivaled by any other semiconductor company growth next year.

Tim Luke – Barclays Capital

Thanks so much. Good luck.

Operator

Our next question comes from Doug Freedman. Please state your company name.

Doug Freedman – Gleacher & Company

My question guys, if I could focus one issue, I don’t think I heard any commentary on was the DSOs, big jump there. Can you give us some details on what happened there, Brad?

Brad Buss

Yeah. Doug, when I talked on the deferred income, which you know follow the DISD that’s all it was. DISD inventory went up late in the quarter to get ready with the backlog. So it’s pretty much consistent, over $50 million of AR was already collected in the first two weeks. The most important thing is the aging. The aging is in great shape like it has been for the last few years so no, issues there. It’s just purely timing.

Doug Freedman – Gleacher & Company

All right. Terrific. If I could move on and talk about some of the new products PSoC 3 and PSoC 5, can you talk about how those are doing ramping versus your expectations? What we’re seeing for design wins and design kits shipped?

Norm Taffe

Hi. Hi, Doug, this is Norm. Yeah. So PSoC 3 and PSoC 5, PSoC 3 development broadly being designed in and going since the beginning of the year. We are very happy about the design. And from a revenue standpoint, it’s still not meaningful impact this year. It will start a little bit in Q3 and Q4, it’s really much more of a longer term cycle, 2011 and ‘12. It will be the foundation for a lot of the PSoC growth. And in PSoC 5, as T.J. pointed out we just did a broad rollout. We got a very, very good reaction to it. I think the combination of arm and flexibility for online and digital is just unmatched in that space. And so we see a ton of attraction.

I don’t have the kit numbers in hand but we’re many hundreds of kits have been sold to even just, I think, in the first week after we launched PSoC 5. I don’t have those specific details. I can get those to you.

Brad Buss

I think once you give him a flavor versus rollout of PSoC 1 and how much better that’s doing, that will be a good anchor point.

Norm Taffe

That’s good point. Relative to PSoC 1, I think two things are happening. We’re seeing design uptake much, much quicker than what we had on PSoC 1. And already, I think it’s interesting the PSoC 3 and 5 family have three times the sales funnel of our long type developed PSoC 1 family. So even though we continue to sell PSoC 1 very successfully as a core product line, the funnel for three and five is now three times its size after only being out for six months. So, we certainly see a much market full for the three and five capability.

T.J. Rodgers

We’re doing something called 10 X plan with our distributors. PSoC 1, also everything we reported is relative to success in a $1.5 billion market and it’s the low end of 8 bit microcontroller market. PSoC 3 takes care of the high end of the 8 bit market and the low end of the 16 bit market. PSoC 5 takes care of the rest of the 16 bit market and about two-thirds of the 32 bit market, except for very, very high end.

So the TAM we’re addressing now is 15 billion versus 1.5 billion. So our expectations are is that we’ll have a shared market team for PSoC 3 and 5 is even approximates what we achieved the PSoC 1. And we’ll be attacking a 10 times bigger TAM and that’s what we’re planning and so far the early returns besides the funnel versus time of introduction is three times bigger for PSoC three and five as it was for PSoC 1.

Doug Freedman – Gleacher & Company

Great. T.J., in the past you’ve spent some time talking about trying to grow the top line at Cypress. And given what you’re seeing and the design wins and design funnel, do you care to throw out where you think you can get the companies top line too for 2011?

T.J. Rodgers

We are going to approach the $250 million mark in each of the next two quarters, not quite the coming quarter but closer to quarter after. So we’ll exit this year at $1 billion run rate. And my target for next year is to maintain that run rate through the year barring some sort of crash and at that point, we’ll be able to talk about growth beyond billion dollars.

Brad Buss

I think we’re going to be able to out pace the growth of the semi industry. I think we have enough new product drivers and new big end markets that we’re going to be extremely well positioned versus the average guy.

Doug Freedman – Gleacher & Company

Great. And Brad, if I could just focus on one of the smaller issues that you guys have seen the nice growth out of emerging, can you talk to where you think the emerging tech segment gross margins can get to? What should we think about for margin ramping there?

Brad Buss

Yeah. I’m very proud of how my division has grown, kind of internal things done with that while they have for that little group. I think you saw it turn from negative to positive, I mean, like we talked before a big chunk of that is really just a reflection of getting revenue up there and the resulting absorption of the fixed cost. I think you’ll see that continue to grow. I don’t see it getting up to really the corporate average for a good year or so. I mean, there’s five or six different groups, all at various stages right from embryonic, all the way up to shipping. So I think net-net, the good thing is like we’ve talked about you’re going to see a very good increase in revenue and we’re going to start to see the OpEx guide. Again, it was about a $0.03 a share drag in Q2. And our goal is to get the margin up but obviously see that $0.03 wittled down to zero, which I’d expect to happen some time in the first half of next year.

Doug Freedman – Gleacher & Company

Great. Thanks and nice job on the execution. Thank you.

Dana Nazarian

The emerging technologies grew. We have a formal business process. The milestones that we track and if you start missing a milestone several quarters in a row, we start questioning, did we bet the right way. Gross milestone, if you hit your $8 million quarter to get a product and get on the map.

