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Microsemi Corp. (NASDAQ:MSCC)

F1Q08 Earnings Call

January 24, 2008 4:45 PM ET

Executives

James Peterson - President and Chief Executive Officer

David Sonksen - Executive Vice President, Chief Financial Officer and Secretary

Steven Litchfield - Executive Vice President and President of Analog Mixed Signal

John Hohener - Vice President - Finance, Treasurer and Chief Accounting Officer

Terri Donnely – Coordinator

Analysts

Rick Schafer - Oppenheimer & Co.

Tore Svanberg - Thomas Weisel Partners

John Lau - Jefferies & Company

Harsh Kumar - Morgan Keegan

Nicholas Aberle - Caris & Company

Vern Essi, Jr. - Needham & Co.

J. Steven Smigie - Raymond James & Associates

Romit Shah - Lehman Brothers

Andrew Huang - American Technology Research

Craig Berger - Friedman Billings Ramsey

Christopher Longiaru - Sidoti & Company

Analyst for Shawn Webster - J.P. Morgan Securities

Steve Park - Wedbush Morgan

Operator

At this time I would like to welcome everyone to the Microsemi first quarter earnings conference call. (Operator Instructions) I would now like to turn the call over to Miss Terri Donnely. Please go ahead.

Terri Donnely

Good afternoon, and welcome to Microsemi’s first quarter fiscal year 2008 conference call. I am Terri Donnely, coordinator of this call. In a few moments you will hear from and have an opportunity to ask questions of Jim Peterson, our President and Chief Executive Officer, of Dave Sonksen, our Executive Vice President and Chief Financial Officer, of Steve Litchfield, our Executive Vice President and President of the Analog Mixed Signal Group, and of John Hohener, our Vice President of Finance. A recording of this conference call will be available on the Microsemi website for 30 days under the investor section. Our website is located at www.microsemi.com.

Let me remind you that during the course of this conference call management will state beliefs and make projections or other forward looking statements regarding future events and the future financial performance of the company. Due to the changes in public companies’ abilities to communicate with analysts and investors brought about by SEC rules on fair disclosure, Microsemi issues guidance in the form of a limited business outlook on our expectations for the next quarter. This business outlook reflects our expectations as of January 24, 2008 and is continually subject to reassessment due to changing market conditions and other factors and therefore must be considered only as management’s present opinion and actual results may be materially different. However, management undertakes no obligation to update these or any forward looking statements whether as a result of new information, future events, or otherwise. If an update to our business outlook is provided the information will be in the form of a news release. We wish to caution you that all of our statements except the company’s top financial results are just our opinions, predictions, and present expectations. Actual future events or results may differ materially. I refer you for some of the risks to Microsemi’s report on form 10-K for he fiscal year ended September 30, 2007 which was filed with the SEC on November 21, 2007. Information about Microsemi filed with the SEC is available free of charge at www.SEC.gov. These reports identify important factors that could cause actual results to differ materially from projections. That said, we can begin. Here is Jim Peterson.

James Peterson

Thank you Terri. I would like to thank all of you for joining us this afternoon for Microsemi’s first quarter fiscal year 2008 earnings call. Net sales for Microsemi’s first quarter were $123.5 million up $3.2 million sequentially from $119.7 million reported in the fourth quarter of fiscal 2007.

The first quarter 2008 produced non-GAAP earnings of $0.31 per share diluted up from $0.28 per diluted share reported in the prior quarter. The non-GAAP gross margins were 51.3% up from 51% in the previous quarter and non-GAAP operating margins were 26.2% up 200 basis points from 24.2% reported in the September quarter. These results show Microsemi’s ability to execute on growth and margin improvement strategy even as others begin to show signs of the much talked about macroeconomic slow down. We’ve grown our revenues through the new product offerings, market increases, and end market growth while also increasing gross and operating margins. The environment for Microsemi’s high performance analog mixed signal business continues to show strength and the high reliability business continues to show very robust demand. We will continue to drive our strategic plan to grow in all of our markets with new product offerings and unique value propositions for our customers. As we execute on this plan we expect to continue to outpace our semiconductor industry peers. Bookings in the first quarter were strong across all major markets. We achieved a book to bill ratio of 1.09 to 1. The particular areas of continued strength this quarter were defense, commercial aerospace, satellite, LCD TV, and notebook markets. The Analog Mixed Signal Group showed strong results this quarter delivering record performance in revenues and profits. Steve Litchfield and his team continue to gain momentum with new product development efforts and remain on track to kick off a record number of differentiated products in 2008 that will drive significant growth in coming years. As I said last quarter, [back lagging] remains one of the strongest drivers of the Analog Mixed Signal Group delivering double digit sequential growth in notebook, LCD TV, end display end markets where we saw record bookings and shipments. We continue to see market share gains in LCD TV business for CCFL with notable design win strength in tier 1 Japanese and Korean markets. We see significant design win traction with the new products and expect to see strengthening throughout all of 2008.

