Xilinx F3Q07 (Qtr End 12/30/06) Earnings Call Transcript

Jan.18.07 | About: Xilinx, Inc. (XLNX)
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Xilinx, Inc. (NASDAQ:XLNX)

F3Q07 Earnings Call

January 18, 2007 5:00 pm ET

Executives

Maria Quillard - VP of IR

Wim Roelandts - CEO

Jon Olson - CFO

Analysts

Michael Masdea - Credit Suisse First Boston

Adam Parker - Sanford Bernstein

Glen Yeung - Citigroup

Mark Edelstone -- Morgan Stanley

Tim Luke - Lehman Brothers

Parag Agarwal - Jefferies and Company

Tim Kellis - Stanford Group

Chris Danely - J.P. Morgan

David Wu - Global Crown

Seogju Lee - Goldman Sachs

Kathy Berger - AG Edwards

Joseph Osha - Merrill Lynch

Sumit Dhanda - Banc of America Securities

Satya Chillara - Pacific Growth Equities

Uche Orji - UBS New York

Presentation

Operator

Good afternoon. My name is Derrick and I will be your conference facilitator today. At this time I would like to welcome everyone to the Xilinx Third Quarter FY07 Earnings Release Conference Call. (Operator Instructions). I would now like to turn the call over to Maria Quillard, thank you. Ms. Quillard you may begin your conference.

Maria Quillard

Thank you and good afternoon. With me today are Wim Roelandts, CEO and Jon Olson, CFO. We will provide a financial and business review of the December quarter. Then we will open the call for questions. I will then end the call with a few housekeeping items.

As published in our press release our business update in the fourth quarter of fiscal year 2007 will take place in the form of a press release after the market closes on Monday March 5. After we update our guidance we will be in a quite period until we report the following month.

Let me remind everyone that during our conference call today, we may make projections or other forward-looking statements regarding future events or the future financial performance of the company. We wish to caution you that such statements are predictions based on information that is currently available and that actual results may differ materially.

We refer you to the documents the company files with the SEC, including our 10-Ks, 10-Qs and 8-Ks. These documents contain and identify important factors that could cause the actual results to differ materially from those contained in our projections or forward-looking statements.

This call is open to all and is being webcast live. It can be accessed from our Investor Relations website. Now, let me turn the call over to Jon Olson.

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Jon Olson

Thank you, Maria. Revenues in fiscal Q3 decreased 3.5% from last quarter to $451 million, in line with the mid-point of our guidance provided during the December business update. Gross margin of 60.5% was lower than our previous estimate due to increased inventory reserve costs.

Now let me turn to operating and net margin. Operating income was $82.2 million, down 12% from last quarter, net income of $87.5 million or $0.26 per diluted share was down 6% sequentially, including stock-based compensation expense of $21 million. Both operating and net income included a $2.5 million patent litigation settlement. Excluding stock-based compensation, operating income was $103.6 million or down 23%, down 10% sequentially.

Net income was a $102.4 million or 22.7%, down 7% sequentially. Interest and other income of $21 million was better than guidance of $18 million primarily due to higher interest income driven by improved yield on investments and a higher cash balance as previously forecasted.

Free cash flow during the quarter was $153 million after $21 million in CapEx. CapEx was impacted this quarter by the timing of new building payments for our Singapore office. We repurchased 6 million shares for a $150 million. We also paid $30 million in dividends. The tax rate for the quarter was 15%, lower that anticipated primarily due to the reinstatement of the R&D tax credit and over provision of income taxes. This impacted earnings per share by approximately $0.02 per diluted share.

Now let me comment on the balance sheet. Cash balance was $1.8 billion, an increase of $19 million from the prior quarter. Days sales outstanding decreased 6 days to 30 days, a reflection of our lower shipment profile at the end of the quarter. Combined inventory at Xilinx and distribution decreased by 8 days to 118 days, internal inventory levels decreased by 5 days while distributor inventory days decreased by 3 days. While higher cost of goods sold impacted our days of inventory number driving it lower than previously forecasted, we continue to focus on managing inventory to match the business environment. Over the past six quarters we have been able to reduce the spikes caused softer market situations.

I will now turn the call over to Wim to comment on our business and products.

Wim Roelandts

Thank you, Jon. And first let me give you my own comments on the December quarter. The December quarter was disappointing, but it was consistent with the softness of other semiconductor companies with exposure to the communications infrastructure market have been seen.

We started December quarter with a lower beginning backlog and therefore required a higher turns rate to make the mid point of our initial revenue guidance. Other time we are comfortable with our higher turns rate expectations, because we are aware of several million dollars of defense orders that were not in the backlog.

Defense revenues came through as planned but we were surprised by the weakness in both wireline and wireless telecom, especially after a very soft September quarter. On a positive note, enterprise networking was healthy in the December quarter; test and measurement and consumer where the other bright spots.

Turns business was decent during the month of October but took a turn for the worst in November. Both November and December, turns orders were below of expectations. Turns bookings for the quarter totaled 55%.

New products grew 12% sequentially, driven by strong Spartan-IIIE and Virtex-4 revenue growth. These 90 nanometer products, along with Spartan-III contributed 24% of revenues this quarter. 24% of 90 nanometer product shipments continue to outpace all other PLD companies.