Second milestone is to break even on the bottom line and this fully loaded bottom line. So you pay for your own way and you’re not detracting from Cypress’ income and then that’s where we headed to hit the $1 million mark. And the third milestone, which is the one that pays off for the employees is you have to have a $10 million quarter, which is significant run rate to Cypress. And you have to produce 20% pretax profit on a $10 million quarter.

That’s the trigger that pays off for the employees from the internal start up. So the way it works is they will stock in their own company. So there is an equity Cypress Envirosystems equity. And I would agree in writing to buy that company out to acquire it, in effect acquire the minority interest, we own 80%-ish of it and employees own 15 or so percent. And when they hit the $10 million quarter and 20% pretax, so it’s not diluted Cypress then we buy it. So we’re now in the get to your million dollar quarter phase of that life cycle.

T.J. Rodgers

Next question please?

Operator

Our next question comes from Chris Danely. Please state your company name.

Chris Danely – JP Morgan

Thanks, JP Morgan. A quick question for Brad. Hey Brad, on the gross margin, can you just maybe go through what the drivers were of the gross margin upside in Q2 and then what you think the drivers of gross margins are going to be in the second half of the year?

Brad Buss

Yeah, I think my answer will probably cover both. I mean, mix is obviously a big chunk right behind that has been the 65-nanometer conversions for the SRAM, as we noted the SRAM margins came up very --, I should say, MID in general have came up very nicely much closer to the average than they’ve really been. And then really behind that really just been, like I mentioned, the factory execution. Our front end and back end both did extremely well. They both ramped up very high and staying with our foundry partners, we haven’t had any issues with yields or anything else.

So it’s really structural changes, that’s the one big thing I want you all to feel comfortable with. They are not some one off in the quarter. We’re not goosing people on pricing. These are very structural changes that have really been permanent and that we expect to be part of our normal model going forward.

T.J. Rodgers

Yeah. I want to comment, our average selling price was about a $1.51. But for the last three days, we’ve had absolute use of divisions all day, every day and each of the divisions is showing less than normal but price attrition. That is, every single quarter, the semiconductor weighted average price across your mix, if you compare a given product quarter-on-quarter goes down.

So every quarter we look at a metric, which is what are you going to shift this quarter, what pricing are you going to ship it at for product X and how much money are you losing relative to last quarter based on price attrition? And the dynamic today is prices are going down as they always have virtually every quarter except for a couple in history. They are just going down more slowly.

So the improvement in price point is pressure. It’s about new product, it’s about higher value-added product, whereas if you look at individual products they are still declining mildly but every quarter.

Chris Danely – JP Morgan

So why would gross margins stay flat in Q3, then, given all these factors out there?

Brad Buss

Well, again, it’s going to be the mix of the business. We had a little bit of end-of-life stuff in the quarter. We’ve had a little lower inventory reserves than I think has been normal. And, like I said, I think the upward bias for us over the next year is probably going to move up but I’m not looking to push it into a level that’s unreasonable right now.

T.J. Rodgers

The reason gross margins stayed flat in the semiconductor industry in an environment of continuously declining Moore’s Law prices, which is really what has set the stage for industry is that I spend probably more of my time than anything else looking at cost reductions. So you heard about the conversion of 65-nanometers and SRAM for example. Okay. That’s a 10 percentage point improvement to gross margin but you don’t get a step function of 10 percentage points in one quarter.

We’re going from 20% current conversion to 40% at the end of the year. So, you ramp in that cost reduction and we’ve got the auto lines. These are machines that take one end and ship a product to the other end to complete assembly and out the door in eight hours. We’re getting higher and higher fractions of our product on the auto lines, which represents a huge cost reductions, even more importantly, a dramatic quality improvement because there’s no human intervention.

So behind the scenes, we’re on the hamster wheel of continuous improvement. And the name of the game in our business is, can you improve faster in cost than your competitors can because we’re all going to live on the same Moore’s law pricing system. So if you can drive your costs down faster than prices go down or faster than your competitors can drive it down then you win and that’s really behind the scenes. We don’t talk about it much what we’re doing all the time. Redesigning a chip, making a chip 3.2 square millimeters instead of 3.9, your cost goes down by a penny and a half times the 100 million units.

That’s why our gross margins stay constant in the face of declining prices plus, new products. Again the sea change is new products where suppose the selling commodity products, we’re selling new value-added products being the SRAM is very high-end SRAM, give us selling prices going to record levels by virtue of new products not by virtue of being able to gouge people during good times.

Brad Buss

Yeah. The other point, I forgot to mention too, Chris, is the emerging tax with the lower margins has come at a higher percent of revenue. I mean, it’s not like its 20%, but that does start to have a little bit of an impact until they get up to the targets.

Chris Danely – JP Morgan

Got it. Thanks for the explanation and my follow-up on lead times. So, do you guys think your lead times will stretch out again this quarter or when do you think you can bring those in? And then maybe if you could compare your lead times versus your competitors and do you have an advantage there?

T.J. Rodgers

I want to make one comment on lead times. There was a comment earlier that our lead times were generally 12 weeks, that’s not true. Chris, go through what our lead times are today and what you expect them to be in the future.