The power ethernet business continues to be very robust as this market develops. The business showed strong bookings in shipments this quarter and we expect to see improvements over the course of the year. In particular we have several new integrated circuits, several system level products, PoE products that will be released to production in the next 2 quarters that are already driving new design wins. Our PoE port shipments grew again in the quarter enabling us to stay ahead of the industry growth rate. Last year we reported greater than 50% growth rate in port shipments. We are on track to meet that growth rate again this year. The market demand is strengthening for client devices such as IP video cameras, phones, and wireless land access points. We see this market growing with the PoE plus standard 802.3AT which enables higher powered devices and expands our opportunity in notebook markets. We again saw strength this quarter with our wireless land power amplifier products. What I liked in this first quarter was the award of a key design win with the major chip set provider. We expect revenues from this win to start in the second half of 2008. The development efforts from this design team are showing excellent results with multiple new products being released this quarter that address the 80211N and WiMax markets. We will see continued proliferation to 80211N product offerings throughout 2008 with WiMax establishing itself as a key future market. The demand for these high bandwidth solutions drive our performance metric unseen by the wireless band marked historically. In the system performance benefits, the Microsemi’s breakthrough applications have added significant value to our customers’ solutions. As expected industrial and semi-cap shipments were down sequentially this quarter. The culprit as we discussed in our last conference call was the semi conductor capital equipment market. While we expect this business to rebound in 2008, the signs are somewhat unclear at this time. Our best estimates suggest weakness again next quarter with a potential return to growth in our third quarter. While this market is weak, our company wide diversity and broad market stability have offset this weakness and will continue to do so in our second quarter.

The industrial piece of this market has continued to show strength. For example, emerging alternative energy applications continue to show strong year over year growth trends. This is the market Microsemi is focusing our resources on to develop new products for growth in 2008 and certainly beyond. Our medical business increased sequentially last quarter driven primarily by our ICD business. Although the markets have been turbulent with the October recall, it appears that it has bottomed and is starting to improve. We expect to see our revenues increase each quarter throughout the fiscal year and as we continue to ship more of our higher ASP product mix which in turn will drive a more significant growth rate than a single digit expectation of the industry. The defense industry, solid. Spending for electronics showed every sign of increasing with new programs continually funded. Microsemi will see growth in all these programs including military avionics, military ground transportation, surveillance equipment, joint service communication systems, naval vessels, radars, missiles, and advanced combat unit electronics.

As we have said and continue to emphasize our satellite and commercial air markets continue to gain momentum despite concerns of the delay of the 787 Dreamliner. The commercial air market was up this quarter. Backlog is exceptional and we expect order rates to remain robust for the next several quarters. Our satellite business remains at record levels driven by strength in both military and commercial satellite platforms. This remains our most profitable product line and should drive improved gross margins as the business continues to grow. Despite the slow down in semi-cap and growing market concerns over the economic environment, our first quarter was a great start to what we believe will be another record year. We executed our business plans this quarter and positioned the company to deliver on its plans for the remainder of the year. Operationally we controlled costs and improved our GAAP and non-GAAP growth margins significantly this quarter. We also made two small yet strategic acquisitions that will expand our product offering that will allow us to further leverage our existing businesses over the long term and will allow us to enter new higher reliability markets. Given our strong position in our current markets, our continued focus on operations, and our new product introductions, we believe that Microsemi will again outpace its peers. With that let me turn the call over to Dave for the financial details of the first quarter of fiscal 2008 and our outlook for Microsemi’s second quarter ending in March.

David Sonksen

Thank you Jim. Now for the first quarter results. Net sales for the quarter ended December 30, 2007 were $123.5 million, sequentially up 3.2% from $119.7 million and up 20.7% from $102.3 million in the year ago first quarter. The book to bill ratio for the quarter was 1.09 to 1. Non-GAAP gross margins for the quarter were 51.3% compared to 51% in the fourth quarter and 50% in the first quarter of last year. This quarter non-GAAP selling, general, and administrative expenses were 16.1% of sales or $19.8 million as compared to 17.1% of sales or $20.4 million in the fourth quarter of last year. Research and development costs were $11.2 million or 9% of sales compared to $11.6 million or 9.7% of sales in the fourth quarter and compared to $8.8 million or 8.6% of sales in the year ago first quarter. We do forecast our R&D dollars to increase nominally as we continue to commit resources in R&D for new product development across our businesses.

Our non-GAAP operating margins were up 200 basis points to 26.2% in the quarter compared to 24.2% in the fourth quarter and 24.9% in the prior year first quarter. For the first quarter non-GAAP net income was $24.4 million or $0.31 per diluted share. This compares to $0.28 in the prior quarter and $0.25 per diluted share in the year ago first quarter, a 24% increase over the year. Our non-GAAP effective tax rate was 27% in the first quarter compared to 26.7% in the fourth quarter and compared to 32.7% in the year ago first quarter. This decrease reflects our corporate-wide tax strategy which is now translating into a lower effective tax rate. For the first quarter our GAAP net income was $8.6 million or $0.11 per diluted share as compared to GAAP net income of $10.1 million or $0.13 per diluted share in the fourth quarter and compared to $10.6 million or $0.14 cents per diluted share in the year ago first quarter.

Our GAAP operating margins decreased from earlier quarters due to increasing stock based compensation associated with adoption of FAS 123R as well as a one time gain of $4.4 million from the sale of two properties last quarter that caused GAAP gross margins to be higher in the fourth quarter of last year. Our first quarter results include restructuring costs and other charges and credits. These include a charge of $10.8 million for transitional idle capacity, $3.1 million in amortization and acquisition related intangibles, $6.1 million related to stock based compensation charges, $0.4 million for process research and development expense associated with our MDT purchase acquisition, and $0.8 million in other charges.

Our GAAP gross margin was 42.6% up from 39.6% in the fourth quarter and our GAAP operating margin was 8.9% compared to 12% in the fourth quarter of last year and compared to 13.7% in the year ago first quarter. Let me take a moment to address our line item transitional idle capacity, an item that affects the GAAP gross margin. Some of these items decreased this quarter compared to last quarter. This progress is reflected in our GAAP gross margin improvement of 300 basis points over the previous quarter. This improvement was achieved even as we ramped up our Ireland facility to support our increased manufacturing needs; in other words, we improved our absorption efficiency. This is expected to continue throughout the year as we rationalize our manufacturing costs at all of our other facilities while we balance these transitions.

