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Vishay Intertechnology, Inc. (NYSE:VSH)

Q2 2007 Earnings Call

August 2, 2007, 10:00 AM ET

Executives

Richard N. Grubb - EVP, CFO and Treasurer

William M. Clancy - Sr. VP and Corporate Secretary

Dr. Gerald Paul - President, CEO and COO

Dr. Felix Zandman - Founder, Chairman, Chief Technical Officer and Chief Business Development Officer

Analysts

Shawn Harrison - Longbow Research

Steven Smigie - Raymond James

Ingrid Tiltmann - Merrill Lynch

Matthew Sheerin - Thomas Weisel Partners

Kevin Kessel - Bear Stearns

Jim Suva - Citigroup

Jason Gursky - JP Morgan Securities

Andrew Huang - American Tech. Research

TRANSCRIPT SPONSOR
Wall Street Breakfast

Operator

Good morning. My name is Juanita, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Vishay's Second Quarter 2007 Earnings Result Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. [Operator Instructions]. Thank you.

Mr. Grubb, you may begin the conference.

Richard N. Grubb - Executive Vice President, Chief Financial Officer and Treasurer

Thank you. My name is Richard Grubb, I am Vishay's Chief Financial Officer. I want to welcome everybody to our second quarter financial conference call. Today with me is Dr. Gerald Paul, in Germany, our CEO and President; Dr. Zandman, is here with me in Malvern, PA, he is our Chairman and Chief Technical and Business Development Officer.

Before I start, Bill Clancy, Vishay's Senior Vice President and Corporate Controller, will read our customary opening statements.

William M. Clancy - Senior Vice President and Corporate Secretary

You should be aware that in today's conference call, we will be making certain forward-looking statements that discuss future events and performance. These statements are subject to risks and uncertainties that could cause actual results to differ from the forward-looking statements. For a discussion of factors that could cause results to differ, please see today's press release and Vishay's Form 10-K and Form 10-Q filings with the SEC.

Richard N. Grubb - Executive Vice President, Chief Financial Officer and Treasurer

Thank you. As usual, I will make some summary comments and Dr. Paul will add a more detailed evaluation of the results, and finally Dr. Zandman will update our R&D activities and acquisition activities.

As stated in our press release, Vishay reported $0.26 operating earnings per share as compared to $0.28 for last year's second quarter and $0.26 for the first quarter of 2007. The operational results of the second quarter of 2007 exclude the automotive business unit acquired as part of the PCS business. Company had announced previously, its intention to sell this business during the last month.

The reported GAAP earnings per share include restructuring and severance costs of $3.9 million. These items and the related tax consequences plus additional tax expense for changes at uncertain tax additions as required by FIN 48 are $3.4 million and a negative $0.04 effect on earnings per share.

Revenues for the second quarter of $760 million were approximately 8% higher than last year's and in line with our previous guidance and also 9% higher than the first quarter of 2007. All of the increases in revenues were due to the acquisitions during the first quarter.

Revenues by segment were semiconductors 53%, assets 47%. Consolidated gross margins for the quarter were 24.9% as compared to 26.6% for the immediately proceeding quarter. Gross margins by segment for the quarter were semiconductors 24.1% compared to 25.4% in the last quarter. And excluding the PCS business the gross margins for the second quarter of 2007 percentage metrics is 24.9%. Asset products 25.7% as compared to 27.7% in the last quarter. As I said before Dr. Paul will go into more details on these margins.

Selling, general, and administrative expenses for the quarter were a $113 million, a $9 million increase over the last year's second quarter, all which relates primarily to the recent acquisitions. Other income consists mainly interest income and is lower this quarter due to the $219 million cash acquisition of the PCS business. We effective adjusted tax rate for the year is approximately 23%. Capital expenditure in the quarter were $42 million, depreciation and amortization was $53 million, and the total headcount at quarter end of employees was 28,000 of which 73% are now in low cost areas.

Some other key amounts; cash and short term investments at quarter end was $387 million. Total debt, substantially all of which is convertibles was $608 million. Total inventory at quarter end was $565 million and the working capital at the quarter end was $1 billion. Bookings for the quarter were $718 million for a book-to-bill ratio of 1:1 for the second quarter. Backlog at quarter end is $677 million.

Cash generated from operations for the second quarter 2007, without the acquisitions, was a $107 million, cash generated from operations for the second quarter, including all acquisitions, $69 million. And as announced in our press release, we expect the third quarter revenues to be in the $710 million to $730 million range. Dr. Paul?

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

Thank you, Dick. Good morning everybody. Well, Vishay, I think had a solid quarter with earnings per share of $0.26, whereby sales were somewhat below our expectations. On the other hand, the integration of the IR discrete progressed according to plan, and they were already accretive by $0.01 in the second quarter, as anticipated. More so, there is a promising outlook for this acquisition for the business development and also for the profit development, and we are proud of a very strong cash flow this quarter.

