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Cirrus Logic, Inc. (CRUS)

F3Q07 Earnings Call

January 31, 2007 5:00 pm ET

Executives

Thurman Case - Acting CFO

Dave French - President & CEO

Analysts

Heidi Poon - Piper Jaffray

Jay Srivatsa - Roth Capital Partners

Dan Morris - CIBC World Markets

Craig Hettenbach - Wachovia Securities

Jason Pflaum - Thomas Weisel Partners

Adam Benjamin - Jeffries & Company

Nimal Vallipuram - Hapoalim Securities

[Jill Mestalone] - Catapult

Presentation

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Cirrus Logic third quarter fiscal year 2007 financial results conference call. At this time all participants are in a listen-only mode. Later we will open the call up for your question. Instructions for queuing up will be provided at that time.

As a reminder, this conference call is being recorded for replay purposes. I’d now like to turn the conference over to Mr. Thurman Case, Acting Chief Financial Officer. Mr. Case, you may begin.

Thurman Case

Thank you, operator, and good afternoon. Joining me on today's call is David French, Cirrus Logic's President and Chief Executive Officer.

As stated in our press release earlier today, we are limited in the amount of financial results we will be able to discuss until our special committee completes its ongoing review of the Company's historical stock option granting practices and related accounting matters. Because of the pending nature of this review, all financial numbers for the third fiscal quarter are preliminary results and will -- are subject to adjustment.

As a result, we will only be able to provide you information and guidance about general trends of our gross margin and operating expenses. Today we also announced that the Company received a letter from the NASDAQ stock market stating that the Company's request for continued listing has been granted, subject to certain conditions. The special committee continues its work toward completing its stock option review in a timely manner; however, in light of the review, the Company may not be in a position to file its 10-Q with the SEC for the third fiscal quarter by the February 8, 2007, filing deadline or the permitted extension of February 13, 2007.

I would also like to remind you that during the course of this conference call we will make projections and other forward-looking statements regarding, among other things, our estimates for the fourth quarter fiscal 2007 revenue, cash generation from operations, as well as our estimates and assumptions regarding our future revenue growth opportunities.

Please keep in mind that these statements are predictions and are subject to risks and uncertainties that may cause the actual results to differ materially from our projections. By providing this information we undertake no obligation to update or revise any projections or forward-looking statements, whether as a result of new developments or otherwise.

Please refer to our press release issued today, which is available on our website at www.cirrus.com, our latest Form 10-K for the fiscal year ended March 25, 2006, as well as our other filings made with the Security and Exchange Commission for additional discussions of risk factors that could cause actual results to differ materially from our current expectations.

I would like to mention that all financial numbers are prepared, unless noted, in accordance with General Accepted Accounting Principles. We believe that certain non-GAAP financial information is useful to investors because it may enhance their understanding of the results and trends in our business. We also use certain non-GAAP financial information internally to evaluate and manage our operations. As a note, the non-GAAP financial information we provide may differ from that provided by other companies and should be used in addition to, and not as a substitute for results prepared in accordance with GAAP.

Now, I'll turn the call over to Dave French.

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Dave French

Thank you, Thurman, and thanks to all of you who are joining us here today.

As stated earlier, due to the ongoing stock option granting review, at this time we are limiting our discussion to preliminary revenue, gross margin and R&D and SG&A expense trends, and some balance sheet items for the third fiscal quarter, which bended on December 30, 2006.

Total revenue for this period was towards the high end of our previous guidance at $45.3 million, down 6% from the previous quarter. Non-GAAP gross margin, which excludes the impact of any potential stock option related expense, was up from the previous quarter and was slightly above the 60.1% reported for the first fiscal quarter of 2007, which was the last quarter that we fully reported.

Excluding the impact of any stock option related expenses and the cost associated with the ongoing stock option review, R&D and SG&A expenses were roughly flat compared to the non-GAAP $21.6 million expenses last reported for the first fiscal quarter of 2007.

These expenses also exclude restructuring charges related to the closure of our Colorado facility and costs associated with acquisition -- with the acquisition of Caretta Integrated Circuits. Cash and marketable securities grew to $264 million, up from $262 million at the end of the prior quarter, and up from $233 million at the end of the third quarter a year ago. This increase is net of the use of $10 million for the purchase of Caretta Integrated Circuits during the quarter.

Later during this call I'll provide more detail regarding our business operations, and Thurman now will review our preliminary financial results for the December quarter.

Thurman Case

Thank you, Dave. Our net revenue for the December quarter was $45.3 million, compared with $48.3 million a year ago -- in the quarter a year ago, and $48.2 million in the September quarter. Our revenue by product line was as follows: Mixed signal audio products contributed $19.7 million; industrial products provided $13.3 million; and embedded products were $12.3 million.