Here are a few income statement details and balance sheet items. Depreciation and amortization expense for the quarter was $6.9 million compared to $5.7 million in the fourth quarter. Capital spending was $5.2 million this quarter compared to $3.6 million in the fourth quarter. Our cash position at the end of the quarter was $105.3 million compared to $107.7 million at the end of the fourth quarter. Excluding the payment of profit sharing in the first quarter and the purchase of MDT and TSI for $8.9 million in cash, our cash balance increased $13.9 million in the quarter. Our accounts receivable were $87 million at the end of the first quarter compared to $81 million at the end of the fourth quarter due primarily to increased revenue. Our DSO was 63 days for this quarter compared to 61 days last quarter. Inventories at the end of the first quarter were $118.2 million compared to fourth quarter levels of $115 million. This increase included the final strategic purchase of $1.9 million in specialized materials and another $1 million from the MDT acquisition. The good news is that our finished goods inventory again decreased by $1.2 million. In addition, our days of inventory improved to 177, down from the prior quarter of 179. Our best estimate of the end market percentage break out of net sales for the first quarter was approximately: defense 32%, commercial air satellite 20%, medical 13%, notebook sales, CD, TV’s, displays 11%, mobile connectivity which includes our PoE products 15%, and the industrial semi-cap sector 9%. Now for the business outlook. We expect that for the second quarter of fiscal year 2008, our sales will be up in a range of 2% to 4% sequentially. On a non-GAAP basis we expect earnings for the second quarter of fiscal year 2008 to range from $0.31 to $0.33 per diluted share. What that I will turn you back over to Jim Peterson.

James Peterson

Okay, thank you Dave. Let’s open the conference call to questions from analysts and institutional investors. All right, we are ready for the fun part, the questions from the analyst and the institutional investors.

Question-and-Answer Session

Operator

Your first question comes from the line of Rick Schafer of Oppenheimer & Co.

Rick Schafer - Oppenheimer & Co.

Hi guys, just a couple questions for you. The first on just on the book to bill. Another big number 1.09, can you just kind of walk us through that, is there anything specific that is driving that sort of reacceleration your book to bill?

James Peterson

I can tell you one area it is not and that is semi-cap. However it is pretty much the strength in pretty much all our markets and I am especially proud of the Analog Mixed Signal Group who came in with not only strong bookings to help that but strong results across the board. It is across almost all our major markets, Rick

Rick Schafer - Oppenheimer & Co.

Okay, I just have a second question here just maybe a little more broad but we are starting to hear more of your analog peers sort of talking up the opportunities in high-rel, some of your key high-rel end markets. Are you seeing any significant change to the competitive landscape out there?

James Peterson

No as a matter of fact, we have been talking about the strength of those markets for quite a while and I think in particular the one that recently came to the party was Intercell guys. As you know 7 to 10 years ago they were aggressively in the military space and chose to exit it. Now realize that they are not in the discrete, they are not in the same market as we are, but they should be side by side with some of the CDC products and other products that Intercell has to offer. I know that they are working on some [rad hard] programs and guess what, that is what we are doing too in that particular area. I don’t think we are going to be competing against them directly but I think we will be entering those markets side by side. One thing that we all remember to get something approved for [rad hard] from conception is certainly a 5 to 7 year project. Anybody that is coming in expecting year term revenues should be realistic.

Rick Schafer - Oppenheimer & Co.

Basically, you are hearing the same things we are hearing but you are not really seeing it sounds like to me in terms of...

James Peterson

No, no, no, I have seen essentially predominately my sole source position has not moved one inch in the last 3 to 5 years and certainly has not moved an inch in the last quarter.

Rick Schafer - Oppenheimer & Co.

Okay, just one last question to just kind of follow-up. I think Dave kind of walked us through this a little bit so I don’t know if it’s your question Jim or Dave but it is pretty obvious you guys are making nice strides to kind of close that gap between your pro forma and your GAAP gross margin. Can you give us some color on what is going on there and wouldn’t you expect those two to meet, be the same number?

James Peterson

Yes, I am going to take it. I am now going to let Dave take this one because this lies right on my shoulders. The word there that we don’t like to speak of is transaction, the item capacity that we got, the transitional capacity. I will be quite honest with you. The fact is that all companies are not created equal and neither is Microsemi. We formed this company with 30 plus acquisitions since its inception. Most certainly what we focus on the last 7 or 8 years was to integrate these companies and do some more acquisitions therefore our business motto and our focus have been in different areas. All that having been said as a team, if there is one metric stat I am most disappointed in predominantly for myself is the transitional ideal capacity. I think that metric is far stretched from where it should be. So what are we going to do here? The fact of the matter is, the plan is that within 6 quarters just to be a little bit conservative certainly within 8, but I will try to get it done within 6 quarters, we’re going to have the gross margin, the GAAP and non-GAAP to be identical. Furthermore, to give you a little confidence let me tell you how I am going to do it. We have kind of a 3 point plan and we are all working with our shoulders to the wheel, 1) because I need to enforce a hard closure on Colorado to get there. Don’t you remember I kept it open as a solid customer and a partner with defibrillator manufacturer Boston Scientific we put a press release out? I need to stop that relationship and move that manufacturer into our other sites and make that hard. Important component, the second one is I want transfers. It’s a new strategy we put in the last couple quarters and we are going to see some great strengthening in operational and some tax advantages moving the operations over to Ireland. That is in play and that will contribute, then of course transfers of our products over to the international marketplace. To recap it, we understand it, I don’t like where it is at, we are gong to fix it, we are going to fix it within 6 quarters and certainly no more than 8 just from a cautious note, because I know you guys measure. Speaking of measure the beauty is, let’s measure it quarterly and my goal and my team’s goal is to deliver, to get that GAAP and non-GAAP to be identical. Thanks for asking, chief.

