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Executives

Rick Crowley – CFO

Ted Tewksbury – President and CEO

Analysts

Sukhi Nagesh – Deutsche Bank

Sandy Harrison – Signal Hill

Glen Yeung – Citi

Tim Luke – Barclays Capital

John Barton – Cowen

Nicholas Aberle – Janney Capital Markets

Integrated Device Technology, Inc. (IDTI) F1Q11 (Qtr End 06/27/10) Earnings Call July 26, 2010 4:30 PM ET

Operator

Good afternoon and welcome to the Integrated Device Technology Incorporated fiscal first quarter 2011 financial results conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. (Operator instructions) As a remainder this conference is being recorded.

And with that said, here with opening remarks is Integrated Device Technology’s Chief Financial Officer Rick Crowley. Please go ahead, sir.

Rick Crowley

Thank you, Lorrie, and welcome to our fiscal first quarter 2011 earnings conference call. I'm Rick Crowley, IDT's Chief Financial Officer. And presenting with me on the call today is Ted Tewksbury, our President and Chief Executive Officer.

Our call today will include remarks about future expectations, plans, and prospects for IDT, which constitute forward-looking statements for purposes of the Safe Harbor provisions under applicable federal securities laws. Actual results may differ materially from our forward-looking statements as a result of various important factors, including certain risks, which are detailed in IDT's most recent Annual Report on Form 10-K as filed with the SEC.

IDT does not intend to update the information provided in today’s call and expressly disclaims any such duty except as required by law. In addition, pursuant to Regulation G, any non-GAAP financial measures referenced during today's conference call can be found in our press release posted on our website at www.idt.com, including a complete reconciliation to the most directly comparable GAAP measures. Also, we have made selected financial information available in webcast slides, which can be found in the Investor Relations section of our website.

Now, I’ll turn the call over to Ted who will provide some highlights on our fiscal first quarter and then I’ll return to give you more specifics on the June quarter results and our outlook for September. Ted?

Ted Tewksbury

Thanks, Rick, and thanks to all of you joining us today. Last quarter I concluded my prepared remarks by telling you that our strategy is working. Today, I am please to provide additional evidence to support that assertion. Let me remind you that our strategy consists of two priorities: first, to defend and grow our leadership in our core timing, memory interface and serial switching businesses; and, second, to grow our available market through analog-intensive mixed-signal solutions that expand our content in communications, computing, and consumer applications.

So, let’s get started. Our Q1 results beat expectations across all metrics. We outgrew the broader semiconductor market with 15% sequential revenue growth driven by broad-based strength across all our end markets. Every one of our core business lines grew quarter-over-quarter and revenue from new products was up 18%.

To recap, revenue of $158.3 million came in above the high end of the range we provided last quarter. Gross margin of over 55% reached a four-year high driven by improved product mix and we delivered non-GAAP EPS of $0.14, $0.03 better than expected.

Let me now turn to our end markets and highlight some of the trends we saw in June as well as some of the innovative new products we announced that will drive continued growth. In computing, we experienced 19% sequential growth, driven by significant strength in servers and moderate improvement in PCs. As of June, more than half of our computing end market revenue came from enterprise computing due to our increased focus on servers. Computing represented about 39% of total revenue, up from 37% in the prior quarter.

The robust increase in our enterprise computing revenue was consistent with Intel’s announcement of a record quarter for their server business. Intel also reported that enterprises are adopting their Nehalem based servers to improve their ROI. As a key partner in the server ecosystem, IDT is positioned to benefit from these trends on several fronts.

First, we continue to defend and grow our core memory interface and PCI Express businesses. IDT remains the market share leader in DDR3 registers and PLLs and this share cuts to grow. We have also sampled customers on the first interfaces for the next generation technology know as LRDIMM, for Load Reduced Dual In-line Memory Modules. This technology will squeeze additional speed and capacity out of DDR3 memory.

We also continue to expand our leadership in PCI Express solutions for enterprise computing and during the quarter we added a new family of PCI Express clocks to our portfolio.

Second, we’ve been investing in new product categories that are enabling us to capture a larger share of the server bill of materials. For example, we recently announced a new family of voltage regulators that combine IDT’s timings and multi-phase controller with the coupled inductor technology we acquired from IKOR. This new product enables customers to improve system performance and power consumption in servers and PCs.

In addition to timing, memory interfaces, PCI Express and power management, our server portfolio is growing to include temperature sensors, signal integrity products and flash memory controllers. We believe the breadth and performance of our new product portfolio will make IDT the most important mixed-signal solutions provider for enterprise computing and drive sustained growth through the ongoing corporate refresh cycle.

We experienced a solid quarter in our PC business. This is also consistent with Intel who reported growth from corporate clients replacing their ageing installed base. Industry analysts expect PC unit shipments to grow approximately 20% in 2010. IDT is positioned to benefit from these trends with our audio, display and power management products. We are the market share leader in audio for enterprise PCs and have also won a significant share of Tier 1 consumer notebooks.