Historical revenue breakdowns for these product lines may be found on our website in the investor section. We had no OEM customer representing more than 10% of revenue and one distributor, Avnet, contributed 32% of revenue. As Dave indicated earlier, prior to the impact of any stock option related expenses, non-GAAP gross margin percentage was slightly above the 60.1% reported for the first quarter of fiscal 2007, and was slightly above the rates we guided to previously.

R&D and SG&A expenses were roughly flat compared to the non-GAAP $21.6 million expenses we reported for the first quarter of fiscal 2007, and excluded approximately $1.6 million in expenses associated with the ongoing options review. We expect to continue to incur significant expenses associated with this ongoing review. Interest income for the third fiscal quarter was $3.6 million, up from $3.2 million in the previous quarter.

Our employee headcount at the end of December increased by 32 employees to 441, up from 409 in September, due primarily to the acquisition of Caretta Integrated Circuits and the accompanying 37 employees. The increase was slightly offset, as we moved to a lower-cost structure through the previously announced closure of our Colorado facility.

Looking at our balance sheet, total cash and marketable securities at the end of December increased to $264 million from $262 million at the end of the September quarter. This reflects the net use of $10 million in cash associated with the previously-announced acquisition of Caretta Integrated Circuits.

Our total cash per diluted share increased by approximately $0.02 and ended at $2.98 per diluted share, based upon 88.7 million diluted shares outstanding. We ended the December quarter with $16.6 million in net receivables compared with $21.9 million at the end of the September quarter. DSO's, or day sales outstanding, were 33 days, an improvement of eight days when compared with 41 days in the September quarter. Inventory at the close of the December quarter decreased approximately $1.1 million in the December quarter to $20.3 million.

Net inventory turns were relatively flat, decreasing slightly. Inventory levels at our distributors were relatively flat during the quarter, and we continued to actively manage our distribution channels to insure proper inventory levels. Our capital expenditures were $3.1 million in the December quarter, compared with $1.1 million in the September quarter. Depreciation and amortization expense totaled $1.7 million compared with $1.2 million in the September quarter

And now Dave will discuss our business operations and guidance for the upcoming quarter.

Dave French

Thank you, Thurman. Given the challenges highlighted by several semiconductor companies recently, I'm pleased that our revenue came in at the high end of previous guidance, and that gross margin and operating cash flow exceeded our stated expectations. Our diversified product portfolio enables us to deliver solid and predictable results.

Within the organization we continue to make progress towards our 20% operating profit business model by driving efficiency improvements and maintaining strong gross margins. Cirrus Logic's analog and mixed signal audio business has formed a solid foundation, with good opportunities for revenue growth and operating margin expansion through fiscal year 2008.

One of the highlights this past quarter was the acquisition of Caretta Integrated Circuits, a fab-less integrated circuit design company located in Shanghai. Founded in 2004, Caretta has focused its initial IT development efforts on battery protection IC's for the single cell lithium ion battery market. Based on our projections, this market represents a two billion unit per year opportunity, driven by growth in mobile communications and portable media devices.

This acquisition accomplishes several things for Cirrus Logic. It provides us with a stronger, long-term strategic position to grow in China by developing a stronger organization there. It expands and diversifies our expertise in analog IC technology to incorporate power management technology. It gives us an additional product line to drive revenue growth.

And finally, this acquisition further diversifies our industrial product portfolio. Caretta employed 37 people, including 30 engineers overall, all of whom have now joined Cirrus Logic. I'm enthusiastic about the opportunities for revenue growth with this product line, as well as Company-wide in China during calendar year 2007 and beyond. As previously stated this transaction is expected to be neutral to earnings per share in the near term.

I would like to now provide a brief update on our products, beginning with our industrial product group. This product line includes integrated circuits designed for a variety of data acquisition, power metering, precision measurement, and energy exploration applications. These products once again demonstrated strong revenue growth in the past quarter and generated our highest gross margins.

Revenue in Q3 was $13.3 million, up $4.4 million or 50% from the December quarter a year ago and up $800,000 from $12.5 million in the September quarter. We are encouraged by the continued strong demand for our products for seismic applications, in particular.

Also, emphasis over the past several quarters on industrial product demand creation in the fast growing China region resulted in revenue growth for both power meter IC's and industrial measurement products during Q3. In addition in December, EDN Magazine recognized our engineering excellence and has given our CS3003 operational amplifier one of its hot 100 product awards for 2006.

The unique chopper-stabilized CS3003 offers a superior combination of high gain and low noise that yields superior accuracy, making this product ideal for applications which are performing the highest precision measuring. I remain encouraged about our growth prospects for the industrial product line in fiscal 2008, as we plan to introduce several new products that leverage our high-precision analog and mixed signal expertise.

I'd like to turn now to our mixed signal audio products. Semiconductor components in this product line, including data converters, class D amplification products and several interface devices, are used in a wide array of consumer, professional and automotive audio applications.