Let me talk about the economic environment we have seen. The friendly and firm business environment really continued also through the second quarter. The pace of distribution continued on a high level. The inventory turns of distributors virtually stayed unchanged. We see a 4.0 inventory turns for all distribution, Americas at 3.2, Europe at 4 inventory turns, and Asia at 4.8.

Book-to-bill of our distributors were a 0.96, whereby the Asian and the US distributors were about 1 in terms of book-to-bill, where as Europe was weaker below 1 after an excellent first quarter. Lead times in the market remained short. We believe it was four to seven weeks for the passives and six to weeks for the actives. We have the seen the quite moderate price pressure to continue. The market conditions did not changed in general. Our EMS business was stable. There was some weakness in mobile phones. On the other hand we start to see the seasonal ramp up in Asia.

Let me talk about Vishay's business in the second quarter, how it developed. Excluding acquisitions, Vishay reported virtually flat sales following a very strong quarter one. This was, as I said, slightly below our expectations which really can be attributed to the European business but also to the market segments in Asia, phones and computers, which developed weaker than we thought.

We achieved sales without acquisitions of $658 million in the quarter versus the same amount in prior quarter and $661 million in the prior year. Exchange rate had an impact; they increased sales by $7 million versus the prior quarter and by $15 million versus the prior year.

The acquisitions performed quite in line with our expectations, we achieved sales of $52 million for the IR -- for the IR acquisition without automotive modules, and 6 million sales for PM Onboard. The orders for the Company remained firm; book-to-bill in the quarter was 1.0.

Now more detail about book-to-bill. It was 1.0 for distribution and 0.99 for OEMs; was 0.99 for actives and 1.0 for the passives; was quite strong in Asia 1.06, as I said before, and 1.0 for the Americas; Europe relatively weak 0.93 this quarter. The backlog was stable at a solid 2.8 month, there was very little price declines. We have seen 0.6% versus prior quarter and 0.1% price decline versus the prior year.

For passives we see continued price stability, we lost 0.3% on price versus prior quarter, but prices were up by 0.5% versus prior year. We have also seen quite moderate price decline for the actives, 0.9% price decline versus prior quarter and 0.7% price decline versus prior year. Inventory terms of Vishay improved to 3.4. Inventories excluding the impacts of the exchange rate went down by $32 million in the quarter, again without acquisitions. They went down by $22 million in raw materials and by $10 million in VIP and finished goods.

Capital spending in the quarter was $42 million as compared to $31 million in prior quarter and to $34 million in the prior year. This compares to a depreciation of $48 million. We continue to expect capital expenditures of about $250 million in 2007. $25 million out of this $215 will be spent for IR, in particular, for expanding manufacturing capacities and for integrating IT. The headcount of Vishay in the quarter increased by 1,300 people, 1,490 people were integrated in this context due to the acquisition. So, the traditional part of Vishay went down in headcount, in variable and to a degree also in fixed headcounts.

The employment in high level countries was 27%, without acquisitions this would have been 25.6, again slightly down from previous, from the previous quarter. Further improvements of this number can be expected from the full implementation of our announced programs mainly in Belgium and in Holland. We generated cash from operations of $107 million in the quarter without acquisitions is except [ph] and this compares to $41 million in the prior quarter and to $77 million the prior year. As I said in the beginning, we are quite proud of this discipline to generate cash.

Free cash in the quarter was $68 million, without acquisition, as compared to $13 million in the prior quarter and to $46 million in prior year. So, we do expect another quite strong year of cash generation.

Let me talk about the results and compare the results to the prior quarter, based on the same level of sales, but actually $7 million lower excluding exchange rate impacts, the adjusted operating margin decreased by $7 million from $86 million... from $68 million, excuse me, to $61 million.

The main elements were lower volume and less favorable mix which contributed $4 million negative and inventory impacts $2 million negative. The cost reduction offset the price decline.

Now, let me compare results to last year second quarter. Based on $2 million lower sales, again $17 million lower, actually, if you exclude exchange rate impacts. The adjusted operating margin decreased by $19 million from $80 million to $61 million. Main elements were lower volume and price attributing together $6 million negative, whereby lower volume was by far the strongest impact. Cost up by $9 million whereby we have a quite dramatic increase of material costs. And inventory impacts increased across by $3 million.

Now, I would like to talk a little more about our recent large acquisition, the IR acquisition. We reached sales in the quarter of $67 million which is inline with our projection. $52 million, we achieved sales for the IR discrete and $15 million for the automotive modules. There was a slow beginning in April due to several transition-related problems, as expected, but through the quarter there was a steady improvement also as expected.

