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Executives

Brendan Lahiff – Senior IR Manager

David Bell – President and CEO

Jonathan Kennedy – SVP and CFO

Analysts

Ross Seymore – Deutsche Bank

Craig Ellis – Caris & Company

Gabriela Borges – Goldman Sachs

Joanne Feeney – Longbow Research

Venk Nathamuni [ph] – JP Morgan

Terence Whalen – Citi

Evan Wang – Stifel Nicholaus

Harsh Kumar – Morgan Keegan

Steve Smicky –Raymond James

Uchechi Orjii – UBS Securities

Chris Caso – Susquehanna

Intersil Corporation (ISIL) Q3 2011 Earnings Conference Call October 26, 2011 4:45 PM ET

Operator

Ladies and gentlemen, welcome to Intersil Corporation’s third quarter 2011 earnings conference call. I will be your coordinator for today.

I’d now like to turn the presentation over to your host for today’s call, Mr. Brendan Lahiff, Senior Investor Relations Manager of Intersil. Mr. Lahiff, please proceed.

Brendan Lahiff

Thanks, Jonathon. Good afternoon and thank you for joining us today for Intersil’s third quarter fiscal 2011 earnings conference call. Today, with me is Dave Bell, Intersil’s President and Chief Executive Officer; and Jonathan Kennedy, Intersil’s Senior Vice President and Chief Financial Officer.

Today we will deliver remarks on the third quarter of 2011 and provide a summary of our fourth quarter 2011 business outlook. After our prepared comments, we will open the lines for questions.

We completed our third quarter on September 30, 2011. An earnings press release was issued today at approximately 1:05 pm Pacific time. A copy of the press release and supplementary slides to accompany the earnings conference call are available on the investor relations section of our website at intersil.com.

In addition, this call is being web cast live over the Internet and may be accessed via the investor relations section of our website. A telephonic replay of the conference call and web cast will be available for two weeks through November 9. Questions during the call may also be submitted online via the web cast but will be answered by e-mail after the call.

Please note that some of the comments made during this conference call may contain forward-looking statements. I’d like to remind you that while these statements reflect our best current judgment, they are subject to risks and uncertainties that could cause our actual results to vary. These risk factors are discussed in detail in our filings with the Securities and Exchange Commission.

In addition, during this call, we may refer to financial measures that are not prepared according to Generally Accepted Accounting Principles. We sometimes use these measures because we believe they provide useful information about the performance of our business and should be considered by investors in conjunction with GAAP measures reported.

Our agenda for the call today is as follows, Dave Bell will discuss key highlights from the quarter, Jonathan Kennedy will review the quarter from a financial perspective, and Dave will follow with additional comments on each of our four key markets, as well as our forward-looking guidance. A Q&A session will follow.

I will now turn the call over to Dave Bell, President and CEO of Intersil.

David Bell

Thanks, Brendan. Good afternoon and thank you for joining us today for Intersil’s third quarter 2011 earnings conference call.

The third quarter was challenging as the worldwide economic environment weakened and demand for our products softened significantly. Various economic problems around the world as well as the tightening of credit in China have resulted in customers reducing inventory levels throughout their supply chains. This has driven both stockings and shipments below demand, as excess inventory is consumed, repeating the pattern seen in many past cycles.

However, unlike prior cycles, the industrial and communications infrastructure market softened quickly, almost in concert with the drop of the computing and consumer markets. This unusual behavior contributed to the surprisingly rapid drop in the third quarter.

We reported third quarter revenues of $186.8 million, an 11% decrease from the second quarter, and a 15% decrease from the third quarter of 2010. The combination of seasonal shifts in product mix and lower manufacturing utilization resulted in our gross margin dropping by 120 basis points to 57%.

In reaction to the downturn, Intersil’s management team reacted swiftly to reduce our operating expenses by 7% compared to our third quarter guidance. This prompt response to the downturn significantly reduced the drop in our earnings, and I have every expectation that we will see further reductions in the coming quarter.

During the quarter, we refinanced our long term debt. This reduced our already low interest expense even further, which will improve EPS by a penny in future quarters. However, as Jonathan will detail, there were approximately $8.4 million in expenses associated with the early retirement of our prior debt, which will negatively impact our GAAP net income and EPS for the third quarter.

As a result, we reported net income of $7.2 million, or $0.06 per diluted share. Our non-GAAP net income and EPS for the third quarter was $25.8 million or $0.20 per diluted share. We generated approximately $24.8 million in free cash flow during the third quarter, and as a result our board of directors has authorized a quarterly dividend of $0.12 per share of common stock. During last quarter’s conference call, I introduced a top 10 list of growth drivers that we expect will result in an estimated $700 million of additional annual revenue within five years.

I’m not going to review this entire list every quarter, but you will see this list as a recurring theme in our strategy, and we will occasionally update you on our progress in those key product areas. The power of 10 is a simple but powerful concept, which has resonated with the investment community and helped focus our resources internally as well.

Our entire executive team clearly understands what our top 10 focus items are. In addition, sales VPs cascading all the way down to each individual sales person has a top 10 account list. Our senior management keeps a constant focus on these priorities, and tracks our progress on a daily basis making tough decisions when necessary to maintain our focus. Despite a quarter that was softer than expected, we continue to focus our investments in the top priorities programs that will drive above average growth in the future.

At this time, I would like to turn the call over to Jonathan Kennedy, who will provide a financial summary. I will then discuss results from each of our end markets in more detail, and finally provide comments on our fourth quarter 2011 outlook. Jonathan.

Jonathan Kennedy

Thanks Dave. Let me start with the results of operations. We achieved $186.8 million in revenue for the third quarter, a 15% decrease from the third quarter last year and 11% sequential decrease from the previous quarter. All end markets experienced revenue declines, with the industrial market showing the largest decrease.

Our lead times remained normal throughout the quarter, with no significant supply constraints and our internal utilization was at normal levels. Third quarter turns were just under 30%, and we expect our Q4 turns to be about 35%, at the midpoint of our guidance, in line with our historical turn rates.

Gross margin was 57% in Q3, 120 points lower than the previous quarter, driven primarily by lower industrial revenue. Looking to Q4, we expect gross margin to be about the same as the third quarter. Our asset light production strategy allows us to maintain gross margins near our 58% target despite significant reductions in production.