This product line contributed $19.7 million of our December quarter revenue, down from $25.5 million in the year ago period and down from $23.8 million in the September quarter, as that anticipated revenue this quarter was impacted by soft consumer demand for mid to high-end audio equipment and DVD-related equipment. In spite a weak consumer demand during calendar year 2006, I remain encouraged by the opportunities that we see for this product line in calendar year 2007.

As you know we have invested heavily in recent years in new product and technology development and we've introduced a variety of integrated circuits that I believe position us well to address the fast growing portable media player market and the DTV market.

During the December quarter we announced the latest in our growing family of products for portable audio devices. This product extends our previous innovation of capless headphone amplifiers, with the integration of class D speaker drivers on a high-quality audio codec. This integrated circuit expands our reach into the low-power portable consumer electronics market, by targeting applications that offer the flexibility of headphone or loud speaker listening experience, such as portable media players, digital cameras and camcorder devices.

In addition, during this past quarter we introduced the first fully-integrated class D codec optimized for digital television application. Because of its high level of feature integration, this integrated circuit offers digital TV manufacturers an easy to use and very cost effective solution for managing the entire audio signal chain. The portable media player market and DTV and game console markets each represent significant revenue growth opportunity during fiscal year 2008 for our mixed signal audio product line.

I am particularly encouraged by our opportunity to gain market share in portable applications, driven by our proprietary technology of capless headphone amplifiers that enables best-in-class audio quality while reducing cost and the number of external components.

Finally, I'd like to commend on our embedded product line, which represented $12.3 million of our December quarter sales, down from $13.9 million in the year ago quarter, but up slightly from $11.9 million during the September quarter. This product line includes our audio DSP's and general purchase ARM-based micro processors for network media servers and intelligent industrial terminals.

Growing acceptance of our ARM-based family of embedded processors in a wide array of applications drove year over year and sequential revenue increases for this product line, partially offsetting the softness we mentioned earlier in consumer demand for products incorporating our DSP's, such as mid to high-end audio equipment for the home. This quarter we also introduced a new audio DSP, which allows digital television manufacturers to quickly and easily incorporate advanced audio processing capability. This IC further assists digital TV manufacturers to differentiate their products by offering superior audio performance.

Looking ahead, we continue to invest in new ARM and DSP products that will position us for a leadership role in next generation products, which leverage emerging audio standards and connectivity requirements. With this focus we believe the long-term growth prospects for embedded products is strong. Our overall expectations for the fourth quarter of fiscal year 2007 are as follows.

Revenue is expected to range between $41 million and $44 million. Prior to the impact of any stock option related expenses, gross margin is expected to remain consistent with our Company target of 60%. Also prior to the impact of any stock option related expenses and costs associated with the ongoing stock option review, R&D and SG&A expenses are expected to remain flat. Cash generated from operations and interest income together are expected to range this quarter between $6 million and $8 million.

To recap, I'm pleased with our third quarter performance. Our diversified product portfolio enabled us to deliver solid and predictable results. We continue to make progress towards our 20% operating profit business model by driving efficiency improvements and maintaining strong gross margins.

Cirrus Logic's analog and mixed signal audio business has formed a solid foundation, with good opportunities for revenue growth and operating margin expansion through fiscal year 2008. Before we take your questions I'd like also to mention that we will be attending three upcoming conferences during February.

We'll be at the Thomas Weisel Partners conference next week on February 6th in San Francisco, as well as the Roth Capital OC conference in Dana Point, California on February 20th and the CIBC World Markets semiconductor conference on February 22nd in Vail, Colorado.

We're now ready to take your questions. Operator?

Question-and-Answer-Session

Operator

[Operator Instructions]

Our first question comes from Tore Svanberg with Piper Jaffray. Please go ahead.

Heidi Poon - Piper Jaffray

Hi, this is actually Heidi calling in for Tore. I have a couple of questions. First of all, in terms of your opportunities in flat panel TV and portable multi-media player, could you give us a little more color on maybe some of the OEM's that you're working close to and do you expect major design wins in either category this year?

Dave French

We've had several design wins already. We usually don't talk specifically about customers' plans and activities until those products are fully in production. Some of them are fully in production. Our targets during the past year have been focused on all the major Japanese brands, as well as the major Korean brands, and we think we've got pretty substantial market share through the design wins we achieved over the course of the past year.

Heidi Poon - Piper Jaffray

Are you referring to the TV segment?

Dave French

In the TV segment, that's what I understood the question to be.

Heidi Poon - Piper Jaffray

Yes, yes. and how about portable multi-media player?

Dave French

Likewise, in portable media players, we really don't want to talk too much about specific customers' engagements, but we do -- we have seen a significant number of design wins over the course of the past year. And coming into this calendar year we think that the expansion of our portable codec portfolio puts us in a significant position to gain share in branded applications.