Chris Seams

All right, so our lead times today are 6 to 12 weeks depending on the product category. We expect going forward in the next quarter, they will actually come down from that as we continue to put on capacity. And again our targets are four to eight weeks and we hope to get there. My guess is in six months if the market abates a little bit. If it doesn’t, we’ll continue to bring it down a little every quarter.

Chris Danely – JP Morgan

Okay. Thanks.

Operator

Our next question comes from Sandy Harrison. Please state your company name.

Sandy Harrison – Signal Hill

Yeah. Signal Hill. Thanks for taking my call. Real quickly, we will talk a little bit about the emerging divisions and talking about the Cypress and Enviro potentially getting to a million dollar quarter in the 2010 time frame. How does that business look? Is there a contract that allows it to grow or gives us the visibility? Is it business that trickles in? How is that business going to -- or how do you expect that business to fill in? Thanks.

Brad Buss

Cypress and Enviro got up to a few $100,000 a quarter and broke down for two reasons. One is, the year ago they had a quality problem which is now behind us. Second one is, they had I guess called CASM. I learned about a new business deal where you have an emerging technology, you get early adopters and many dead zone where especially in the building industry which is not exactly, your advance -- new technology.

You go into a CASM where you’ve got to get more adopters. To get through the CASM, the theory is you have to get focused on one market and CASM momentum in that market. So we have focused on two markets with -- thermostat, the ability to automate the heating and air conditioning control in the building, which is totally lacking, big problem with energy in the U.S. today.

We focused on the university market where they have a desire, a driving desire to improve both from a cost point of view and because they like green and the government markets where there’s a mandate for all of these government buildings burning a lot of air conditioning to get more efficient. And we’re now making significant progress in those markets. We’ve broken through and had a decent quarter in the last quarter and that’s why we’re expecting just by turning up the business whether it’s a different marketing focus to achieve a $1 million quarter in either the third or fourth quarter this year and move forward from there.

We’re also getting traction in industrial base. We make, I’ll give you one example. Uninterruptible power supplies are very common. Cypress has a bunch of them. Anybody who has a factory has got it. And uninterruptible power supply is basically a bunch of batteries that kick in automatically if the power goes out and they allow you to shut things down in an orderly way. So you don’t lose data or lose your product in the middle of your line. Those batteries are dangerous. You charge and discharge them in series. You have no way of knowing if the thirtieth battery in a stack is faulty.

When it gets faulty, it becomes resistant. And when you start running kilowatts of power through a resistant battery you heat it up and this is a safety problem. We actually had a fire two years ago in our assembly test plant in Manilla because a UPS power supply caught on fire. So, one of the products we make is a little RF battery monitor that allows you to look at the two to 300,000 batteries you’ve got in this pack and determine if any one of them is bad. It goes out to a personal computer.

So, we’re starting to see traction with a product like that. There’s several, I just described one to take your time. In the industrial market, that’s a slower ramp than turning on buildings. So if you look at the market and where we expect to grow with Enviro Systems that’s where we’re headed.

Sandy Harrison – Signal Hill

Got you. Thanks for that. Brad, as far as with your fab and your capacity utilization where it is now, is there some -- as you look at your gross margin and some of the questions prior to mine is there some fab loading strategies that you guys can do to manage gross margins. So that the lower margin wafers aren’t being put through the fab now or has the mix that you’re putting through the fab changed, that it’s not going to -- you’re not going to have the capability of doing that too dramatically?

Chris Seams

Let me answer that one. The fab 4 is running at capacity. It was labeled 92% this quarter. What that really means is 92% of theoretical capacity and the 92% is not that we don’t have orders. The 92% is that it’s very difficult to get with 100.0% of theoretical capacity.

So our growth is all coming and this is in line with our strategy from the foundry. So, what we plan to do is keep our fabs loaded. It’s one of the reasons that there’s a downturn of some kind where we’ll keep our fab loaded and not suffer a loss of fab loading is that if it hits profit. And we are growing in our foundry. So our RAM business is growing immensely and our other businesses are growing at Grace Semi in China, and we’re -- as Brad said earlier, you’re alluded to it. We go out of our way to be a special strategic customer. So we’re not just wafer hires, we help you with yield, we help you work on transistor parameters, we help you work on modeling. And therefore, we have special relationships.

And I personally work on those with our fabs. I’m the fab guy. I understand their language. I understand how they think. And therefore, we are getting the capacity we need to grow outside. That’s our strategy.

Sandy Harrison – Signal Hill

Got you.

Chris Seams

To answer your question directly, we don’t have to deal with mix.

Sandy Harrison – Signal Hill

Got you.

Chris Seams

We’re going to make every wafer we need to make and ship it. And the only thing that gets in the way of that is a standard thing that happens to fabs during up time. They jam too many wafers in the front. It takes them too long to get out and you can’t ship all your orders on time.

Sandy Harrison – Signal Hill

Got you. And then lastly, I think Chris you were getting to that earlier. But if you look at your SRAM mix now, what percentage of your SRAM would you characterize as proprietary currently. And do you see that mix changing going forward in any meaningful manner?