Q3 operating expenses were 7% lower than expected with R&D expenses of $45.7 million or 24% of revenue, and SG&A expenses of $34.2 million or 18% of revenue. We expect fourth quarter operating expenses to be slightly lower as labor costs and outside spending decreased with year-end holiday work schedules.

We expect R&D expense to be approximately $44 million and SG&A expense of approximately $34 million, both including equity compensation. Amortization of intangibles was $6.5 million during the quarter and Q4 amortization is expected to be about $7 million.

Our Q3 operating margin was 11% on a GAAP basis. Our Q3 operating income was impacted by $8.4 million in one-time costs, associated with early retirement of our long-term debt. During the quarterly we executed a new five-year $325 million revolving credit agreement, which replaces our current long-term debt, and reduces our cost of debt. The current after-tax interest rate is approximately 2%.

Losses on our deferred compensation investments were $1.1 million in the third quarter and reduced SG&A expense by approximately the same amount.

Interest income was $700,000 for the third quarter and we expect Q4 interest income to be at a similar level. Interest expense was slightly less than prior quarter at $3.8 million due to lower interest rates on our new debt agreement.

We expect Q4 interest expense to be lower than Q3 at approximately $2 million as we realized a full quarter benefit of the refinancing. Our Q3 tax rate was approximately 4%, and our non-GAAP tax rate was about 13%, both lower than our expected range due to lower profit expectations for the year.

We expect our Q4 GAAP effective tax rate to be more normal rate of about 20%, and non-GAAP to be in the mid-teens. Equity compensation was $7.1 million for the third quarter and we expect it to be approximately $7.2 million for the fourth quarter. By classification, Q4 equity compensation is expected to be about $400,000 in cost of sales, $3.5 million in R&D, and about $3.3 million in SG&A. On a GAAP basis, we earned net income of $7.2 million or $0.06 per diluted share for the quarter.

Now, let me spend discuss our results on a non-GAAP basis. We present non-GAAP measures because we believe they add additional analysis that when considered with GAAP information, can help investors more thoroughly understand the results of our normal on-going operations.

Our non-GAAP EPS estimates exclude equity compensation, in addition to one-time items and intangible amortization. As always we continue to publish and maintain our primary focus on GAAP financial results.

Non-GAAP operating income was $32.7 million and our non-GAAP operating margin was 17.5%. Our Non-GAAP net income was $25.8 million or $0.20 per diluted share for the third quarter. Again, these amounts exclude equity compensation, one-time items and the amortization of intangibles and the related impact on income tax expense. A reconciliation between GAAP and non-GAAP measures can be found on Page 8 in today’s press release.

Now, to the balance sheet and cash flow. For the third quarter, we generated $24.8 million in free cash flow, or 13% of revenue. Our cash and short-term investments increased by approximately $4 million during the quarter, and we exited the quarter with approximately $421 million in cash and short-term investments and $278 million in debt. And we paid out approximately $15 million in dividends during the quarter.

Our days of sales outstanding were 38 days and did not change from the previous quarter. Our net inventory increased $3.6 million from the second quarter to $103.5 million as demand weakened during the quarter, and we ended the quarter with 115 days in inventory. Looking ahead to Q4 we expect inventory dollars to be flat to slightly down while days will increase on lower revenue expectations.

Our Q3 ending worldwide distributor inventory was approximately 72 days, which is about a week higher than normal levels, but positions us well for an upturn in demand that typically follows a downturn. Q3 depreciation was slightly up compared to the second quarter at $5.8 million and CapEx remained flat at $3.5 million, and we expect Q4 CapEx to be about $2 million to $3 million range.

Our weighted average diluted share count was 126 million shares in the third quarter and we expect fourth quarter weighted average diluted shares to be about the same. Now, back to Dave.

David Bell

Thanks Jonathan. I’ll now address our business in each of our four end markets beginning with industrial.

Revenue in the industrial market represented approximately 27% of third quarter revenue and decreased 21% sequentially. During the third quarter, demand for industrial products fell across the board. Unlike most prior downturns, the industrial business was impacted quickly, in concert with the PC and consumer markets. Customers around the world quickly took a very conservative stance and began to reduce inventory levels.

Last quarter I spoke about the automotive market being one of our top growth drivers. This quarter I would like to expand upon that updating on today’s business and what opportunities lay ahead for our automotive product line. The automotive market is rapidly changing and growing, presenting many new requirements and opportunities for automotive designers. ICs in cars 10 years ago were very simple function products, such as DC power switches. Today’s automotive ICs have much higher levels of performance and integration, and are focused on safety, connectivity and efficiency.

New functions include rear camera displays, collision avoidance systems, lithium ion battery protection, start stop systems, LED headlights and increasingly sophisticated infotainment systems. The majority of our present automotive revenue is being driven by the infotainment and rear camera displays from our Techwell product line. Revenue has increased 96% year-over-year and will only continue to rise as LCD proliferation continues and the kids’ safety act goes into effect.

According to Databeans, approximately 50% of cars will contain at least one LCD panel next year, and by 2014, the average is expected to rise to more than one panel per vehicle. All these automotive displays represent multiple part opportunities for Intersil. In prior quarters, we spoke about our engagement with European auto manufacturers on their hybrid and electric car programs. I am pleased to say that consumer demand for these cars is absolutely exploding right now, and we are now working closely with North American and Japanese auto manufacturers as well.

We are currently sampling our lithium ion cell balancing products to a growing list of automotive customers, with many citing we have the best performance and robustness in the harsh automotive environment. In our security surveillance product line, we are now beginning to see the benefits of entire portfolio of products to Techwell customers. Parts such as real-time clocks, the interface ICs, the MegaQ video equalizer and power management products are now being designed alongside Techwell’s products.

Our proprietary security link over coax technology allows connection of HD digital cameras over existing coaxial cable. As expected, these products are being very well received by customers and will begin shipping products in the fourth quarter. We continue to sample innovative new products, such as a 4-to-1 decoder for the 960H video standard and a nine-channel H.264 decoder for standalone DVR solutions. And a revolutionary fisheye processor is receiving a huge number of customer requests in a wide range of applications.