And we can say that May and June sales run rate, without automotive modules is at $240 million, quite according to our expectation. There is a quite strong book-to-bill ratio for these products, 1.13 in the quarter. We can say that the integration of all relevant functions is completed to a large extent. Still we need support from IR, mainly in IT and in planning, but there are service... transition service agreements in place which costed us in quarter two $1.6 million. They will gradually go down and they will end in the first quarter '08, all according to plan.

There are manufacturing projects having been started to move the front end and the packaging out of IR facilities. We expect full implementation by the first quarter '09, and in steps this will yield substantial savings. The decision has been taken, Dick mentioned it, to sale the automotive modules business with annualized sales of approximately $80 million.

We studied it and we found that this business is not really complimentary to Vishay's business. We also believe that we would have been too small in this market... this is the only business of this kind we would have had, so we decided to sell it. Gross margin in the quarter was $10 million or 19% of sales. If you excluded automotive, the operating margin was $3.7 million or 7%. As I said in the beginning it was... this acquisition was already accretive in quarter two by $0.01.

We expect improved profitability in the third quarter because of higher sales, because of lower costs for the transition service agreements, and of course we expect better efficiencies, there will be no repetition of our startup problems.

Let me come to the traditional lines of Vishay, and I start with the resistors and inductors. There was a decrease of the sales volume after a very excellent first quarter. Sales in the quarter were $161 million which is 4% below the prior quarter and 2% below prior year. Book-to-bill was at 0.98. Backlog was stable at 2.6 months.

Despite lower volume, gross margin remained at a quite satisfactory level of 31%. The positive ASP trend for resistors and inductors continued, we saw a price decline of 0.3% versus prior quarter, but the price increase of 0.5% versus prior year. Inventory turns were at a satisfactory level of 4.1. We had continued strong business with thin film chips, SMD wire-wounds, and chip inductors and we continue to expand our manufacturing capacities.

Talking about capacitors, the business indeed has stabilized after a successful implementation of our new pricing strategy. There is a promising increase at power capacitors which offsets some erosion which still exists at low margin film capacitors. So, we do expect, within capacitors, a positive mix impact going forward.

Sales in the quarter were at $126 million which is down by 9% versus prior year, but only by 1% versus prior quarter. Book-to-bill was at 1.03. Backlog is quite comfortable at three month. Gross margin of 16% of sales was negatively impacted by a less favorable product mix as compared to the first quarter, by inventory reduction and other inventory-related items. There was price stability also for capacitors. There was price decline by 0.4% versus prior quarter but a price increase by 0.5% versus prior year.

The inventory turns at capacitor start to improve as in particular tantalum powder and wire inventory levels decreased. Turns in the quarter were at 2.1. The turns, excluding the excess powder and wire, were 3.8. Inventories went down by $18 million in the quarter by $11 million in raw materials and by $7 million in VIP and finished goods. The already announced restructuring projects are on schedule, which will give us positive P&L impacts in the year 2008.

The decision has been taken to develop tantalum chips or fordel two in them so called Map Technology [ph] which is a special technology for miniaturizations.

Let me come to the Measurements Group, the latest acquisition of PM Onboard in the UK compliments the business and will add approximately $30 million of sales. Sales in the quarter were $49 million including $6 million already from PM Onboard, this compares to $44 million in prior quarter and to $42 million in the prior year.

Book-to-bill was at 1.0, backlog at 2.3 months, and the gross margin remained at an excellent level of 34% of sales. Also PM Onboard, the acquisition was already accretive in the second quarter. The inventory turns were at 2.7, there was a positive impact in inventory turns from PM Onboard. Restructuring measures are being evaluated for our new acquisition.

Now to semiconductors, I like to talk about our semiconductors without Siliconix, first. Strong orders have... and I also exclude in this display the impact of IR, the IR acquisition. There were strong orders in the prior quarter and this led to an increase of revenues, as expected, for all product lines. Sales in the quarter were $187 million which is 4% above prior quarter but 2% below prior year. Book-to-bill was at 0.99.

The backlog of this business was at 2.3 months, the gross margin remained at the level of 23% of sales, there is a steady and very reliable performance of this product group to be noted. The ASP decline remained moderate minus 1.4%, I mean, 1.4% decline versus prior quarter and 1.4% decline also versus prior year.

This product group shows quite excellent inventory turns of 4.5, they have been noticeably improved versus prior quarter. We continue to convert products in our German factory from 4-inch to 6-inch technology, quite important for us for mid and long-term cost reduction.