Rick Schafer - Oppenheimer & Co.

Okay, great. Thanks guys, nice quarter.

Operator

Your next question comes from Tore Svanberg of Thomas Weisel Partners.

Tore Svanberg - Thomas Weisel Partners

Congrats on another solid quarter. If I look at the outlook here there is a lot of nervousness yet you are getting another Steady Eddie 2 to 4. Could you comment a little bit more on your visibility, where you stand right now. I know you mentioned backlog and book to bill but just give us a sense of visibility where you stand here at the end of January.

James Peterson

Visibility is good. Our turn rate is about 33%. More importantly I think the macroeconomic concern is certainly in the consumer end of it. We see what is going on out there but we are not a big part of it. Cycle time is 65% of our business is greater than 30 weeks, 30 to 52 for the military aerospace and defense, so we have great visibility in our customer base. There might be a concern if a young child is going to get a new iPod or a new pair of jeans versus the ones that they got last week. However, we don’t see that in the satellite market, we don’t see that in the commercial air market, we certainly don’t see it in the defibrillator market where people medically need these devices. 65% you don’t see it. Let’s talk about high performance analog mixed signal. That is what people are saying is our market is quite honestly once again kind of a little immune to it. LCD TVs and the like they are strengthening some people call it the Shirley Temple phenomenon. Even if there is a war, recession, depression people want to be entertained so for some strange reason flat panel TV’s and LCD TVs are growing. The other area of focus for us is power amplifiers the 80211N and everybody knows that is becoming a standard and that market is growing. We see that there is going to be issue out there, we pieced a little piece with the semi-cap business but we are not entrenched in it at all.

Tore Svanberg - Thomas Weisel Partners

Good, on the medical side you seem to be a little more upbeat this time around. Does that mean that the high ASP products are now really going into production and that backlog that you talked about before is moving in?

James Peterson

Yes, we spoke a couple quarters back in particular strongly last quarter that our dollar content hit the magical goal of the $100 which I am never going to mention again and beyond and that product certainly is shipping into the market space. Let’s touch on your original phrase in this thing, it’s this time. It is a questionable market, it has gone through some interesting cycles, however the signal that I am getting from our customers and from product demand are all to the upside. They are predicting in excess of 7% to 11% organic growth in that area. I am still conservatively thinking 3% to 5% but the dollar content is going to boost us way above that curve.

Tore Svanberg - Thomas Weisel Partners

Good, finally on PoE and you mentioned PoE plus, when should we expect to see some production volumes there?

James Peterson

PoE plus is still a few quarters out, maybe 3 or 4 quarters out. However, we did put our double stacking out there with the next generation product and the market is strong. You might see a little flattening to a slight down take next quarter in an overall PoE but strangely enough we found a market where there are cycles so my GAAP end this market. Overall we expect 2008 to be a banner year ideally.

Tore Svanberg - Thomas Weisel Partners

Last question. Semi-cap industrial is now 9%. Should we assume that the semi-cap of that is almost zero?

James Peterson

No, there is a bit in there strangely enough, but what you should not assume is that it... I thought it hit that trough last quarter. I don’t think so. There's still some more downtick from Microsemi in the semi-cap market space.

Tore Svanberg - Thomas Weisel Partners

Great, thank you very much and good quarter.

Operator

Your next question comes from the line of John Lau from Jefferies & Company.

John Lau - Jefferies & Company

Given your leadership in the lighting area I had more of an industry question and it has to do with the conversion from CTFL to LED for key applications such as notebooks. You are designing parts for both of those. When do you actually see the volume transition occurring, thank you?

James Peterson

We are in luck, I got Lichfield here he is all dialed in. He just got back from CES and he’s close to the equation. Steve?

Steven Litchfield

John with regard to that transition I think it is kind of interesting over the last probably 12 to 18 months we have seen that kind of shift back and forth where we thought it was coming very fast and then it clearly slowed down. I would say in the last 4 months or so that we have seen the interest level pick up a little bit and so we are seeing a lot of interest on the notebook side. I think you are still talking single digits penetration for 2008 for sure, 2009 maybe you are at the 8% to 10% maybe as high as 12% of the market converts over to LEDs in the notebook space. So, I think we are well positioned with products in CTFL as well as in LEDs. I will take the opportunity to speak about the TV market as well because I think that is something coming. Just coming back from CES we are really very excited about the product that we have. The DAZL products with the zone dimming capability, the color management capability. These are great features that we have. I think we are ahead of the market. I think TV is probably going to lag notebook just a little bit. I think we are well-positioned in both markets and it is actually a pretty exciting time and it is always nice to be ahead of the market before you see the big transition coming so I think that it will be good. The great thing is this all brings me back to our CTFL business. Our CTFL business for backlighting for notebooks, I think we are taking share there. I am actually excited about the year to come in notebook. I am also excited about the TV market for our CTFL products. We got some new products that actually just came out last quarter as we spoke a little bit about them at the last conference call. I expect those to ramp during our 2008. We should probably have record levels this year.

John Lau - Jefferies & Company

Great, thank you very much.

Operator

Your next question comes from the line of Harsh Kumar from Morgan Keegan.

