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Cypress Semiconductor Corp. (NASDAQ:CY)

Q2 2007 Earnings Call

July 19, 2007, 11:30 AM ET

Executives

T. J. Rodgers - President and CEO

Brad W. Buss - EVP and CFO

Chris Seams - EVP of Sales and Marketing

Norm Taffe - EVP, Consumer and Computation Division

Dinesh Ramanathan - EVP, Data Communications Division

Shahin Sharifzadeh - EVP of Manufacturing and R&D

Ahmad Chatila - EVP, Memory and Imaging Division

Analysts

John Barton - Cowen & Co

Srini Pajjuri - Merrill Lynch

Glen Yeung - Citigroup Smith Barney

Alex Gauna - UBSWarburg

Chris Danely - JP Morgan

Tim Luke - Lehman Brothers

Tore Svanberg - Piper Jaffray

Adam Benjamin - Jefferies & Company

Craig Hettenbach - Wachovia Securities

Louis Gerhardy - Morgan Stanley & Co., Inc.

Sandy Harrison - Signal Hill

Douglas Freedman - Amtech Research

Presentation

Operator

Good morning and welcome to Cypress Semiconductor's Second Quarter Earnings Release Conference Call. Your lines have been placed on a listen-only mode until the question and answer segment of today's call. This call is being recorded. If you have any objections, you may disconnect at this time.

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

T. J. Rodgers - President and Chief Executive Officer

Good morning and we are here to report the second quarter of 2007. The main event is that the company for the first time since the fourth quarter of 2000 hit record revenue. This is due of course to the explosive growth of our subsidiary, SunPower. We'll do finances, followed by marketing, followed by some product and technology comments and then questions. Brad?

Brad W. Buss - Executive Vice President and Chief Financial Officer

Thanks T.J. Good morning. I would like to thank everyone for attending. I just want to remind you that we will be making many statements that you should consider to be forward-looking. They'll entail a lot of risks and please see our SEC filings for more detailed discussions.

Just a quick housekeeping, you have probably seen the press release, the format was a little different. We have some comments from the SEC mainly around non-GAAP reporting, and that's the result that you are now seeing.

I'll now take a quick look through Q2 and then I will give you the guidance for Q3. So consolidated GAAP revenue for Q2 was an all-time quarterly record, as T.J. mentioned, and exceeded our guidance. Revenue increased 9% sequentially, on a year-over-year basis, was a strong 41%. SunPower continues to grow strongly and accounted for 47% of revenue, which was a new record.

Semiconductor revenues totaled $199 million. They decreased slightly on a sequential basis due to the divestiture of the SVTC product line in Q1, which was $6 million in revenue that did not repeat in Q2.

PSoC revenue was better than expected and set a new quarterly record and we also had some final transition revenue from the 1T business in MID which was sold and will not repeat going forward.

On a GAAP basis, we posted a net profit of $363 million, resulting in record diluted earnings per share of $2.29 for Q2 versus last quarter's loss per share of a penny and the year ago second quarter $0.04 gain.

Q2 GAAP results were favorably impacted by a large realized gain from the sale of 7.5 million shares of our SunPower common stock. We still continue to own 44.5 million Class B shares of SunPower.

Net non-GAAP net income was $27 million and resulted in diluted earnings per share of $0.16. This was consistent with the prior quarter's 16% and is an increase from $0.13 in the year ago period. It's important to note that for Q2, the semi business increased the non-GAAP net income sequentially by 25% even with the lower gross margins and contributed $0.09 of the $0.16, as you will see in the table, in the non-GAAP diluted EPS.

Consolidated non-GAAP gross margin for the second quarter was 34.7%. It was down from 40.2% in the previous quarter, mainly due to a larger percentage of revenue from SunPower. Just to put that in context, as I mentioned, they were 47% of revenue in Q2 versus 42% in Q1 and we also had some revenue mix shifts in the semi business. Non-GAAP gross margin for our semi business was 44.9, down from 48.2 in the previous quarter, as we expected and near the low end of the guidance. So we obviously had some revenue mixes going on there between divestitures, 1T and the SVTC. We had the absorption of some fixed manufacturing costs and we also had a standards change that impacted that. Just as another reference point, the Q2 margins without any 1T business would have been almost 46%. Our direct margins to our customers continue to remain strong across all divisions including SRAM and our average corporate ASPs increased sequentially from Q1. So seventh consecutive quarter of ASP increases and it's about a 12% increase on a year-over-year basis.

Non-GAAP operating expenses in dollars, which includes R&D and SG&A, decreased by $8 million, partially due to the SVT divestiture and also increased cost management that we have in the company. Total OpEx is at 26% of sales and it's at its lowest level since the third quarter of 2000 and semiconductor R&D in absolute dollars is at the lowest level since 1999. However, we continue to focus heavily on design and software for our programmable solution products, which includes our next-gen PSoC touch screen easy color, or Ovation laser sensor, West Bridge, Cypress Systems and other products. And we expect these investments to continue to drive long-term revenue and gross margin expansion.

Turning over to the balance sheet. Consolidated cash equivalents and investments totaled $986 million, again, a level we haven't seen since early 2001. Semiconductor cash balances grew significantly and totaled $810 million as we received $437 million in proceeds from the sale of our SunPower common stock. Net inventory was up 23 million from the previous quarter. SunPower accounted for the entire increase, partially offset by a $4 million decrease in the semi business. As we stated in Q1, we plan to bring down semiconductor inventory in our Memory group, which we did by $15 million or 27% and to increase slightly our DCD and CCD inventories to support our West Bridge and PSoC growth, again, which we did. Inventory in the channel with our disti partners was essentially flat and we expect growth from them in Q3, and I expect our semiconductor inventory dollars to remain relatively flat to potentially slightly down since we do have a decent revenue ramp. AR was 200... accounts receivable was $208 million. It was up $22 million from the previous quarter, $10 million from SunPower, $12 million from the semi business. DSO was up slightly, and most of it in the semi business was really just due to the linearity of the shipments in the quarter as the ageing remains very good.

CapEx for the quarter was $56 million, of which 47 million was for SunPower and $9 million was for the semiconductor business. And again, this is our lowest quarterly semiconductor spend in many, many years and reflects the positive cash impact of our flexible-manufacturing and "No More Moore" strategies. Depreciation for the second quarter was $25 million, and $6 million of that was for SunPower.

So as you recall, we issued a $600 million 1% convert back in Q1 and we used 100% of the net proceeds of $571 million to implement an ASR. That ASR was completed in early June. We repurchased 28.9 million shares at an average cost of $19.78, which was a 29% discount to our closing price yesterday. And as well, remember we still have the $300 million authorized share buyback still outstanding because that was not used at all during this ASR.

Turning to our ownership of SunPower. Our basic ownership was approximately 59%, fully diluted was 55% and it obviously declined from Q1 due to the sale of our 7.5 million shares. Please ensure that you get your minority interest calculations right for your models. We currently control 92% of the voting rights due to our Class B shares and, as I mentioned, our 44.5 million shares are still outstanding.

I am now going to turn to some guidance. We expect our consolidated revenue to be in the range of $403 million to $417 million, a sequential increase of 8% to 12% and significantly above the range of guidance that the Street is expecting. SunPower will grow strongly as T.J. mentioned and we expect revenue from the semi business to be slightly up sequentially even with divesture of our 1T business, which totaled approximately $8 million in Q2 that will not repeat in Q3. If you normalize for the 1T divestiture, our Q3 revenue would be about a 4% to 6% sequential growth and we expect revenue growth in all divisions. Another record quarter for PSoC and increased production ramps for West Bridge.

SunPower gross margins are expected to be in the range of 20% to 22%. I expect a strong rebound in the semiconductor gross margins due to the product mix and higher factory loadism [ph] that should be in the range of 47% to 48% and our overall ASPs in customer direct margins are expected to remain strong across all divisions. And we are very focused still on our 50% margin target and expect to get there over the next few quarters.