We are also growing the business with new French short-key rectifiers. Sales already, is at the run rate of $15 million per year. We are the technical market leader. We are on the way to expand our manufacturing capacity for these new products in factory. A new division, based on IR rectifiers, thyristors and IGBT modules has been established. The run rate of sales of this segment of the business is expected to be $130 million per year.

There is also promising potential for this group for improvements in approach to market, in product development and in cost reduction. We are quite excited about the potential, in particular, of this product group.

Let me come to Siliconix. The business continues to grow year-over-year. It was up by 5% for the first half of... vis-à-vis the first half of '06, which has been a record year. The sales in the quarter were $141 million down by 3% versus prior quarter but up by 1% versus prior year. This Siliconix business, indeed, developed somewhat below our expectations, but there is no doubt in our minds that Siliconix has the potential to grow faster than the market going forward.

Book-to-bill has recovered further 2.99 after 0.88 in the first quarter and 0.79 in the fourth quarter '06. There is a comfortable backlog of three months which supports the expectation of continued growth in the second half.

The gross margins -- our gross margin remained at a level of 28% of sales. There was no price decline versus prior quarter and prior year. We have established additional manufacturing capacity for Siliconix in order to participate in future market upturn. Inventory terms declined lightly to 3.7. We have initiated a program to reduce inventories by 10% by yearend.

Based on the IR acquisition, we have established within Siliconix a new division for high voltage MOSFETs. The present sales run rate is a 110 million. The business at this point in time is still burdened by a relatively high inventory levels at distribution but contains a very promising potential going forward. We will move manufacturing out of the IR sites within the next 18 months.

Let me summarize, after so much detail. I think, Vishay has stabilized on a solid performance level in terms of P&L and cash generation. Expecting a continuation of the present friendly market conditions, we will see another successful year which will be further enhanced by our recent acquisitions. The adjusted earnings per share of $0.26 represent stability. Integration of the acquisitions, namely of IR, is well underway and performs as anticipated.

Including acquisitions, we, for the current quarter, guide Vishay to a sales ranges to exceed between $710 million and $730 million.

Thank you. And I turn towards Dr. Zandman.

Dr. Felix Zandman - Founder, Chairman, Chief Technical Officer and Chief Business Development Officer

Hello, I am the Chairman of the Board and Chief Technical and Business Development Officer of Vishay.

Just to summarize a few numbers. Earnings per share, $0.26, net profit, approximately $50 million, cost generated $107 million, free cash $60 million, IR and PM acquisitions accretive in the first quarter of their operations.

As Gerald said, everything is on plan, and now I am going to speak a little bit about the other issues concerning acquisitions and R&D. They are integrating successfully the Power Control System Division of IR while divesting the Automotive System business of IR as announced previously. This divestiture is due to the fact that after a very carefully analysis and consideration we came to the conclusion that this business will not fit properly with Vishay; it's not for us. There is not enough synergy with Vishay. Components... small dollar value of Vishay components in the system. Customer base has to be served with a completely different sales force. And market is very narrow and somewhat unknown to us. Those were the main reason why we decided to divest ourself from this business. However, the power control business of IR, $240 million run rate is doing well and is on target, as you heard from Gerald.

Our acquisition of PM Onboard, a $30 million company, is in the midst of restructuring and is being absorbed by Vishay as planned. This business is a complement to our Measurement Group System and will provide additional strength to our growth in Europe and potential to expand into US and Asia.

What is PM? PM is a sophisticated specialist in onboard weighing, such weighing trucks while the trucks are moving, while they are transporting all kind of cargo. Lately the UK parliament approved a recommendation to introduce a law to weigh all domestic waste and send automatically the information for billing; as done already in Ireland and some other countries. This would be a introduction of a major growth to the business unit for PM, we count on it and we know this will happen. If this goes through faster or slower; we don't know. But this represents a major, I mean, major increase potential for PM.

R&D in all Vishay divisions is proceeding as planned. We intent to increase our present 26% of new products as a percentage of Vishay sales to a level of 36% in 2010. In our business we believe that we should we have an average of 40% to 45% of new product in the pipeline. New products will represent a growing proportion of our sales in the future. Acquisitions are always a part of our strategy and we continue to investigate opportunities in this area.

We are now open for questions Thank you. Juanita?

Question And Answer

Operator

[Operator Instructions]. Your first question comes from the line of Shawn Harrison [Longbow Research].

Shawn Harrison - Longbow Research

Hi. Good morning. I was hoping, first, you could just provide the sales in the other semiconductors business as well as gross margins for both other semis and Siliconix, including the PCS acquisition?

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

Excluding the sales of Siliconix, including this portion which goes under Siliconix, you said.

Shawn Harrison - Longbow Research

Yes. As well as the corresponding gross margin, so the aggregate numbers?