The issue we faced once again this quarter is that our mainstream product revenues continue to decline and more than offsets the growth of the new products. Once our communications customers inventories are in better balance, mainstream product should not continue to see the declines of the last two quarters.

Total Virtex revenues were flat with last quarter of 55% of total revenues, Spartan revenues declined 6% to 25% of total revenues and CPLD remained on 9% of total revenues. All geographies decreased quarter-to-quarter. Asia-Pacific decreased the most followed by North America, Europe and Japan. Asia-Pacific weakness is mainly attributable to continued slowness in China as well as software business, which is heavily wireless and [Virtex] related.

North America's strength in defense revenues was offset by declines in communications and data processing. The Europe's weakness was related to a decline in wired, industrial and test and measurement. In Japan, although it was almost flat, it was primarily impacted by the slowness in communications.

Due to another inventory situation in the EMS channel, and many of our large wireless customers are communications end market declined to 44% of our total revenue, its lowest percentage in history.

Data processing of 9% of revenues is also at his historic lows. The weakness in data processing continues to be driven primarily by storage applications. Sales from non-storage applications such as office automation, servers and computer peripherals were actually up slightly on the year-over-year basis.

In the consumer and automotive end markets, the consumer segment grew double-digit sequentially. It was also a standout on a year-over-year basis growing nearly 50%. The growth of consumer applications, however, was offset by declines in audio, video, broadcast and the automotive sector for this quarter.

The industrial and other end markets grew this quarter due to the strength in defense and in test and measurements. Defense sales increased to 13% of overall revenue. At 13% of revenue it is the third largest contributor to revenues behind wired and wireless up 29% and 15% respectively. After three sequentially down quarters, test and measurements were up 11% quarter-to-quarter.

Let me now say a few words about Xilinx's performance in 2006. First of all, revenues grew 14% year-over-year, which is better than the overall semiconductor industry. Even though, our primary competitor has yet to report, we believe that the annual growth rates will be very similar for both PLD companies. We also expect to gain PLD market segment share this year.

This first year, we continued to make excellent strides in diversifying our revenue. In calendar year 2006, both consumer and automotive, and industrial and other showed year-over-year revenue increases of approximately 30%. Communications grew 8% and data processing declined 14%, mainly due to weakness in storage.

On the product front, we are the clear technology leader with 24% of sales coming from 90 nanometer products, up from 11% the same quarter a year ago. We currently supply approximately 70% of the world's 90 nanometer FPGAs and 100% of the worlds 65 nanometer FPGAs. Our foundry partners CMC and Toshiba have ramped 65 nanometer production quickly and with excellent yields, allowing us to complete a seamless rollout of our entire LX platform on time and over one year ahead of our competition. Our rollout also includes delivering the industry's largest FPGA, the Virtex-5 LX 330.

In addition, we are shipping three devices of our Virtex-5 LXD family with hardened PCI express and Ethernet Mac box, along with the industry's lowest power transceivers. Customer response to the LXD family has been overwhelmingly positive, there are no competitive offerings yet announced on 65 nanometer.

On the Spartan side we introduced our latest Spartan-3A family of devices this quarter, which is optimized for I/O, in terms of designs.

Let me now turn to the guidance for the quarter. The March quarter has almost always been very strongest revenue growth quarter. It is also rare for us to have more than two quarter of sequential revenue decline back-to-back. However, we enter our fourth fiscal quarter with the weakest beginning backlog position and the knowledge that our defense business will decline over 10% sequentially.

We also remain somewhat cautious regarding communications, and in particular the wireless sector. As a result, we are forecasting March sales to be flat-to-down 5% sequentially. The midpoint of this guidance is based on the terms that are flat with the December quarter. While this may seem conservative given the typical seasonal strength of the March quarter and the fact that there are more selling days in March, versus December, we believe it is the prudent quarter action. We expect all geographies to be flat-to-down sequentially.

From an end-market perspective, we expect communications to be down, sequentially driven by wireless applications; industrial and other to be down, driven by decline in defense sales; data processing to be flat-to-down sequentially; and consumer and automotive to be up, driven by strength in audio, video and broadcast area.

Looking out beyond March, we do believe that Xilinx will enjoy better than average growth rates, once the inventory correction and merchant disruptions in the communications sector are complete. We think the second half of calendar 2007 will consist of stronger quarters for Xilinx.

Let me now turn the call back to Jon for some final remarks.

Jon Olson

Thank you, Wim. Gross margin is expected to be approximately 51% including $2 million of stock based compensation. Combined inventory days are expected to be approximately 125 days. Operating expenses are expected to increase approximately 1% sequentially, including $18 million in stock based compensation expense. Amortization expense will be approximately $2 million. Other income is expected to be approximately $21 million. The share count is expected to be 336 million shares. And finally, the tax rate is expected to be 22%.

Let me now open the line for questions. Back to you, operator.

Question-and-Answer Session

Operator

The floor is now open for questions. (Operator Instructions). Your first question comes from the line of Michael Masdea with Credit Suisse First Boston.