Our display portfolio for PCs has expanded to include timing controllers, display port, power management, and video post processors. Just this week, we introduced the industry’s first embedded DisplayPort controller to support 3D video in LCD displays. This new TCON bring the 3D viewing experience to the portable realm, allowing gamers and video enthusiasts to enjoy mobile 3D for the first time.

Excluding PC clocks, which we continue to de-emphasize due to their low gross margins, IDT’s content in the notebook computer can be up to $3 depending on the configuration.

Let me now turn to our consumer end market where we experienced over 20% in June. Overall, consumer sales represented 17 % of total revenue, up from 15% in the prior quarter. IDT’s consumer strategy combines our digital heritage with our new analog capabilities to deliver system level solutions that simply our customers’ designs while enriching the end user experience. We just announced two innovative new products that exemplify this approach.

Today, we announced the industry’s most flexible and intelligent power management IC. This innovative and highly integrated ASSP is optimized for portable consumer products such as smart phones, portable navigation, mobile Internet devices, and ebooks. IDT’s unique architecture integrates a CPU, hi-fidelity audio subsystem, Class-D amplifier and headphone driver, clock generation, touchscreen controller, LED drivers, battery charge management, multi-channel DC-to-DC converters and LDOs, high-resolution analog to digital converter, and other key functions.

The embedded CPU offers full programmability and manages all on-chip resources and power management, thereby offloading the application processor in order to provide superior system performance and longer battery life. This is the first in a series of intelligent system power management solutions being developed by IDT as part of our analog-intensive ASSP strategy.

Our investments in video also continue to pay off with innovative new products. Last week, we announced the industry’s first 3D-capable frame rate conversion processor with an integrated motion-compensation engine for 120Hz and 240HZ televisions and high-definition video projectors. The new FRC devices feature our industry-leady HQV MotionSMART technology, which provides smooth motion and full-detail images while minimizing side effects seen in competitive solutions.

Our video processing products continue to gain momentum in high growth new applications. For example, we recently won several high profile sockets in set-top boxes and panels for IPTV and were in the docking station for an enterprise tablet recently announced by a Tier 1 OEM.

Moving on to communications, our revenue increased 7% sequentially on strength in RapidIO, timing and standard products. Communications represented 44% of total revenue compared with 48% in the prior quarter. We have now posted four consecutive quarters of growth in communications and we anticipate that this strength will continue into the September quarter and beyond.

We are beginning to benefit from several secular trends that we discussed in prior quarters. One of the most exciting of these is wireless infrastructure, and particularly LTE. LTE is a matter of when not if. Verizon Wireless has already begun user trials of its 4G LTE network in five U.S. cities and just last week Nokia Siemens Networks announced a $7 billion contract to deploy an LTE network in the U.S. for LightSquared. According to ABT Research, 20 carriers will launch LTE networks by the fourth quarter of 2010.

These rollouts benefit IDT because virtually LTE base stations require second generation serial RapidIO switches and IDT is the sole provider. In Q1, IDT announced the world’s first family of Gen 2 SRIO switches. These products have already been designed in by Tier 1 wireless infrastructure manufacturers and we have an average of $50 of content in every LTE base station. In addition to LTE, IDT’s first generation RapidIO switches are used in today’s 3G and HSDPA base stations. The increasing deployment of infrastructure using these protocols drove 50% sequential revenue growth in June.

Now, I would like to turn to our projections for our second quarter of fiscal 2011. Overall, we expect revenue to grow sequentially by approximately 5% plus or minus 2%. Keep in mind that that growth is off of much higher-than-expected June base. Our September quarter growth will be lead by strength in the consumer and communications segments.

Before I turn the call over to Rick, I would like to briefly discuss how our recent investments in analog have created new opportunities which expand our available market. In addition to the analog and power management solutions we’ve introduced for our target segments, we recently announced our entry into the smart grid market with our first family of metering ICs. These products feature the widest dynamic range in the industry and extremely high accuracy thereby improving the performance of smart meters.

According to ABI Research, the number of smart electricity meters deployed worldwide will grow by a factor of three to 212 million by 2014. This is just one of several emerging market opportunities enabled by our new analog emphasis. Whereas most companies view analog as an end market in itself, IDT sees analog as an enabler for system level solutions. Our 30-year digital heritage coupled with our new analog capabilities give us a unique advantage as the industry’s premier analog and digital company.

So, as you can see, our strategy is working and IDT metamorphosis is nearly complete. Our prolific new product introductions are driving high profile design wins and strong revenue growth. We are not just riding a cycle, but are tapping into strong secular growth trends in each of our end markets. I am very proud of all the IDT team has accomplished in the past two years and thrilled to witness the accumulating momentum. Yet, IDT remains the best-kept secret in the industry.

In order to get the word out, we have overhauled our sales and marketing organizations and have begun to turn up the volume. Expect to hear a lot more about IDT in the near future. With that, I will turn the call over to Rick to expand on the financials and our guidance for the September quarter. Rick?