In parallel with these development activities, we continue to increase the breadth of our product portfolio aimed as the horizontal market, with several new switching regulators and amplifiers introduced during the last quarter. Looking ahead, we expect sales into the industrial market to be up moderately in the fourth quarter.

Now, let’s look at our computing market. Revenue in the computing market represented approximately 27% of third quarter revenue, and declined 10% from the prior quarter.

Although the computing end market as a whole was weaker than forecasted, we maintained our 70% market share in the Sandy Bridge notebook processor arena, and shipments into the notebook market actually increased 2% in the third quarter. The present disconnect between Intersil sales and overall notebook shipments is due to inventory consumption in the supply chain.

Design activity on the upcoming Ivy Bridge platforms has been strong. We expect to retain similar market share in Ivy Bridge notebook platforms and gain share in the desktop and server markets as well. Intersil consistently delivers the best performing power management solutions and dispositions allowed for early designings in all categories and continued dominance in notebooks.

There is presently a lot of development activity on the new ultrabook platforms. Ultrabooks require much smaller printed circuit boards because the PCB no longer extends beneath the keyboard. We are working closely with customers and processor suppliers to design new power solutions that provide the absolute smallest footprint. We expect the non-PC infrastructure market to become a much larger opportunity for Intersil. Products such as servers, routers, base stations and network attached storage are all targets for dense power MOSFETs and power modules, both items on our top 10 list.

Our growing family of digital power modules based on Zurko Labs technology continues to accumulate design wins, now that digital power has finally reached the tipping point. We expect new products aimed at the infrastructure space to drive significant growth in the next two years.

Looking at the fourth quarter, we expect computing sales to decline moderately, as worldwide notebook sales decline and inventory levels continue to stabilize.

Now, let’s look at our consumer market. Revenue in the consumer market represented approximately 23% of third quarter revenue, and declined 7% from the second quarter.

Tethered gaming console sales accelerated and peaked in the third quarter, representing the strongest area of consumer revenue growth. However, sales into the tethered gaming consoles are expected to decline sharply in the fourth quarter, as our primary customer reduces production on the 2011 chassis. We have a strong relationship with this customer and won the design on the 2012 chassis, ensuring continued revenue for this product line.

In addition, we expect the two hand-held gaming systems going into mass production in the fourth quarter will partially offset the normal seasonal declines in tethered gaming systems. The designs will increase content and revenue in both tethered and hand-held gaming products through 2012.

Ambient light and proximity sensors also performed very well during the third quarter, showing slight growth over the second quarter, and the highest revenue per date for the product line. Smart phone proliferation continues, and we’re seeing additional opportunities with manufacturers new to the smart phone market. These new customers represent excellent growth opportunities over the next year.

Notebooks and tablets are also a growth area for light and proximity sensors, and we are now one of two sensors on the window 8 reference design. Sensors are now being designed in a wide range of applications. For instance, the ISL29102 light sensor has been designed into a security keypod and will go into high-volume mass production in 2012.

Our sensors deliver the best performance, through superior infrared rejection, the lightest dynamic range, and the lowest power consumption. This quarter we released the ISL29033, which has the industry’s best low light sensitivity, and we are sampling the ISL29038, which provides the most reliable proximity detection in high ambient light conditions. These feature-rich ICs sustain Intersil’s leadership in this rapidly growing market segment.

The display market continues to be weak, with the one bright spot being sales of programmable gamma buffers into tablets. We expect the market to remain weak during the fourth quarter, partially offset by strong sales into the tablet market. Our D2 audio product line continues to impress both equipment designer and listeners. Boston Acoustics designed their sound bar using our DAE-2 solution, and their product was recently rated best performing sound bar overall, by Sound and Vision magazine.

Numerous design opportunities in the consumer audio and automotive markets are expected to drive strong growth in the coming years. In the handheld business, our combo USB switch and video driver is selling into an industry leading smart phone, and the recently introduced Next Generation smart phone is selling at record levels.

Looking ahead to the fourth market, we expect sales into the consumer market to be down significantly, as the holiday season builds taper off and inventory continues to stabilize.

And finally, moving to the communications market. Revenue in the communications market represented approximately 23% of third quarter revenue and decreased 1% from the second quarter. During the quarter we saw increased sales of radiation-hardened ICs for satellite applications. Unfortunately we have lost some business to foreign competitors due to the US government’s increasingly stringent ITAR restrictions. While this has had an impact in Intersil’s rad-hard sales, it is likely to have an even bigger impact on our US competitors sales as future restrictions are tightened.

The only beneficiaries to this policy appear to be foreign rad-hard IT suppliers. Regardless, we continue to invest in our very profitable rad-hard product portfolio. During the quarter we introduced a new rad-hard quad precision (inaudible), with specifications far superior to other amplifiers in the market. And we are sampling a rad-hard FPGA power solution set for delivery in early 2012. This is the only complete FPGA power solutions suitable for satellite applications.

Zurko Labs Digital Power Products continued to accumulate design wins with communications and networking infrastructure customers. Our new ZL9117M Digital Power module packs a complete 17 amp power supply into a small 15 mm square package. The simplicity, reliability, and digital control features of this module have resulted in several new customers during the last quarter, and we expect many more infrastructure customers in the coming quarters.

Looking ahead, we expect the communications market to be down significantly as the rad-hard business enters a seasonally soft quarter, and the broad communications market remains soft.

Now, let’s turn to our outlook for the fourth quarter. We expect the present downturn to extend until at least the end of the fourth quarter. However, given that shipments are presently below consumption levels, we also expect gradually increasing bookings during the fourth quarter. With the normal turns percentage built into our guidance, we expect our fourth-quarter revenue to be in the range of $162 million to $170 million, a reduction of 9% to 13% from the third quarter.

Given the anticipated revenue reduction in the fourth quarter, we will also be carefully controlling operating expenses with further slight reductions expected during the quarter.

Gross margin is expected to remain close to the 57% reported in the third quarter, due to reduced utilization levels.

On a GAAP basis, we expect fourth quarter earnings per share to be in the range of $0.04 to $0.07. Excluding one-time charges, amortization of intangibles and equity-based compensation, we expect non-GAAP earnings per share in the range of $0.14 to $0.17.