Harsh Kumar - Morgan Keegan

Solid guidance. A couple of questions. OpEx control, you guys did a tremendous job this quarter. Can you tell us basically on a fundamental level what you are coming back on and how you are saving costs and what we should expect going forward?

James Peterson

The principal reason for the decline in SG&A this quarter in terms of dollars was the reduction in legal expense associated with the settling of the potential litigation with O2 Micro. We're already in a position to control those costs, the growth of those costs. We feel real strongly about that going forward.

Harsh Kumar - Morgan Keegan

What I mean, hearing is that we should be looking at a sort of a downward draft moving forward as a percentage or absolute dollars?

David Sonksen

A downward is a percentage of total revenue.

Harsh Kumar - Morgan Keegan

Then Jim maybe you can give us an idea of how much semi-cap was in the last quarter and what it was this quarter so we can gauge how much the rest of the business grew just on an organic basis outside our semi-cap.

James Peterson

I will give you a large number and let you break down out your crayon Harsh. Essentially the bucket that we have for industrial and semi-cap was 11% of our sales. Last quarter was pushing towards a low 9%. It took 2 total percentage points out of our total sales.

Harsh Kumar - Morgan Keegan

Got it. Jim you talked a little bit about the PoE port growth of 50% for yourself. We have heard of revenue numbers of around 25% CAGR going out. Do you think when you convert the ports to revenues do you think you will be able to out perform the market this year calendar ‘08?

James Peterson

Most certainly.

Harsh Kumar - Morgan Keegan

Okay, fair enough, thanks guys. Thank you

Operator

Your next question comes from the line of Nicholas Aberle from Caris & Company.

Nicholas Aberle - Caris & Company

How is it going guys?

James Peterson

Hey Nick how are you doing?

Nicholas Aberle - Caris & Company

Good, I just wanted to talk about MDT and TFI a little bit. Can you give us a little more color on operational strategy there and then the product strategy going for it?

James Peterson

Essentially dollar-wise it was lets say small to quasi-insignificant; however, very strategic in nature. Essentially what we are doing is vertically integrating our liability business, our discrete business, into next level next generation business looking for some higher packaging and some substrate products essentially allowing us to enter into a market which is maybe $700 million to $800 million market. Not to repay a premium for some of that there, but just by acquiring 2 to 3 maybe a few more small guys and putting them together. Essentially its why should [Hiti] have all the fun?

Nicholas Aberle - Caris & Company

Production for those products are being brought in house?

James Peterson

You know we are going to keep the sign at TSI open. The fact of the matter is some were better in acquisition with tremendous amount of value in manufacturing equipment. They did honor about, I don’t know, what was it, $1 million worth of revenue but I think they can do $10 million or $15 million there certainly by us bringing some customers to them. Then we are working obviously with [SC] and the military organizations to get them qualified as quickly as possible.

Nicholas Aberle - Caris & Company

Got ya. In terms of gross margin, continued nice steady upticks there. Should we assume that it will kind of stay on that same pace going forth?

James Peterson

You know we’ve got two things going on right. We certainly want the gross margins to go up quarterly. I think we said we were guiding on or about 20 basis point quarter by quarter strengthening. More importantly not to beat a dead horse but we are on track to close the gap between non-GAAP and GAAP in that particular area. It is going to take a lot of focus and hard work of the company.

Nicholas Aberle - Caris & Company

In terms of visibility I was just curious how is your visibility looking into the March quarter relative to what it was when you guys were guiding for December?

James Peterson

Not much different than last. Turns rate is somewhere around 33%. You know I am extremely comfortable obviously with the higher liability because the lead times get us there and cycled times get us there and in the analog Mixed Signal Group we are finding strength because there is a lot of new product in there. We are getting a lot of design wins. I am not uncomfortable at all. Our visibility is very good and fair and very crisp.

Nicholas Aberle - Caris & Company

All right Jim. The last question on a segmented basis in terms of revenues should we expect that the analog group will be down seasonally or are you guys going to do something to offset that?

James Peterson

Strangely enough, strangely enough because once again leading the markets are LCD TVs. They just continue to grow and Litchfield and his team are gaining market share. The 80211N, the power amplifiers, and that standard is growing, that market is growing. The way it looks right now and I am sure the way it will look for close of that quarter is possibly up in both buckets

Nicholas Aberle - Caris & Company

Awesome, good luck you guys.

James Peterson

Thanks.

Operator

Your next question comes from the line of Vern Essi, Jr. - Needham & Co.

Vern Essi, Jr. - Needham & Co.

I just wanted to dive into that LCD TV point here and I think on the last time around here for the third quarter your September quarter rather, you underperformed your competitors in that space. I am just wondering if there was, I mean you are claiming market share gains but was there anything else in terms of channeled inventories that may have impacted a more robust number?

James Peterson

Let me bring you back to what it was. We actually outpaced them last quarter, taking market share in LCD TVs, and quite substantially we, in the tier 1, particular tier 1 in Japan and Korea, continue to take market share in that particular area. We're not losing traction at all. Now, this is CCFL, LCD TV, my friend.

Vern Essi, Jr. - Needham & Co.

So, I mean if I go back and look at the numbers I talked about this offline with you folks. I am just trying to understand if there was something else in that mix which caused that it to perform better or more delayed rather than it should have seemed in the December quarter.

James Peterson

I am a little fuzzy about the question you are looking at. With what at my numbers are in front of me all I am seeing is strengthening in those are areas, Vern.

Vern Essi, Jr. - Needham & Co.

Okay.