I don't see much change in the tax rate, so about 8% for semi, 12.5% for SunPower. Remember, we got the convert expenses for the semiconductor side, $1.2 million for interest, $1.5 million for the bond amortization. The share count should be around a basic level, around 155 to potentially 165 on a fully diluted. And again, that's going to vary with the stock option exercise and the price of our common stock. I don't expect any dilution from the convert at all. So those numbers will change and obviously will change depending on as we buy back stock, how much and when.

On an ownership basis of SunPower, it will most likely decrease due to the pending offering that you probably saw this morning, but we will continue to own our 44.5 million shares. And EPS on a fully diluted non-GAAP basis I am expecting to be in the range of $0.19 to $0.21, again, significantly higher than where First Call is at right now.

Capital expenditures, I am going to be lowering those again, like I did the prior quarter. I expect capital to be around the range of $55 million to $60 million, and SunPower will provide their own guidance in the call.

As usual, all the above guidance is subject to change due to many things, including the customer order patterns, mix, manufacturing absorption, the recent SunPower offering etcetera, etcetera.

In summary, I think we had a good quarter. We've made very good progress in a lot of our strategic fronts, and I think we are setting up for some good things going forward. And just another quick housekeeping, I think you've all seen the SunPower announcement on the pending offering. The only two comments we can make are that we are not selling any shares in this offering and that, as usual, we'll be entering into a customary 90 day lock up agreement. Other than that, we can't take any comments and we won't be able to answer any questions.

So thanks a lot. I want to thank the company for a great quarter and I will turn it over to Chris for a discussion of our end markets and sales trends.

Chris Seams - Executive Vice President of Sales and Marketing

Good morning. The usual indices I give out, revenue splits by geography, no change in the order. Asia grew to 49% of our sales, North America slight declined to 26% and Europe is at 15% and Japan stayed around 10% of our sales. We have no end customer that's greater than 10% of our sales. Units were up slightly at 156 million for the quarter. And as Brad said, we enjoyed a continued stable pricing environment as the corporate ASP rose to $1.34 in the quarter.

Our semiconductor book-to-bill was 1.0 unity entering the quarter. We were 86% booked entering the third quarter, which is a relatively still a high number and a trend we've enjoyed for a while. Our semiconductor backlog grew to $244 million, up slightly from the previous quarter and, as Brad said, PSoC set a record revenue quarter and the momentum continued with customer growth growing 11% in design [ph] and setting another record were up 40% year-on-year.

In terms of end market picture, in terms of handsets, well, there has been some jockeying for the positions in the top 5 in the market. We are deployed to get in most of those and we enjoy a penetration role there in the mid and high-end handsets and we see a relatively strong market. Basestations has been a market that's been an issue of us in the past in terms of an over inventory situation. We are seeing some signs of recovery, but not across the board in that end market. The networking market remains healthy and in consumer, we are seeing in a third quarter the usual strong second half seasonal cyclicality.

A market that we have been out for a while since we divested of PC Clock in the PC market, we are repenetrating that market with PSoC and we are seeing growth in that market segment as well.

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

T. J. Rodgers - President and Chief Executive Officer

First, a couple of comments of clarification, on finance, Brad misspoke on the 90 day lockup; it's a 60 day lockup. I would like also to talk a little bit more on the gross margin. Last quarter we reported... quarter before last, Q1 we reported 48% gross margin, this quarter at 45. We are forecasting it to bounce back to 47, 48 this quarter. The reasons for the bumpdown for the second quarter, the two big ones, were standards write down. When you manufacture, it becomes more efficient. Your internal costs go down, you are required to write down the inventory that you've got to the value that you could manufacture for it at that time... you could match manufacturing for at that time. That was a roughly 3 percentage point drop in gross margins right there. And we had last time buy on $8 million worth of dynamic RAMs to get them out. We only had about 20% gross margin on that sale, and that blended into our overall gross margin. Those are both one-time events in the quarter.

On bookings, I would like to just add a little more color. Book-to-bill for the quarter was 1.07, the static RAM, a business unit, had a book-to-bill of 0.95. The rest of our divisions had a book-to-bill of 1.04 to 1.15. SunPower was the highest with a book-to-bill of 1.15.

Our backlog stands at $445 million. So that supports the estimate that Brad just gave you of revenue for $403 million to $417 million for the next quarter. Our average selling prices have gone up over the last six quarters, every quarter upward. There is one quarter that was flat and was $1.13, but our average selling prices have gone up from $1 to $1.26 in six consecutive quarters. And the last quarter, the ASPs were up in every division.

Some comments on the breakdown of the finances between the divisions. Semiconductor revenue was $199 million or 53.4%, SunPower was $173.8 million or 46.6%.That makes for consolidated revenue of $372.8 million. Our second largest division after SunPower was CCD. That's the division that handles our programmable products, Consumer and Computation Division, $85.5 million, up 11.3% quarter-on-quarter. The Memory division, MID, was $83.4 million, roughly flat down 1.5 point quarter-on-quarter in revenue. Datacom was $27.4 million, so it is our smallest division by margin, but its gross margins was 55.2%. So that's a $100 million business at 65%, and we are obviously trying to do everything we can do to grow that division.

Some comments on technology and products. One of our biggest hits with PSoC is the CapSense technology. This is when a PSoC is used to dispense a finger touching a capacitor, for example, a piece of copper on a printed circuit board buried in a panel. It changes the frequency of an oscillator and then the computer inside a PSoC can detect that and make changes based on it. CapSense, for example, is the kind of solution that is designed into our design win into the scroll wheel of the Apple iPod, which is the round CapSense array. This quarter we brought out CapSense for flexible screens, mobile handsets, smartphones, portable media players etcetera. It's not a huge change from printed circuit boards, but they are different, they have different resistance and we've in effect reprogrammed our product with software to move into that new market.

A totally different market for PSoC this quarter was an introduction of a product we call EZ-Color. This is where we put software into our PSoC and "teach" PSoC how to drive high-brightness LEDs. It gives superior solutions for driving LEDs for efficiency and color control. Efficiency is extremely important because that's the reason for LEDs. There are states in the United States and even countries like Australia that have outlawed these incandescent lights and high-brightness LEDs and compact fluorescent lights are taking over because they produce more light per unit of electricity consumed. One of the downsides of LEDs in that market is that LEDs are in their infancy and their color varies and their brightness for a given input also varies. And that has to be taken care of in a real-time manner. For example, if you order a green LED, you might get two or three different shades of green and you might get two or three different brightnesses. And that would be literally 10 different bins you would order from the vendor.

With PSoC, because it's programmable and it can remember things and it's not just a dumb analog chip, it's an LED driver, with PSoC, you can program the bins into the chip and therefore the premium that the light customers are forced to pay to buy exactly bin 2 that's what's designed in and that's what I am driving. And I don't want it to look yellow green; I want it to look green. Our customers can order whatever bin is available, not pay the premium for a specific bin and simply tell PSoC what that particular bin is and their product goes out.

We believe in EZ-Color and using PSoC to control LEDs will be another big hit for us along the lines of CapSense. We got CapSense, the old fashioned one, designed into a Hewlett-Packard Compaq notebook personal computer. That was a big win for us.

We released version 4.4 of PSoC Designer, which we are call an IDP or integrated development environment. It sounds like dry engineering stuff. It was done because of Windows Vista coming out. We wanted to move our software across and improve our software.

But I will just point out that this is platform software along the lines of the software platforms that come from Xilinx and Altera, and this particular product has 70 nan [ph] years in it. So it is a big effort on our part. It offers a lot of usefulness to our customers and makes our product picky. You can't just get a lower price from somebody else on a flex for flex [ph] product in switch. And we published a book called the beginners guide to PSoC Express, and it is literally the sixth book written on PSoC, a couple of them in China. We are doing a lot of work trying to train people and even train students from universities so we can build a PSoC franchise.