Michael Masdea - Credit Suisse First Boston

Yeah, thanks a lot. Basically you are calling the bottom here in Q1, I just want you to get a more color on what your customers are saying and what's giving you the confidence that all of this will be behind us after this quarter and you will start to catch up a little bit?

Wim Roelandts

I don't think that we called the bottom of Q1. What I said is that we expect the second half of year to be better and not Q1. We don't have enough real data about, especially communication market to make any judgment at this time. I think that once we get further into the quarter it will be easier to give some guidance. But I believe that second half of the current year will be better but not the first half. Next question please.

Operator

Your next question comes from the line of Adam Parker with Sanford Bernstein.

Adam Parker - Sanford Bernstein

Can you remind us the magnitude of some of the one-time defense orders? What they were dollar terms in December? I am trying to figure out if your turn requirements excluding the defense stuff are actually higher in the March quarter than they were in December? Or to make the mid point of your guidance you need more turns ex-defense?

Wim Roelandts

Well, we thought the defense orders will be down about 10% and you know the percentage of our total defense business. So, --

Adam Parker - Sanford Bernstein

Right, but that all wasn't incrementally. You said you started off the quarter knowing you were going to have a certain amount more, I just want to know what that was?

Jon Olson

I think, if I understand your question right Adam, this is Jon. Going into the quarter, we didn't -- we knew there was about, somewhere between $10 million and $15 million of orders that we knew. We talked very strongly we were going to come in, that were in our backlog which drove our number up. That's what we said before. I would say we are probably in the same relative position now on defense in terms of things that we know and things that we don't know. So, I don't -- the turns with and without to be any different than what we forecasted going into last quarter.

Adam Parker - Sanford Bernstein

Okay, got you.

Wim Roelandts

Next question please.

Operator

Your next question comes from the line of Glen Yeung with Citigroup

Glen Yeung - Citigroup

Thanks. Question is, can you help us to understand, Wim you made the comment about comps as a percentage of your sales. But on an absolute basis, can you talk about where wireless comp business is compared to where it bottomed in 2004, and then can you also give us a sense of what you are seeing in the enterprise market, the networking market?

Wim Roelandts

Sure, if you look at -- the data is in front of me, our wireless communication business, if you compare calendar year '06 with calendar year '05 was up 24%. So, even with the decline over the last two quarters we are still up 24%. So we had a very strong growth over the '05 and '06; the end of '05 and the beginning of '06. The enterprise market, it really is more to Datacomm market and is based on the big Datacomm guys, Cisco and Juniper, and so on. I don't have the exact numbers of growth, but these were the exception in a week market that grew somewhat.

Glen Yeung - Citigroup

But Wim, just as to be clear because you gave me the numbers on a yearly basis, I am think on a quarterly basis, if you think about your expectations for comm., wireless communications to be down in Q1 of calendar '07. How does that number compare with the lowest quarter that we saw in '04 if you happen to have that data?

Wim Roelandts

I don't -- I am trying to look at it, but if I remember it correctly, even with all the decline on this quarter compared with the same quarter last year, wireless is still up. So, even if it goes down a bit further we will not reach the bottom in wireless.

Glen Yeung - Citigroup

Okay, good to know. Thank you.

Wim Roelandts

Is there other question?

Glen Yeung - Citigroup

Yes, there is.

Wim Roelandts

Next question please.

Operator

Your next question comes from the line of Mark Edelstone with Morgan Stanley.

Mark Edelstone -- Morgan Stanley

Good afternoon guys. Wim if you look at your fiscal 2008, can you just give us a sense as to you think some of the drivers for the company are going to be?

Wim Roelandts

Sure Mark. The situation is really pretty simple. If you look at our more older businesses, the more traditional business for Xilinx which is communications and the whole storage area. They have been declining. If you look at for instance, wired communications on a year-over-year market grew only 1%? If you look at however some of the new business that we are focusing on, computing, audio-video, automotive, consumer, defense, industrial and scientific and medical, test and measurement, these are all seeing double-digit growth rates typically between 20% and 50% in the names that I mentioned. So, we are kind of in a race where the newer markets, the new initiatives like consumer and automotive are growing very nicely, typically in 30% plus or minus 10% growth rate on a year-over-year basis. It is the communication especially the wired communication and storage that is holding us back.

Now over time of course, the impact of communications will be getting smaller and smaller. Wired communications today is only 30% of revenue, storage that used to be a very significant part is only 2% of revenue in the last quarter. So, the impact of these low performing markets will decline. And of course if we see a revival in these markets and it is very well possible that over time the impact of Triple Play and so on will start growing some of these markets again or because the mergers are finally behind us because, I think, the merger also have a role to play in this weakness that we are seeing than the company will do very well.

Jon Olson

I think if I can add something that, I think you're looking from a design win perspective. While we are seeing a good number of design wins in communications, it's not like communications is all of a sudden fallen off the table for us for some reason from design win perspective. The end demand sell-through of our customers is just – is not very brisk and the balance and diversification efforts, I think in addition to hanging in there on the communications are the keys for us. We really have to find the other markets and really push those hard in addition to working through those design win end market delays that we maybe having in comps.