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

Well, we would have to add this together. I would have to come back. We didn't split it that way, but here I can give you the sales. Sales must have been... but this is approximately plus/minus $2 million approximately. It's the 141, which I said about Siliconix, and then it must be around 27, 26 portion for the HEXFETs; it means for the high voltage MOSFET. But we didn't split it like that for this presentation. We can... of course, we can bring this number.

Shawn Harrison - Longbow Research

Okay. My second question just has to deal with the weakness you witnessed in Europe. If you could just comment on, just, what end-markets in particular that was and some of the outlook here in the third quarter, maybe breaking out what is seasonally soft versus maybe the underlying weakness that could be out there.

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

There is, for sure, some seasonality in that. But normally the seasonality is seen in the current quarter. We have seen it this time earlier, and it couldn't be nailed to a specific area in the industry, we tried to, but it's across the board. Also distribution was relatively weaker in Europe than it was, especially in the first quarter, very strong in the first quarter, now dropping off to a degree, but it's broad, and it goes over most of the products. But in Europe... yes, particular strong in the passives, so it was particularly seen in the passives.

Shawn Harrison - Longbow Research

Okay. Just final question, you had mentioned inventory is a headwind to EBIT margin expansion this quarter. I was just wondering if you could expound upon that a little bit and whether that's going to be a drag in the third quarter as well?

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

Well, we continue to reduce inventory, but you have seen a major part of the inventory reduction going forward will come, of course, from just raw materials. This, of course, has no impact by definition. So, a major part of the reduction we expect to come from raw materials.

Shawn Harrison - Longbow Research

All right. Thank you.

Operator

Your next question comes from the line of Steve Smigie [Raymond James].

Steven Smigie - Raymond James

Great. Thank you. I was wondering, if you talk a little bit about the timing for the sale of the IR piece, the automotive piece?

Richard N. Grubb - Executive Vice President, Chief Financial Officer and Treasurer

We announced last week, I guess, last month that this sale was going to take place, we are engaged in conversation with interested parties. We hope to... by the end of the year... to have some type of a deal.

Steven Smigie - Raymond James

Okay. And then just generally on gross margin. Is there something you could talk about -- I mean, there is a lot of moving parts, just give some general color for the coming quarter and the next several quarters, what you are sort of anticipating on aggregate basis.

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

Well, we don't forecast the gross margin, but I can comment, of course, what has happened in the second quarter... try to say that. In resistors, we have seen the impact really of lower sales, first of all, and we have seen the impact, of course, of the reduction of inventories. In capacitors, as I mentioned after the first quarter, we have seen in the first quarter a very favorable mix in general and this is a more normal mix we have seen, maybe even on the lower side on the more negative side. Also in capacitors, we have seen the impact of inventory reduction. So, we feel that this quarter in passives we had a relatively low gross margin.

Steven Smigie - Raymond James

Okay. Great. Thank you.

Operator

Your next question comes from Steven Fox [Merrill Lynch].

Ingrid Tiltmann - Merrill Lynch

Hi, it's Ingrid Tiltmann in for Steven Fox. Just a couple of question, on that gross margin that you just spoke about, do you expect that you are going to see any improvement over the next couple of quarters?

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

As I tried to say just now, the gross margins in this quarter... in the second quarter were impacted negatively by the reduction of inventories... by inventory-related issues and were impacted negatively by some mix change, unfavorably mix change, from a very positive first quarter to a relatively negative second quarter. I think you can draw the conclusion. We feel that the gross margin of passives in the second quarter were relatively low.

Ingrid Tiltmann - Merrill Lynch

Sure. And then I was wondering if you could just give me a little bit of better idea if you were to review the timeline for realizing the accretion from the acquisitions?

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

It is already accretive. In both acquisitions; IR, the large acquisition as well as, PM Onboard, the small acquisition have been accretive already in the first quarter under Vishay, as we anticipated and forecasted. IR was accretive by $0.01 --

Ingrid Tiltmann - Merrill Lynch

But going forward --

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

It is going to be better, according to plan. You know there is a projection which indicates substantial improvements for the quarters to come. We are going to follow our projection.

Ingrid Tiltmann - Merrill Lynch

Okay. Great. And then lastly, in terms of Siliconix, where are you at the capacity expansion and --

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

We put capacity in the Siliconix which enables us to above $600 million sales per year but we have seen in this quarter some weakness in the main market that means in Asia, in particular, in mobile phone. So we have, from a capacity standpoint, we are in good shape, you remember we wanted to put additional capacity in, in order to exploit future upturns in a better form than we did in the past. So, the manufacturing capacity is there but in the second quarter we have seen a downturn, another downturn. We have seen relatively weak market. But we already foresee for the coming quarter an improved situation.