Heidi Poon - Piper Jaffray

Great. Also follow up on seismic, you mentioned earlier that you see continued strong demand, but I think there are some concerns recently, given the volatility in oil prices. Could you give us a sense of the visibility you have in that segment?

Dave French

We have good visibility. We work closely with the customer set that we have in the seismic arena, and we've asked for a little better visibility. And to my understanding I think almost all the customers have helped us get a good view of at least the next six months, anyway.

I wouldn't want anybody to believe that near-term demand for exploration-related hardware is directly coupled with day-to-day fluctuations in oil prices. The strategic trend towards higher oil prices, as compared to the $20 a barrel for crude we might have seen a couple years ago, is still driving substantial overall increase in the overall capital investment in exploration worldwide.

Heidi Poon - Piper Jaffray

Great, and just one final question. In terms of achieving the operating margin target of 20%, given the new structure of operating expenses, do you think we could maybe hit closer to that in fiscal 08, maybe towards the end of that?

Dave French

Yes. I'm still pushing very hard to be able to achieve the originally-stated model of 20% operating, operating profit, excluding the cost of stock options as we originally stated, during fiscal year 2008. Probably not for the whole year, but for the better quarters during the year is what we're targeting right now.

Heidi Poon - Piper Jaffray

Great, thanks very much.

Operator

Our next question comes from Jay Srivatsa with Roth Capital Partners. Please go ahead.

Jay Srivatsa - Roth Capital Partners

Yes, hi, Dave. Hi, Thurman. Congratulations on beating consensus.

Dave French

Thank you.

Jay Srivatsa - Roth Capital Partners

A couple questions, if I may. Dave, you alluded to just softness in the semiconductor market. Van you elaborate on that? Are you seeing specific softness in certain markets, are you seeing it across the board, and what is, in your opinion, causing that?

Dave French

Well, maybe I misspoke. I meant to say softness in consumer-related sectors, which drives some of the semiconductor market, certainly. The areas that we have seen through calendar '06 that look pretty widely to be experiencing sluggish demand in a lot of regions are mid to high-end home audio equipment -- surround-sound equipment -- and equipment -- DVD-related equipment of all sorts -- DVD players, DVD recorders, portable DVD to a large extent, home theater in a box implementations. Many of those applications seem to be experiencing slow demand.

My theory on that is that, with digital television manufacturers bringing out some extremely exciting equipment at continually lower prices, many consumers worldwide -- including myself, I'd have to point out -- are withholding expenses that might have historically been allocated towards audio equipment upgrades to identify what kind of display we want to buy next and when we want to buy that.

And as these new price points are achieved and new capabilities are offered, I think consumers may actually launch these buying decisions for the TV. And subsequently we may have a pickup during calendar '07 in mid to high-end home audio hardware.

Jay Srivatsa - Roth Capital Partners

Okay. In terms of your margins, I know you've guided to a flat margin, but given Q1 tends to be a soft quarter for consumer electronic products -- meaning your mix in industrial products will likely be better -- would it be fair to assume that there could be some upside to your margins?

Dave French

Well, I'd never want to discount the possibility of upsided margins. We think we've done a pretty good job of managing progress on that front and we will not stop. Historically the first calendar quarter has been relatively soft for consumer. However, we did have a slow December period relative to historical trends, at least on a sequential basis release it active to the previous quarter, the September quarter.

So we're not anticipating really much decline during the March quarter anyway. So while we might see some movement in the gross margin line up or down, I wouldn't expect a huge mix shift during the March quarter.

Jay Srivatsa - Roth Capital Partners

Okay. In terms of Caretta, I know it's neutral in the near term, when do you expect contribution to start hitting your top line?

Dave French

Well, we ex -- we will see some revenue for that product line during the current quarter. We're not going to break it out, it's still too small to really warrant breaking it out. We're going to include that in the industrial products revenue numbers going forward, and we'll start seeing something this quarter and we think it's got good opportunity to grow in '07 and in '08.

Jay Srivatsa - Roth Capital Partners

Okay. Last question, what -- can you give us a sense of backlog going into Chinese New Year and how do you expect it to shake out following the New Year?

Dave French

Our backlog coverage for the March quarter is all right, we feel since the middle of November booking's picked up enough such that we're reasonably well supported to our current internal plan as well as to the forecast that we put out. And how things are going to look like after the New Year for consumer manufacturing in China is difficult to predict.

I think that our inventories in distribution and in our customer base, particularly in Asia, I think we've been looking at that pretty closely over the course of the past year, I feel pretty comfortable with those. And those are usually the first predictor of how things are going to proceed after the New Year, and I think this year we're a little bit better than we were a year ago.

Jay Srivatsa - Roth Capital Partners

Thank you much. Congratulations on a good quarter.

Dave French

Thanks Jay.