Intersil is past the midpoint of a multi-year transformation. Customers and investors are just beginning to see the stream of new, highly differentiated products and many more are in the development pipeline. Newly introduced products are being very well received, with design wins showing significant growth in several sales regions.

We are confident that Intersil will deliver exceptional growth, because of the sensible investments we are making. During last quarter’s conference call, I will give some perspective on why we are so confident in our business transformation by providing a list of Intersil’s top-10 growth drivers. Earlier today I also commented on how the power of 10 has infiltrated the daily decision-making process of our top management, and I mentioned several products from our top 10 list that have made significant progress this last quarter.

I like to share a chart that we created to illustrate the progress we have been making since the current management team began our business transformation in mid-2008. When I became CEO in 2008, it was apparent that a significant percentage of our revenue was dependent on just four product lines that were becoming commoditized or obsoleted, and that Intersil needed to diversify.

Those deteriorating product families are shown in the red band at the bottom of the chart. Since 2007 the four product lines of red laser diode drivers for DVD players, lithium ion battery chargers for cell phones, DSL line drivers, and military encryption ICs that decreased by over $140 million in annual revenue. During the last several years, we have replaced the revenues from these deteriorating product lines.

The sales represented by this band are now stable at a low level, and there is no longer any headwind for future growth. The next band up, the green band, represents PC power sales. As you can see this was a significant growth driver in 2007 and 2008, and represented 32% of Intersil’s sales by mid 2008. It has been a deliberate strategy to hold revenues reasonably stable in this very competitive market. This strategy results in the PC business becoming a gradually reduced percentage of our business over time.

The third band, the purple band represents our broad stable business comprised of over 40 different product families. Products from this category are sold at tens of thousands of customers around the world in all four of our end markets. The top blue band represents the products listed in our top 10 growth drivers list, except for PC power management, which is shown separately.

These are the products that will drive significant growth in the next several years pushing revenues beyond the $1 billion mark, and changing the mix of Intersil’s business towards more integrated higher value parts. While the business transformation may not be evident by looking at the top line alone, looking at these separate product categories hopefully provides insight into our ongoing transformation, and why we are so confident that Intersil is positioned for exceptional growth in the coming years.

With that I would now like to open the call to questions for either Jonathan or myself. Operator?

Question-and-Answer Session

Operator

(Operator instructions) Your first question is coming from the line of Ross Seymore with Deutsche Bank. You may proceed.

Ross Seymore - Deutsche Bank

Hi guys. Just talk a little bit about the bookings side of things, can you talk about the linearity of bookings, and specifically Dave your comment that you expect bookings actually to start rising through the fourth quarter. Give us little idea of why you expect that to be the case?

David Bell

Well, a lot of it is based on what we have seen so far. When we revised our guidance in early September, we made some comments that we were just beginning to see signs booking might be improving a little bit. And we have seen some gradual improvement in those bookings during September and so far in this quarter. So that was kind of a bottom in bookings, I would say in late August, and we have seen some gradual upward trend in the bookings.

That said Ross, I wouldn’t say the bookings are yet at the level that matches consumption yet easily, but the trend is encouraging there.

Ross Seymore - Deutsche Bank

I guess for my one follow-up, just talk a little bit about what your expectations are for the disti, you talked about inventory rising there. I think it was on a day’s basis you gave it. Are you expecting disti inventory to come down as part of your guidance going forward, and if so by how much?

David Bell

Well, you know, disti is kind of a couple of different buckets if you look at. For one, if you look at Europe and North America for instance, most of the disti business is industrial. And like I mentioned in my prepared remarks, we saw industrial get hit very early unlike most prior downturns. So we are carefully controlling the inventory that they have in the shelf, and of course the distis themselves want to control that.

So a lot of that inventory I would say actually came down a little bit during the third quarter, and we would expect it to remain fairly stable. Now if you look at Asia, we have a portion of our sales even in the PC market and some consumer customers that go through distribution. It is much more of fulfillment business there, and there we actually have seen our inventory go up slightly with those distributors, and again that is a deliberate action, and the reason why is that we have seen this moving many times before Ross.

We see we have a downturn, we see inventory get lean. Everybody in the supply chain leans the inventory down, and then as soon as there is a little bit of an uptick, we see a lot of very short-term orders, particularly from our PC customers. So we are being very deliberate and selective here in making sure that we have got sufficient inventory on our shelves, particularly in Asia to deal with that snap back that will be coming eventually.

Ross Seymore - Deutsche Bank

Great. Thank you.

David Bell

You are welcome.

Operator

Your next question is coming from the line of Craig Ellis with Caris & Company. You may proceed.

Craig Ellis - Caris & Company

Yes, thanks for taking the questions. Dave can you provide some more color around some of the things that you are doing on the operating expense reduction side, the 7% decline in the third quarter was pretty impressive. How much of the decline that we are getting over the multi-quarter period are going to be more temporary and how much of that is going to prove structural, and really improve the operating margin for (inaudible)?

David Bell

Well, it is a good question. There are some things that are temporary, and there are some things that are structural. One of the benefits we have in the fourth quarter every year is that we do have more vacation holidays. So that helps there a little bit. We had a normal holiday shutdown during the holiday period, and we had some other vacations surrounding the Thanksgiving holiday.

So that is one kind of structural benefit that we always see in Q4. Another thing that we have done during the downturn is that we have just been very, very cautious on hiring. There is always some degree of attrition, and we have been selective on the new hires be brought in either for replacements or new positions. So that is something we can control there.

And then just overall, if there is expenses that we can defer, and push out until business is stronger, we are doing those things as well. So it is a combination of things. Some things related to Q4, some things are structural, and some things are just being very, very cautious.

Craig Ellis - Caris & Company

Okay, that is helpful and then as a follow up, on the PC business can you just provide a little bit more color in terms of where your engagement stand with ultrabooks and you talked about share gain in both server, networking and other applications. What gives you confidence that the business can really grow in those areas next year?

David Bell

Well, two different pictures, first of all in the notebook and ultra-book area,

And I would lump ultrabooks into the notebook category of course, is that we have a really dominant position there. We have about 70% market share in the Sandy Bridge, and hoping that we will have close to that in the Ivy Bridge platform. So we’re engaged both with the OEMs and the ODMs in Asia on that.