Mark Edelstone -- Morgan Stanley

And just a quick follow-on, Jon or Wim. Can you just walk us through the methodology of how you might have incorporated the Telco mergers into your guidance here in the current quarter?

Wim Roelandts

We -- the way that we have looked at -- at that is that all the companies are merging were down significantly from a revenue point of view. So, it is very typical when a merger happens that management pays more attention to the new structure integrating things, killing projects and stuff like that. And, I think that's what you see happening here. And, now that the Lucent-Alcatel merger has been approved, I think we will very quickly get back to business as normal.

Jon Olson

But clearly it has an impact on this current -- this coming quarter's forecast that we gave you. I mean we have played it such that we're protecting ourselves as much as we think is prudent given the fact that we would expect a little -- continue to live as long as in that area.

Mark Edelstone -- Morgan Stanley

Okay, thanks a lot.

Jon Olson

Next question please.

Operator

Your next question comes from the line of Tim Luke with Lehman Brothers.

Tim Luke - Lehman Brothers

Thanks. This is respect to you -- the energy picture, it looks like you are guiding for it to be a little higher, and could you give us some sense as where the inventory lies in your opinion? Because in talking about software wireless infrastructure you are suggesting that there is incremental inventory there, or where else in the channel does it lie guiding to 125? Thanks.

Jon Olson

Yeah, while the 125 up -- up is really driven by the fact that we had an, I think, a higher cost of sales number impact from the inventory reserves driven down officially. I think practically we think we are in a reasonable balance in total, total inventory if you just adjusted for that one phenomenon, but relative to where it is, we were lighter than we would like to see in distribution. And, I think that we've -- held more back. There has been a lower shipments into distribution that some of where the weakness has been for end of December, going into the January month. I think even when talked a little about the build up in the EMF area for us relative to the slow sell-through of comps, so you can understand that we have -- believe there is some finished goods build up there, even though we don’t think there is a lot of our piece part build there because of the way we supply them.

Tim Luke - Lehman Brothers

Just a follow up on that Jon, did the -- could you just help us remind us within come under the break up networking wire line telecom, wireless infrastructure as we try to gauge the impact there. Because obviously within wireless infrastructure, there are some people who did very well and obviously within networking these guys seem to be pretty robust. So, to just where the merger impact is, at the same time your OpEx seems to be higher than you previously guided, if you could make any comments there? Thanks so much, bye?

Jon Olson

Wow, several questions put in there, Tim, pretty good. All right, so the wireless versus wire line components, about a third of our businesses is in the wireless segment in terms of comps. So, if you take the portion that's totally in the communications about third of is wireless and then other two thirds is wired communication Within the split between enterprise and metro and whatever, I don't think we feel comfortable coding that without doing little more digging there. Over the last two quarters that has shifted on us., We've historically done some analysis in that area and I would rather wait and maybe show you some of that at the Analyst Meeting in March and do that.

Relative to the spending comment, I think it did a really nice job of lowering spending this quarter compared to the previous quarter. So, from that perspective, I think even though we did do an acquisition in India, acquired several employees,. we’re able manage our spending down. We did such a nice job. It's actually made a pretty good challenge for us in this coming quarter, which is why we guided 1% up. And, I think one of the bigger drivers of that is the fact, is something we talked about in the last quarter's call, which is related to the introduction of additional SKUs in the Virtex-5 65- nanometer product family. We have several of those rolling out of the factory tape out in the quarter coming up here. And , while we are going to try really hard to lower our spending number, I think the 1% growth is the right forecast for now.

Tim Luke - Lehman Brothers

Thank you.

Wim Roelandts

Next question please.

Operator

Your next question comes from the line of Chris Danely with J.P. Morgan. Mr. Danely your line is open. Your next question comes from the line of Parag Agarwal with Jefferies and Company.

Parag Agarwal - Jefferies and Company

Hi this is Parag for John Lau. Just had a question about your gross margins going forward, you've guided to 61% and typically you have been guiding between the range of 61 and 62. Just wondering, what is -- has your long-term growth margin model changed? And is it due to the increased contribution of new products? Thank you.

Jon Olson

So we guided to -- our guidance is 61%, approximately 61% this time. Our long-term model really remains at 61% to 63%, we have on a pro forma basis 61 to 63, in other words without share-based expenses involved in that. So, essentially we are trending towards the lower end of our model right now. There are some mix issues. We've talked about the mainstream products being a little softer than anticipated. Those have higher margins than our new products. We are quite comfortable with where our margin improvements on the yields have been on the new product family, as Wim talked about how pleased we are with 65 nanometer roll out even though the revenue contribution is de-minimus at this point in time. So, I think it's really more related to the mix, the softness in communications where we typically have pretty strong mainstream product built.

Parag Agarwal - Jefferies and Company

Thank you.

Wim Roelandts

Next question please.

Operator

Your next question comes from the line of Tim Kellis with Stanford Group.

Tim Kellis - Stanford Group

Yes. Good afternoon. You guys generally give some dialogue on new product revenues. I was wondering, if you could may be elaborate on Virtex-II Pro business and then other than the 90 nanometer revenues as a percent of total. If you can maybe give some more color on the Virtex-4 versus the Spartan-3 revenues?

