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Semtech Corporation (NASDAQ:SMTC)

Q2 2009 Earnings Call Transcript

August 20, 2008 5:00 pm ET

Executives

Todd German – Director of FP&A, IR

Mohan Maheswaran – President and CEO

Emeka Chukwu – CFO and VP

Analysts

Shawn Webster – JP Morgan

Rick Schafer – Oppenheimer

Steven Smigie – Raymond James

Sumit Dhanda – Banc of America Securities

Harsh Kumar – Morgan, Keegan & Company

Manoj Nadkarni – Chip Investor Group

Craig Ellis – Citigroup

Operator

Good evening. My name is Brianna and I will be your conference operator today. At this time, I would like to welcome everyone to the second quarter fiscal year 2009 Semtech Corporation earnings call. All lines have been placed on mute to prevent any background noise. (Operator instructions) Mr. German, you may begin your conference.

Todd German

Thank you, operator. Good afternoon, ladies and gentlemen, and welcome to Semtech Corporation’s fiscal year 2009 second quarter conference call. I’m Todd German Director of FP&A and Investor Relations. We have just released unaudited results for our second quarter that ended July 27, 2008 and for the next 45 minutes or so, Mohan Maheswaran, Semtech’s President and Chief Executive Officer and Emeka Chukwu, our Chief Financial Officer, will be discussing those results and answering your questions.

Before I turn the call over to Emeka, I want to remind everyone of the following important information. This call is open to all interested parties in accordance with Reg FD. Any questions about our performance, operations, plans or our estimates of future financial results will be considered now. We are unable to say if there will be another Reg FD plan opportunity for you to ask questions before the next quarterly conference call.

Semtech reports results based on generally accepted accounting principles, commonly referred to as GAAP. The results today are preliminary, as the quarterly review by the company’s independent registered public accounting firm is still under way. As such, these results are subject to revision until the review is completed and the company files its quarterly report on Form 10-Q.

This quarter, we have also made reference to certain non-GAAP measures. These non-GAAP items are provided to enhance your overall understanding of our comparable financial performance between periods. In addition, management generally excludes certain items in managing and evaluating the performance of the business.

This conference call will include forward-looking statements. Forward-looking statements are statements other than historical information or statements of current condition and relate to matters such as future financial performance, future operational performance, the anticipated impact of specific items on future earnings, and our plans, objectives, and expectations.

Forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those projected. Some of these risks are discussed in our most recent filings with the SEC on Form 10-K and 10-Q. Although a replay of this call will be available on the Investor Relations section of our website, we assume no obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

For those interested in learning more about Semtech, CEO Mohan Maheswaran will be presenting at the Citigroup Investment Research and Technology Conference in New York on Thursday September 4, at 9.50 am Eastern Standard Time. Additionally Semtech will be ringing the opening bell in the NASDAQ stock market the following days September 5, a webcast link of the Citigroup conference presentation as well as the link to view the bell ring ceremony via the NASDAQ website are available through the Investor Relations section on the Semtech website. Thanks for your attention to this important preliminary information and I will now turn the call over to Emeka Chukwu, Semtech’s CFO.

Emeka Chukwu

Thank you, Todd. Good afternoon ladies and gentlemen. As previously announced, we had a fire on July 31 at our Reynosa manufacturing facility in Mexico. The Reynosa facility primarily supports our Power Discrete business unit. The fire affected operations in our fabrication facility and affected both the butane and the fiber equipment. While this did not affect second quarter of fiscal year 2009 results. We do anticipate an impact to earnings during the third quarter of fiscal year 2009.

The fire was contained to the fabrication segment of the facility allowing backend process into proceeds. However, during the clean-up, retooling and retrofit of the damaged segment to the building new stocking material into the Fab will be delayed, which will impact revenue and overhead absorption in the third quarter of fiscal year 2009. There will also be additional costs incurred related to the fire that will impact the third quarter and while the insurance claims should cover most of the increased cost. The timing of the insurance recovery may lag the quarterly expense occurrence.

At this time our best estimates is that the third quarter revenue, will be negatively impacted by approximately $1 million and fully diluted earnings per share will be negatively impacted by approximately $0.01 to $0.02 and it is reflected in our Q3 guidance. We believe that our Q4 revenue will be impacted by $2 million or $3 million. However, at this time we cannot quantify the impact on Q4 gross margin or earnings per share, while we are disappointed with this set-back at our Reynosa facility. We are pleased with the progress we have made in executing our recovery plan and still we will be able to resume full operations by the fourth quarter of fiscal year 2009.