Harman Kardon introduced a Media Manager, a thing that controls an iPod plug in, satellite radio etcetera to basically our home entertainment system and they are doing it with PRoC, Programmable Radio-on-a-Chip which is the PSoC with a radio in it for the remote control, which for a system like that is to be a fairly sophisticated and complicated device.

Electronic Engineering & Product World magazine, a leading Chinese electronics magazine recognized PRoC with an Editor's Technology Innovation Award.

Finally, we introduced what we call the optical navigation system, ONS, code named Ovation, a laser mouse chip. This chip uses an infrared laser, a solid state pixel infrared laser which is about the size of a grain of salt, not even quite that big, shines it down on to the surface, receives it invisibly. The laser's frequency is not visible to the human eye and detects motion. So this is the next step in laser-based mice, and we've got a product and a roadmap for it that you'll be hearing more about as time goes on.

Moving on to data communications, West bridge, is the chip we introduced along... named after the North and South Bridge, which are the chips in personnel computers that connect memories and I/Os into the personnel computer. So we staked out the term West Bridge. It is a chip that connects memories and I/Os into cell phones, which obviously is obviously is becoming a bigger deal.

One of the things West Bridge does, if not all, it connects the card and USB etcetera. One of the things that West Bridge does is allow a cell phone to download music faster, faster than any other solution. For example, today if you download a full CD of music on to a cell phone, it takes about 10 minutes. And when West Bridge is shipping, that time will be reduced with our USB technology to about a minute. West Bridge is shipping this quarter and we expect it to ramp up to be a big deal product for us over the next year.

In the Memory and Imaging division, EE Times in China named our non-volatile SRAM, which we introduced this year as "Memory Product of the Year". I described in some detail in the last meeting in non-volatile SRAM, it is in effect a shadow RAM where every bit is an SRAM and every bit is also a non-volatile RAM. So when you run the product, it's fast and it uses an SRAM. But when the power goes off, each bit dumps the data that it's holding into the companion bit that is non-volatile.

The unique thing about this product is that you don't need power to do that data conversion. You put a capacitor on one of the pins of the chip and the capacitor stores enough energy, especially when the power crashes, the chip switches over to the capacitor to take power from and does the memory transfer from SRAM to nonvolatile RAM from the power of the capacitor. Hence, this chip is a high performance SRAM that can store data in any system. I like to call it a black box. The most important thing is it will be embedded in the system, it would be monitoring critical data and at the time the system crashed for some, whatever reason, it will dump the critical data into the SRAM. You all know about black boxes in airplanes. The fact is black boxes in a few years will be in cars. So when there is an insurance claim for example in a car wreck, we will be able to dig the black box out of the car and say whether or not the breaks had been put on, how many milliseconds prior to the crash, whether or not the car had been accelerating or decelerating and whether the steering wheel was being turned left to right at the time. So this kind of black box technology can tell you what happened in a system of any kind and computer or router, any system just prior to a crash. I think it's going to be a big deal, and I will try to talk more about it overtime.

Finally, Elite Semiconductor company, a Taiwanese-based company, acquired our pseudo-static RAM line, and while I use that acquisition of our inventory and our product line to talk about a one-time gross margin hit earlier, the fact is on the good side we got rid of all of our DRAM inventory with the 20% margin on top of it.

Turning to SunPower, National Laboratories... Sandia National Laboratories certified SunPower's newest panel, it's a 315-watt panel to have a 321.65 watt output. So that's like a stamp of approval. It also was made with our most high efficiency cell to get that power into most highest recorded efficiency as a true, commercially available mass produced panel ever. SunPower has introduced the Tracker system. If you go on our website and get our report and put a picture of the Tracker system in it that you can click on and understand it. But for the sake of a verbal discussion, think of sort of a plywood looking kind of structure with ten panels glued together and a little bit of an odd shape. They are mounted on a set of pipes which allow them to rotate and track the sun and then those pipes are mounted into concrete seats that are about 3 feet in diameter and about 2 feet high. When you set one of these things down, it locks on to the sun and it attracts the sun.

The advantage is that even though SunPower has the highest efficiency cells available that are economically feasible, you can get 30% more power from those array panels as they track the sun. The problem is trackers are expensive. This is the lowest cost tracker available. It is the third power tracker from PowerLight. It is the tracker being used in Nellis Air Force Base. Last quarter I told you that we had gotten a 15 megawatt contract at Nellis Air Force Base. That is a 140 acre 15 million watt 7000 trackers equivalent, 70,000 solar panels. And it goes on an Air Force Base that's near Nevada... Las Vegas rather. That will produce 25% of the power of that base. The tracker is worth looking at. I have also put a picture in the report, a satellite picture of the installation at Nellis is quite big enough when seen from a satellite.

SunPower has gotten into Wal-Mart for the first 4 megawatts. SunPower has gotten into Macy's for the first 8 megawatts in 26 stores and SunPower's, Chief Executive, Tom Werner has won the Entrepreneur of the Year Award for Engineering and Manufacturing, Ernst & Young. I won that award in 1991.

One last thing, other developments again on SunPower. We have redesigned our website. That matters to investors because what we have done is we've started making our website more customer friendly. For the consumer like market, we going in with PSoC. Newark Electronics, a subsidiary of the distributor Premier Farnell, signed a franchise agreement with us to sell PSoC USB and timing products. That is the products with CCD and this is a catalogue store and this is our effort to increase our customer count.

Brad already mentioned that we sold 7.5 million shares at $58 each to each to bring in $437 million at SunPower in the quarter. We still remain... we still own 59% basic ownership and 92% voting rights on SunPower. We also did a $600 million convertible bond in the quarter, the purpose which was 100% to retire 28.9 million shares of Cypress common. We got it out of the market at a price of $19.78, which right now looks like a very good deal.

So with that, let's turn over to questions.

Question And Answer

Operator

Thank you. [Operator Instructions]. John Barton, you may ask your question and please state your company name.

John Barton - Cowen & Co

Hey, it's Cowen & Company. Thank you very much. T.J., on the topic of PSoC, obviously the CCD product line jumped back very significantly in gross margins back at 47.4. Could you talk about how you are thinking about the profitability of that diverse product line as you go forward? Looking at the press release, obviously, it's a multitude of design wins as you get smaller number of customers... or excuse me, a larger number of small usage customers. Where can that gross margin trend and with all the other IP that your adding to it please?

Norm Taffe - Executive Vice President, Consumer and Computation Division

Hi. Hey John, this is Norm Taffe, the EVP for the CCD division at Cypress. Thanks for pointing out the PSoC growth in the gross margin. It is growing because we are diversifying our customer base. And as we grow that customer base and lower our costs at the same time, our blended ASP is going up and our margins are increasing. I think in the near term, we expect that margin to exceed... for the division to exceed 50% and I think on the PSoC business, I think the long-term expectation is to be north of 60% gross margin.

John Barton - Cowen & Co

Great. And then T. J. had elaborated on the easy color, and we are hearing a lot in the channel with respect to excitement about that product. Norm, any take on how quickly they could ramp, what the overall TAM could be could be, etcetera?

Norm Taffe - Executive Vice President, Consumer and Computation Division

So just to give you kind of some rough numbers on the size of that market, the market is very large on the LED side certainly. It's already about a $3 billion or $4 billion market. Now the controller side of that is much smaller at this point. It's really an emerging market. We estimate that the SAM of the controller of LEDs to be around $100 million, a little more that, like growing very, very quickly as people adopt it into more complex areas. Just like with CapSense, we expect that we can be a major player in that segment and do expect it to grow. I don't think, because it's not a consumer space, will grow as fast as we did with CapSense, but it is another example that's getting into a much broader customer base, not as concentrated and I expect it to have both very good gross margins and very good long-term growth.

John Barton - Cowen & Co

Alright. And, T.J. or whoever, you made a comment about some gyrations going on with respect to market shares shifts in the handset domain. You talked about Antioch growing in the back half of the year. Could you update us on your thoughts on what the revenue contribution could be in light of all the variables that are going on for the back half of the year please?