Ted Tewksbury

Thank you, Ted. Let me start by going over our non-GAAP results for Q1, which reflect a very strong start to our fiscal 2011. Total bookings for the June quarter increased on a sequential basis and the book-to-bill ratio was well above one. As Ted mentioned, total revenue of $158.3 million was up 15% quarter-to-quarter and above the high end of the range we’ve provided in May on broad based strength across all of our end markets.

We believe inventory levels in the channel remained relatively lean at the end of June and days of inventory in our Asian POP [ph] distribution channel remained consistent with both the prior quarter and the June quarter of last year. Fiscal Q1 gross margin was 55.6%, up 250 basis points from the prior quarter, driven primarily by more favorable product mix. This is the highest gross margin IDT has recorded in four years.

It’s worth noting that as the fab runs at essentially full capacity, we are optimizing our product mix. We achieved this by selectively producing wafers that will generate the greatest revenue and highest gross margin. These factors, together with our ongoing cost reduction efforts enables us to exceed our previously articulated long term gross margin target range of 53% to 54%.

Total operating expense was $64.2 million, up from $58.9 million in the previous quarter. The quarter-to-quarter increase was primarily the result of variable expense items correlated to better business results such as incentive compensation and sales commissions. R&D and SG&A expenses during the fiscal first quarter were about $40 million and $24 million, respectively.

Our operating profit increased sequentially by 66% to $23.8 million from $14.3 million in Q1 due to higher revenue and gross margin. This resulted in operating margin of 15%, up from 10% in March.

Interest income and other was about $400,000, up $100,000 from the prior quarter. For Q1, we reported non-GAAP net income of $23.3 million, or earnings per diluted share of $0.14. This was up $0.05 from the March period and was $0.03 better than the midpoint of our expectations provided in May.

Now, let me summarize our results on a GAAP basis. We reported GAAP net income of approximately $10.4 million, or $0.06 per diluted share in the June quarter. This is up $0.05 from the $0.01 per share recorded in the March quarter and represents a $0.15 improvement from the year ago period. The difference between our GAAP and non-GAAP results, that’s up to our $13 million, r $0.08 per diluted share.

Fiscal first quarter 2011 GAAP results include approximately $6 million in acquisition and divestiture related charges, $5 million in stock-based compensation, and $2 million in restructuring related costs.

Further information, including a detailed reconciliation of GAAP to non-GAAP results is provided in the financial tables of today’s press release and can also be found on our website at www.idt.com.

Now, I will turn to our balance sheet. Cash and investments totaled approximately $332 million at the end of the June quarter, a sequential decrease of about $11 million. We generated approximately $27 million of cash from operations during the quarter, paid $8 million of the IKOR transaction, and spent about $5 million in capital expenditures. During the quarter, we spent $24 million to repurchase $4.2 million shares of common stock. Earlier today, we announced that the IDT Board of Directors approved a new $225 million share repurchase authorization.

Net inventory was about $50 million in June, down $1 million sequentially. Days of inventory were also down to 64 days from 71 in the prior quarter due higher cost of goods sold and a lower inventory balance. Our trade accounts receivable increased $6.5 million to $75.5 million in June due to increased shipments while DSO decreased to 43 days from 45 days in the previous quarter.

I’ll now turn to our forecast for the September quarter. As lead times stabilized in June and July, our bookings have moderated from the unsustainably high levels we experienced in March and April, but our book-to-bill ratio remains comfortably above one.

As Ted mentioned, we currently project revenue for our fiscal second quarter 2011 to be $166 million plus or minus $3 million. We expect this solid increase despite growing off of a higher June base. On a non-GAAP, we currently project gross margin to remain roughly flat quarter-to-quarter at 55.6% plus or minus 50 basis points depending primarily on the revenue range and product mix. We anticipate our Oregon wafer fab will remain fully utilized in Q2.

Based on the success of our ongoing cost reduction efforts and improved product mix, we are revising our target gross margin models upwards to 54% to 56%. We currently project operating expenses in the September quarter will be approximately $66 million plus or minus $1 million. R&D is expected to be approximately $42 million and SG&A is projected to be flat at about $24 million.

We currently anticipate interest and other income to be about $400,000 and we expect our taxes during fiscal Q1 to be about $1 million as we continue to benefit from tax credits accumulated in previous years. We project Q2 share count to be about $163 million on a diluted basis and project non-GAAP EPS to be about $0.16 at the mid point of our revenue guidance.

On the balance sheet, we expect to generate approximately $26 million in cash from operations during the September quarter. Our on-hand inventory is expected to be roughly flat in dollar terms while days of inventory should decline sequentially. We project that cash balance at the end of September will be approximately $355 million, which does not include any impact from share repurchases.

In summary, our strategy is working. We’ve been successful in defending and growing market share in our core business line. At the same time, the investments we’ve made in new growth platforms have yielded a product pipeline that should fuel sustained, above market growth for the company in the years to come.