Now, to our Q2 results, revenues for the second quarter of fiscal 2009 were $78 million a 16% increase from the same quarter last year and up 5% sequentially. The increase in year-over-year revenue was driven by strength in sales of our Protection products and our Power Discrete products. As expected, revenues increased sequentially due to strong demand for our high-end consumer products.

During the second quarter 59% of our revenues were derived from customer in Asia, 27% from North America and 14% from Europe. For the second quarter OEM sales represented approximately 43% of total revenues, while distribution represented approximately 57% of total revenues. Orders were up sequentially in Q2 resulted in a book-to-bill above one. We saw strength in our high-end consumer and computing end-markets driven by demand for our Protection and Power Management products. Net terms orders accounted for 33% of shipments during the quarter.

Our GAAP net income for the quarter was $11.7 million or $0.19 per diluted share, up from $9 million or $0.13 per share for the same quarter last year and up from net income of $8.1 million or $0.13 per share for the first quarter of 2009. We expect GAAP net income of $0.17 to $0.19 per diluted share in the third quarter of fiscal 2009. For the second quarter, expenses related to equity-based compensation were $4.4 million or 6% of revenue. This is a decrease of approximately $400,000 from the first quarter of fiscal 2009.

The decrease was due to unanticipated for future of equity compensation during the quarter. We expect equity compensation expense of approximately $4.7 million in the third quarter of fiscal 2009. During the quarter expenses under the company’s previously announced restructuring plan was $148,000. Our GAAP tax rate in the second quarter of fiscal 2009 was 19% compared to 22.3% for the first quarter of fiscal 2009. The lower tax rates reflect the impact of higher sales into results with lower tax rates. We expect our GAAP tax rate for the remainder of the year to approximately 19% based on projected, original mix of income.

The non-GAAP numbers discussed today excluded impact of stock-based compensation amortization of acquisition-related intangibles, expenses and a recovery associated with the now settled insurance litigation. Certain restructuring expenses, expenses related to now computed stock option investigation and as past this related to ongoing option related matters.

On a non-GAAP basis, net income was $15.4 million or $0.25 per diluted share for the second quarter of 2009. Net income for the same quarter last year was $12.5 million or $0.18 per share. For the first quarter of 2009 net income was $13.4 million or $0.22 per share. We expect non-GAAP earnings in the third quarter of fiscal 2009 to be between $0.23 and $0.25 per diluted share. Non-GAAP gross margin for the second quarter of fiscal 2009 was 55.4% and 10 basis points increase from the first quarter of fiscal 2009.

We expects non-GAAP margin during third quarter of fiscal 2009 to be approximately flat to down 100 basis points primarily due to the impact of the recent fire at our manufacturing facility in Reynosa, Mexico and also for our all revenue mix. Non-GAAP research and development expenses were $9.4 million for the quarter down $600,000 sequentially. This decrease was primarily due to timing of new product expenses. R&D spending in the second quarter was 12.1% of sales compared to 13.5% in the previous quarter.

We expect R&D spending in the third quarter of fiscal year 2009 to increase to $10 million as we accelerate our new product development efforts. Non-GAAP SG&A expenses were $15.3 million for the quarter, an increase of $100,000 from the first quarter of fiscal 2009. These represents 19.7% of sales compared to 20.4% in the first quarter of fiscal 2009. We expect SG&A spending in the third quarter of 2009 to increase $500,000 to $15.8 million. The increase is mostly due to one-times severance expense years associated with the departure of our General Council and Executive in the Business Development Office.

Interest on other income was $1.2 million in the second quarter compared to $1.7 million in the first quarter. This decrease is due to lower interest rates. For the third quarter of fiscal year 2009 we expect interest on other income of approximately $1.1 million. The company’s non-GAAP effective tax rate for the second quarter of 2009 was approximately 21.6% compared to 24.5% in the first quarter of fiscal 2009.

The lower tax rate reflects the impact of higher sales into regions with lower tax rates. We expect our non-GAAP effective tax rate for the reminder of the fiscal 2009 to be approximately 22%. As a reminder the actual rates can vary from forecast based on geographical mix of our income. Fluctuations and currency exchange rates and changes in estimates of projected benefits from deferred tax assets and liabilities.

The diluted share account for the second fiscal quarter was 62.6 million shares. We expect diluted weighted average shares outstanding to be sequentially flat in the third quarter of fiscal 2009. This forecast can vary based on the average stock price for the quarter and the level of stock option exercises and buybacks. Moving onto the balance sheet, our balance sheets remained very healthy.

In the second quarter we generated $18.3 million increased cash flow, which is approximately 23% of revenue and we ended the quarter with approximately $204 million of cash and investments on the balance sheet. During the quarter we repurchased approximately $10 million or 685,000 shares of common stock under a program previously authorized by the Board of Directors.