So just because of our engagement there and knowing that we are on reference designs for Ivy Bridge, and already designed in in many Ivy Bridge platforms gives us that confidence. Now it is a little bit hard to be terribly precise about it because we can tell what programs were designed into, and which were not. But we have to make estimates about the volumes on each one of those programs. So it is a little bit uncertain until you actually start seeing the shipments.

So we also have some new products that are being designed specifically for ultrabooks. As I mentioned in ultrabooks there is a new challenge because with ultrabooks being very thin, you no longer have that big area underneath the keyboard for the printed circuit board. So you have really a very tiny printed circuit board area in an ultrabooks, and we have got some new products that are in the pipeline. We had engagement with our ODM and OEM customers on the definition of those.

And we think those are going to be perfect fits for the ultrabooks market. When you turn to servers, our market share in the servers is much, much smaller. So I would say a lot of the growth that we’re counting on the server space isn’t necessarily predicated just on overall server on units going up, it is predicated on gaining some market share where we have fairly small market share today. So two different stories.

Craig Ellis - Caris & Company

Okay, and when does your ultrabook product ship?

David Bell

I don’t know the exact answer to that. But I know that we have got products today that are suitable and designed into some early ultrabook platforms, but then there is the other products that I talked about that are not going to be shipping for a while, and I don’t know the exact date on those, nor would I really want to tell you even if I did.

Craig Ellis - Caris & Company

Got you. Thanks, Dave.

David Bell

You are welcome.

Operator

Your next question is coming from the line of Jim Schneider with Goldman Sachs. You may precede sir.

Gabriela Borges - Goldman Sachs

Thanks for taking my question. This is Gabriela Borges on behalf of Jim. You outlined some of the secular drivers of growth in automotive, and some of your peers have also described this area as an area of relative strength, can you quantify about how much exposure you have to automotive and is this the main driver of the anticipated growth in industrial in 4Q?

David Bell

Well, the automotive business is a relatively slower growing business. So I wouldn’t say that that is the main driver of growth in the fourth quarter. Overall, the industrial business frankly, whether you are talking about automotive business, whether you are talking about makers of instruments and various things like that, it is a slow-moving market.

We have been gradually growing our horizontal business, which is kind of another name for that broad industrial market, and we expect that to continue growing because of the portfolio additions we made over the years. We have dramatically expanded our portfolio, and the focus that our distribution and direct sales people have on that market. So I think the underlying base, the horizontal market is going to continue growing gradually as it has been for years.

Automotive is a little bit different because they are more targeted customers, and they are more specific products. Right now the largest piece of our automotive sales is in the display area, products from our Techwell product line that are going into LCD displays for applications like rear view cameras, and displays on the back of headrests and so forth. But some other areas that we are very excited about, which don’t really have any revenue today, but will begin in 2012 would-be things like our lithium ion cell balancing parts, which are designed for hybrid and full electric vehicles.

I’m very excited about that and that represents a very large revenue opportunity that we’re going to see the beginnings of in 2012, and more so in 2013. These other things in automotive, things that are going into the entertainment area, our D-2 audio product family has a lot of excitement there and some early design wins that we have got there. General-purpose power, LED headlights, many, many different applications that drive us to be very confident about the long-term growth in automotive.

Gabriela Borges - Goldman Sachs

That is helpful color. Thank you and as a follow up if I may, you provided some details around inventory levels at distributors, I was hoping you could also describe inventory levels at OEM customers, are you seeing any difference in order patterns between distis and OEMs? Thanks.

Jonathan Kennedy

Sure. Gabriela it is Jonathan. We almost have no visibility to inventory at the OEMs. We see it in the disti channels, and we partially see what is on our books, but that is it. So there is really no color for us to add there.

David Bell

You know, one thing I would add is that I think there probably was more inventory in total in the supply chain that we don’t see. We obviously know exactly how much inventory is on our own books; we know how much is at our distributors, but beyond that, the compounded inventory at our ODM manufacturers, their whip, their finished goods, their finished goods in their supply chain to their customers that is the piece that we really don’t have visibility on. But clearly I think there was more inventory in that part of the supply chain that we don’t see it and we anticipated at the beginning of the downturn.

Gabriela Borges - Goldman Sachs

Great. Thank you very much.

David Bell

You are welcome.

Operator

Your next question is coming from Joanne Feeney with Longbow Research.

Joanne Feeney – Longbow Research

Hi, good afternoon both. Could you talk a little bit about the communication side of the business? I’m hoping you can help us understand on your exposure by the different players in communication infrastructure in your different regions around the world?

David Bell

Well, Joanne, I don’t know if I can give you a whole lot of color by region. But there is certainly some segments to our communication, and I suppose I can talk about a little bit here. One of them that I started about talking about in my prepared remarks was our high reliability, the rad-hard products, and we continue to invest there. Satellites are going to continue to go up into space, and despite the ITAR headwinds that our own government is placing on this right now, we think that that is going to be a pretty good business going forward, and we are investing in that.

So it is not the business that moves really quickly, unlike the consumer PC business, but we think that is going to be good. Now if you start looking at other areas, the broader infrastructure equipment makers, and by that I am talking about everything from cell base stations to routers and switches and things of that nature. There is a lot of opportunity that we have not yet exploited there, and we’re just kind of scratching the surface there.

There are some opportunities in things like our DSL and VDSL line drivers, where we have some new developments and new parts that are coming to the market. In some cases we have got some new high-speed data converters that are gaining some traction in those areas as well. But broadly I would say one of the biggest growth opportunities is going to be in power. And when I talked about digital power reaching a tipping point, I am really talking about the way that the infrastructure customers are now all of sudden starting to embrace digital power because they like the ability to basically communicate with every regulator on every board on their system remotely, and being able to monitor its status, how much power, how much current it is delivering.

Even reprogram it if they want to. So that kind of maintainability and capability is really now catching on with these infrastructure customers, and that is what is driving a lot of our module sales and our general-purpose power sales as well.