Dinesh Ramanathan - Executive Vice President, Data Communications Division

Hi John, this is Dinesh Ramanathan. I manage the Data Communication Division. On the West Bridge or the Antioch front specifically, we are looking at doing about $3 million this year. And anywhere between $7 million to $10 million actually this quarter, and we are expecting to see between $5 million and $7 million next quarter. So I am expecting to end the year or exit the year at about between $30 million and $40 million run rate.

John Barton - Cowen & Co

Great, thanks. And then last question, if I could, T.J., any thoughts on further divestures or anything we should be keeping our eyes on there?

T. J. Rodgers - President and Chief Executive Officer

Love to talk about it, but we've got this offering going and I've got the lawyers writing specific memos to me not to be my usual data pill self today. So I can't talk about that.

John Barton - Cowen & Co

We'll catch you next time. Thank you.

Operator

Thank you. Srini Pajjuri, you may ask your question and please state your company name.

Srini Pajjuri - Merrill Lynch

Thank you, Merrill Lynch. Hey Brad, a couple of housekeeping items first. The factory utilization, you said that's going to increase next quarter. Could you give us what it was this quarter and what you expect next quarter?

T. J. Rodgers - President and Chief Executive Officer

I'll have Shahin give you that.

Shahin Sharifzadeh - Executive Vice President of Manufacturing and R&D

This is Shahin Sharifzadeh, I run the... the fabs... fab utilization last quarter was in the low 80s. We expect it to increase to operate close to 90% and in terms of capacity, our flex staff [ph] strategy has been working very well. We have lots of capacity and our flex partners in Grace. So I don't think fab capacity should be a big issue for us second half.

T. J. Rodgers - President and Chief Executive Officer

With regard to our fabs, there is an uneven picture. Fab 4 is running full enough, about 85% that its costs are where they ought to be. Fab 2 on the other hand is running at about 67... in the mid 60s percent and it's the 6 inch fab. So loading of that is a problem. We have got a bunch of capacity online in China. We have begun to... spent a lot of money in getting up foundry partners and they are making wafers for us right now, but in the idle mode. So there is a lot we can do going forward as we ramp up our particular PSoC volume start in Antioch as well, the West Bridge and start filling that capacity.

Srini Pajjuri - Merrill Lynch

Okay. I guess you mentioned that your inventory is going to come down a bit and then you're guiding for flattish revenues. So my question is why is the fab loadings going up? Is it just a product mix issue here?

T. J. Rodgers - President and Chief Executive Officer

Regarding flat revenue?

Brad W. Buss - Executive Vice President and Chief Financial Officer

No, I mean the revenue is up absent the divestiture of the 1T, but flat on a revenue basis sequentially.

T. J. Rodgers - President and Chief Executive Officer

So the revenues flat, but divestitures counts. And when you have $6 million worth of revenue from 1T RAM that comes from foundries, then you place it, the revenue from your own fabs, then that does increase utilization.

Srini Pajjuri - Merrill Lynch

Okay, got it. And then T.J., when you talk about the corporate ASP, are you including SunPower in this or is it just for the semi business?

T. J. Rodgers - President and Chief Executive Officer

The ASP figures are always semiconductors only. As far as ASPs, let --

Srini Pajjuri - Merrill Lynch

Okay.

T. J. Rodgers - President and Chief Executive Officer

They are about $700 each. So, no, that's --

Srini Pajjuri - Merrill Lynch

Okay. That's what I guessed. Well, my final question is on SRAM business. I am just looking for the outlook for the second half in terms of units as well as ASPs. Thank you.

Ahmad Chatila - Executive Vice President, Memory and Imaging Division

Hi Srini, this is Ahmad. I run the Memory and Imaging Division. I expect SRAM to grow quarter-on-quarter and it will replace a lot of the 1T reduction. I expect my overall division to be flattish.

T. J. Rodgers - President and Chief Executive Officer

We are expecting that the SRAM division is going to see a good second half and a good 2008.

Srini Pajjuri - Merrill Lynch

Thank you.

T. J. Rodgers - President and Chief Executive Officer

Driving force behind that is the excess inventory that had been built up in the high performance synchronous RAMs is, are a few customers that are starting to go back to normal ordering patterns this quarter. And secondly, and similar to SRAMs, the large amount of Samsung inventory out in the marketplace is also going to dry up over the next six months to a year.

Brad W. Buss - Executive Vice President and Chief Financial Officer

Just another comment Srini. The MID gross margins, we expect them to bounce back up with the loading and inventory standards change. He took the biggest hit and he'll be back up in the low 40s.

Srini Pajjuri - Merrill Lynch

Okay. And Brad, maybe one final one. The standards change issue, is it going to impact you again next quarter? Is it going to be positive or negative?

Brad W. Buss - Executive Vice President and Chief Financial Officer

I don't expect any more negative impacts, slight positive, but noting material.

Srini Pajjuri - Merrill Lynch

Okay, got it. Thank you.

Operator

Thank you. Glen Yeung, you may ask your question and please state your company name.

Glen Yeung - Citigroup Smith Barney

Citi. Hey Brad, I just heard you give us some details on why MID gross margins will be up in the third quarter. Can you just give us the same thoughts on why DCD is going up?

T. J. Rodgers - President and Chief Executive Officer

You want to take that, Dinesh?

Dinesh Ramanathan - Executive Vice President, Data Communications Division

Hi, this is Dinesh again. Our gross margins... well, actually two reasons: one is we are seeing some of the revenue coming on the comm business, which is typically our higher gross margin business come up, and we are also seeing the West Bridge business kick in with good gross margins.

Glen Yeung - Citigroup Smith Barney

That was sort of my follow-up question. So does West Bridge come at higher than DCD average gross margins?

Dinesh Ramanathan - Executive Vice President, Data Communications Division

Yes, just a little bit though.

Glen Yeung - Citigroup Smith Barney

Okay. And then when you are talking about the comm. business, are you specifically talking about that? You said you saw some uneven, but yet recovery in wireless infrastructure business.

Dinesh Ramanathan - Executive Vice President, Data Communications Division

Yes.

Glen Yeung - Citigroup Smith Barney

Okay, all right, good. And that kind of leads to a question actually that I wanted to ask you T.J. When you hear that wireless infrastructure may be coming back, your networking looks pretty solid, we heard some good reports overnight. Big picture wise, what's your sense here in where we are in terms of enterprise spending, if you've got an opinion there?

T. J. Rodgers - President and Chief Executive Officer

Enterprise spending, i.e., our customers enterprise.

Glen Yeung - Citigroup Smith Barney

Yes, yes, your customers.

T. J. Rodgers - President and Chief Executive Officer

I'd be speculating. I'd like to give you an answer and sound like I know what I am taking about, but it ain't fair.

Glen Yeung - Citigroup Smith Barney

Okay, that's fine. Let me ask one other question then either of you or of Brad. Because you're talking about a scenario where you've got good backlog, you've got a good order trend, your fab loadings are going up towards 90%. Yes, you have got Grace coming increasingly on line for you. But is there any potential as we move into the back half of the year that we actually start getting tight, that we see lead times stretch out, that things get a bit tougher for you to deliver?

T. J. Rodgers - President and Chief Executive Officer

We might have problems with delivery. I have already told you our fab story, and our fab story is such that we have large fabs in China, high volume low cost fabs on line with good yields and quality right now. So if we have troubles, they'll be spot troubles and they will be due to back-end constraints. Our ASP is $1.26. So if you want to grow $20 million, it's approximately 20 million units. So from time to time, there could be some constraints as we ramp up our back end or try to turn on a new subcontractor. I don't see a structural, long-term ghost recorders kind of shortage capability. In our new business, PSoC and programmable products, they are proprietary and we simply have to deliver everything our customers ask for without excuses. We are deployed for that.

Glen Yeung - Citigroup Smith Barney

So just to be clear, to the extent that you will have a sport shortage, I mean ostensibly, you are sort of finding the products where you are most... it's most manageable, i.e., these are the kind of things where, if you were to miss some spot revenue here and there, you would make up it for the next quarter. Is that something where you feel like you would lose business?