Operator

Our next question comes from Rick Schaefer with CIBC World Markets. Please go ahead.

Dan Morris - CIBC World Markets

Hi guys, this is actually Dan Morris calling in for Rick. I just want to drill down a little bit more on the DTV and PMP product lines. I know you mentioned a number of new products that you'd launched over the last couple of quarters and wonder if you could describe maybe what your potential dollar content, how that's increased?

Dave French

For TV's?

Dan Morris - CIBC World Markets

Yes.

Dave French

Yes, I think that right now most of our revenue for televisions is selling data converters, (inaudible) and A-Z converters, for the audio chain. Typically we're well under a dollar per box for this sort of converter product. Going forward, we have the opportunity to expand our share of selling this kind of product into these applications.

We also have an opportunity to move up in content per box as our class D amplification products become more accepted. In cases where we sell it to the integrated product I mentioned earlier, which is the first class D codec optimized for digital television applications, we have an opportunity to sell product up to $2 a box or more, as we sell the converter integrated with the amplifier itself.

Further out in time, probably more in calendar year 2008 than in calendar year 2007, we think that our embedded digital signal processing capability, along with the firmware that allows us to sell complete solutions to our customer base, will allow us to serve the needs our customers see to try to differentiate their product, not just through bigger displays with better contrast and better image quality, but also, as with some of the branded companies in this field in the past, by selling through their channels to end customers based on superior audio performance.

We now have the capability to bring this feature set into their TV's for relatively low cost. But moving from less than $1 today to $2 or more including our amplifier products, to maybe as much as $4 a TV including our DSP products over the next couple years, allows us not only to attack one of the fastest growing arenas in the world, but to attack it with increasing dollar content per box.

Dan Morris - CIBC World Markets

Great. Now looking at your mixed signal audio, I know you mentioned that it was negatively impacted by DVD and also the overall consumer weakness, it seems like the DVD audio portion has been trending down over the last few quarters. How much more exposure do you have there and does the mix signal audio business, do you see it bottoming in this next quarter?

Dave French

We have very little exposure left in the DVD-related audio chip market, I can tell you that. We don't break it out, but it's pretty small. Going forward, it's hard to tell. March is almost always down from the December quarter for that product line. Right now it looks like we're in the process of bottoming and my sense is we'll have much less seasonal downtick in March from December. And then from there we've a lot more upside than downside, I would think.

Dan Morris - CIBC World Markets

Okay. And just one last question, you'd mentioned that you thought inventory levels were relatively healthy, could you talk about how much -- I know you've added a few [distees] the last few quarters, could you talk about how much of your business goes through distributors, and then maybe if you could comment a little bit more on where you see inventories overall?

Dave French

Let me get somebody here working on the percent of business that goes through distribution, I don't know that number off the top of my head. But overall I think that inventory -- there's still inventory issues out there in the marketplace it feels like to me. I feel real good about ours, but probably because we've been paying close attention. I pointed out nine months ago in April that I thought the industry had an inventory problem brewing.

We already saw it in our numbers in April of last year, and we've been working aggressively to contain that issue and we think that we've done a pretty good job of that. So I'm in a position right now where, coming into the March period, I don't think I have a problem here.

Now, going into the second calendar quarter, typically we see a seasonal pickup, and maybe we'll end up seeing the other side of that coin where people run a little bit short, but that's difficult to predict at this stage. The overall distribution number as a percentage of sales -- I don't have that number. I'm going to have -- about half. That's what I thought. It's roughly half the revenue worldwide is sold through distributors of some sort.

Dan Morris - CIBC World Markets

Great, thank you very much.

Dave French

Thank you.

Operator

Our next question is from Craig Hettenbach with Wachovia Securities. Please go ahead.

Craig Hettenbach - Wachovia Securities

Yes, thank you. Dave, if I can follow up on the Caretta design team, two questions there. What are the implications for margins, be it gross margin or operating margin, longer term? And then the second question is just other opportunities you might see as you dig deeper into China and have more exposure there for design engineers?

Dave French

I'll ask another clarifying point on the second half of that question. The first half of the question, the products that Caretta has brought to market already will tend to run gross margin a little bit lower than our corporate average. If they get hugely successful that will probably diminish our ability to expand margins further from the current level.

I don't anticipate that the difference in gross margins combined with the size of that product line revenue will be significant enough to change our modeling for the Company as a whole. The second part of the question, were you asking about further opportunities to sell product or further opportunities to expand our technical capability in China?

Craig Hettenbach - Wachovia Securities

More on the technical capabilities an other potential, whether it's design teams or on the R&D side, if you will?

Dave French

Yes, there's quite a bit of -- I would say, I'd put it in the category of fledgling design groups that have begun working in China. There's about six entities over there that I think are highly attractive, in terms of their skills and the application space that they're going after in analog and mixed signal.