Joanne Feeney – Longbow Research

Yes that is perfect segue Dave. I was curious about what was going on with Zorko, you have talked about a number of design wins and activity there, do you have any sense you can give us as to the timing of product ramp and revenues from that area.

David Bell

Well, we’re beginning to see some product revenues ramping right now, but I think we’re really going to see more of that takeoff in 2012 and even more so in 2013. We talked I think on the last call Joanne about a very large, a $15 million per year design win on our digital power modules, and that is an infrastructure customer. And now we’re starting to see more and more customers just like that that want to use our digital power modules, because of the simplicity, because of the density, because of the programmability and telemetry functions they bring.

That is again why I see it just reaching a tipping point with these guys. So I think you are going to see some really strong growth in Zorko, not all in 2012, but certainly in 2012 and 2013 you are going to see that ramp come.

Joanne Feeney – Longbow Research

Okay, great. Thanks so much.

David Bell

You are welcome.

Operator

Your next question is coming from the line of Venk Nathamuni [ph] with JP Morgan. You may proceed.

Venk Nathamuni - JP Morgan

Hi yes. Thanks for taking my question. So the first one again going back to the inventory comment, obviously your comments are mirroring what a distributor this morning stated with regards to stabilization. So David I was wondering if you could give some color on the stabilization in orders across the different end markets is it pretty broad based or is it more specific to one to two and markets because you are guiding industrial to be up. So any color you can provide on that would be helpful?

David Bell

Yes, it has been a very broad based downturn, and I would say that the modest recovery that we have seen in bookings so far has been fairly broad based as well. I wouldn’t single out any particular market as really coming back faster than the others at this point. So it is a little bit unique in that way because typically with these downturns, we see PC and consumer go down first and then a quarter or so later we start seeing the infrastructure and industrial good on.

This time it was pretty much in concert. They all went down together, and it looks like they are kind of all following the same pattern, no real obvious distinction.

Venk Nathamuni - JP Morgan

Okay thanks for that, and then a question for Jonathan, now with regards again to inventory given the elevated levels that any concerns about inventory write-downs this quarter that would be atypical?

Jonathan Kennedy

I wouldn’t say atypical, I mean obviously as revenue comes down you run the risk of excess inventory. We are fairly conservative of inventory. So I would say at the risk of higher than normal with revenue coming down, but not anything that is extraordinary.

Venk Nathamuni - JP Morgan

Okay, thanks a lot.

Jonathan Kennedy

We keep most of our inventory in a dye bank, which allows it to have a multi-year life. So the demand (inaudible) pretty far out before it becomes excess or obsolete.

Venk Nathamuni - JP Morgan

Okay, thanks.

Operator

Your next question is coming from the line of Terence Whalen with Citi. Your may proceed.

Terence Whalen - Citi

Hi, thank you for taking my question. Good afternoon. I found the slides particularly interesting and the slide pack that shows the revenue categories, deteriorating revenue in the PC power versus stable and versus new. I was hoping to get a very general prospective from your view, what are the pluses and minuses of having a deteriorating revenue sort of lying down, versus having say in the product portfolio either by selling a business unit or a portion of that product portfolio?

David Bell

Well, Terence, I think that if there were opportunities to sell some of these products, we knew were deteriorating, that would have been attractive. But there are a couple of problems, so that one is that most of these product families are fairly small discrete areas. And I think it will be difficult to sell. For instance, take red laser diode writers for DVD writers, the handwriting was on the wall that that was being absorbed by Japanese makers and becoming commoditized.

So trying to sell that one discrete product family when it was all so obvious that it was deteriorating I think would be a problem. The same is probably true in all of those areas, frankly, the lithium ion battery chargers, linear chargers, sold into some major Asian cell phone makers. That was being commoditized by makers of their discrete product and later that function became just integrated in the power management ICs.

Things like the military encryption ICs, I don’t think we would be allowed to sell that, even if we wanted to, but that was reaching end of life as it was being replaced with a different technology. Our DSO line drivers is maybe the one case where we could have considered that. We actually retained leadership in that area from a market share standpoint. It is just the ASPs in that area down to about a third of what they were previously.

So I would have loved to have been able to sell some of those things off if I could, but I think there are some pretty practical reasons why it wasn’t going to happen.

Terence Whalen - Citi

Okay, that is helpful, and then to follow up is regarding dividend, I mean the dividend out there of 4.7% is very appealing, I was wondering what kind would it take for you guys to increase the dividend given that you are covering it certainly nicely with your free cash flow and your are doing (inaudible) margins even as revenue comes down?

Jonathan Kennedy

Terence it is Jonathan. Having a 4.7% yield is really no reason to increase it. I doubt it would do much for the stock. Then there is practical considerations of domestic cash, so you have to use domestic cash to pay the dividend. The majority of our cash flow comes from offshore, and so to repatriate the cash, pay 35% on it, then the dividend back to shareholders who have to pay their taxes on is a pretty inefficient way to do it.

So we think at the yields that we see today, there is really – there is no pressure to increase it, and then practically it is just not very efficient use of cash.

Terence Whalen - Citi

Okay, great. Thank you, very helpful.

David Bell

You are welcome.

Operator

Your next question is from Tore Svanberg with Stifel Nicholaus.

Evan Wang - Stifel Nicholaus

Yes, hi, this is Evan Wang calling in for Tore. I like to visit your question of your visibility, could you talk a little bit about what your lead-times are likely now, as well as what your customer sentiments are that might give you some reason for optimism for 2012?

David Bell

Well, I think unfortunately I think we’re all on the same boat. We are looking at pretty dark crystal balls here. So I don’t think I am any more clear of volumes than you are, or our customers for that matter about what the road ahead looks like. Other than to say that recovery will come, but exactly how fast and when is a little bit hard to predict. As far as lead times are concerned, lead times are very low. I think we always have done a great job at making sure we have got the material that we need for our customers.

In fact, we just recently just during the last quarter or two received a number of supply of the year awards from major ODMs like Quanta, Compel, Winstron, and so forth because during the rapid ramp that was on 2010 we supported them well. So I think we have done a great job of anticipating that, keeping our lead times low. You might have heard a previous comment when we were talking about inventory that we even deliberately made sure a little bit of excess inventory in specific part types, where we are expecting a snap back to come.