Wim Roelandts

Yes, well, we have given you the total percentages of the Virtex business and the Spartan business. Virtex-4, we don't give really data on that level because of competitive information. But I can tell you that Virtex-4 did extremely well this quarter from a growth rate point of view. Spartan-3, overall was kind of flattish, but because we are in this transition from the Spartan-3 to Spartan-3E, Spartan-3E grew also very significantly during the quarter.

Tim Kellis - Stanford Group

Does that mean the Virtex-II Pro business was up or down or can you give --?

Wim Roelandts

No, Virtex-II Pro was down, because these are part of the mainstream business. These are, in general products that are in -- whether we call production, mainstream is really products that are in production of our customers and these were all down. So, Virtex-II Pro, Virtex-II was down. Some of the older Spartan family members were down, then so on.

Tim Kellis - Stanford Group

Okay. Thanks.

Wim Roelandts

Next question please.

Operator

Your next question comes from Chris Danely with J.P. Morgan

Chris Danely - J.P. Morgan

Can you hear me guys.

Jon Olson

Yes, we can hear you now.

Chris Danely - J.P. Morgan

Okay. Sorry about that. Okay, just a question for Wim, a little bit on longer-term. I am looking at the model here and if I go back 12 months, the revenues are flat. But the op margin is down about around 8 points or something like that. So I guess, I'm just curious as to why we are not seeing a little bit more sharper cuts on the operating expenses?

Jon Olson

Yes, Chris. First, the reason is that we had a very unusual year, where we saw some very nice growth in the beginning of the year and then declines in the second half of the year. I don't -- I hate to cancel projects that are half done, things like that. So, I'd always feel that once the product is launched, and most of the efforts are made, you just have to finish the job. And we are in this finishing mode, like we said, we introduced Virtex-5 LXT. We have two more families coming in the Virtex-5 family, which will be introduced this year. We did our Spartan-3A introduction. So we had it all and this whole negative trend started to become visible. We had all of the products that were in the final phases of [staples] or introductions and I just don't think that we wanted to cut them back. I can tell you that we have efforts underway to reduce our expenses and our long-term goals don't remain -- are remaining unchanged. So we will bring expenses down overtime.

Chris Danely - J.P. Morgan

Can you just give us your estimate of your long-term growth rate?

Wim Roelandts

If you know, it's for 2008, sorry 2007. Like I said, my expectation is that one or two weak quarters, or certainly the March quarter doesn't look that good at the moment. June quarter, difficult to forecast, but we believe that the second half of the year will be stronger, probably because these mergers will be behind us. I think we will see the impact of Virtex-5 ramping more. Today Virtex-5 is still a small number in our revenues, but of course given a few quarters of design, activity and the successes, that will start to have an impact on us. Virtex-4 will start entering production, in some cases already in the production. But we will see more and more of the Virtex-4 entering production. That should increase the volumes. So, that's why we are bullish on the second half of the year. I can at the moment not give you a really forecast. We do the most of that work on our fiscal year basis. So, by the next call, I will be able to give you a forecast for our fiscal year rate.

Chris Danely - J.P. Morgan

Okay, thanks.

Wim Roelandts

Next question please.

Operator

Your next question comes from the line of David Wu with the Global Crown.

David Wu - Global Crown

Yes. Jon, can you explain -- talk about where are you taking these reserves? I assume that these are mostly in the mainstream products. And also if you can explain, historically when you are ramping, your relatively new products like Virtex-4 in the high volume, the gross margin actually goes down more than it appears to be the case in the guidance for the March quarter. Why is it we are having less of an impact as your mainstream and base go down and your new products grow than we have seen in the past?

Jon Olson

Well, there is a couple of questions there. First, relative to the reserves and the nature of the reserves in this particular quarter and a bit of a spike we had, they were mostly related to either a miss-match of inventory, of supply and demand on a couple of specific SKUs. And they were due to either something as far back in the line as Piece Parts are also mainstream products. In any given new product situation, we always end up early on in the life of a product, we do end up producing some parts that do have reserves from time-to-time. So, to kind get to your second question which is really around why aren't we seeing may be a bigger negative impact; it's really because of the maturity of the 90-nanometer process, quite frankly. So, Spartan-3 had been there for quite a while. So, we already had quite a bit of experience there. So, as Virtex has come on, certain SKUs of product families or Virtex we have been doing pretty well with and we are reasonably pleased with that. As you know, we have had some challenges on our V-4 FX part and that's actually been dragging us down and we are continuing to see the lagging effects of some of that margin. But all-in-all, we've been pretty happy with 90-nanometer yields, which is obviously the predominance of our new product. So, we haven't seen a strong dip below 61%.

David Wu - Global Crown

Okay, thank you.

Wim Roelandts

Next question please.

Operator

Your next question comes from the line of Seogju Lee with Goldman Sachs

Seogju Lee - Goldman Sachs

Thanks, most of my questions have been asked and answered. Just in terms of the tax rate Jon, as we look into next year, obviously it's bounced around a bit this year and you have the reinstatement as tax credit. Any insight into what you might expect it will next? Thanks.