T. J. Rodgers - President and Chief Executive Officer

That's correct. And if we have to make a call on wafer capacity, for example, we will always make the call to our proprietary product.

Glen Yeung - Citigroup Smith Barney

Perfect. That's helpful. Thank you

Brad W. Buss - Executive Vice President and Chief Financial Officer

And that's the other reason. I think, as I mentioned in Q1, we took our CCD and our DCD where we are seeing the growth, we have taken those inventories and we are holding more than we traditionally have to fit the customer demand as well as take care of any potential upside.

Glen Yeung - Citigroup Smith Barney

Actually, now that you mentioned that Brad, has there been a change in how you hold this between holding it in die form versus wafer form?

Brad W. Buss - Executive Vice President and Chief Financial Officer

I mean, not really. I think the company has done a fantastic job of holding most of the stuff in die bank. We have got the auto lines where we can sell some die bank and pump it out quite quickly. I mean our finished goods, for example, is less than 20% of our inventory, which is extremely low and has been very consistent.

Glen Yeung - Citigroup Smith Barney

Good. Thanks.

Operator

Thank you. Alex Gauna, you may ask your question and please state your company name.

Alex Gauna - UBSWarburg

UBS. Thanks very much. Norm, you gave some color on gross margins for the PSoC division. I was wondering with seasonality and some of the broadening design wins, is it fair to expect CCD sales here to even accelerate from what was already fairly powerful growth into second quarter?

Norm Taffe - Executive Vice President, Consumer and Computation Division

Yes, I think that is fair.

Alex Gauna - UBSWarburg

And if we think about momentum exiting the year, how does the fourth quarter from a seasonality standpoint shape up? Is it a deceleration or is there an opportunity to hold sort of accelerated rates?

Norm Taffe - Executive Vice President, Consumer and Computation Division

I think Q3 and Q4 both will show good accelerated rates.

Alex Gauna - UBSWarburg

Okay. And with the new iPhone that's out, and you've had some historic strength in the iPod platform, there's a change now with the touch screen. How should we think about your exposure there to the click wheels and going forward what your opportunities might lie like in that segment?

Chris Seams - Executive Vice President of Sales and Marketing

Glen... Alex, this is Chris Seams. We've said before on certain counts, we can't comment. So we are not going to comment specifically. But as far as touch screens go, you will see us be a force in the touch screen market just the way we are a leader in the CapSense market. As I told you today, we already have over a dozen design wins on touch screen opportunities around the world. So we are coming.

Alex Gauna - UBSWarburg

Okay, very good. With regard to what's going on in Memory right now, and you talked, T.J., I believe you touched very quickly on the excess Samsung inventory out there. Do you think the market in the first half was impacted by capacity shift when DRAM and NAND got in trouble, meaning, some capacity shift to seek some better profitability in SRAM? And is that an overhang or a risk going forward to the SRAM segment?

Ahmad Chatila - Executive Vice President, Memory and Imaging Division

Hi Alex. This is Ahmad. I cannot put my hand on it. The main thing that we can really see is that the basestation folks ordered more than they needed in 2006 and they corrected their situation in early '07. I think that's what you can count on. In the long run, I do not see a real problem with DRAM and SRAM in terms of like people coming back and forth because the manufacturing lines are totally different. So they will not compete for the same business.

Alex Gauna - UBSWarburg

Okay. And you mentioned some networking strength there, which surprised me for MID. Given seasonality that we typically see in the September quarter, I would not have expected that. Can you give a little more color on perhaps where some of the strength is coming from? I know you mentioned a little bit in wireless basestation.

Ahmad Chatila - Executive Vice President, Memory and Imaging Division

You know, wireless basestation came in a little bit versus Q1. But networking, we have a lot of new products and our design wins are accelerating. I do want... I do not want to overstate it, but that's what it is. You see, what you are seeing in MID is a lot less cyclical business than before. Aside from basestation, across the board order patterns continue to be flattish to up across all products. You are not going to see the situation that you used to see in '05 and '04 from us anymore.

Alex Gauna - UBSWarburg

Okay and last one if I could. You've got some licensing revenue coming from licensing the SONOS to NEC. Is there further licensing opportunity on the horizon here and where are you going to be accounting for this licensing revenue? What bucket will that fall into?

Shahin Sharifzadeh - Executive Vice President of Manufacturing and R&D

This is Shahin Sharifzadeh. Again, I handle the licensing business. We are actually working in other opportunities and we have a couple of companies in the pipeline, and we are creating a new business unit called the IP business unit and we are going to be accounting in that one, the revenue that we get from licensing. And we should start seeing it towards the beginning of '08.

Brad W. Buss - Executive Vice President and Chief Financial Officer

Alex, just to clarify on the external P&L that you'll see, that would show up in the other bucket from a revenue stand... and that will be the royalty that results from that. We sometimes get a little transitional payment under the licensing, and that's generally just a cost offset down in R&D, but it's minor.

Alex Gauna - UBSWarburg

Okay, very good. Thank you very much.

Operator

Thank you. Chris Danely, you may ask your question and please state your company name.

Chris Danely - JP Morgan

Thanks, JP Morgan. Hey guys. Good job on bringing the OpEx down. How do you expect that to trend for the second half of the year and any sort of update on the long-term goals there?

Brad W. Buss - Executive Vice President and Chief Financial Officer

Yes. Hey, Chris, it's Brad. I think from a semiconductor side, I don't think you are going to see much increase in OpEx. Probably, just variable stuff as revenue grows maybe $1 million, $1.5 million. I think R&D will be fairly stable from a total dollar standpoint. You might get a little fluctuation between quarters depending on take up [ph] from assets, etcetera. But I think we are at a model now where on the semi side, we are going to get pretty nice fall through from incremental gross margin. And I think our target of 50, 30, 30 PDT... they still hold. I think we are expecting to hit the 50% on the gross margin in the next few quarters, and I think with revenue growth, we can start getting in line with that. And as we go through our new ALT, our annual planning process, which will keep off soon, we'll be evaluating the model, and I would expect to see the gross margin model and the PDT numbers move up for our long-term model.

Chris Danely - JP Morgan

Okay. And what was the PSoC revenue in Q2 and how do expect that to trend for the rest of the year?

Norm Taffe - Executive Vice President, Consumer and Computation Division

Hi, this is a Norm Taffe. We have not traditionally been providing specific revenues on the business units and our line of divisions. I can tell they've... the business, it is continuing to grow and I expect to set records in both of the next two quarter just like we did in Q2.

Chris Danely - JP Morgan

That will work. And then also, can you guys go through the book-to-bill by segment one more time? I think I have missed that.

Unidentified Company Representative

Yes, Chris. By division is what I'll give it to you. I don't have it by market segment. But DCD was 1.04. I think T.J. said Memory and Imaging division 0.92 and Datacom was 1.07 and he gave you SunPower of 1.15, already.

Chris Danely - JP Morgan

Great.Thanks guys.

Operator

Thank you. Tim Luke, you may ask your question and please state your company name.

Tim Luke - Lehman Brothers

Thanks. Just with respect to the wireless infrastructure arena, should we think about that sign of some recovery developing in sort of fairly late in the quarter, or was it a fairly steady, linear improvement in the bookings and that you were suggesting in the wireless arena?

Chris Seams - Executive Vice President of Sales and Marketing

This is Chris. I can't comment on it because I specifically don't know how layered in over the quarter. Can comment for you. I can get that to you offline, if you are interested.

Tim Luke - Lehman Brothers

Okay. And --

T. J. Rodgers - President and Chief Executive Officer

I can give you a little bit of color. It's turning on a little bit a couple of accounts, but we also know of accounts that will be loaded with inventory all the way through this year and won't turn on until the first quarter. So staggered, retarded, and it will phase in during the last half of the year.

Tim Luke - Lehman Brothers

Okay. Thanks T.J. And with respect to maybe just framing the PSoC, is there any way you can give us some sort of range or percentage of CCD that it may now be, or maybe where it will end up, or maybe where it will end up by the end of the year just as a framework for how significant it is for the CCD?