Despite investing for long term growth, we’ve driven a five-fold increase in our operating margins over the past year. This highlights that we are on the right path to achieving our long term operating model, which should deliver increased value for our shareholders.

With that summary, I will turn the call over to the operator for the Q&A portion of the call. Lorrie?

Question-and-Answer Session

Operator

(Operator instructions) And we have a question from the line of Sukhi Nagesh with Deutsche Bank. Please go ahead.

Sukhi Nagesh – Deutsche Bank

Thank you. Great results, guys, and nice guide as well. I had two questions here on the gross margin front, if I start out with. Can you provide some details on how you had such a big upside in the quarter? I know you said most of it was product mix, but where you able to get any benefit as well from your utilization rates as it relates to your current fab or outsourcing or whatever that you have to do, can you delineate the mix versus utilization, please?

Rick Crowley

Yes, the vast majority, Sukhi, was mix. We got a little bit of benefit from utilization, but not a lot. As you know, in the March quarter we were already running over 90% utilization and we didn’t really get benefit yet from our back end consolidation, we got a tiny bit. So the most of it was mix and I think the key point is one that we mentioned in the prepared remarks, which is we are trying to optimize our mix, since we are capacity limited. We are trying to build to the extent we can those wafers with the highest revenue and gross margin per wafer and I think you are seeing some of the effects of that here in the first fiscal quarter.

Sukhi Nagesh – Deutsche Bank

Right. And you are – you just took your guidance up for at least your target gross margin up to 54%-56%. If you look at the gross margin for you guys moving into next year, say the March-June quarters of next year, you clearly are going to be in that range this year, but how should we look at that moving into next year I guess?

Rick Crowley

Well, when we set that longer term target, we can vary plus or minus around that, but that’s kind of our view for the near term right now, we think we can achieve that. Of course, our fab is running at 100% utilization at least up until the time we begin to ramp it down. So, we think we see positive turns in our cost profile and we balance that out with both product mix and ASP expectations over the intermediate term to come up with that model. So, I can't give you any specifics necessarily about margin in June. Gross margin, obviously, we’ll give you updates as we move forward, but I think we felt there is importance in message out to the investment community that we think we can sustain higher gross margins in the intermediate term.

Sukhi Nagesh – Deutsche Bank

Fantastic. One last question I had, clearly your first half calendar results have been better than normal. If you – and given you guidance for the September quarter, how should we be looking at your December and March quarters at least? Are you able to – given what you have in your new product ramp, will you be able to sustain the growth in terms of outgrowing the overall industry? Thanks. That’s all from me.

Rick Crowley

Well, I think we are, as you heard, we are bullish about our new product pipeline, Sukhi. We think that that the added soft [ph] if you will on top of the growth of our core business that has been performing well also. I think the wild card is the macro. So I think it’s pretty mature to say what December and march is going to be because obviously there is a lot of cross currents in the macro environment that can really push us one way or the other and from quarter to quarter. But, overall, I think that we agree with the point you are alluding to is that our product pipeline should help us be able to grow better than the semiconductor market.

Operator

And our next question is from the line of Sandy Harrison with Signal Hill. Please go ahead.

Sandy Harrison – Signal Hill

Yes, sorry about that. Real quickly, just a quick note on housekeeping. You said your new products grew 18% or grew to 18%?

Ted Tewksbury

That’s correct, Sandy; our new products grew 18% sequentially quarter over quarter. In terms of the new products as a percentage of total revenue, we are still roughly flat with where we were last quarter at about 15%. If you recall that probably about a year ago, back when we were at 5% new products, we forecasted that we would do roughly 20% new product revenue by September. The reason we are sitting here at 15% right now, frankly, is because our core product business has grown much more rapidly and robustly than we expected and that actually masked the 18% quarter-over-quarter that we saw in our new products. So, right now if we stay on track to our current plans, we will probably come in somewhat below our 20% target in September and again that’s a good thing because it’s on account of core product growth.

Sandy Harrison – Signal Hill

Right, so it’s just the math, it’s not the – yes, just the math.

Ted Tewksbury

Yes, exactly. By the time we get to December, we expect to be closing in on that 20% target, but overall the new products in terms of absolute revenue and sequential growth are right on target.

Sandy Harrison – Signal Hill

Got you. Thanks for that. Secondly, as far as your pure computing revenues, you said servers or – that was about 39%. What’s the mix of your business? I think you said half of it was servers, what’s the other half of that 39% of computing made up of?

Rick Crowley

Sandy, this is Rick. Yes, we are now a little bit more than half of our total computing mix in enterprise. And the other half is really pc related. So, it includes our PC clocks, audio solutions, the (inaudible) and power – modest power revenue in there as well.