During the second quarter the company spent approximately $3 million of property, plans and equipments. Depreciation and amortization for the second quarter was approximately $2.1 million included approximately $273,000 of intangibles amortization. In the third quarter we expect capital spending to be approximately $5 million, the higher level of capital spending is to support the expected production ramp up of our newer product platforms and to get our Reynosa manufacturing facility back to full production. We expect depreciation and amortization to be approximately $2.2 million in the third quarter of fiscal 2009.

The day’s sales outstanding and accounts receivable was 43 days in the second quarter up slightly from 42 days in the first quarter. In absolute dollars net inventory increased by $2.7 million in the second quarter as compared to the first quarter of fiscal 2009 and the days of inventory increased to 88 days form 84 days in the first quarter. Inventory of our distribution partners was down approximately 7 days to 68 days. We believe that both our internal inventory and our channel inventory are the right levels to support expected stronger demand for our products in the second half of fiscal 2009.

In summary, we are pleased with the company’s financial performance in the second quarter where we grew our earnings almost three times faster than we grew revenue.

I will now turn the call over to Mohan.

Mohan Maheswaran

Thank you, Emeka. Good afternoon everyone. I will discuss our Q2 fiscal year 2009 performance by end market and by product group, and then discuss our Q3 fiscal year 2009 outlook. Q2 fiscal year 2009 was another outstanding quarter for Semtech. We achieved the highest Q2 revenues in the company’s history. This now represents our fourth consecutive record revenue quarter.

Semtech achieved $78 million in revenues in Q2. This represents a 5% sequential increase and a 16% increase versus Q2 of fiscal year 2008. Non-GAAP gross margins were 55.4% and non-GAAP EPS grew on an annual basis by 39% to $0.25 per diluted share. We are very pleased with both our revenue and EPS performance in Q2.

In Q2, our high end consumer revenues increased and represented 39% of total revenues. Our high end consumer segment includes cell phones, multi-media handhelds, MP3 Players, set-top boxes, digital TVs, games, digital video recorders, digital still cameras, blue tooth, headsets, and other consumer equipment. Now high end consumer customer base is very broad and geographically well balanced. We sell products from our Protection product group, our Power Management product group and our advanced com and sensing product groups into the segment. We expect our high end consumer business to increase again in Q3.

Revenues from the industrial segment increased and represented 27% of total revenues. Industrial revenues included revenue from automated meter reading equipment, military and aerospace equipment, medical equipment, automated test equipment, security, automotive, home automation, and other industrial equipment. Our industrial business includes 1000’s of customers across many different applications. Revenues in the segment come from all four of our product groups. We expect our industrial business to be approximately flat to slightly down in Q3.

Our computing segment revenues decreased and represented 17% of total revenues. Computing segment revenues include revenue from desktop computers, servers, notebooks, graphics, printers, and other computer peripherals. Historically, most of our computing revenues have come from our Power Management products. Today the contribution to our computing revenues, evenly divided between our Power Management and our Protection products. We expect our computing business to increase in Q3 due to seasonality.

Finally, our communication segment revenues declined in Q2 and represented approximately 17% of total revenues. Our communications revenue includes revenues from base stations, passive optical networks, switches and routers, wireless LAN, voice over IP and other communications infrastructure equipments. Revenues in this segment come from our Protection, Power Management and our advanced com and sensing product groups. We expect Q3 revenues in communications to be approximately flat in Q2.

Now let me discuss the performance of each of our product groups. In Q2, our Power Management revenues declined sequentially by 1%. The demand in Q2 was driven mostly by the high-end consumer and the computing markets. Our strategy of minimizing some of that participation in margin challenged monetized segments continues to play out as we have planned.

In Q2, we also hired a new Vice President and General Manager Simon Prutton to run our Power Management business. Simon is taking a critical look at the strategy, products and focus of the business and he is already fine tuning the business accordingly. Simon has also recently hired a Vice President of Marketing for the business. Our Power Management business unit is becoming more balanced with revenue contribution from the communications, industrial, high-end consumer and the computing segments.

Our Power Management bookings in the quarter remained healthy and in Q3, we expect our Power Management business to increase driven by growth in high-end consumer and computing systems. In Q2, our protection revenues increased sequentially by 12%, and increased 32% on an annual basis to achieve a new quarterly record. Not only with this record for our Protection business, but it was also a record for any business in Semtech’s history.