Brad Buss

So, if you look at where my Field Apps engineers and the Product-Line Apps engineers have to do -- help the customer engineer design in a product, in SRAM that happens predominantly in the high speed synchronous SRAM space and some on the high density in Dana’s asynchronous line. So percentage is probably 70%.

Sandy Harrison – Signal Hill

70% of your SRAM? Okay. Great. Thanks for taking my questions, guys.

Operator

Our next question comes from Steven Eliscu. Please state your company name.

Steven Eliscu – UBS

Yeah, UBS. First of all, I just want to ask about -- with regards to how you think about what is going on with ASPs, given the supply constraints. You talked about ASPs declining less than they have historically. Your customers, the purchasing people are obviously more focused on expedites right now. How do you see pricing in 2011 as supply constraints should ease. And they start re-honing their negotiating skills and push you for more aggressive price reductions?

Chris Seams

Hi, Steven, this is Chris. It’s kind of a two-sided answer. Let me give you an answer where there is a competitive answer for the customer and that particular case will probably revert more towards historical per quarter reductions on the order of Moore’s law, which is about 3% per quarter, where a normal decrease would be for a multi-sourced competitive Moore’s Law market.

Having said that, we’re not in many of those markets anymore. Even in what traditionally had been a multi-sourced market, take the high performance static RAM market, there’s only a couple of guys left in the world that are able to make those high performance RAMs and they need design in help and support. So even in those cases, even in a more normal market, procurement managers, again they get their raises based on negotiating cost reductions. They retain their job by assuring supply.

So in that type of market, the assured supply is probably still a larger factor. So I ascribe to the model that says even if we get back into a more normal market, I think most of the markets that we’re in and applications are in are going to be less than the traditional Moore’s Law 3% per quarter.

Steven Eliscu – UBS

That’s helpful. Also, just switching to gross margin, I know we’ve had a number of questions on this. Want to ask it in a different way. We’ve seen COGS relatively flat here just under 100 million the last five quarters. Based on your guidance, we should see a reasonable step up. Is it fair to say that the low hanging fruit in terms of gaining model leverage is, it’s basically gone and now we’re looking at this more steady increases assuming, if you can get those increases based on mix and move to foundries?

Chris Seams

Yeah. I think like I said before the bigger levers we still have before are going to be around the mix. And it’s going to be around the increase through the foundries to our fab, to a lesser degree, as it is approaching near capacity. I think the other big thing that’s still really that I get excited on is I think distribution is still a lot more especially in the PSoC area, right? And that’s an area that T.J. alluded to the 10 X plan.

We’re doing a tremendous amount of focus there. And it’s all of the PSoC families, including the power PSoC, which we don’t talk on a lot but the LED lighting but that’s getting big and getting a lot of generation into the smaller tier guy. And so will PSoC and if that chunk of the business grow, those are generally substantially higher, five to 10 points higher as a percentage of the revenue.

So I think that’s another level you’ll see, but I don’t think you’re going to see two and five percentage point step ups over the next few quarters. I think that would be very unrealistic to expect that to happen.

Steven Eliscu – UBS

Got it. And one last question here, just in terms of your sales guidance for Q3, how do you see each of the divisions growing relative to your guidance?

Chris Seams

Like I said in the release, I think you’ll see CCD, no surprise. It’s a big quarter, normally seasonally plus the strength that we have in TrueTouch. We’ll definitely be the biggest leader by percent in dollars and I think you’ll see the emerging tech and then to a lesser degree, the other two divisions.

Steven Eliscu – UBS

So those will be, you still expect MID and DCD to be up sequentially?

Chris Seams

Yeah, I would say…

T.J. Rodgers

We’re forecasting 5% to 8% revenue growth in Q3 on Q2 and we expect DCD to lead that but all of our divisions to have some growth.

Steven Eliscu – UBS

Thank you.

Operator

Our next question comes from John Barton. Please state your company name.

John Barton – Cowen

It’s Cowen. Thank you. T.J., when you’re talking about the emerging technology division, you highlighted the optical navigation system exceeding the first $1 million quarter. When I think of that division, I think of it as a sub-system group, put PSoC, laser, lens, power, interface in a module and then sell it in the marketplace. From a strategy perspective, how do you think about that? Is it truly to enable PSoC sales meaning kind of the mother of all app notes or is there margin dollars, profit dollars, that can be gained through that design effort, mark-up on the rest of the components that go in it? Please.

T.J. Rodgers

Both answers. Both answers are correct. If you look at the body parts of an [O&S] sensor, it’s exactly -- our highest volume PSoC is called Crypton and it is exactly Crypton process, very specialized optical sensor. So then if you take your next step and say I drove the module and adding software, then it’s PSoC. Now, the fact is, that adding on a vertical cadmium mini-laser and running it properly and adding on optics as the laser focus properly back on to the sensor and learning how to read a sensor, which by the way is not an image sensor that looks at an image.

It looks like the transform of an image, it’s not really an image like you would see with your eye. And then making all that work in a system with Firm Ware, those are not gimmick. The net result is if that shift has been created in our PSoC group, it wouldn’t be alive right now.