So I think we are really well positioned there and it is probably just due to the way we manage our business. But again wrapping back as far as overall big picture, I expect recovery to come. Look at past downturns, we have had usually one or two down quarters sequentially followed by the beginning of an upturn. So kind of if you look at this one I would hope that they're going to start to see the beginnings of an upturn before too long.

Evan Wang - Stifel Nicholaus

Great, and if I may ask a follow-up question, on your fab utilization what is your ratio of internal versus outsourced wafer production and is that fairly stable, and do you expect that ratio to remain roughly the same going forward or are you going to fill your internal fab first.

David Bell

No, the ratio is on a wafer count basis we are probably close to 85% wafers being manufactured outside the company, and 15% internally, and our revenue scenario probably close to 80-20. The internal fab is run at a level that is relatively efficient. There is a lot more capacity in Mumbai [ph] to run more wafers but the technologies run in Mumbai just aren’t suited for a lot of our products. So we pretty much run specialty products in Mumbai only.

Evan Wang - Stifel Nicholaus

Thank you.

Operator

Your next question is from Harsh Kumar with Morgan Keegan.

Harsh Kumar - Morgan Keegan

Hi guys, thanks for taking my question. Dave wanted to understand the hard drop in industrial space. Could you tell us if it was just spread all over across the entire product portfolio with areas that were worse. Also if disti drawing down inventory was a big factor here bigger than what the market is doing, any color would be very helpful. Thanks.

David Bell

Yes, it was pretty broad-based harsh. I would say ironically perhaps the one area in industrial that seems to be faring relatively better is automotive, and we have heard that comment from a number of suppliers. So automotive is down but I would say it is not down by as much as the broad-based industrial, but beyond that I couldn't really give you any real differentiation that we are seeing there. It was rapid and pretty broad-based.

Harsh Kumar - Morgan Keegan

Got it, and then interestingly you are one of the few companies that are actually talking about increases in that sector in the fourth quarter. TI made some qualitative type comments. Wondering if it is the same area automotive that's driving it or is there anything else behind and also Jonathan if you could give us the tax rate going forward that would be helpful as well.

David Bell

I will probably help you with both of those questions. Our automotive what's unique about Intersil is our Techwell automotive products that are part of the backup camera legislation. So what we're seeing is more and more adoption of back up cameras in cars as that legislation kicks in. So pretty straightforward and simple, and then we also have the Techwell security business in industrial that's growing pretty well going into the fourth quarter.

So we're a little bit unique in automotive in that we aren’t really broad-based under the hood type stuff, and then on the tax rate like you said that our normal GAAP rate is above 20%. Our normal non-GAAP rate is about 15%. It came down quite a bit on a GAAP basis in the third quarter because we had a quick drop in revenue and profitability forecast which you know, which you do on your taxes, you basically are constantly truing up what you think your annual profit is going to be, and therefore your annual tax expense.

So we trued that up in the third quarter and having recognized you know, in retrospect more tax expense than the first two quarters, then the annual forecast shows which trued up with a much lower tax rate in Q3, and now going into Q4 we will be back on a normal schedule. We think we have a pretty good line of site to the end of the year and your Q4 tax rate is really your actual. There is no estimating going on there. It is pretty much our actual tax expense. So that's the difference, that's the drop in Q3 going into Q4.

Harsh Kumar - Morgan Keegan

Okay, thanks guys. Thank you.

Operator

Your next question is from Steve Smicky with Raymond James. Please proceed, sir.

Steve Smicky - Raymond James

Yes, I just want to follow up on a previous question. You indicated that typically it's one or two quarters' downturn, it doesn’t look like even second quarter here, even 2008 (inaudible) pretty strongly. It doesn't seem like the orders are necessarily supporting a market recovery but you know, to the extend you want to talk about more is it reasonable to think that as you get back in the quarter you might see those orders come in.

David Bell

Well, as I commented earlier Steve, we are seeing some gradual improvement in bookings and my expectation or at least hope is that we will see that trend continue through the fourth quarter here with some gradually improving bookings. Looking at it another way our turns expectation at the beginning of the quarter was a pretty normal one.

What you tend to see is when things are dropping you get very little turns or lower turns percentage in the quarter and when things are going back up, accelerating we tend to see higher turns in the quarter, and the number that we're using is kind of a midpoint number which I think is appropriate for us given that they were kind at the flat part of the bottom of the curve, or at least we hope so, but commenting beyond that exactly what we think Q1 is going to look like it's obviously really premature but you know, we are hoping obviously in early next year that we are going to see the recovery take hold.

Steve Smicky - Raymond James

Okay, and just a couple of broad questions on the ultrabook product, upon management given it seems like there is a lot more (inaudible) good performance, does that suggest higher gross margin to those products relative to the existing portfolios of major controllers.

David Bell

Well, it's yes or no. I would say that with the first ultrabooks that are coming along they’re being based on our existing notebook portfolio. They're just kind of using the same products that we're shipping into notebooks today, and just having to pack them as tightly as they can. I would say with those products since they're already out there and going into other notebooks, they won't really be any improvement in gross margin.

On the other hand I did refer to some new products that we're doing specifically for ultrabooks, which are going to offer better performance, better density, and those yes I would expect we would have a little bit higher gross margin, but let us face it, we are still talking about the PC market. So I think it's still going to be below corporate average, but probably better than it is right now with our PC products.

Steve Smicky - Raymond James

And just one more product question. You mentioned an FPGA for satellite applications and is it the only – that would be the only product in the market there. My understanding was (inaudible) had a number of FPGAs in the space of satellite market. What will be different about the product versus what they have?

David Bell

Well, to clarify what we're talking about is we're talking about our power solution. So it's a multiple set of management ICs with the related discrete components. We've got basically a reference design, and it supports a rad-hard FPGA made by one of the leading FPGA companies. So, you know, that FPGA supplier will sell their FPGA and we provide all the power management stuff that goes around it.

Steve Smicky - Raymond James

Okay, I see. Thank you very much.

David Bell

You're welcome.

Operator

Your next question is coming from the line of Uchechi Orjii.

Uchechi Orjii - UBS Securities

Sure, thanks very much. Can you hear me?

David Bell

Yes, we can.