T. J. Rodgers - President and Chief Executive Officer

PSoC right now is an annualized business of a little over $125 million a year. We were trying to push to $200 million a year. We are an $800 million company, we wish it were $500 million a year, and that's the reluctance dancing around here. How's that?

Tim Luke - Lehman Brothers

Fine, that's good. That's very helpful. And just on USB as well as to what's been happening there, and if you could provide any color within DCD that's not West Bridge. How we should think about that trending for the third quarter?

T. J. Rodgers - President and Chief Executive Officer

Let me clarify. I made comments about USB and West Bridge, and it is true that West Bridge has advanced USB capability on it and it is a Datacom product. However, the Datacom group borrowed its USB intellectual property and reused it from CCD. So CCD, our PSoC group has USB as a division. All of our USB solutions are programmable microcontrollers with USB IO and general purpose IO. So the comment on USB business per se, not West Bridge, will come from Norm Taffe.

Norm Taffe - Executive Vice President, Consumer and Computation Division

So just to give you some flavor. Actually, USBs remained quite strong for us; in fact, had a very good quarter again in Q2, driven by actually a lot of growth in our wireless portion of the business, wireless USB is growing... the fastest growing piece of that. From a business unit standpoint, the basic USB business is holding strong kind of at a flat level. We still are... our data says we are still quite strongly the number one supplier of USB port hole devices.

T. J. Rodgers - President and Chief Executive Officer

It's becoming a relevantly large, significantly in the mid 100X business. And we are currently in the process of making our final products, making them extremely cheap and transforming our product lines such that it is operating from low-cost areas for... an end of life which will go for decades. But we want to make money on it during that time.

Tim Luke - Lehman Brothers

Could you also just provide any color on DCD in terms of the outlook excluding the West Bridge or is that --

Dinesh Ramanathan - Executive Vice President, Data Communications Division

Hi, this is Dinesh Ramanathan. It's going to be flat compared to the growth that we are going to see in the West Bridge family.

Tim Luke - Lehman Brothers

What are some of the dynamics there?

Dinesh Ramanathan - Executive Vice President, Data Communications Division

Again, it's the comm business, which primarily goes into basestations and networking, specialty memory business, which also goes into basestations and networking. So we are not seeing a full blown recovery there as we pointed out earlier.

Tim Luke - Lehman Brothers

Brilliant. Congratulations on a strong quarter guys. Thank you.

Operator

Thank you. Tore Svanberg, you may ask your question and please state your company name.

Tore Svanberg - Piper Jaffray

Yes, Piper Jaffray good morning. You talked about the gross margins in each business unit, but we you look at the 200 to 300 basis point improvement next quarter, where would that come from let's say between mix and utilization?

T. J. Rodgers - President and Chief Executive Officer

Let me take that. Number one is utilization. That will lower our wafer costs and obviously ripples right on through. Number two is mix. By virtue of the fact that our base and more profitable businesses are growing and they are filling in the whole of the $8 million a quarter that we had a last time buy on dynamic RAM. So if you had par ado [ph] discussions of where the improvement in gross margin is coming from, those are the two biggest buyers.

Tore Svanberg - Piper Jaffray

Great. And you mentioned some design wins with PRoC. Is PRoC actually contributing to revenues today?

Brad W. Buss - Executive Vice President and Chief Financial Officer

It is contributing revenues today and will grow its contribution going forward.

Tore Svanberg - Piper Jaffray

Very good. And then just looking at OpEx and maybe on PSoC specifically, as T.J., like you said, hoping it could be a $500 million business, as that becomes a bigger and bigger part of revenues, will the R&D profile change? I guess I am just trying to understand how the operating margins would be in PSoC versus the rest of the company.

T. J. Rodgers - President and Chief Executive Officer

Let me answer that one. Our current R&D expense on PSoC?

Brad W. Buss - Executive Vice President and Chief Financial Officer

Current R&D as a percentage of sales?

T. J. Rodgers - President and Chief Executive Officer

Yes.

Brad W. Buss - Executive Vice President and Chief Financial Officer

Around 23%.

T. J. Rodgers - President and Chief Executive Officer

So. And how about semiconductors was 18?

Brad W. Buss - Executive Vice President and Chief Financial Officer

Yes.

T. J. Rodgers - President and Chief Executive Officer

Okay. Currently, PSoC is at Cypress Semiconductor's 18% R&D, which is getting quite close to our model. PSoC's ahead of it at 23%. That's because we have the $125 million plus business, but we've still got some big projects going. So point one is there will be obvious amortization of a given R&D effort over time. Point two is that I think the dollars that we think we need to spend on PSoC may modestly decline over time actually. The reason being is we are not... PSoC is a programmable system; it's not a microcontroller. But if you look in analogy at microcontrollers, the companies that make them, Freescale, Microchip, have 5000 or 10,000 products. And every time somebody wants a new one with six channels of pulse width modulated control to run backlighting for LEDs, something like that. These guys will bring out a new chip that's got... they mix and match the IP, they don't design it from scratch. But they have to bring on new chip and hard silicon. The PSoC family we have got today is only a set of products. So all of the hoopla that the first design win to a motor controller and the NordicTrack treadmill, the Apple iPod, the high-brightness LED driver etcetera. All of those, all comes from only than seven chips. And PSoC can morph itself. So the big economic advantage we are going to have over traditional microcontroller companies is the ability to have fewer designs and fewer products and to jump into markets by changing software, not by changing hardware.

Tore Svanberg - Piper Jaffray

Very helpful. Thank you very much.

T. J. Rodgers - President and Chief Executive Officer

I have a comment. I think R&D, we are adding level roughly as a company where I rhymed off half a dozen big areas we are investing in to drive growth, and I don't see it driving R&D dollars up. Because between the divestitures and then reallocating dollars in other divisions that aren't on the same growth curve, we are able to move people around and dollars around yet continually invest in huge growth and margin areas without cranking up R&D $10 million. So, I don't expect to see huge increase in R&D at all.

Tore Svanberg - Piper Jaffray

Understood. Thank you very much.

Operator

Thank you. Adam Benjamin, you may ask your question and please state your company name.

Adam Benjamin - Jefferies & Company

Jefferies. Just Ahmad, can you just clarify, I think you mentioned MID would be flattish in growing throughout the rest of the year. That would imply pretty big growth to get back to flat year-over-year. I just want to make sure that's what you were talking about.

Ahmad Chatila - Executive Vice President, Memory and Imaging Division

Yes. So I expect SRAMs to grow 93 quarter-on-quarter.

Adam Benjamin - Jefferies & Company

And you would expect to get back to on a year-over-year basis flattish?

Ahmad Chatila - Executive Vice President, Memory and Imaging Division

Yes.

Adam Benjamin - Jefferies & Company

Okay.

Unidentified Company Representative

Hang on. Year-over-year or quarter-on-quarter.

Ahmad Chatila - Executive Vice President, Memory and Imaging Division

quarter-on-quarter, sorry.

Unidentified Company Representative

Yes, I think his earlier comments, Adam, were quarter-on-quarter, not year-over-year. So he did $83 million, $83.5 million this quarter. Of the $83.5, $6 million was DRAMs, which is going away; $8 million was DRAMS, which is going to go away, but he is going to stay at flat revenue quarter-on-quarter by building the SRAM business significantly.

Adam Benjamin - Jefferies & Company

Right. That's what I was trying to get to. If you take out the $8 million a quarter, it would imply a pretty significant growth on a steady state for the rest of the year.

Ahmad Chatila - Executive Vice President, Memory and Imaging Division

Yes.

Adam Benjamin - Jefferies & Company

Okay. Just on OpEx, you guys have historically given the earnings per share on a segment basis. Brad, can you walk us through why you didn't do that this quarter and if you can give us some of the detail there?