Sandy Harrison – Signal Hill

Got it. And then if you look at sort of the enterprise component of your business, you made some comments that you were seeing many things that Intel had talked about as far as enterprise spending. What do you guys see as one of your bigger catalysts or where – may be asked a little differently, where do you participate the most in the enterprise spending upgrade that we are seeing here away [ph], which shall we be looking for as far as end markets or products?

Ted Tewksbury

Well, the biggest, immediate growth driver that we are seeing, Sandy, is DDR3 registers and PLLs which are taken off. And we’ve got the leading market share in this.

Sandy Harrison – Signal Hill

Got it. And then my last question is as far as running wafers to the fab and associated with utilization rate and product mix, do you think that some of these older products bleed down, that you will be able to replace most of them in your fab or a lot of your newer products go into outside boundaries?

Ted Tewksbury

Well, we are – we actively manage our fab capacity and we have been bleeding off some of the lower gross margin products such as the PC clocks and SRAM and replacing those in the fab with higher gross margin products like our DDR3. A lot of the new products are indeed going to foundry, but we’ll be keeping our fab 100% utilized through the bulk of that transition.

Sandy Harrison – Signal Hill

Great, nice quarter, and thanks for taking my questions.

Ted Tewksbury

Thank you.

Rick Crowley

Thank you.

Operator

We have a question from the line of Glen Yeung with Citi. Please go ahead.

Glen Yeung – Citi

Thanks. Hey, Rick, you mentioned macro economy earlier in the conversation. And I notice that your Europe business was down quarter-on-quarter. Was that something that was macro driven? Were you actually seeing signs of that and if so what are you seeing now?

Rick Crowley

Glen, I don’t think we read through to the – our customers’ end market geographic mix, Europe, China, U.S. necessarily, so I don’t think (inaudible) too much of that. So, right now I think we can't say we’ve seen a direct impact from Europe. And I know it’s about all we can say I think geographically.

Glen Yeung – Citi

Fair enough. The other thing I wanted to ask about was one, you mentioned that orders are moderating and I think a function of them being very high. Then may be just give us a sense as to what you are seeing. And then secondly, at the same time orders may be moderating. It sounds like you guys are – is anything slightly tighter this quarter on capacity than you were last quarter? So, also part of this question is how do you see the utilization rate trending on one end and any other sources of capacity that you see available to you?

Rick Crowley

Okay, so with respect to the orders, I mean obviously when lead times expand, and this sounds pretty obvious, when lead times expand, bookings react and move up and that’s what we were seeing in the March and April quarter. And as I have mentioned in the prepared remarks as lead times started to stabilize for us kind of still on that 10-13 week range as we mentioned in the last call, then if you then start to get into equilibrium and you got start to see I think orders rates moderate as we got out of through late of May and into June-July. And they have been pretty consistent since than, as I said, and book to bill still comfortably above one or just good. Backlog is building reasonably well for the December quarter already, which I think you can relate to lead times. Frankly, it doesn’t feel that much difference from a capacity standpoint right now than it did in April, or (inaudible) April. We already knew where we will fall internally. It’s just a matter of what wafers we are going to start and how we’ll just meet the demand. And I think we are watching the PC space and we obviously have a little bit sub-seasonal view of what that PCs normally would do in the September quarter right now and that’s okay, because we’ve actually allocated more wafers away from that space starting last quarter and that continues into this quarter.

Glen Yeung – Citi

Did you mean subs-seasonal in terms of your view of the actual PC market or your view of clocks end of the PC market?

Rick Crowley

Just overall PC market.

Glen Yeung – Citi

Do you have any way of quantifying that?

Rick Crowley

Well, I think we basically think that the PC market is flattish to down for us in the September quarter and that’s why we have computing generally flattish in our outlook. I think there is pretty – lot of fear and uncertainty and doubt out there, that came up throughout the June quarter about the PC build rate and for our sense that there is a lit bit of an adjustment right now.

Ted Tewksbury

I don’t thing we are saying we’re saying anything that you haven’t heard from other–

Glen Yeung – Citi

Sure. Understand.

Ted Tewksbury

– there is general software sub-seasonal builds in PCs. For our business, there is really two dynamics, one is that softness and the other is the deliberate decision that we’ve made to walk away from some of the lower margin PC clock business, so we expect our overall PC revenue to be roughly flat, maybe slightly down in September with audio and display products growing, but that being offset by the decline in some of the PC clock revenue.

Glen Yeung – Citi

Just one last question on that point, Ted, is you mentioned $3 per PC minus the clock business. What actually is the clock dollars per PC at the moment? And is there some target number you are shooting for or you are shooting to be ultimately out of clocks altogether?

Ted Tewksbury

So, the PC clock – the actual ASP is –

Rick Crowley

Sub $0.50.

Ted Tewksbury

Sub $0.50. The PC clock gross margins are actually at the low end of our range, actually below SRAM gross margins, so it’s not a business that we’ve been savoring.

Glen Yeung – Citi

Okay, thanks.

Operator

We have a question from the line of Tim Luke with Barclays Capital. Please go ahead.