James Peterson

Maybe it is blended that in that particular box or that bucket for the field, but the whole thing to me looks like it is on the upside and gaining.

Vern Essi, Jr. - Needham & Co.

And then one other thing, the hard drive business, have you gotten back into that customer, or is that--?

James Peterson

Yes, here is the deal. What we do on the hard drive, we work with one guy and one guy only, and that's Seagate. Okay? Last quarter Seagate was stronger than forecasted. We picked up a little more market share and rode some of their successes. Next quarter, I expect that to be down slightly. Nothing material, but down slightly, and that's our, that's our only HDTV customer.

Vern Essi, Jr. - Needham & Co.

Okay, finally on aerospace you obviously got some phenomenal visibility. How should we be modeling that now on sort of an annual basis?

James Peterson

You know what? To the upside I think we could find growth in there. I mean the growth that is out there for the analyst that write on that segment is somewhere between 8% and 13% so I thing for organic growth you can certainly feel that’s a comfortable number. There’s been a lot of things happening in the commercial aerospace. Forget the strength and the backlog of aerospace with Airbus and Boeing which is 3 to 4 times greater than you have ever had before, subtract the little concern about the delay in the Dreamliner and then look a the refurbishments that are going on internationally because of the strength in the national market and in the private sector market for private airplanes and the like. You go 8 to 13 the equivocal price positioning around it and some new product around it. You got yourself a solid for Microsemi, a solid 15% to 18% growth.

Vern Essi, Jr. - Needham & Co.

Thank you very much

James Peterson

You’re welcome, my friend.

Operator

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

J. Steven Smigie - Raymond James & Associates

I was hoping you could comment a little bit on the products coming out of Steve Litchfield's group. You mentioned a bunch of new products, some you could talk a little bit about, the timing of that, and what that would look like as a bunch of new products all at once in Q1, or does it sort of stream out over the course of the year?

James Peterson

They rolled it out nicely over the last couple of quarter. We spoken to the fact of some new PoE product, both ICs and certainly in the systems for the PoE product, with wonderful traction there with the design wins going forward. Certainly in the power amplifier area, we seem to have slid a year back behind our major competitor. Steve and his team have aggressively gone after winning market share for 80211N, for the wireless LAN and then getting into the WiMax market space and securing some design wins there, and strangely enough a design win in some mobile portable ones for handheld applications, so they're rolling out some products in that area. LCD TVs, digital controllers, fine tuning and shrinking, and next generation products, they're doing a great job there, and then strangely enough, a handful of products for the set-top box TVs. I think what Steve and his team have done is picked out their markets, focused on it, and worked on improving products and working on next generation products, and then the DAZL product, which is certainly usurping the industry, and I think will pass the test of time as being probably the most successful product in next generation LCD TVs.

J. Steven Smigie - Raymond James & Associates

Great, then my next question is let’s talk a little bit a bout R&D dollars or potential revenue in that group. Where do you want it, do you have to take it up? How do you see the R&D best investments?

James Peterson

Oh that is you know Steve always wants more. I have to control him. The good old R&D is a percentage versus our peers we are significantly lower but strangely enough if I don’t invest in it I am not going to be successful and continue market share for my customers. So overall, the percentage of sale I like to try to keep it flat to slightly up. In Lichtfield you will get the larger proportion of it.

J. Steven Smigie - Raymond James & Associates

Great, thank a lot.

Operator

Your next question comes from the line of Romit Shah of Lehman Brothers.

James Peterson

Hi Romit, how have you been?

Romit Shah - Lehman Brothers

Good thanks. Just from the defense business a couple of your competitors talked recently about some lumpiness there. Are you guys seeing any of that at all?

James Peterson

No, not at all, I mean the lumpiness always fell from the fact that the government would issue the funding on 1 October and if there is lumpiness it is usually between September and October 1 is where people start calling lumpiness. Most certainly I have seen nothing but strengthening from 1 October to where we are right now and I have no reason to believe that’s going down.

Romit Shah - Lehman Brothers

Okay great. Then just on stock competition expense. Looks like there was about an $0.08 impact in December. Can you just walk us through that? Was there anything there that was one time? I actually think about stock contour at the beginning of the year.

James Peterson

Sure, David?

David Sonksen

Yes, the charge in the quarter was $6.1 million up considerably from the prior year because of the continued effect of the adoption of FAS 123 and also because we have restricted stock grants from the first quarter some of which suggests immediately that this number is higher than in that quarter. Looking out going forward we expect about $5 million per quarter.

Romit Shah - Lehman Brothers

Okay, great thanks a lot.

David Sonksen

Okay.

Operator

Your next question comes from the line of Andrew Huang of American Technology Research.

Andrew Huang - American Technology Research

Hello everybody. I am glad I made it into the queue.

James Peterson

Sometimes you’ll be first and sometime the first will be last and the last will be first. Isn’t that how it goes?

Andrew Huang - American Technology Research

I guess the first question is on the defense side. I think over the past 12 months you have been talking a little bit about capacity constraints of the back end and I was wondering if you could first kind of talk a little bit about that going forward?

James Peterson

Yes, the capacity constraints continue. The fact of the matter is when you book a 1.13, 1.08, 1.09, and you ship it on or about 3% quarter-over-quarter, you're going to find yourself with predominantly sole source application waiting product; you're going to be behind the curve. That having been said, we don't have any customers lying down. So we're working on with the customers is a very close interactive meetings predominantly weekly on making sure they get the exact number of products that they need for their programs. That's going to continue. The question is how long does that continue? That's probably going to continue the next 18, 24 months. We are putting in additional back end new burning capacity in Ireland, and that takes a while to get in. When you are building product where the cycle time is 30 to 50-plus weeks, if you put in new burning equipment, by the time you get it set up, you're still 30 to 50 weeks away from it. So we're working on the manufacturing constraints, we're hand to mouth, no customers are lying down, and somehow it turns out to be a pretty good position. You would be surprised; you can actually strengthen your relationship with your customers when you talk to them on weekly basis.