T. J. Rodgers - President and Chief Executive Officer

I'll answer that question. We thought that giving EPS by division provided a lot of clarity for investors. People were apprehensive about giving that much detail to investors. I thought it was a good idea. The Securities and Exchange Commission or rather some clerk buried inside of the Securities and Exchange Commission decided it wasn't a good idea. And it's got to do with GAAP, non-GAAP, FASB and all that stuff that I complain about. So we've had to take it away, and we are now disclosing to you as much as we can disclose. The technical problem lies in the fact that earnings per share, you can't really calculate GAAP and non-GAAP earnings per share on a divisional basis; it's pretty much impossible. And if you can't state them both, then you can't report them both. So we were reporting in effect non-GAAP only without special events right after amortization etcetera on our divisions, and we couldn't calculate a GAAP number for our divisions. And that's a no-no, so we had to pull the plug. Too bad, I think. So just to give you a directional feel, all divisions contributed in Q3... in Q2 and all divisions will increase in Q3.

Adam Benjamin - Jefferies & Company

Okay. And then lastly on the DCD front, there was pretty significant decline sequentially. Can you give us more color as to which specific area, I mean the NSEs have been running flat I think around $7 million a quarter. I don't believe it was there. So can you give us a little more color on that one?

Dinesh Ramanathan - Executive Vice President, Data Communications Division

It's one-time events in the PLD business. This is Dinesh.

Adam Benjamin - Jefferies & Company

And that doesn't come back, Dinesh?

Dinesh Ramanathan - Executive Vice President, Data Communications Division

No.

Adam Benjamin - Jefferies & Company

Okay. Great. Thanks a lot guys.

Operator

Thank you. Chris Hettenbach, you may ask your question and please state your company name.

Craig Hettenbach - Wachovia Securities

Yes, it's Wachovia. Chris, Brad mentioned that Cypress's semiconductor inventory was down a quarter and that channel inventory was flat. As we go into the seasonal stronger part of the year, do you think inventory levels are appropriate or are potentially even too lean in the channel?

Chris Seams - Executive Vice President of Sales and Marketing

No, I think in the channels we have stocked them up in the first half. They are proper for the second half of the year seasonality.

Craig Hettenbach - Wachovia Securities

Okay. And if I could follow up on the PSoC front, obviously, diversified product line, but can you give us a sense by end market nearer term where you are seeing the most momentum in terms of converting design wins into revenue?

Chris Seams - Executive Vice President of Sales and Marketing

Probably the biggest revenue momentum we have is in the handset space, just because of the sheer volume you get with a design win in that space.

T. J. Rodgers - President and Chief Executive Officer

There is another one that's turned on quarters recently that is going to grow, it's the e-bike, the electric bicycle in China. For about $250 for the bicycle base model and about $2500 for the motorcycle looking model, the Chinese have taken small electric motors and put them on a bicycle. They are driven with normal lead-acid batteries out of a car, only small form factor batteries. And the motors are three phased motors that are controlled by power semiconductors that go bang, bang, bang in three phases for every revolution to power the bike from the battery. That control and the sensing is done by a microcontroller and the power is controlled by a pulse width modulator, which is dead center in PSoC's domain. We have taken a 21% share on a market that is currently 10 million units, on its way to 50 million units in China. And we are close to introducing a custom... not custom, a PSoC, our eight PSoC, which is optimized for electronic motor control in that and other markets. So that's another one that's going to be taking off for us. And let me pile on one more, the announcement we have listed in the press release. The win in the HP style notebooks. If you look at most notebooks coming out this season, they have the multimedia button at the top of the PC. And those are all converting over to capacitive sensing by and large from the big OEMs, and you will see us penetrate more and more of those as time goes on.

Craig Hettenbach - Wachovia Securities

Excellent. Thank you.

Operator

Thank you. Louis Gerhardy, you may ask your question and please state your company name.

Louis Gerhardy - Morgan Stanley & Co., Inc.

Good afternoon, Morgan Stanley. Just a follow up on the West Bridge gross margins. You think they are going to be sustainable above the DCD average or are we just in the early stage of that product cycle and they should come down?

Dinesh Ramanathan - Executive Vice President, Data Communications Division

So we are in the early stages in the product cycle. But we will see price pressure on it as the volume mounts. We will see how it goes and in which direction. Again, the wins that we have there are broad based and they are platform wins, which means once we get designed in, we are going into multiple models. So we have to manage volume versus the pricing pressure that comes in when we are in that market.

T. J. Rodgers - President and Chief Executive Officer

I would like to make a clarifying comment there. DCD gross margins of 65% are almost 20 points above Cypress's gross margin. The West Bridge can "degrade" 10 percentage points relative to DCD and so be at 55% pulling Cypress up in a high volume market of cell phones.

Louis Gerhardy - Morgan Stanley & Co., Inc.

If I could follow up on the programmable product thrust at Cypress, seems to be really important going forward and you mentioned it's 43% of revenue. I have a sense given your comments on how significant PSoC is, but can you comment on some of the other programmable product areas maybe in terms of size and how the gross margins are for some of these segments as well?

T. J. Rodgers - President and Chief Executive Officer

Sure. The three biggest moving parts in our programmable products CCD division are PSoC programmable USB chips, and that's all we make are the programmable USB solutions and our programmable clocks. And that's all we make since we sold our personal computer clock division, which was hardwired custom clocks. That's all we make are programmable, really more programmable timing systems, I would call them, rather than just clocks. But we have talked about all the clocks. Norm, maybe you could talk about that.

Norm Taffe - Executive Vice President, Consumer and Computation Division

Yes, the gross margins in that business, I guess, in respect is also very good, actually in the 50% to 60% range, so very strong.

Louis Gerhardy - Morgan Stanley & Co., Inc.

Thank you.

Operator

Thank you. Michael Masdea, you may ask your question and please state your company name.

Unidentified Analyst

Thanks. This is Amit calling in for Michael Masdea. We've heard from a couple other semiconductor companies that the lead times are stretching. Can you comment on where your lead times are right now? And what is the risk that as other companies lead times stretch, you may see an over statement of your orders?

Chris Seams - Executive Vice President of Sales and Marketing

This is Chris Seams. Obviously, if other companies lead times are stretching and people are coming to us on a commodity type part, that's always a risk. But as we talked about programmable and proprietary being a bigger part of our portfolio, now we can get hit by that less. Our lead times today in memories are generally on the order of four to six weeks. Norm's division, Consumer and Computation, is about 6 to 8 weeks, actually our longest lead time division right now and Data Comm is around four weeks these days. So we don't have any huge lead times out there. And I don't think see them stretching through this quarter yet.

T. J. Rodgers - President and Chief Executive Officer

We believe the 6 to 8 week lead time is too long and we are actively working on back-end bottlenecks to try to bring it down in the event that we are hit with more orders faster than we anticipated. I think our actions will cause us at least to be able to hold lead times.

Unidentified Analyst

Got it. Thanks. And to the extent you can comment here, as you look to monetize your SunPower state over the long term, what would be your plans for the cash and would you use it to return to shareholders, acquisitions, more R&D investment? Could you comment on just if you thought about that and what you would likely do?

T. J. Rodgers - President and Chief Executive Officer

Please give me 91 days, and ask me that question again. I just don't want to run crosswise with the lawyers. I have got the SunPower guys out doing a road show as we speak and I just can't talk about it.

Unidentified Analyst

I understand. And then just the last quick follow up, outside of PSoC, West Bridge, and even SunPower, what are the one or two product lines that you think could be also potentially materially ramp over the next two to even three years a Cypress? What are items we should monitor closer?