And the reason is, they are focusing on their big events and this is a high-tech event so the O&S, even though it’s from a body part point of view, nothing but a PSoC with an image sensor on it. It’s in our data communications division, that is being managed there. And it’s a big deal and we expect there’s FingerNav and associated. FingerNav, if you want to think about it, is the miles turned upside down. And we expect that to be an important business for us. And we’ve got independent people with independent business unit that looks over it, that doesn’t even record it into in the norm.

John Barton – Cowen

And just as we think about it going forward and potentially getting much larger just the accounting for the PSoC sales from CCD to O&S?

T.J. Rodgers

When we report PSoC sales, regardless of where they are and we now have PSoC sales in every division. When we report, for example, we have automotive PSoC sales, which are in the MID division, part of the MID number. We have O&S PSoC sales which are in data come number. But when we tell you PSoC, we go back and aggregate all of PSoC revenue regardless of where it comes from.

John Barton – Cowen

Got it. DCD in the quarter was up about 8.5% sequentially. How much of that was I’m guessing specialty memory driven by Com versus what was West Bridge doing and your thoughts on West Bridge going forward?

Dinesh Ramanathan

Hi, this is Dinesh. So, West Bridge was flat quarter-on-quarter and the Com business is the one that grew, we essentially got more revenue coming in from some of the growth that we saw in MID, which is on the wirelined platforms. And then we also had military last time buys.

John Barton – Cowen

Military last time buys for the old Programmable Logic, is that correct?

Dinesh Ramanathan

No, well, yeah, and no there, some of them were old Program Logic, some of them were what’s called DMEs.

John Barton – Cowen

Okay. Last question, if I could. T.J., I think what I heard you say is thinking in terms of $250 million-ish in revs in the fourth quarter that would be up somewhere around 5% or 6% above your mid-point of your Q3 guide. If I understood you correctly, I take it from that that you’re looking at no seasonal impact in the reported CCD number. Is that because of the ramps of the new products or how are you thinking about seasonality at the back half of the year?

T.J. Rodgers

I was asked a question about aspirational revenue of the future and I used as a basis for it the fourth quarter. Brad, give guidance for the third and fourth quarter please again?

Brad Buss

Yeah. So the third quarter we gave kind of the $234 million to $240 million. We haven’t given guidance for Q4. And I don’t think T.J. meant to give a specific number. I’d expect some normal seasonality in Q4.

T.J. Rodgers

So, let’s say the third quarter is $240 million and we manage to hold flat in the fourth quarter which is a nice trick given that the fourth quarter is typically down from the third. So, when asked about where are you going to go in the future, $240 million rounds to $250 million, $250 million times four is a billion. Billion is the target for next year. We move forward from there.

John Barton – Cowen

Understood. Thank you.

Operator

Our next question comes from Jeff Schreiner. Please State your company name.

Jeff Schreiner – Capstone Investments

Yeah. CapStone Investments. Thank you for taking my questions, gentlemen. It seems like there was a trifecta in the MID division this quarter with market share gains and market demands and possible some stable up pricing. What I’d like to understand is maybe what’s still left on the table in terms of market share gain opportunities.

Dana Nazarian

Hi, Jeff. This is Dana. So, plenty, we’ve been gaining steadily for the last 20 years if we just expect to stay on the same trajectory. You talked about a trifecta and the market is good right now. But the fact is we’ve got -- we’re not a one trick pony in memory. We’re in all sectors, enterprise, networking, telecom, military, POS terminals, et cetera. So, when you’re in that position, it’s a lot more stable and you can just continue to gain share based on performance and momentum.

Jeff Schreiner – Capstone Investments

Okay. And there, would you say that where does Cypress classify itself in the overall SRAM market? Have you guys now become the market share leader in that market?

Dana Nazarian

We believe we are, yeah. Though it’s hard to dissect exactly what our market share is, but we think we’re definitely over 30%, somewhere between 30% and 40% right now and we clearly think we’re number one in those SRAMs.

Jeff Schreiner – CapStone Investments

Okay.

T.J. Rodgers

Yeah. And if you ask where that can go, we’re debating that internally and Dana is pushing back on me, but Intel has 80% market share in micro controllers or micro processors, rather and half way between where we are and 80% is like 55%, so we need to become a better supplier and we need to have perfect delivery and we need to have short lead times. And, when we do that, there’s absolutely no reason we can’t gain the trust from our customers to get to 50% market share, because we have 5,000 products in every segment and we absolutely are the leader. We continue to improve our service performance and just start taking share.

Jeff Schreiner – CapStone Investments

Thank you, T.J. Very helpful. Norm or Brad, if you could maybe help on this one. I believe that previously you’d kind of guided us to expect that the second generation touch product, which I believe is based on PSoC 3, would likely equal around 50% of your total calendar year 10 volumes within TrueTouch. Has that changed at all?

Norm Taffe

Yeah. This is Norm. Just to kind of correct things, we call it Gen 3, not using PSoC 3, in reality, but our Gen 3 product, which is the all point product, in terms of units going out of this year it will be about 50% run rate. It is the product that ramped. First significant ramping was in Q2. We did several million units and it’s growing very, very quickly. By the end of the year, it will be roughly half of our unit volumes and that’s a mix towards even higher ASPs than the volume we’ve had.