Jon Olson

We really haven't looked into next year much, into our next fiscal year in that regard. There are two or three things going on that could cause it potentially to change, but right now I wouldn't expect any of -- either from that thing that would go out, I wouldn't expect it to be radically different next year based on what I see right now.

Seogju Lee - Goldman Sachs

So, we should look at around 22%?

Jon Olson

I would say 22% or 23% is a reasonable thing to plan on for us.

Seogju Lee - Goldman Sachs

Okay, great, thanks.

Wim Roelandts

Next question please.

Operator

Your next question comes from the line of [Kathy Berger] with AG Edwards.

Kathy Berger - AG Edwards

Yes, thanks. You I think talked about once customer inventory balances have improved, you should bolster the main-stream product sales. I take that particularly in communications. Could you pass on any insights you might be getting from your customers on the time frame for that improvement.

Wim Roelandts

Yes, well, the inventory situation I think is pretty well known both of the EMS and at our end customers and it really goes back to I think the first half of last year where there were shortages. I think people over purchased in the fear that there would be shortages, and then probably a decline in their own customer's demand created the situation that we are in. People are working very hard on it. My expectation is that it should be resolved at least to a large degree by the end of this coming quarter, but it is difficult to say. And especially difficulty to say for us because, it means these inventory are known as part numbers, these are part stuffed on board and things like that, and therefore it is extremely difficult for us to figure out how much FPGA are sitting there on these boards or other material that they are buying. But people are working hard on reducing that inventory, so I would assume that probably at the end of this quarter we should -- most of this resolved. Next question please.

Operator

Your next question comes from the line of Joseph Osha with Merrill Lynch.

Joseph Osha - Merrill Lynch

Hi Jon, how are you.

Jon Olson

I am pretty good Joe and you?

Joseph Osha - Merrill Lynch

Just fine. If I do some simple math here, the stock has gone from 40 to 25 over the last three years and the cash is gone from $700 million to above $1 billion. If I look at this year, you guys did more than double your payout ratio without even eating into the cash reserves. Why not double the dividend tomorrow?

Jon Olson

So, Joe, we've had this conversation a couple of different times.

Joseph Osha - Merrill Lynch

Think that I may as well ask the question again.

Jon Olson

Right. So --

Joseph Osha - Merrill Lynch

Still looking for the answer.

Jon Olson

You are consistence. So on an annual basis, we go through a review of our cash policy and with the board, the board is the deciding body for our cash policy and we are in the process of working through a variety of analysis in that area. So, it's really kind of premature for me to say too much about it. I like to be in a position to talk little bit more about it in our Analyst Meeting that isn't a firm commitment to you yet, but between now and then, there is a Board Meeting where this is a topic and it's a quite significant topic quite frankly. So, it's a little bit early for me to talk to you about it.

Joseph Osha - Merrill Lynch

Fair enough. Thanks, I appreciate it.

Jon Olson

Next question please.

Operator

Your next question comes from the line of Sumit Dhanda with Banc of America Securities.

Sumit Dhanda - Banc of America Securities

Jon, I wanted to follow-up on your operating expenses, I think last call you had indicated that your target was to get to about 17% R&D, 15% to 16% SG&A, clearly last quarter you seem to make some stride in that direction. Any sense on when you could get that, not necessarily timing, but kind of revenue level would support that kind of operating margin, operating expense profile? And then, your share repurchases has been sort of aggressive here in the last three or four quarters, can we expect that to continue or even accelerate from here?

Jon Olson

So the second question, I will answer the same way I answered Joe's question is this all wrapped up as part of our cash policy discussion and then hopefully I will be able to talk a little bit more about in the March Analyst Meeting that have we have scheduled.

The answer to your first question a quarter ago we are seeing or looking at what I thought the second half of our fiscal year will look like, I was certainly a lot more bullish on revenue when I was talking about getting our expense ratios on a pro forma basis much closer to our targets. I think, it would take us -- take somewhere in the neighborhood of $500 million plus or minus $10 million to get ourselves more on a quarterly revenue level in order to get ourselves in line. And those numbers meeting the operating margin approximately 28% versus where it is today at 25%.

Sumit Dhanda - Banc of America Securities

And I just had quick follow up, data processing down to 9% of revenues, it stabilized a little bit last quarter down again, up last quarter -- the prior and then down again 11% after that. Storage is down to 2% of revenues. What sort of is left in that data processing segment, which you think has another shoe to drop or you think we are sort of done at this point in terms of decline in that business?

Jon Olson

Well, I think relative to the storage my portion of that particular segment, I don't think there's anymore shoe to drop quite frankly. It's a pretty small component of that area. And the - by and large, it's really in the computing and data processing area where we are experiencing flat to very slightly up quarter-over-quarter kind of numbers. And that's a very range of things that could be in PCs or servers and specifically things around encryption and virus scanning and those kinds of things are quite popular for FPGAs to use in those kinds of applications. And, we have several innovations in that particular area and are doing well in design wins in that area, but we've been seeing this drag, continual of the storage market as we -- essentially, this has to be a really smaller number.