Uchechi Orjii - UBS Securities

Sure, can I just follow up real quick on the ultrabook question? Obviously you talked about your market share there. I just wanted to understand how defensible that is. I mean this market tends to be very competitive and you know, every once in a while we get in the lines of (inaudible), who have been very competitive obviously in the last few years is other platforms. So within the ultrabook, are there anything that makes your position here a little bit more defensible and also what lessons can you leverage from that into other markets where your sale position hasn't been that strong say in mobile or tablets?

David Bell

Well, one thing I would say there is really good news is that ultrabooks are not going to be a cheap product. You know, unlike net books, which were small kind of thin and light notebooks those are kind of real bottom end products. And the price competition was really intense there. Ultrabooks are going to be pretty expensive premium products. So the makers of those products are willing to pay for performance and that's where we shine.

So if they’re looking for the most efficient, the best performing, the densest solutions I think we're going to fare really well, especially when it comes to the products that are in development that are aimed specifically at ultrabook market. Now, when it comes to tablets, tablets are kind of a different animal. One of the things about the notebook market is that the architectures if you peel back the skins on almost any notebook, it's almost identical, the architecture there.

Not the case in the tablet market. In the tablet market you have multiple processor vendors, and a lot of different feature sets there, different sizes, different battery stacks and so forth. So it's a lot more flexible and a lot more fragmented in the tablet market. I would say right now in the tablet market where we are really making some good gains is in the display area, same as like the programmable gamma buffers that are going into panels, going into tablets.

Also a lot of opportunities in LED backlighting, very efficient parts. We make the most efficient LED backlight parts whether it be for single cell or two cell lithium ion solution, things like ambient light sensors as well. That's a great opportunity and eventually I think we'll probably find some really nice business doing power management ICs, probably more integrated solutions though than they are today in the notebook space.

Uchechi Orjii - UBS Securities

That's a great answer. Thank you very much. Can I just ask you one quick follow-up, if I look at the consumer electronics business, especially on the PC side you've got good position with the customers that are gaining share, but sometime we've seen you know, Broadcom have now exited from that business, Intel strategy is a little bit unclear, which obviously speaks to the fact that the end market is strongly involved. Maybe that’s a shakeout happening. Can you just talk around what you’re seeing in that market, how your position is, and how you view it in the medium term; I mean is this going to be the case where we continue to see sluggish growth on. Do you see anything that will help revive growth in that market for you, thank you?

David Bell

Well, it's got to be two-part question I guess. First of I would comment that where we play in TVs is a different area than where say Broadcom would be playing.

Uchechi Orjii - UBS Securities

I bet that.

David Bell

Yes, we are primarily in the display panel itself. So the programmable gamma buffers, the power management ICs, ambient light sensors, things of that nature there and the back lights that are with the panel. We are excellently positioned there in fact, I think we're probably even gaining share when it comes to some of the new panels going into TVs. The problem is that the whole TV market is terrible right now. So you know, the reason we're not seeing great display in TV business right now is not because of market share, on the contrary it is simply because TVs aren't selling. Now as far as when they come back I know your guess is probably as good as mine. Consumers have to be willing to spend fairly large chunks of money on a discretionary item before TV sales really pick up.

Uchechi Orjii - UBS Securities

Thank you very much.

Operator

And your final question is common from the line of Chris Caso with Susquehanna. You may proceed.

Chris Caso – Susquehanna

Hi, thanks for fitting me in. Just wondering if you could give some more color on the rad-hard business and what we should expect on that going forward. It sounds like the decline there may be I guess somewhat longer term in nature that perhaps you can give us an idea of the size of that business.

David Bell

Well, we don't break it out Chris. It is a sizable business for us right now. It's certainly a very profitable business. So its significance to the company's profits outweighs its revenues, but what I will say is that we have been investing in rad-hard business. In fact part of the transformation of the company I would point to involves rad-hard. When I took over as CEO of the company, we were investing zero in new rad-hard products and simply kind of milking the portfolio.

During the last three or four years we've been investing fairly heavily in that. We’ve got a bunch of new products that have come out, that have been very well received by our rad-hard customers and there is more in the pipeline. So satellites are going to keep being launched into space. We’ve got more and more products that we're selling and getting designed into satellites. So I'm very bullish about that. My comments about the ITAR restrictions which we and other US companies face is a little bit of a headwind, but I wouldn't say that that's going to be a huge impact on us. We're still going to be growing our rad-hard business.

Chris Caso – Susquehanna

Okay, so the business still grows. It just – it's got a headwind in front of it?

David Bell

Yes, a little bit of a headwind and I suppose I am being a little bit political here perhaps, but it's an example where when we have our own ITAR restrictions here, it really doesn't prevent foreign entities from buying the product. They just simply buy it from other foreign companies that make similar stuff.

Chris Caso – Susquehanna

Right, right. Okay. And there is a follow up. One of the things you mentioned I think in some of your opening comments where you know, some potential credit issues in China. We hear that that's one of the things that we remember back in 2008, just you know, and I'm not sure that is what you meant to say, but perhaps you could just explain what you are seeing with that.

David Bell

Yes, what we're seeing is we're seeing a small and medium-sized companies basically just not having access to credit. So if they need to finance growth or even finance inventory purchases they are having a very hard time doing that. The big companies the names we all hear about you know, Huawei, ZTE, Foxconn and so forth that doesn't really impact those guys at all, but I think it is having an impact on smaller and medium-sized companies.

Chris Caso – Susquehanna

Okay, thank you.

David Bell

You're welcome.

Operator

And with no further questions in queue, I would like to turn the call back over to Mr. David Bell, CEO, for closing remarks.

David Bell

Well, thank you for joining us today for Intersil’s third-quarter earnings conference call. We're excited about the business transformation that we're executing and the customer acceptance of our innovative products. Despite the current downturn we're focused on building a great company and rewarding investors with earnings leverage when growth resumes in the near future. We look forward to updating many of you on our progress at the Credit Suisse technology conference on December 1 in Scottsdale, Arizona. And with that I will say thank you and have a good evening.

Operator

Ladies and gentlemen, thank you for your participation in today’s call. This does conclude the presentation. You may now disconnect. Have a good day.

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