Tim Luke – Barclays Capital

Just a couple of quick things with respect to communications and your commentary on the opportunity in LTE base stations. How do you see that market sort of the developing? You were inferring that the old LTE base stations would have, I think you said $50 of content for you in them. Is that correct and how long would you expect that to be the case for, any color there would be very helpful?

Ted Tewksbury

Yes, thanks for the question, Tim. Yes, every LTE base station will ship with roughly on average $50 worth of IDT content in it and that’s a combination of RapidIO Gen 2 switches together with timing solutions. And we expect to hold on to that share for as long as – as far out as we can see. Right now, we are the only company in the world that offers these Gen 2 RapidIO switches and they require and immense amount of R&D. So, we don’t see any up and coming competition anywhere on the horizon.

As far as our wireless infrastructure business is concerned, most of the strength that we saw in fiscal Q1 where we saw RapidIO switches up about 50% quarter-over-quarter, a lot of that strength, keep in mind, was coming from present generation 3G and HSDPA base stations. A lot of it was being driven by the fourth round of TD-SCDMA build out in China. So, we are getting a lot of volume in RapidIO switches from current generation base stations and then when LTE and 4G start rolling out in earnest, which we are starting to see right now with Verizon, AT&T and so forth, we expect to dominate that share.

Tim Luke – Barclays Capital

Thank you. Ted, just to get back to the PC commentary, what were the factors that you believe have lead the market to be flat to down in terms of just the July [ph] seasonal end market there and – what’s the trajectory of that PC clock business in as much as it is I believe we should expect to be flat to lower through calendar ’11 and less relevant in calendar ’12, how should we think about it? Thank you.

Ted Tewksbury

Good question, Tim. So there is really two parts to that question. As far as the softening of PC demand, we were getting pretty over heated for a while. I mean last quarter, beginning of the quarter, our book to bill was at unsustainably high levels. So, demand had to soften up at some point. Now, as far ad the PC clock question is concerned, let me address that one head on because I think there has been quite a bit of hand-wringing out there about the eventual integration of clocks by Intel. So, let’s talk about that for a minute.

PC clock integration has actually been on Intel’s roadmap for years and they will be introducing a new microarchitecture at the end of this year called Sandy Bridge that will integrate PC clocks. Now, this is not news to us. We’ve known about this for a long time and we’ve been planning for it. And so is this something that you guys should be worried about? No. And there are two reasons for it. First of all, as we talked about, PC clocks are a mature, commoditized business with gross margins at the low end of our range. Now we actively manage our portfolio and we continuously replace undifferentiated, low gross margin products like SRM and PC clocks, with differentiated high gross margin, new products like the ones we talked about today.

So, we’ve been preferentially walking away from some of that low gross margin clock business and devoting fab capacity to higher gross margin wafers. And the favorable impact of that strategy is apparent in the higher gross margins that we experienced in the June quarter and what we anticipate to see in September.

Second, over the past two years, we’ve been shifting R&D away from PC clocks to higher growth, higher gross margin consumer and communication clocks. And revenue in these areas will more than compensate for any decline in PC clocks. So, the overall revenue and the overall gross margin of our core clock business, which includes consumer, communications, and computing, will continue to grow despite any decline in PC clocks. So, just want to hammer home the point that our timing strategy is not being driven by Intel, it’s being driven by our goal to maximize profit growth.

Tim Luke – Barclays Capital

Could you just remind us of the relative size of the PC clocks and the comm clocks, currently?

Rick Crowley

Yes, sure, Tim. Let me try to frame the scope or size of this for you. When we look at the Intel integration, and try to size it, we think that the impact to IDT all other thing being equal is approximately 6% to 7% of current revenue and this will occur as Sandy Bridge ramps, which is projected I think beginning really Q1 mass production of calendar ’11 – through calendar ’11. So, it will happen over next calendar year.

From a profit perspective, we think the impact is relatively small, about $0.03 to $0.05 per share because of the relatively low gross margin that PC clocks have. And ironically if you take that revenue out, our op margin and gross margin would improve, holding everything else constant so that while – talked about may be 6% to 7% of revenue as the dollar top line impact, the gross profit impact is well below 5% in our view.

And, the benefit of running additional wafer and incrementally higher margins as well as the ramp of our core new product categories could offset and provide accretive results.

So, really three key takeaways from this discussion. Number one, we’ve been deliberately de-emphasizing PC clocks to maximize our profits. And that’s independent of any integration decision by Intel. Second, revenue in our core timing business will continue to grow and that growth will more than offset any decline in PC clocks. And then third, we’ve got a bunch of new products, which we talked about, which will layer on top of the core and enable us to outgrow the market as a whole in FY12. So I hope that clears up some of the confusion out there on the PC clocks–

Tim Luke – Barclays Capital

Yes, could you clarify the comm clocks side relative to the PC side; the 6% to 7% for the PC clocks, what’s the scale of the comm clocks, could you just remind us?