Ingrid Tiltmann - Merrill Lynch

And your competitors are they adding capacities, or anything alarming or are they under-investing there?

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

Don't know exactly each competitor but I think Vishay had to add capacity, the other have added earlier --

Ingrid Tiltmann - Merrill Lynch

Added earlier. Okay. Thank you very much.

Operator

Your next question comes from Matt Sheerin [Thomas Weisel Partners].

Matthew Sheerin - Thomas Weisel Partners

Yes. From Thomas Weisel Partners. Just to follow-up on the previous question regarding gross margin and not just in passives. It sounds like you had some, both, volume-related but also internal inventory etcetera, reasons why margins were a little depressed. I guess the question going forward is, do you expect margins to stabilize here in the third quarter or will product mix still work against you, particularly, as Europe is going to be weaker and Asia is going to be stronger. What should we just expect in general for margins?

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

Matt, we believe that the product mix in capacitors was really unfavorable in the second quarter; to the same degree as in the first quarter, as I said, was very favorable for us. So, what we have seen in the second quarter is maybe the other extreme.

Matthew Sheerin - Thomas Weisel Partners

Okay. And how are things trending this quarter, then?

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

I cannot comment on that, so... but I think I answered it --

Matthew Sheerin - Thomas Weisel Partners

Okay.

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

We feel that in the second quarter, we have been on the low side of the product mix impact. On the inventory story, going forward we are really reducing most of the inventory or a major share of the inventory from raw materials.

Matthew Sheerin - Thomas Weisel Partners

Okay. And then on your SG&A line overall, are there still more cuts that you can make with IRF or what should we be expecting about SG&A in the third quarter, it's going to be flattish or --?

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

In IR, we took on very little SG&A to start with. So, we will review it going forward but we started already low. The improvements on IR are going to come from the manufacturing side obviously. We... March... April... the first month was of course a difficult one as you can imagine.

Matthew Sheerin - Thomas Weisel Partners

Okay. But in terms of your overall operation, are you looking to take anymore costs out of SG&A, or is it going to be --?

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

At this point in time we are studying it. I think... I don't think there will be a major impact on SG&A, I don't think so --

Matthew Sheerin - Thomas Weisel Partners

Okay --

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

It was very low to start with.

Matthew Sheerin - Thomas Weisel Partners

Okay. And my final question, just regarding Siliconix, I know there is a good bit of exposure to handsets, and specifically a large handset maker that's been having some difficulties; was that a reason for kind of stable margins in the book-to-bill and what is the outlook there for handsets and notebooks and PCs, which is also strong for Siliconix?

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

First of all, you are absolutely right, your suspicion is correct. It was not only this one, we saw it in general. But we also have seen book-to-bill for Asia coming up in the second quarter which makes us believe, and I think, positively believe, that quarter to come already will show a better performance for Siliconix.

Matthew Sheerin - Thomas Weisel Partners

Okay. Thank you.

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

Let me just add... I've forgotten an issue on the SG&A. You should remember that we did include some transition service agreement costs into our SG&A... they're included in the SG&A costs, and these costs will go down by nature. Hello?

Richard N. Grubb - Executive Vice President, Chief Financial Officer and Treasurer

Next please.

Operator

Your next question is from the line of Kevin Kessel [Bear Stearns].

Kevin Kessel - Bear Stearns

Thanks. Good morning guys.

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

Good morning.

Kevin Kessel - Bear Stearns

So, in terms of these transition service agreements that you mentioned. Do you foresee them declining in a linear fashion?

[Multiple Speakers].

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

Not strictly linear. But they will go away in the first quarter '08 and will reduce step-by-step in between.

Kevin Kessel - Bear Stearns

Does that mean in the first quarter of '08, they are still there and then they are completely gone --

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

In the first quarter it's minor. It's really minor then.

Kevin Kessel - Bear Stearns

Okay. So, they start to decline towards the end of the year?

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

Yes.

Kevin Kessel - Bear Stearns

But you --

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

No. Well they go down quarter-by-quarter.

Kevin Kessel - Bear Stearns

Each quarter. Okay. And then in terms of your cash flow and free cash flow, you mentioned -- in the quarter it looked good but at the same time if we kind of look at it this year versus last year, based on what I have, you've generated $20 million in free cash flow in the first six months of this year. But that compares to $60 million last year.

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

No. You have take out the acquisition, Dick, maybe you want to explain.

Richard N. Grubb - Executive Vice President, Chief Financial Officer and Treasurer

Kevin, the acquisition... we did not buy any bigger side. We didn't buy any receivables, so that the $50 million some odd, worth of receive... sale that took place in this quarter were a drain on cash, and as they end up being cash receivable period. So that won't happen again.

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

Apples-to-apples, we have higher free cash generation than in prior year.