Andrew Huang - American Technology Research

Does Ireland already, is that facility already qualified? With your defense --

James Peterson

We are been building partners with Ireland for probably about 10 years. When we hadn’t chose awhile back we said you know we probably should unplug Ireland. Then when we took a further look at it we said, my gosh there is change in Ireland because electricity has gone down substantial. The work force has improved dramatically with Poland joining the EEU. The work force quite honestly has tremendous ability to put out some quality product in a timely fashion, then we find out that there are wonderful tax advantages to being there on top of all that. So Ireland is then qualified, what we are doing now is reshipping a lot of our capacity over to that direction as we speak all to the betterment of that country.

Andrew Huang - American Technology Research

Okay, great, and then just a question on the notebook and TV market. You guys are pretty adamant about that you're taking market share at the expense of your competitors…

James Peterson

Flat out telling you taking market share in LCD TV, right? Without a doubt, and in notebooks, we settled litigation with O2, and I'm here to tell you, and you'll see the results in Q3 and most certainly in Q4, we are without doubt taking market share from the entrenched competitors in that market space.

Andrew Huang - American Technology Research

My question is going to be can you explain how you are able to do it? I mean is it performance or is it price? How are you able to take share?

James Peterson

You know what; I'm not taking it on price. Quite honestly I'm taking it because of fear. Customers don't like being litigated against, or threatened to be litigated against. They're comfortable with the fact they're not going to be litigated against. We've worked with them for the last three to five years on trying to ease their fear, and then at the end of the day, a little touch of performance doesn't hurt.

Andrew Huang - American Technology Research

Okay thanks a lot guys. Bye

Operator

Our next question comes from the line for Craig Berger of FBR.

Craig Berger - Friedman Billings Ramsey

Hi, can you guys just explain to me a little bit more about this book to bill. You know your orders have grown about 80% over the last 8 quarters and your organic revenue growth is much less than that. How far out do those orders go and how do you know that those orders are the real thing?

James Peterson

Excellent question. They go out, maximum a year. The way we know they're real is I have them coming in weekly reviewing their demand schedule for projects that quite honestly their cycle time, my cycle time to build the product alone is 30 to 50-plus weeks, their cycle time is two to three years. These are high-end systems for satellites and aircraft and the like, and watch their reports, look what Rockwell Collins came out with, look at what Boeing came out with, look at Lockheed came out with, look at what all of those peers in that segment, every one of them have pronounced higher margins and strengthening going forward in their two-year projects, so I'm pretty comfortable that since we're working with them on this manufacturing constraint which turned out to be in a way, a way to get closer to your customers. We have a pretty good feeling for what their projects are, and even if 5% of those projecting fell south, we would still be way ahead of the curve because of the strength of the backlog. But that's a good question. It's a much different market than most of us are used to.

Craig Berger - Friedman Billings Ramsey

How often do you scrub your customer forecast?

James Peterson

Weekly, in that particular area, absolutely because we are on allocation. So I mean they want to know weekly so you have to scrub them weekly.

Craig Berger - Friedman Billings Ramsey

Separate topic, how much of the transitional idle capacity charges were cash this quarter?

David Sonksen

Probably about 80% of that is cash. There is some depreciation in there, some building costs, things like that. It is mostly cash. The nice part of it is Craig is that as we wind that up and close that gap that drain on our cash will go down.

Craig Berger - Friedman Billings Ramsey

I know you guys said you want to address this over the next 6 quarters. Should we expect supportive levels for the next 6 quarters or up or down?

James Peterson

We want it to go down, obviously we want GAAP and non-GAAP to meet, and that's the measure I like over the next quarter to quarter, as we go through this thing, that's where we're working. I think this quarter, 300 basis points improvement. Have a statement as to '08, we know what's going on and we're starting to move in that direction. So I think we're pretty much on track. We have identified the points of action within Microsemi which is the important part, and we luckily get to report quarterly.

Craig Berger - Friedman Billings Ramsey

Okay, well good job guys. Your report looks pretty clean.

James Peterson

Thank you my friend very much

Operator

Your next question comes from the line of Christopher Longiaru of Sidoti & Company.

James Peterson

Hello Christopher. What do you got?

Christopher Longiaru - Sidoti & Company

A couple things, first of all can you just talk about the Boeing 787 and you mentioned just how they orders are coming in and how you see this business going over the next year?

James Peterson

They have pushed out of course and they pushed when this thing is going to take off the ground and fly. I know that they have a shortage of components and I think it is pretty much aluminum, rivets and the like. The fact of the matter is that we are in system units. We are not seeing a lot of delays. Our customers are not saying, hey Boeing has pushed out 50 aircraft for sale. We are not seeing, right at this point we are not seeing anything. We are oblivious to it just because of the product that we are in.

Christopher Longiaru - Sidoti & Company

Now, is this something, though, that could just kind of come out of nowhere and slow down at this point in the next couple of quarters?

James Peterson

I don’t think we are going to see a lot of slow down on this thing. Even if Boeing is off, I just heard a report from one of the large aircraft manufacturers and they pretty much said that if Boeing was off 50 airplanes, if Boeing was short 50 airplanes, Microsemi wouldn’t see a penny moved in either direction.