Rick Crowley

Yes, it’s a sizably a larger portion of the total. I think overall timing is about 45% of revenue roughly. And the PC clock is in the low double digit of that. So the vast majority today already is consumer and communication clocking. And not all the PC clock revenue is going to go away. I think that’s another sorry misunderstood item or assumption that’s out there, because products – and we classified then PC clocks then will continue to be used in servers, Netbooks, embedded applications like workstations and things like that. So that’s our view.

Tim Luke – Barclays Capital

Thank you very much, guys. Good luck.

Ted Tewksbury

Thanks.

Operator

And we have a question from the line of John Barton with Cowen. Please go ahead. Hi, Mr. Barton, Please go ahead...

John Barton – Cowen

Can you hear me now?

Operator

Yes.

John Barton – Cowen

Then I am sorry. You were clear about the strategy behind optimizing wafer starts based upon profits, et cetera. I would assume that some of that was accelerated based upon hitting virtual full utilization. I am curious about customer perspective, the business is just walking away from the PC clocks and SRAMs, are there enough other suppliers out there where you are not challenging those relationships, which could potentially impede your designing efforts on the products that you are focused on?

Ted Tewksbury

Yes, good question, John. And, of course, we take care not to drop products off which were single course so the products we are talking about that we dropped out of our fab are that the highly commoditized products, which are multiple sourced like the PC clocks and SRAM.

John Barton – Cowen

And Rick, you talked about the book to bill trend being down below unsustainable levels before obviously book to bill was high when your customer have given you more visibility it has to come down closer to reality. When they are just giving you replacement booking for what they are consuming on a weekly basis, so to speak. Am I interpreting your statements right, that’s what you are seeing now and if you could elaborate on that with respect to what you’ve seen any trends as far as push out cancellations, et cetera.

Rick Crowley

Hey, John, actually I think that the – I’ll characterize it as stabilized from a lead time standpoint and bookings standpoint. The real positive from our standpoint is it stabilized at a book to bill above one. We think that’s a good think. Obviously, if lead times are compressed in the industry dramatically then you see the book to bill typically go below one. We have not seen that. And we are seeing I think healthy order pattern and that makes sense. We are not seeing large cancellations, push-outs anything like that, that would be signals or signs of major fluctuation [ph] in the marketplace or in end demand.

John Barton – Cowen

Just going back to the fab, full utilized, obviously, putting a lot of money and cash flow into the company. Does the strong environment, this full utilization, does it change the strategy of the eventual fabless model so to speak either from timing or just overall?

Ted Tewksbury

This is Ted, John, no, it does not. There is three reasons we made the decision to get out of the fab. One was capacity. I mean, frankly, we don’t have enough capacity in the Oregon fab to support the ambitious growth goals that we have. The second was gross margins. We are able to get better cost structure by going with the outsourced arrangement, and that was done largely for gross margin reasons. And then the third reason is technology. As our digital products go to final line lithographies and our analog products and power management products require higher voltage, more exotic technologies, it’s advantageous for us to do that in a foundry environment rather than make the prohibitively large investments that we have to do in-house. We want to be able to focus on our core competencies, which are differentiation through design and definition rather than process technology development, which is too costly for us. So, all of the reasons we decided to get out of the fab are still sound.

John Barton – Cowen

Okay. And there is no reason to delay – push it out of – as long as you are running fully utilized, et cetera?

Rick Crowley

Exactly.

John Barton – Cowen

Okay. Last question, if I could. You highlighted recent success in Capacitative Touch. Just update, if you would please, strategy as far as future generations of Touch, just the overall direction from a product offering there please?

Ted Tewksbury

So, what you are seeing right now in Touch is the traction that we are getting with buttons, sliders and scroll wheels, which are used in an increasingly large number of appliances, both electronic light goods and so forth. We have design wins in everything from monitors to ebooks to rice cookers and then white goods in China, smart phones. So, those touch buttons and scroll wheels and sliders are getting good design wind traction. However, it’s still at a relative low level as far as our overall revenue is concerned. The real reason, the strategic reason that we acquired latest technologies was for the full screen Touch technologies, which are in development and I am not at liberty right now to talk anymore about those products, but we will be introducing Touch products later on in the year. We are also integrating some of those technologies in more highly integrated ASSPs such s the intelligent power management IC that we talked about in the prepared remarks, which also has an integrated Touch controller. So that’s a quick status on Touch.

John Barton – Cowen

Thank you.

Operator

We have a question from the line of Nicholas Aberle with Janney Capital Markets. Please go ahead.

Nicholas Aberle – Janney Capital Markets

Thanks, guys, for taking my questions. Nice quarter. First question, I appreciate you laying out the product roadmap overview at the beginning of the call. Clearly, Ted you’ve put together some of the strategies here to take the company to the next level. What inning of the ball game are we in with respect to benefiting from some of those strategies put into place and given the big buyback are you guys kind of done on the acquisition front here in the near term?