We continue to talk to a lot of people over there to find ways to do what we've done with Caretta, which is add a product line, enhance our ability to attack the fastest growing market in the world, enhance the opportunity for us to grow through additional products in our portfolio, and strengthen our technical expertise to be a broader line, more diversified analog semiconductor Company and drive increasing profits. Some of that may end up to fit all those criteria. As we continue to talk to them we'll certainly keep you apprised of any progress on that front.

Craig Hettenbach - Wachovia Securities

Okay. As we look at growth opportunities in calendar '07 here, do you think that the industrial space will continue to power the growth, or how is does that size up versus the opportunities in digital TV and MP3 players.

Dave French

Well, we're not guiding past the March quarter, so I'll just give you a qualitative answer to that. I think that the best growth prospects we have during calendar year 2007 include: Digital TV market expansion, as well as penetration gain; portable audio penetration gain; gaming consoles, particularly at Sony, where we have got a good long-term relationship, and their launch of the PS 3 is looking better than it has in prior quarters; and seismic still has an opportunity for growth. In calendar 2006 seismic and industrial applications grew while mixed signal audio actually declined. I think in calendar year 2007 we have a more balanced set of opportunities going forward.

Craig Hettenbach - Wachovia Securities

Okay, and last one, if I could. As you look at your own internal inventory, any sense as you go through the March quarter what your own internal inventory, how that will trend?

Dave French

Right now I'm going to take it down a little bit. We took it down in the fourth quarter -- fourth calendar quarter about as much as we wanted to. We anticipated the issues out in the marketplace, so there were no surprises for us during the quarter. Although I ran higher than model in inventory because we expect that March -- we expected and continue to expect that the March seasonal trends will be a little bit better than usual. So right now we're on a path to reduce inventory slightly, maybe 10% during the current quarter, going into what should be a pretty strong seasonal trend in the June period.

Craig Hettenbach - Wachovia Securities

Great, thank you.

Dave French

Thank you.

Operator

Our next question is from Jason Pflaum with Thomas Weisel Partners. Please go ahead.

Jason Pflaum - Thomas Weisel Partners

Yes, good afternoon, guys.

Dave French

Hi.

Jason Pflaum - Thomas Weisel Partners

I guess two quick questions. As far as the March quarter outlook I was hoping you could give us a little better sense by segment what your expectations are sequentially?

Dave French

We don't usually break that out on a guidance basis, nor do we want to start getting into that. It gets a little too complicated to keep all the moving parts. Right now we see consumer seasonally down in March, as I mentioned earlier probably going down less than usual.

Usually it's a pretty substantial drop-off from December to March. We normally don't see a meaningful calendar-oriented trend on industrial products and we still don't. That business is fundamentally pretty strong in all product areas and I don't think there's a big trend for March from December there anyway. And the embedded products are somewhere between where half of that business or so, it's consumer, and that should see a seasonal downtick and the rest of it not and should be cruising along on a stable basis.

Jason Pflaum - Thomas Weisel Partners

Okay. And the better than seasonal consumer segment, is that just because things have corrected already or are you anticipating some new design wins that start?

Dave French

We have a little bit of both going on for us. We had a little bit softer December on sequential basis, as the world dealt with what appeared to be a relatively sluggish demand and maybe some inventory but there in the channel, it's hard to tell. So we think that we're in a little bit better position coming into March off a little bit lower base. But also we've a lot of new products we brought out in calendar '05 and calendar '06 that are really starting to see some momentum coming into calendar '07.

Jason Pflaum - Thomas Weisel Partners

Okay, great. And just lastly to follow on your previous answer, you suggested that June usually is seasonally strong, (inaudible) couple of years you were up upper single-digits, is that kind of a good baseline assumption it at this point.

Dave French

Well, I'm not guiding June, so I'll probably stop short of really answering that question. Hates hard to tell whether -- or how these trends are going to play out, because the last two years our December quarter was sequentially flat, this year our December quarter was a little bit down. Our March quarter has been down 10% or more the last couple years, and this year we're guiding it only down quite a bit less than that. So it's really hard to tell what June is going to look like, and we'll certainly keep people apprised of our view on the world as this quarter unfolds.

Jason Pflaum - Thomas Weisel Partners

Great. Thanks guys, good luck.

Dave French

Thank you.

Operator

Our next question is from Adam Benjamin with Jeffries and Company. Please go ahead.

Adam Benjamin - Jeffries & Company

Good afternoon. Dave, you guys have done a very good job increasing the margin here, both on the gross and the operating margin line, getting the gross up to 60% level and bumping that operating margin line into the low -- you know, low teens.

Off of relatively $45 million revenue base a quarter, give or take a couple million per quarter, you haven't seen a quarter with a five in front of it until -- since the June of '05 calendar quarter. So I guess, as you look out and you talk about operating leverage, how maxed out are you with respect to the gross margin and the operating expense line that it really is just going to depend on increasing revenue?