Christopher Longiaru - Sidoti & Company

Okay, the other thing is we talked about pretty much everything across the board was showing improvement in the section of semi-cap. What I wanted to know is that is there one particular market segment where you are a little more conscious of what is going on, one that is a little more questionable in your mind?

James Peterson

You know, we got pretty good visibility here. I mean even Lichfield, even analysts say the lead times are about 12 weeks plus. I think right now we are safe.

Christopher Longiaru - Sidoti & Company

All right, my last question is for Dave. Could you break down just different stock based costs and R&D and SG&A?

David Sonksen

Yes, in cost of sales about 10%, in SG&A about 60%, and in R&D about 30%.

Christopher Longiaru - Sidoti & Company

I see, can you give a share term for next quarter?

David Sonksen

About 80 million

Christopher Longiaru - Sidoti & Company

Okay, thanks guys.

James Peterson

Okay thank you.

Christopher Longiaru - Sidoti & Company

Thank you David.

Operator

Your next question comes from the line of Shawn Webster of J.P. Morgan.

Shawn Webster - J.P. Morgan Securities

Thanks for taking my calls. A couple of quick questions. Is this possible lead time of 12 weeks, how does this compare to what it has been recently for you?

James Peterson

Let me give you the buckets. We are looking at 3 areas okay to make it easy. One is in the analog mixed signal it is on or about 12 weeks, okay. There are 2 other units you need to look at. One is higher reliability. Higher liability with the exception of satellite is somewhere between 22 and 30 weeks.

Analyst for Shawn Webster - J.P. Morgan Securities

Can you also comment about your utilizations rates?

James Peterson

Yes, sure. In the analog mixed signal, it's all fabless, so I don’t really have to engage in it and quite honestly in the Microsemi high reliability, I'm pretty much hand to mouth, I think in the fabs, we're certainly 85% to 90%, in the back end, I need help.

Analyst for Shawn Webster - J.P. Morgan Securities

Okay, thank you very much

James Peterson

Thank you my friend.

Operator

Your next question comes from the line of Steve Park from Wedbush.

Steve Park - Wedbush Morgan

I have a quick question. In terms of the deeds inventory. Are you guys more comfortable at this kind of 170-180 range going forward or do you expect that to kind of turn down over the year?

James Peterson

I was comfortable with 190, however what is it at right now today Dave?

David Sonksen

177.

James Peterson

177. So it's been trending down, so obviously if I was comfortable with a higher number, I'm real comfortable with that, but I think the game is here is to drive that down in days, and that's

Steve Park - Wedbush Morgan

I just have a quick question on LCD TVs. Do you guys expect kind of a bump up for ‘08 because of that transition from analog to digital for February 2009?

James Peterson

I think as part of it, the real bump up is the price coming down and people want them.

Steve Park - Wedbush Morgan

Okay, could see those peaks then do you expect that market slows down in 09?

James Peterson

I think as the prices come down, the demand is going to be there. I think technology, guys like you and I, yes, we'll focus on that, but the fact of the matter is the worldwide demand for these, conversion from the older TVs is catching on not only domestically but worldwide, it's just moving.

Steve Park - Wedbush Morgan

Okay, thank you.

Operator

Your next question is a follow up question from the line of Tore Svanberg of Thomas Weisel Partners.

James Peterson

Hey Tore.

Tore Svanberg - Thomas Weisel Partners

A couple of follow-ups here. First of all, when you mentioned $5 million in stock comp per quarter, was that after tax or pre-tax number?

David Sonksen

That is pre-tax.

Tore Svanberg - Thomas Weisel Partners

Do you have a rough estimate of what the other adjustments will be next quarter? Will it at least be higher or lower than the December quarter?

David Sonksen

Are you talking about the differences between GAAP and non-GAAP?

Tore Svanberg - Thomas Weisel Partners

Correct.

David Sonksen

I would expect, other than the transitional idle capacity, I expect them to be all about the same. The transitional idle capacity, we would expect to go down some. Remember Jim indicated that he expects that to decline zero over some six quarters going forward, and let me go back to your first question. I want to point out and this is kind of a jab at the FASB, but that stock compensation number is both before and after tax, because it's not deductible for tax purposes.

James Peterson

Correct.

Tore Svanberg - Thomas Weisel Partners

Okay, then lastly should we still assume a 27% tax rate for the foreseeable future?

David Sonksen

Yes.

Tore Svanberg - Thomas Weisel Partners

Thank you very much

Operator

Your next question is a follow up question from Shawn Webster from J.P. Morgan

Analyst for Shawn Webster - J.P. Morgan Securities

Good afternoon again. You talked about your turns requirement being about --

James Peterson

About 33%, my friend.

Analyst for Shawn Webster - J.P. Morgan Securities

33%, that is for the upcoming quarter?

James Peterson

Yes it is and you know what, it was about the same last quarter.

Analyst for Shawn Webster - J.P. Morgan Securities

Okay perfect, thank you.

James Peterson

Thank you.

With that, thank you for joining us today, and for your questions. By way of review, here are the main points we covered. The high performance analog mixed signal business showed impressive results this quarter. The group is driving strong new product development efforts with record product releases planned for 2008. Our reliability business continues to see very robust demand with tremendous strength in defense, satellite and commercial air markets. For a list of our financial conferences please refer to the website. We encourage you to attend one or all of our conferences. If you are not able to attend, we encourage you to listen to our presentations via webcast. Thanks again for being with us, and have a great day.

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Source: Microsemi Corp. F1Q08 (Qtr End 12/30/07) Earnings Call Transcript
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