T. J. Rodgers - President and Chief Executive Officer

I can talk about one that is not visible to our investors today. Cypress Microsystems was an internal start up that we transplanted a few Cypress people into and then built PSoC in Seattle starting in 2000. And it's turned into the business we have described today and it was our seventh start up, and by far our most successful start up. We have a new start up called Cypress Systems. I had been frustrated that we sell PSoC for a couple dollars and then I look at the very next person who designed the little printed circuit board, 2X3 inches. It has a bill of materials that may be $10 on it and then proceeds to sell that printed circuit board for $100 to $300. So I've... we have formed a company called Cypress Systems. We brought a senior manager named Harry Sim out of Honeywell. And his job is to build a mini systems company inside of Cypress. They have been here now for a year, we've been investing something in the order of $0.005 of EPS per quarter in them, and that shows up in other. And that's our best shot to bring another $100 million plus business into Cypress with very good margins going forward. When we will... when they introduce their first product, which will be this quarter, they've been working for a year on it, we'll be able to start to put more information on that. I didn't talk about it earlier because I didn't want to talk about wafer, where I wanted to wait till we had something to show.

Unidentified Analyst

Got it. Sounds good. Thanks.

Operator

Thank you. Sandy Harrison, you may ask your question and please state your company name.

Sandy Harrison - Signal Hill

Yes, Signal Hill. Can you guys hear me okay? Just a quick question, T.J. You've got pretty much a good job on the market with PSoC now with the 8-bit stuff. You've talked in the past about perhaps doing 12 or 16 or some others. If you can just give us a quick update on kind of where your mindset is on that.

Norm Taffe - Executive Vice President, Consumer and Computation Division

Hi,this is Norm responding. We are interested, we haven't made any formal announcements yet, but we have announced that we do intend to expand the PSoC really into both the 16 and 32-bit space in the microcontroller market.

Sandy Harrison - Signal Hill

And what do you think, or what are some of the markets that those are applicable for, just not necessarily you're jumping the gun on what you might do, but just what are some of the demands and what are some of those markets that would require and utilize the technology?

T. J. Rodgers - President and Chief Executive Officer

Let me talk about PSoC going forward, and I'll kind of fill in the gap between the size of the business and the fact that we keep saying it's the future of the corporation. 32-bit PSoC, using an ARM core is something that we are investigating, doing the marketing on right now. It looks attractive. For people who want PSoC, but don't want the little 8-bit engine inside; they want something that can crank MIPS [ph]. We have not launched that product yet. We have the product very much designed in that it would look like almost all what we have in PSoC now with a different microcontroller inside of it. That's one effort.

Another effort is an integrated RF PSoC. Right now, when we talk about PRoC, Programmable Radio-on-Chip, it is literally a two chip product in PSoC, connected and tested with a radio and certified for SBC use to make it easy for somebody to hook up anything they want to the PSoC and then take the data through the radio to another radio that can talk to it. We are investigating, launching. We actually have launched a PRoC which is monolithic. So we will have PSoC radios. Another thing we are looking at and have launched, but all these things I don't want to give you the impression or vapor where they basically take PSoC that we have got, with all the parts we have got and add some extra feature to it and put us into a different space.

The next one is Power PSoC. What would happen if instead of having a PSoC that operated at 5.5 volts and ran typical tens of million milliamperes of input and output drive? What would happen if you had a PSoC that had, for example, multiple channels on it that could handle 36 volts and 1 ampere of current? And you could start driving things that needed power directly with something that had all of the power conversion circuitry and all of the brainpower inside just to do the job. We are investigating that.

The next thing is nonvolatile PSoC. I told you about nonvolatile memories. I described how black boxes in cars or in any other system could describe the... on a nanosecond basis, describe what happened to a given system as it went down. So for example, if an EMP RAID controller that contained the bank accounts for the Bank of America went down, they sure as hell would want to know what caused the system to crash and what they have to change out to prevent it from ever happening again. And they actually have nonvolatile computers today that store data real time and tell them that. So if one would take a nonvolatile memory, like I described earlier and mix it with PSoC, you then would have in effect a black box on a chip that could measures things, do things conditionally based by measuring them and store data when the power went off to remind you where you were.

Those are the main ones. So those are concepts, those concepts are in the middle term in terms of introduction to market. And what they can do for us is they can involve all of our divisions, MID, volatile, PSoC, DCD, Power PSoC etcetera. They can involve all of our divisions in PSoC and... because they have families of products and close to one family.

Sandy Harrison - Signal Hill

Thanks for the update.

Operator

Thank you. [Operator Instructions]. Doug Freedman, you may ask your question and please state your company name.

Douglas Freedman - Amtech Research

Amtech Research, thank you. A lot of questions have been asked and answered. Let's see if, Chris, could you talk about the bookings trends that you saw in Q3 and what you're expecting them to look like... I am sorry for Q2, and what you are expecting them to look like for Q3?

Chris Seams - Executive Vice President of Sales and Marketing

Q2, we track... well, I've got a profile of bookings versus historical patterns and Q2 fit right in the slot. I will say two weeks into the quarter, Q3 is fitting into the slot.

Douglas Freedman - Amtech Research

Is it a front-end loaded... what does that slot look like? Is it a front-end loaded quarter or is it back-end loaded?

Chris Seams - Executive Vice President of Sales and Marketing

Well we were 86% booked entering this quarter; that's a slightly high number historically over the long haul for Cypress. But it's been that way about the last six plus quarters; I'd have to go back and look how long we were not at that level.

Douglas Freedman - Amtech Research

So no real expectation of a sort of summer bookings slow down at all?

Chris Seams - Executive Vice President of Sales and Marketing

No.

Douglas Freedman - Amtech Research

Right, terrific. One quick clarification if you could. I think maybe for you T.J., or Brad, on the factory loadings, I would have thought that with the outsource strategy, once you do get the internal factories loaded, do you have enough products that are presently qualified to outside for us to start to see sort of a mix shift towards the fab light strategy?

T. J. Rodgers - President and Chief Executive Officer

We will be able to do a mix shift towards fab light. As our volume picks up and we saturate internal capacity, we have preferentially put the things in the outside fabs that drive volume so that even though the number of products is currently single digit that are transferred and running, they represent a very large wafer volume for us. Currently, we have qualified and even shipped PSoC products from Grace Semiconductor in Shanghai. We have qualified some of our highest volume commodity memories at place and we are in the process of qualifying Antioch at Grace. So you've got some big runners there, and since wafer capacity is fungable, they are running precisely our process. Neville [ph], pretty seem... we have spent the money, we have had 13 people in Shanghai for two years, we've done it right, we even call them Fab 5. We've connected to them, we test, we look at everything, we are not just buying wafers. They look like a fab and we have done that right and that will not be an impediment to ramping when we need to do it.

Douglas Freedman - Amtech Research

Alright, terrific. If you could talk a little bit about, well, maybe for you Brad, can you give us when the gross margins are expected to reach your target over the next couple of quarters, get into that 50% range? Do you have a timeframe when you think you're going to reach the rest of the operating model targets?

Brad W. Buss - Executive Vice President and Chief Financial Officer

I expect to be on the model, our current model, definitely early in '08.

Douglas Freedman - Amtech Research

And that includes the 50... all three of them, the 50, 30, 20 numbers?

Brad W. Buss - Executive Vice President and Chief Financial Officer

Yes. Most importantly, the 50 and the 20. They fit in the middle, could flop a percent or too, but we expect to be there with the growth that we are looking at, and again the margin expansion. And to your other point Doug, after this quarter, a lot more of the business comes through the foundry and into '08 and we do get a nice margin impact on that because it is a positive move for us as a company.

Douglas Freedman - Amtech Research

Alright, terrific, and congratulations on a strong quarter. Thank you.

Brad W. Buss - Executive Vice President and Chief Financial Officer

Thank you.

Operator

Thank you. At this time, we are showing no further questions. Mr. Rodgers, I will turn the call back over to you for any closing comments.

T. J. Rodgers - President and Chief Executive Officer

Thank you very much. We've just reported the second quarter where we achieved record revenue for the first time since Q4 of 2000. We feel like we are positioned well in terms of products and SunPower is of course growing very rapidly and adding a lot to our profitability and revenue. Thank you very much for calling.

Operator

Thank you. This does conclude today's Cypress Semiconductor conference call. Have a nice day.

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Source: Cypress Semiconductor Q2 2007 Earnings Call Transcript
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