Kevin Kessel - Bear Stearns

Are you saying, you did not acquire $50 million in receivables.

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

Yes.

Richard N. Grubb - Executive Vice President, Chief Financial Officer and Treasurer

We do not acquire any of the receivables, that's correct.

Kevin Kessel - Bear Stearns

Okay. And so that had a negative effect on your working guide.

Richard N. Grubb - Executive Vice President, Chief Financial Officer and Treasurer

Sure.

Kevin Kessel - Bear Stearns

So, that would be put you... then, yes, you are right at $70 million, I guess, versus $60 million last year.

Richard N. Grubb - Executive Vice President, Chief Financial Officer and Treasurer

Approximately.

Kevin Kessel - Bear Stearns

And what would be the expectation, because you know you've spoken in the past about the ten-to-one impact being favorable this year by maybe on --

[Multiple Speakers].

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

Overall, we had a very strong cash flow last year. We expect this year to be better than last year.

Kevin Kessel - Bear Stearns

Okay. But can we assume by more than $60 million, given the tantalum boost that you should see?

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

It's in the area... you are not completely wrong in your estimate.

Kevin Kessel - Bear Stearns

Okay, and then just one last clarification here. When you talk about $11 million in operating profit that you are expecting in the first quarter from IRF?

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

Yes.

Kevin Kessel - Bear Stearns

So, that's 11 million a quarter I assume.

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

Yes.

Kevin Kessel - Bear Stearns

$44 million annualized.

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

Yes.

Kevin Kessel - Bear Stearns

So that works out, I guess, first all to like an operating margin of 18%, and then secondly, my math says about a $0.04 bottom-line tax affected... impact to EPS. Does that sound accurate?

Richard N. Grubb - Executive Vice President, Chief Financial Officer and Treasurer

What rates did you used for tax?

Kevin Kessel - Bear Stearns

I was using 25%.

Richard N. Grubb - Executive Vice President, Chief Financial Officer and Treasurer

I think it's close.

Kevin Kessel - Bear Stearns

Okay. Okay, so then... so, I guess, in other words, it's basically you expect to be at your target level on a run rate basis by Q1 of '08?

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

I mean, we are very happy to see IR working according to our plan, and the first quarter was the most difficult one. From an operational standpoint, it is behind us and it was accretive. The order intake is according to plan, the sales run rate is according to plan, so we are happy.

Kevin Kessel - Bear Stearns

Okay. And then just last, just housekeeping, I guess. What take should we be modeling for tax rate going forward? I heard you say 23% effective this quarter. Is that a good rate to use going forward?

Richard N. Grubb - Executive Vice President, Chief Financial Officer and Treasurer

That's a good rate to use going forward.

Kevin Kessel - Bear Stearns

And then what about interest expense. With the change in converts, I was expecting to see a decline in your interest expense in the quarter, I don't think that happened.

Richard N. Grubb - Executive Vice President, Chief Financial Officer and Treasurer

Well the change... what do you mean? I am sorry.

Kevin Kessel - Bear Stearns

I am sorry, just accounting for your convertible.

Richard N. Grubb - Executive Vice President, Chief Financial Officer and Treasurer

Oh, yes, for the accounting, it did... I mean it did have an impact but no interest expense wise. There wasn't any reduction in the interest expense.

Kevin Kessel - Bear Stearns

Should we be expecting one?

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

I would sure like to, but I mean, until it has been negotiated that's going to happen. It's a 3.58 that's the stated rate.

Kevin Kessel - Bear Stearns

Right. Okay, but I thought that when you saw a reduction in your share count, you'd see a corresponding reduction in --

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

Yeah, the share count compensation is something that takes place often in prime estate and lift interest as it is.

Kevin Kessel - Bear Stearns

Okay, okay. So then in your other income that's strictly down $3 million due to cash decline for the acquisition?

Richard N. Grubb - Executive Vice President, Chief Financial Officer and Treasurer

We actually stated $300 million on a $330 million --.

Kevin Kessel - Bear Stearns

Great. All right. Thanks guys.

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

Okay.

Operator

Your next question comes from the line of Jim Suva [Citigroup].

Jim Suva - Citigroup

Great. Thank you, this is Jim Suva of Citigroup. Can you talk a little about now that Q2 is over and you've already had a full month of July behind you, a little bit about the demand and mix trends as well as the European seasonal slowdown; are you expecting it to be normal, a bit better, or a bit worse?

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

Well, first of all concerning Europe. We have no reason to believe that it's less than it's normal than the normal situation in the third quarter. Secondly, July indeed has shown some good book-to-bill ratio. So, we are quite confident that our projection which we gave for the quarter will materialize.