Jeff Schreiner – CapStone Investments

Okay. Thank you. A final question for me. Just within mobile, it’s been something I believe Brad, you and T.J. have talked about is a new opportunity that you’re just starting to get your foot into and I’m just trying to wonder if we’re kind of handicap it like the baseball game, what inning are we in for mobile and what’s the content capture ability still available for Cypress?

T.J. Rodgers

You say mobile, you mean cell phone?

Jeff Schreiner – CapStone Investments

Cell phones, thank you.

T.J. Rodgers

Related. Well, what we have the (inaudible) cell phone. Of course we’ve got PSoC, we’ve got the ability to touch button. We’ve got the ability to do TrueTouch which is panel. We’ve got the ONM sensor which is the finger navigation. We’ve got the West Bridge which is side loading and we’re doing second generation products as we speak in every one of those. So, I wouldn’t go so far as to say we’re building a franchise there, but what we are doing is we’re making enough products that we become noticeable to our customers and still build strong relations.

So when I made my comments about RIM before, they understand that we’re committed because we not only have new products, we have a roadmap and we have a roadmap to several places. But they may not go to the next phone. But they know that they should deal with us because we can add value to them. That’s how you get to be important to a customer or try to be important.

Chris Seams

Jeff, this is Chris. Let me just add my $0.02 to T.J.’s 98. That sort of arsenal and that sort of offering of solutions, is striking up all of the strategic supplier conversations with all of the major handset guys. So, even if we didn’t want to be important to them they want us to be, so pretty much how they look at us is kind of the user interface one stop shop for handset and that’s really our game in that end segment.

And the fact that we’re all programmable really differentiates us and with the quick turns that this are going to price upon, we’re truly looked at as a strategic supplier. And, my comments before were two years ago, we pretty much did zero in handsets. We’re on an easy path to 20% to 25% and I think more importantly, now, that we’re in there with those products, what else on the cell phone that’s not one of our solutions and our chip.

Can we implement within the PSoC because we have such flexible architecture and extra analog and programmable blocks that we could use. Or, more importantly new features to get jammed into those things that may require someone else to add a chip, we may be able to integrate that so that’s kind of the next phase that I think you’ll see us look at over the next couple of years.

Jeff Schreiner – CapStone Investments

Thank you very much, gentlemen.

Operator

Our next question comes from Raji Gill. Please state your company name.

Raji Gill – Needham and Company

Needham & Company. Congrats on the good results. Just a follow-up question on the SRAM side. The SRAM business has been growing consecutively on a quarter-over-quarter basis as well as year-over-year basis. Do you see any concerns about a potential inventory overbuild at some of your major customers? You made your customers on the networking equipment side? Also, if you could maybe describe a little bit about your kind of strategy into China SRAM market, any color there would be helpful.

Dana Nazarian

Sure. This is Dana again. We touched on a lot of the abstracts of this question earlier, Telecom build-out is happening, video-on-demand is driving much more content requirements, carriers are upgrading, the need for more wireline to the home is going up. So, I think it’s a pretty sustainable business.

On the China side, China was growing leaps and bounds last year, slowed down a little bit in the first half of this year but it’s going to continue to get driven in more rural areas. So, in terms of strategy, strategy in China is the same as our strategy in rest of the world. We’re the biggest player. We matter the most and they’re counting on us to deliver the solutions for them. So, we’re heavily engaged at all of the top Chinese suppliers in both wireline and wireless.

Raji Gill – Needham and Company

Okay. Great. And just on the margin front again, the margin by segment I look at the kind of the margins, where, for the – of the MID business peaking out around, Well they’re at 57.5% up from 51% last quarter. Is there room for that margin to go up, as you transition more of this production to 65-nanometer as well as in moving to UMC. Would you get a benefit from both of those aspects?

Dana Nazarian

Both are true. Conversion of 65-nanometer will definitely help the margins and T.J. alluded to it earlier. Working on gross margin cost reduction efficiency improvement is in our DNA. That’s what we do. And that never stops, so it’s not just increasing our ability to shift 65-nanometers. It’s thousands and thousands of little things. In addition, I told you that mix will improve continuously. These demands on the internet, the internet is 100 times faster than it used to be five or 10 years ago, but I don’t think there’s a single person on this Conference Call that thinks it’s fast enough right now. And that’s not going to change and all of those demands increase the need for super high performance memories so that’s going to drive margins up as well.

T.J. Rodgers

So the ability to improve margins in MID kind of relates to the cost curve versus price curve. Price curve looks stable right now with mild declines quarter-on-quarter and it could go to bigger declines, approaching more [offset] decline. And we’re in a fairly steep cost reduction curve right now, because we’re changing generations. So we’ve been investing for two years to move to 65-nanometers.

We’ve got the products and we’re actually in the customer call mod. So in short-term, we might be – assuming the marketing is in there, we might be able to reduce our cost by 65-nanometer faster than the prices go down and eke a point or two out of margin, but long haul, if somebody would say, would you want to sign up for 57.5% for MID for outright, I’d sign on the dotted line.