Sumit Dhanda - Banc of America Securities

Is it fair to say that all the weakness concentrated in storage last quarter?

Jon Olson

Could you repeat that please?

Sumit Dhanda - Banc of America Securities

Was all the weakness last quarter concentrated in storage with the data processing or was there other processes?

Jon Olson

Primarily storage.

Sumit Dhanda - Banc of America Securities

Okay. Thank you very much.

Jon Olson

Actually almost entirely storage.

Jon Olson

Next question please.

Operator

Your next question comes from line of Satya Chillara with Pacific Growth Equities.

Satya Chillara - Pacific Growth Equities

Yeah, hi Wim. Question, you commented on wireless, you're being cautious. Can you walk us through which regions and what technologies you are cautious on and basically, how long do you think this is going to continue?

Jon Olson

Well, the whole wireless industry of course was much more bullish. People are thinking of not so long ago selling [and building] cell phones in 2006 and that didn't happen. The other thing that is happening is that, the Chinese government is that dragging their feet on giving out licenses for 3G. And so, that is a slowing factor. If I look at the overall wireless business, Europe is doing reasonably well. The European players probably because lot of 3G deployment are taking place in Europe or the adjacent area. It is really -- the weakness is mainly in Asia and to some degree in Japan.

Satya Chillara - Pacific Growth Equities

Okay, great.

Jon Olson

Okay. Next question please.

Operator

Your next question is a follow-up question from the line of Glen Yeung with Citigroup.

Glen Yeung - Citigroup

Thanks. Wim, you made a point that second half of calendar '07, you think you can see some growth. Within that outlook, can you talk about what the assumption is for wireless component sales? Then can you still be declining in wireless at that point, and you've seen other elements of growth drive growth in the business then?

Wim Roelandts

Yes, well -- and again this is based on my personal feelings, but also talking with some of our customers there. My expectation is that in the second half, wireless will be growing more from the levels where -- the low levels that we achieve this quarter or next quarter. For a couple of reasons, there is more deployment going on, but also especially there is a lot of activity in WiMAX, and WiMAX capabilities, and WiMAX equipment that is being readied for deployment. I also have hope that by the time the Chinese government will have given out the license, so we'll see some 3G deployment in China happening. So all of these makes me believe that we'll see a more better position in the wireless side in the second half.

Glen Yeung - Citigroup

Have you given any thought to what we might see at that time in enterprise and/or wireline?

Wim Roelandts

You know on the wireline side -- when we call enterprise, it's really data networking and there is routers, which are used both for enterprise, but also of course, in the whole Internet infrastructure. There is no doubt for me that the whole triple play is rolling out, more and more companies are accepting it. We see a lot of design activities in high performance routers, but also in new services to guarantee quality of service for Voice-over-IP for instance, and any new type applications like video servers. So, there is a lot of activity going on in the design labs, it all depends, of course how quickly the service companies are going to deploy some of these new capabilities. But from a design activity, a lot of stories going on, that I believe if the EPF deploys some serious grow in the wireline side also, the wireline data communications side also.

Glen Yeung - Citigroup

Thanks.

Wim Roelandts

Next question please.

Operator

Your next question is a follow-up question from the line of Parag Agarwal with Jefferies and Company.

Parag Agarwal - Jefferies and Company

Hi. Just wanted to get your outlook on your defense business? It tends to be lumpy, but going forward, can you quantify the growth rate or can you give some idea how fast that business is going to grow for you?

Wim Roelandts

The defense business -- well, it's a business where indeed we're doing very well. And it's mainly, based on the strengths that we have in some of the other areas, wireline, communication side of course in defense. Lot of communication is wireless, so lot of the same technology that made us successful in the wireless communication side is also applicable to defense. The other success that we have seen in defense is the whole area of encryption that Jon mentioned about in the computer side, of course, that is also there. I think that we probably continue to see very nice growth in defense, but I think the reason why defense as a percentage grows so much is mainly because of the consumer decline in some of the other areas. It is the only -- pretty much the only group together with consumer that is really growing. So, that's why the percentage is running so much faster. But yes, our business in defense will continue to grow for a foreseeable future.

Parag Agarwal - Jefferies and Company

Thank you.

Wim Roelandts

Next question, please.

Operator

Your next question comes from the line of Uche Orji with UBS New York.

Uche Orji - UBS New York

Good evening guys. Just very quickly, if I look at your wireless business, can you share with us some insights as to how you -- what you are seeing in the Japanese markets, and how you can -- you see that playing out for the rest of the year. And some sort of insight, if given in the other market. And just another question is on the 2007 forecast that you've gained share, apart from the contribution from 65 nanometer's, what else you see in areas where you see Xilinx's position being superior as being the driver of share gain for '07?