Dave French

It's kind of hard for me to understand that question.

Adam Benjamin - Jeffries & Company

I guess what I'm trying to ask, Dave, is at this point is the gross margin and the OpEx, which is relatively flat, is that maxed out? How do you get operating leverage in this model. Is it 90+% coming from increasing revenue opportunities?

Dave French

Well, if the revenues go up a lot, yes, 90% increasing revenue opportunities with superb fall through. If the market languishes or we fail to show the ability to expand our revenues at a good clip, we've indicated that we can reduce operating expenses as a percent of sales anyway.

Adam Benjamin - Jeffries & Company

Right, but can you also get any more leverage -- without increasing revenue, can you get any leverage just on the OpEx line as well as gross margin? Gross margin I know fluctuates on a mixed basis, but is there any room for improvement there?

Dave French

Gross margin has fluctuated at a mix basis and consistently increased over the last several years, regardless of mix, and I think we could still work that line for some further improvement.

Spending we brought down pretty consistently over the years., and as we've held it kind of flat lately as revenue was held kind of flat. Obviously we're still spending above industry levels in product development R&D. And I believe that that's warranted, as long as we believe that we can grow, also, at above industry revenue growth levels.

Adam Benjamin - Jeffries & Company

Okay. Just changing gears, with respect to your audio product for the TV market, who are you really seeing there as competition?

Dave French

For audio for TV's?

Adam Benjamin - Jeffries & Company

Yes.

Dave French

In Japan [Acem's] a good competitor. TI is a competitor, Wilson's a competitor, the traditional guys.

Adam Benjamin - Jeffries & Company

That's it?

Dave French

No, that's not it, those are the major guys that we deal head to head with most of the time.

Adam Benjamin - Jeffries & Company

Any new competitors, anyone else interesting?

Dave French

There's always a bunch of little companies, but those are the main competitors.

Adam Benjamin - Jeffries & Company

Okay, thanks Dave.

Operator

Our next question comes from Nimal Vallipuram with Hapoalim. Please go ahead with your question.

Nimal Vallipuram - Hapoalim Securities

Hi, thanks for your time. And first of all let me congratulate Dave and Thurman on you're managing your balance sheet very well.

Dave French

Thank you, Nimal.

Nimal Vallipuram - Hapoalim Securities

Congratulations. Also beating the Street numbers on the sales. I have a question for Thurman, then two for Dave. First for Thurman is that you gave the guidance cash generation for the fourth fiscal quarter between $6 million and R8 million. If you look at your cash balance out there, your operational cash flow would indicate between $3 million and $4 million. Is that net of what is expected of the options-related expenses or it is not"

Dave French

Operating cash flow should be -- including interest income is the number that we're referencing there, net of fluctuations and associated with the stock option related activity, as well as probably a slight increase in receivables during the March quarter, because it went down more than it should have in the December quarter. But I'm not sure I understood the question.

Nimal Vallipuram - Hapoalim Securities

No, I think you answered the question. Because Thurman indicated that you have spent $1.6 million or so on expense related -- expense -- options related expenses in the last quarter.

Dave French

Mostly that was in accrual, not a cash outlet.

Nimal Vallipuram - Hapoalim Securities

Okay. The next --

Dave French

The actual cash payment for that would probably come in, in the current quarter.

Nimal Vallipuram - Hapoalim Securities

Okay. And then, just if you look at on a longer term basis, Dave, I have two questions for you. Number one is that Wilson this morning indicated a pretty significant weakness in their high-end audio business, and you also have seen some weakness in the high-end audio business.

I'm trying to understand this market. Number one is that last quarter U.S. GDP was 3.5%. It came out today, which is a pretty good number. Worldwide last quarter GDP was reasonably healthy, I believe. However the consumer demand in some cases has been pretty strong, in some cases has been somewhat sluggish.

What I try and understand that is there any thing on cyclical basis going on here, which is impacting the high-end audio demand; a.k.a., what the iPod has done in the sense that, number, one customers going for convenience and giving up on high-fidelity sound? Number two is that, with apple integrating iPod into iFone -- and few other companies are doing that -- would you be put into a position to compete for design circuits with the handset companies?

Dave French

Okay. Let me try and take on that question. The high-end audio equipment for the home opportunity is a sub-set of dollars that people would allocate to home electronics, and I think a higher than normal percentage of that is getting allocated to TV's right now. I think most of that'll correct itself over multi-year periods.

So that's hurting it overall I think, in spite of a relatively good economy. I also think that the amount of money people spend on electronics probably doesn't move around all that much, and certainly the attractiveness of the iPod brand has drawn a lot of the expending by consumers for entertainment devices in that direction.

So that might have further reduced the amount of money people are allocating to home electronics upgrade. So I think both of those issues are playing against us in terms of the mid to high-end home audio electronics market.