Ted Tewksbury

So, I would answer your question about what inning we are in, in two ways. With respect to the organization and putting in place the right technologies, skills, and capabilities realigning the company to the strategy, putting in place the new product development engine, I would say we are right in the middle of the seventh inning, we are in very good shape and most of the heavy-lifting is behind us right now and it’s a matter of implementation.

In terms of revenue growth, we are getting very good design win tractions, but I would say that we are probably in the second or third inning and most of the upside is still ahead of us – it all starts with, you got to put in place the team, then you got to introduce the products and you got to design wins and the customers have to qualify the products and get ramped up before you start realizing the revenue ramp.

We’ve talked in past calls about how in FY10 we doubled new product introductions year-over-year. FY11 we intend to double new products again. So, the products are coming out of the pipeline. As we mentioned, we are getting a lot of high profile design wins and so that – those are the leading indicators of the revenue ramp, which is yet to come.

You had another part of your question—

Nicholas Aberle – Janney Capital Markets

Yes, with respect to the big buyback, is that kind of indicate here we’ve no more real bolt-on acquisitions in the near or do you guys believe in yourself, some where (inaudible) still do stuff strategically there?

Ted Tewksbury

Well, we continue to monitor strategic acquisition activities that would accelerate our growth prospects and our profitability prospects, but right now we think there is no better stock out there than IDT. I mean if you look at our progress over the past year, our revenue is up 36% from first quarter a year ago. Gross margin is up nine percentage points, operating margin up over 12 percentage points, EPS is up $0.12. We have doubled new product introductions year-over-year. New products have gone from 5% of total revenue to 15% of total revenue, so we can think of no better way to use our cash right now than to purchase IDT stock.

Nicholas Aberle – Janney Capital Markets

Got you. And then – and Rick, with respect to the buyback and what’s the strategy there, I mean, how price-sensitive are you guys, what – how shall we look to see how you guys play this out?

Rick Crowley

Well, I think as we’ve articulated in the past, we are trying to take a disciplined approach of this, so last several quarters we have consumed some cash to buyback stock. And roughly $20 million to $24 million last couple of quarters in cash consumption. Of course, we are preferring a lot more cash now, so, our view is that based on Ted’s I think excellent synopsis of where we are today versus a year ago, while our stock is down I think a number of 10% or 15% or whatever it is, year-over-year, in the absence of a strategic alternative we are not averse to consuming cash to buyback stock. But we intend to do it on a disciplined fashion.

Nicholas Aberle – Janney Capital Markets

Got you. And then just back to kind of the big picture commentary, Ted, so you guys are going to come in a little below that 20% threshold for the new product business. Obviously that’s a bigger function of the math and the legacy businesses and core businesses are growing faster. If you look out next couple of years, I mean is that – that 20% is may be well behind us. I mean we are looking at the new products being half of IDTI’s revenues or I mean not that you need to put a specific number out there, but what should we be thinking about just in the ballpark of new products in the next couple of years, percentage revenues?

Ted Tewksbury

That’s a good question, Nick, and we probably need to redefine our new product categories. What we’ve talked about so far over the past two years is what we call the first wave of new products, which is in serial switching, i.e. the PCI Express and RapidIO solutions, the audio technologies and the display port technologies. Now, beyond that, we’ve got what we call the second wave of new products and that includes the enterprise flash controllers, signal integrity products, temperature sensors, a lot of the new power management products, a lot of the new video processing products. We’ve got RF products in development. So, if you look at all of that in totality, that’s going to comprise much greater than 20% of our revenue a year from now. But we probably need to redefine the categories to give you a more precise response.

Nicholas Aberle – Janney Capital Markets

Got you. Thanks and good luck in Q3.

Ted Tewksbury

Thank you.

Rick Crowley

Thank you.

Operator

Thank you. (Operator instructions) And we’ll go back to the line of Sukhi Nagesh with Deutsche Bank. Please go ahead.

Sukhi Nagesh – Deutsche Bank

Yes, hi, Ted, I had a quick followup on your computing business. You didn’t – you forgot to mentions what you would expect for your DDR3 business to do in the September quarter. I was wondering if you give some color on that.

Ted Tewksbury

Yes, so DDR3, Sukhi, will continue to grow double digits in Q2

Sukhi Nagesh – Deutsche Bank

Okay, alright. Thank you.

Operator

And we have no further questions. I will turn it back to our speakers at this time.

Rick Crowley

Great. Thank you very much for joining us today. We appreciate your interest in IDT and look forward to meeting with you on our marketing trips this quarter and our next earnings conference call. We will also be attending the Citi and Deutsche Bank conferences this quarter and look forward to seeing you then. Thank you and good bye.

Operator

Thank you and, ladies and gentlemen, that does conclude our conference call for today. We thank you for your participation and for using AT&T’s Executive Teleconference. And you may now disconnect.

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Source: Integrated Device Technology, Inc. F1Q11 (Qtr End 06/27/10) Earnings Call Transcript
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