Raji Gill – Needham and Company

Okay. Great. So last minute questions on the touch side – The TrueTouch. Maybe if you could describe a little bit about the competitive landscape relative to, say, Synaptics or Atmel. How do you see that this quarter and going forward? Also, you talked about I believe, you being the number one unit supplier in the capacity touch market. I just wanted to see if that’s still kind of holding up the case.

And then lastly, you might have highlighted a little bit before, but are you beginning to offer potentially bundling strategies in TrueTouch, so combining finger navigation with your TrueTouch solution, possibly your West Bridge, are there any bundling strategies you are offering or you will offer going forward? Thank you.

Brad Buss

All right. That’s a long question Raji, so let me try and take it. First of all, I guess from a competitive environment statement and kind of where we see our unit volume, so from competitive, you mentioned the two competitors we see everywhere we go for the most part in this space. I think I would highlight that there really is three guys that really do have the technology to guide almost all of this. And I will repeat what I’ve said before on this call a couple times.

In these handset accounts, many of them are going not just with one supplier, depending on the model because it is such a critical component. So, we fully expect to reach our goal to win at every one of the handset suppliers before the end of the year. I said, we’re already shipping volume at five of the top eight and the only guy that we wouldn’t be is a customer that has chosen to do it themselves or independently. But, at the same time, our competition and I always respect the competition, is the guys you mentioned and we see them also going to – I’m sure grow this year. because the market is growing so quickly. We still believe that for the year, we can hit our target from the number one unit supplier.

We believe we haven’t passed through that as we expected and grow very nicely from that standpoint. And then I guess the last question you said, I don’t like and wouldn’t use the term bundling strategies for a lot of reasons. And I don’t think it applies the same as bundling, I certainly think Chris said it the right way that we are seeing customers pulling us in as a user interface expert and then they also – with relative to the USB interface and West Bridge stuff.

They see us as there’s a bundling nature of –I now have a supplier and it’s important to me. I have multiple engineers talking to eliminate and solve multiple problems on my handset whether it would the CapSense Plus, touch interface or the optical navigation requirements or the high speed downloading as the main issues today. So, I don’t think that there’s any sort of a bundling going on, but absolutely synergy in selling to those accounts.

Raji Gill – Needham and Company

Okay. Excellent. Thank you and congrats again on very good results.

T.J. Rodgers

Thanks. Thank you. Specifically, on the ONS chip, it is the Crypton plus an image sensor. Crypton is our highest volume product that can be in capacity buttons and it also can do a simple screen. It can do two fingers, two fingers and gestures, so a Crypton chip could run a screen, could run a touch of the FingerNav interface and a couple of other buttons, all with one chip, all for a price in the neighborhood of value-added.

Chris Seams

We’ll add it together.

T.J. Rodgers

I insist.

Raji Gill – Needham and Company

All right. That clearly is a strategy you are pursuing as a potential differentiation, say from other competitors who are unable to offer that complete solution.

T.J. Rodgers

Exactly. So, bundling everybody backs off of the word, because it’s an anti-trust thing. So, you never take two products and say, this is right with that. But one of the forms of bundling that’s very legal and is called integration. And the ONS has got buttons plus touchscreen, plus FingerNav, also capability all in one chip. And any time we can walk in and say if you buy our chip, you get two or three functions instead of one. You don’t have to buy chips from three different vendors and do the work together yourself. That’s an advantage.

Chris Seams

I mean it’s lower resources they spend, again, don’t forget the programmability. That’s the big differentiator that is setting us apart in the marketplace, in every single one of those, big deal.

Raji Gill – Needham and Company

Are there any plans to maybe integrate the touch control or chip on the mother board, itself on the handset?

Chris Seams

Well, as far as its location, it’s off and on the motherboard, something we put on a tailwind with the FTC, but I don’t know if that’s exactly what you mean, but it is usually on the handset mother board depending on the supplier.

Raji Gill – Needham and Company

Okay.

T.J. Rodgers

When you say motherboard, are you talking about the handset?

Raji Gill – Needham and Company

Yeah. The handset motherboard, yeah. Specifically, it’s usually a flex tail connected to some sort of sensor laminated on top of the panels.

T.J. Rodgers

We’re flowing – If you look at the most advanced products, you have a sensor, there’s a flex tail as you call it, LS Printed Circuit Board and then there’s a flip chip to scale package on that that controls it and then the connection to the motherboard and main PC is the digital connection. All right, next question?

Operator

Our next question comes from Vijay Rakesh. Please state your company name.

Vijay Rakesh – Sterne Agee

Sterne Agee. Hi guys, just wondering on the DCD side or the side loading, how do you see that going into Q4 and into next year, what kind of growth are you expecting next year?

Dinesh Ramanathan

Two trajectories. So, we see it actually flat or for the year, is what I’ve been saying and we still continue that as a projection. Going into next year, we are going to be introducing some new parts that are going to come out into the marketplace. Two of them – One a much higher performance part with the USB2 interface and a significantly higher performance part with the USB3 interface next year. So, my expectations are it’s going to grow from this [period].