Over the course of calendar 2007 we think that in portable audio devices we've got a substantial opportunity to take significant market share, which allows us to play in a field that, through calendar 2006, we had trivial market share. And I think that'll help us overall end up putting up much better numbers than we have in the past, even if home audio expenditures by consumers worldwide continue to be sluggish or a lull, which is what we're anticipating that they will continue to be.

Now, selling into high-volume cell phone applications has never been a target that I have strategically, and I think I've made that pretty clear to everybody. It continues not to be a target. However there is a segment of cell phones that might be sold as entertainment devices that also have communication capability, and I might suggest iFone seems more like that than it does seem like a cell phone. In those applications superior audio quality might worth something, and if it is worth something, then we might want to participate very strongly and we plan to do so.

Nimal Vallipuram - Hapoalim Securities

Just a final question on that longer term trend. On the DVD market when you talk about the future consumer electronics market you always mention the digital TV market and the MP3 player market. And so far -- at least I haven't come across you mentioning anything about high--end DVD market or the Blu-ray high-definition DVD market. Do you -- are you there right now or you're planning to be there?

Dave French

Yes, Blu-ray and HT DVD are going to be a huge trend. We have -- if you look at the relative size of our numerous internal development programs, high DEF DVD-related hardware and the chips and technology that goes in there -- particularly in processing audio signals -- is probably one of the biggest single applications in terms of -- as measured by the amount of R&D expense we're putting in.

We've got some pretty good technology, got some pretty good products right now. I don't think they're drive meaningful revenue during calendar year 2007, so we really haven't talked much about them in this arena. Although in 2008 I think there's a pretty good shot that they'll be noticeable. In '08 and 2009 there could be some pretty substantial contribution to our top line, as well as our bottom line through growth of that application.

Nimal Vallipuram - Hapoalim Securities

Thanks Dave. Thanks Thurman. Again congratulations on a good quarter.

Dave French

Thanks, Nimal.

Operator

Our next question is a follow-up from Jay Srivatsa with Ross Capital Partners. Please go ahead.

Jay Srivatsa - Roth Capital Partners

Yes, a quick follow up. Dave, as you look ahead to '07, maybe more into '08, beyond the obvious, which is your low power and digital TV markets, have you considered another growth vector, and if so, with the cash you have in hand, can you speak to us on what your plans are?

Dave French

Analog and mixed signal diversification through wise use of the cash is something we think the Caretta acquisition represented. Things that fall in the category of enabling us to penetrate growing regions like China more rapidly, to extend into new technologies, like power management, to increase our growth prospects by putting on a new product line, or diversify our capabilities such that we become a more broad line supplier and less nichey and less dependent on a consumer, all those things are good.

Anything we can do creatively that meets those criteria will be interesting to me. As I mentioned earlier there's a half a dozen companies that look attractive from that perspective and we'll continue to look, but we're not going to rush things and we're not going to force fit things.

If we can find a good fit where we can expand our earnings, and expand our technologies, and accelerate our growth and allow us to penetrate the markets that matter, we'll do that. If we can't, we will continue to drive interest rates -- interest income on the existing cash balance as much as possible and consider other ways to use the cash wisely.

Jay Srivatsa - Roth Capital Partners

Thank you, good luck.

Dave French

Thanks, Jay.

Operator

Our next question comes from [Jill Mestalone] with Catapult. Please go ahead.

Jill Mestalone - Catapult

Hey, David, I'm not quite sure if you answered this question already. I've been on and off the call. Can you talk a little bit about -- you've talked about your gross margins being at a very attractive, north of 60% and moving towards your target goal of operating margins near 20, sort of the timeframe you're looking at potentially attaining that, even despite some maybe modest revenue growth for 07?

Dave French

Yes, I think we did get that mentioned earlier. But in any case, I'm pushing quite hard to drive during calendar '08 to achieve the 20% operating margin in the better quarters of the year, excluding stock option related expenses. Right now we've got some work to go do that. A lot of things can contribute to that, but I think that during '08 -- sorry, fiscal '08, I think that that's still a very good objective for us.

Jill Mestalone - Catapult

Fiscal, so mean exiting calendar year '07 we could be -- we could be there?

Dave French

Right.

Jill Mestalone - Catapult

Given only like 10% to 15% revenue growth?

Dave French

Yes.

Jill Mestalone - Catapult

Okay. Great, thanks again and congratulations. I know it's been a difficult environment for a lot of competitors in your space, so congratulations again.

Operator

Management, at this time there are no further questions. I would like to turn the conference back to you for any additional remarks.

Dave French

All right. And I'd like to say thank you again to everybody who attended here today, and we look forward to catching up with you at some of the upcoming conference.

Operator

Thank you. Ladies and gentlemen, this concludes today's teleconference. Thank you for participating, you may now disconnect.

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