Jim Suva - Citigroup

Okay. Then as a quick follow-up. On your sales of 710 to 730, can you just remind me again what amount of that is organic growth quarter-over-quarter and year-over-year versus acquisitive?

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

I can tell you what is included for IR, approximately $60 million is included for IR.

Jim Suva - Citigroup

$60 million. Okay. Thank you.

Operator

Your next question comes from Tom Dinges [JP Morgan Securities].

Jason Gursky - JP Morgan Securities

Good morning. It's Jason Gursky stepping in for Tom. Perhaps just a... another follow-up question on IR. Just looking back to some of your previous statements about the operating margin contribution. I think last quarter you stated that in the first quarter of '08 it ought to be about $14 million, you are now saying it's going to be about $11 million, and it seems that the business which you are about to divest is loosing money. So, I was just wondering if you could walk us through perhaps what's change?

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

From operating margin standpoint... operating margin standpoint, we have to expect this level of sales a positive contribution. This is our acquisition plan, and what you see, $11 million is exactly the same number which we have announced only subtracting the impact of the automotive business. You see, we are not running at $80 million at this point in fact, in July sales.

Jason Gursky - JP Morgan Securities

Okay. So, the assumption then previously was that the automotive business... the automotive business lost business, lost money this quarter end.

Richard N. Grubb - Executive Vice President, Chief Financial Officer and Treasurer

Correct.

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

Operationally yes, it was low... it was really low sales.

Jason Gursky - JP Morgan Securities

Okay, but the expectation was that it was going to be running at a $3 million positive?

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

Yes.

Jason Gursky - JP Morgan Securities

Okay, great. That helps. And then secondly, just, can you talk a little bit more in detail about trends with the distributors and perhaps what their weeks of inventory are at this point and what expectations are on stocking going forward and then --

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

Distribution inventory, let's face it, is on a relatively high level. On the other hand they have reasons to be on a high level. The POS is unbroken... it's quite... it's really strong, really strong. And book-to-bill of their business is principally, as I said, all together it's 0.96, what we have seen for our product. But we may not forget that American, Asian distributors are above one in their book-to-bill, and only Europe, I'd say, is a collection of an excellent first quarter was substantially below. So distribution is confident, no question about it. So they tolerate, the high... relatively high inventory at or the lead terms, could be high, I guess, as they feel, but principally speaking the progress of the situation continue to order. Europe I think was kind of single, I would call it, singularly it is stronger, but for sure it was, I think it was a correction vis-à-vis two strong first quarter.

Jason Gursky - JP Morgan Securities

Okay. Great. Thanks guys.

Operator

[Operator Instructions]. Your next question comes from Andrew Huang [American Tech. Research].

Andrew Huang - American Tech. Research

Hello, can you hear me?

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

Yes.

Andrew Huang - American Tech. Research

Oh, hi. So, first, can you comment in general what the linearity is normally for the September quarter?

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

What do you mean by linearity?

Andrew Huang - American Tech. Research

Oh like, maybe the percentage of revenue on a month-to-month basis, like for, I guess, July, August, and September.

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

We don't do it by a month. I could develop that. But of course, and we say August is a relatively weak month because we have more than a third of our business in Europe, but unfortunately, I'm not able to give it by month. But take, August is relatively low. It's not quite linear in the second quarter. July should be the average more or less and September should be above average something.

Andrew Huang - American Tech. Research

Okay. And then maybe you can help me paraphrase because when I heard commentary from you and your kind of passive figures suggesting that, just the POS is strong. But if you look at Arrow, they kind of guided down their revenues for the September quarter. LifeChecks [ph] are kind of suggesting that the POS may not be so strong, so?

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

They have a strong branch in Europe. They have... it is not only the US, they are quite strong in Europe. Maybe they see some seasonal effects in Europe.

Andrew Huang - American Tech. Research

Okay. Great.

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

But I'm not the one to comment on them to be honest, it's only my opinion.

Andrew Huang - American Tech. Research

And then for clarification purposes. You said that for the September quarter you expect IR to contribute $60 million in revenue?

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

Yes.

Andrew Huang - American Tech. Research

And on an apples-to-apples basis to the June quarter, will that compared to the $67 million or compared to $57 million?

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

It was $52 million, compared to $52 million.

Andrew Huang - American Tech. Research

Got it. Thank you very much

Dr. Gerald Paul - President, Chief Executive Officer and Chief Operating Officer

Thank you.

Operator

At this time we have no further questions. Gentlemen do you have any closing remarks.

Richard N. Grubb - Executive Vice President, Chief Financial Officer and Treasurer

No. I would like to just say that we appreciate you tuning into our conference call. We look forward to getting together again sometime in early... late October. Thanks very much.

Operator

Thank you for joining us on today's conference call. You may now disconnect.

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