Vijay Rakesh – Sterne Agee

Okay. And on the PSoC side, on the PSoC and the TrueTouch, outside of handsets, if you look at the notebook, netbook side not being a great market, but wondering what are your expectations there for PSoC and TrueTouch here in the second half and for next year?

Brad Buss

Okay. So let me clarify your question. Did you say the notebook and netbook market not being a great market? What did you say?

Vijay Rakesh – Sterne Agee

Not the handset market.

Brad Buss

Okay. Good point. I’m glad you bring that up and both kind of like the notebook, iPad space, so that’s certainly a big growth driver I think for 2011. I don’t think we’re prepared to give you any kind of guidance that way because it’s hard to tell but I think that will be the potential contributor.

I’d also like to (inaudible) point out, we do get wrapped up in handsets because of their volume but we have begun shipping to some significant non-handset markets particularly like the GPS segment, which is going to start contributing meaningful revenue this quarter, Q3 and we’re also seeing a lot of uptake in markets like digital cameras and even touch printers. I think those are going to give us substantial volume drivers. Back half of this year a little bit and then certainly into 2011, so the touch phenomenon, well, is certainly being driven into space by the handset vendors and absolutely being picked up as a user interface of choice, a ton of different applications and I think that’s going to give us a lot of market growth for both overall and in Cypress.

Chris Seams

And Vijay, this is Chris. When we have gotten tired of talking about all of those applications, we’ll probably start talking to you guys about automotive and white goods after that.

Raji Gill – Needham and Company

Okay. Great. Thanks a lot, guys.

Operator

Our next question comes from Charlie Anderson. Please state your company name.

Charlie Anderson – Dougherty & Company

Dougherty & Company. Thanks for taking my questions. And glad to hear my fellow Minnesotans helping out in the quarter here. Norm, to go back to tablets for a second here, if we look at the iPad and maybe some of the others out there in the market, we bust them open and we look at what’s controlling the screen right now, does it validate the multi-chip type solution, the types of ASPs we could hope for you guys, in 2011?

Norm Taffe

Yeah. I think it does, I think certainly there will be a path for future convergence, but controlling a very, very large screen, could ends up requires a parallel approach. I think you’ll find that is the approach taken in the marketplace today, but obviously – I’m sure a lot of people working on trying to limit that over a period of time and I think out through 2011 that will be a predominant solution.

Charlie Anderson – Dougherty & Company

Great. And then quick question on SRAM for Dana. When you look at going from this 30% to 40% range to market share and T.J. winding up to 55%, how much can you get just off the low hanging fruit of Samsung and the life in various products? How much more do they have to go on sort of reaching an equilibrium level where they are at with products?

Dana Nazarian

Yeah. I think there’s a lot to be had there, because there’s still – Although they are not, they haven’t been investing and they are probably going to exit the business There’s still a significant chunk of the business now. So when that goes away I think there’s going to be a large piece of the pie, a very significant piece that we should be able to take.

Charlie Anderson – Dougherty & Company

Great. Thanks guys.

Operator

Our next question – Our last question comes from Srini Pajjuri. Your line is open. Please state your company name.

Srini Pajjuri – CLSA

Thanks, CLSA. Brad, one quick one. Given your comments about stock price being pathetic, I’m just curious as to what’s the minimum cash balance you prefer to have on your balance sheet and also does it make sense to kind of look at the capital structure and maybe rate some debt to buyback shares here? Thanks.

Brad Buss

Yeah. Neil and I debate that number quite a lot. I think somewhere in the range of $75 million to $100 million is more than sufficient. I mean we’re generating very strong cash flow and I only see that is improving over time. We have very limited CapEx. So I think that’s a number I feel pretty good with, so that being the case we obviously have a couple pf hundred million excess cash and we’re generating more.

So I think we can take a pretty big bite out of the market, assuming pricing and dynamics. I wouldn’t be opposed, again, depending on the pricing evaluation to taking off some debt, to take a bigger chunk, I mean. We’re one of the very few companies, if remember when the ship hit the fan in Q4 of ‘08 it actually went for the market and bought a bunch of stock back out. So we act, when we think it makes sense for the interest of the shareholders then we consider that as well.

Srini Pajjuri – CLSA

Thanks, Brad.

Brad Buss

I’ll just make one comment. The price of sales ratio I talk about all the time that’s available to you on our website. It’s not a metric that we sort of play with. When I bought a million shares for my own account that metric was under one and when I sold the million shares back, the $3 million worth of stock I bought back for $12 million, I made my personal decisions based on the price of the sales metric.

Also on the website there is a thing called “Thinking about Cypress Stock”, that I wrote in 1996, which shows that if you look at Cypress’s entire history and apply buying the selling decisions to the price of the sales metric in the long haul, with algorithmic buying and selling you can make money. So, when I buy from my own accountant and when a company buys for its account, that graph is on the table for what we’re talking.

Srini Pajjuri – CLSA

Thank you.

Operator

I will now turn the call back over to T.J. Rodgers.

T.J. Rodgers

Thank you very much. We’ll wrap it up. We’ve had a good quarter. We’re looking for a good rest of the year, but meanwhile, we’re holding our expenses in line just in case.

Thank you very much for calling in.

Operator

That concludes today’s conference. Thank you for participation.

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