Wim Roelandts

Unfortunately I cannot -- I really don't have very specific date on the Japanese market. Because Japanese wireless market is very unique, they have their own standards, so it's pretty much an internal driven market. As far as successes for -- you know, apart from Virtex-5 and the 65 nanometer, I think lot of our successes are due to our strength in DSP. There was a study done by a company called BDTI, which is a market research company, that compared DSP performance on FPGAs and processors, and Xilinx came out way ahead of our competition, FPGAs and by about two orders of magnitude better than DSP processors. And I think a lot of our successes that we have seen in the wireless side, in the defense in audio, video, even to some good reason, consumer, really comes, thanks to our strength in DSP. Another area that is doing well for us, although it's more difficult to pinpoint, is the embedded processing. We have some really good solutions in the space and that is our area where we bring additional value to the market. Not so much that, we have unique capabilities but we take away components from the below materials. We suck components that are on the board into the FPGA and are able of course to get more revenue there in that way. So, these are the things with the success factors. From a new market penetration, I think our successes in automotive, but especially in consumer I think are doing very well, with the growth rates in the 40%-50% range year-over-year. So, that is quite successful for us as a new market of that penetration. So, when you look at the overall picture, like I said before, if you exclude wireline communications and storage, the newer businesses that we have, being diversifying in are doing well with growth rates in the 20% and 40% per year on all of these different segments.

Uche Orji - UBS New York

And just as a follow-up, these segments you mentioned in terms of the incremental contribution to your gross margins, should we expect that they will contribute upwards or is it just going to come in at a corporate level?

Wim Roelandts

Our corporate level margins, I still believe that they will remain in the same range, on a pro forma basis of 61% to 63%. It doesn't mean that some markets are much more aggressive, consumer or gross margins are much lower than that. But, on the other side, consumer drives all the volume which then allows us to have more margins as the same products get sold to our customers are moving in these high-volume business. So, overall, if you look at on a per-product basis and per-industry basis, gross margins are quite different but on a corporate level, I believe that 61% to 63% on a pro forma basis is still that I have targeted, I don't see any good reasons why that would change in the short or medium-term.

Uche Orji - UBS New York

Thank you, very much

Wim Roelandts

Next question please.

Operator

Your next question is a follow-up question from the line of Tim Luke with Lehman Brothers

Tim Luke - Lehman Brothers

Wim, just sort of a respite to your commentary there in growth in DSP and embedded, can you give us a sense as what these new product lines are beginning to contribute? Or when it may reach 5% threshold or something?

Wim Roelandts

Tim, unfortunately there are no new product lines, you know our capabilities and on all of our chips. So, that's what part of the difficulty that we have is that some people use the DSP capabilities in an LX device or an FX device. Of course, when its FXT base -- FX base of V-4 FX that is almost 100% DSP related, but not 100% because some people buy FX devices because they contain more memory or for other reasons. So, but the difficulty we have in exactly pin-pointing how much DSP contributes outside of the FX device is very difficult because people buy -- companies buy lets say an LX for one application, the same LX for another application, one application uses the DSP capability of LX the other one doesn't, and it is difficult later on to figure out how much of our sales really go to one purchase or another when a customer buys LX devices. So, that's part of the difficulty we have. So, the best way that I found to measure our success is really to look at these industries where DSP is critical and that's where we are doing very well and that's what I referred to as our success. So, if you look at like I said wireless, a look at the year-over-year growth, calendar-year over calendar-year growth of 24%, you look at the audio-video, 26% year-over-year growth and so on and so on. So, we see quite significant growth rates in the 20% to 40% range for these areas where DSP is an important factor.

Tim Luke - Lehman Brothers

Thank you.

Wim Roelandts

Next question please.

Jon Olson

Last question.

Wim Roelandts

Last question.

Operator

Your final question is a follow-up question from the line of David Wu with Global Crown.

David Wu - Global Crown

Wim, I am going to ask you this question. Your alma mater came out with some new design capability for connecting in some future FPGA. It sounded so good that you get better performance and with less silicon space. So, is that technology somewhat reasonable or good enough to explore because presumably if it works, it will give you tremendous performance improvement and not add to your cost, which means you are going break in to some new markets you've been talking about all these years.

Wim Roelandts

Yes David. In fact we are very well aware of that and because we -- it's in their research organization and there is a lot of interactions between HP's research and Xilinx research organizations. This is using nanotechnology as an interconnect and even the privileged people agree with will tell you that making that technology in production is at least 10 years away. So, clearly if it works, it will be a major breakthrough because it will eliminate all the configuration transistors, the configuration memory and all these kind of things. But I will not count on it in for the next 10 years to be a reality here. It sits together with all the other nanotechnology research that is going on, it is all very promising, but it is at the research level at the moment, not at even probably development level or even at production.

David Wu - Global Crown

Yeah, I understand. Thank you.

Jon Olson

Thank you very much.

Maria Quillard

Okay, we thank you all for joining us today. We have a playback of this call beginning at 5:00 PM Pacific, 8:00 PM Eastern. For copies of our earnings release, please visit Xilinx's Investor Relations website. To reiterate, our guidance update for the March quarter will be posted after the March 5. Our next earnings release date for the fourth quarter FY07 will be Wednesday, April 26 after the market close. This quarter Xilinx will be appearing the Morgan Stanley Technology Conference in San Francisco. We will also be having an Analyst Meeting in San Francisco on March 5. This completes our call and thank you very much for your participation.

Operator

This concludes the Xilinx third quarter FY07 earnings release conference call, you may now disconnect.

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