Demand for our Protection products remained strong in the quarter, driven by strength in the high-end consumer market, communications and the computing markets. The increase in demand for our Protection devices has been driven by the increase in the number of ports requiring protection, increasing bandwidth of these ports, and the increasing needs of small form factor green highly efficient devices.

In addition, our Protection business services thousands of customers with many different products. The breadth of markets that our Protection business serves, includes smart phones, digital TVs, set-top boxes, internet switches, DSL line cards, note book computers, industrial automation systems and voice over IP phones as well as many others.

Our Protection business unit continues to execute tremendously well, and strategically, we are very encouraged by the design win momentum of that Protection productions across all our target markets. In Q2, we’ve released a new Protection platform for ADSL, VDSL and RS232 interfaces and a new Protection device for fast Ethernet and gigabit Ethernet interfaces.

In Q3, we expect our Protection revenues to increase driven by continued strength in the high-end consumer and computing segments. Our Power Discrete revenues in Q2 increased sequentially by 1% and on an annual basis grew 33%. Once again we are delighted with the execution within this product group and we continue to see opportunities to increase our penetration in this market. This business is driven by demand from the aerospace, military, industrial and high-end medical markets.

While the recent fire at our Reynosa manufacturing facility is a setback to our momentum. We do not believe that it will have a significant long-term impact. Our focus continues to be on improving our supply throughput and improving cycle times in order to service unfulfilled demand in the market segments. We expect our Power Discrete revenue to be down in Q3 due to the impact of the fire.

Revenue for the advanced communications and sensing business decreased 4% sequentially. Progress with our wireless and sensing platform was somewhat offset by a continued decline in our ATE business and lower than expected communication revenues. The decline in our ATE business and the softer communication business also somewhat negatively impacted gross margins in the quarter. Excluding our Test and Measurement business our advance com and sensing business would have been up 15% on an annual basis.

Our advanced communications and sensing business momentum is beginning to accelerate as we introduce new exciting wireless sensing and consumer analog platforms to the market. Solid development execution on our new road map is critical to the future success of our advanced com and sensing business. As we expect these new platforms positively accelerate the top-line and drive further operating leverage.

In Q2, we announced our new timing synchronization platform ToPSync, which is already gaining design and momentum. We also have design wins at two tier one communications infrastructure manufacturers and we are close to design wins at several tier one WiMAX infrastructure manufacturers. ToPSync is the result of over five years of R&D investment by our advanced com and sensing business unit. We expect the first material revenues for ToPSync to begin in fiscal year 2010.

In Q3, we expect revenues from our advanced com and sensing business to increase modestly. From a distribution POS standpoint in Q2 fiscal year ’09, we saw a total POS for the company increased by 6%. The POS increase was driven by Asia and Europe. Distributor inventory decline in the quarter as expected.

Moving onto new products, we released 18 new products in Q2. In addition to some of the platforms mentioned earlier in the call, we also released several new leading edge Protection, Power Management and advance com and sensing platforms. New product development continues to be an area of focus for us as we try to change our mix and address new market segments.

Revenue from new products is now increased for three consecutive quarters. Turning to design wins we recorded over 640 new design wins in Q2 which represents another good design win quarter for the company. This quarter the forecast of future revenue from these design wins was the highest in the company’s history. With new platforms we have recently released, we expect to see a continuation of the strong design win momentum in the future.

Now let me discussed our outlook for Q3. While the market environment is challenging due to macro economic factors and many customers have reduced their overall build plans for the year. We believe that Semtech’s breadth of customers market and products does put us in a unique class of company in our sector. We also believe that as we continue to expand Assam with new product families, we should be able to grow at a faster rate in the overall market if we execute well.

Our book-to-bill going into Q3 was about one, we also entered Q3 with strong backlog and there is positive momentum in all four of our product groups. Despite the impact of the fire on our Power Discrete business we expect our Q3 revenues to be flat to up 4% sequentially. If we achieve the mid point of our guidance are approximately $18 million, Q3 revenues would again be the highest in the history of the company. To attain the mid-range mid-point of that Q3 guidance, we needed net terms orders of approximately 34% at the beginning of Q3.

I will now hand the call back to the operator, and Todd and Emeka and I would be happy to answer questions. Operator?

Question-and-Answer Session

Operator

And your first question comes from the line of Shawn Webster with JP Morgan

Shawn Webster – JP Morgan

Yes, thank you for taking my questions. Good afternoon. On the – can you give us an update on where you lead times where at the end of the quarter maybe some commentary on the linearity of your backlog and then I have a follow up or two.

Mohan Maheswaran

Supply lead times in the 6 to 12 weeks are very strong bad operation and back end, but in that range obviously our Power Discrete business the lead times are little bit longer and orders are coming in about 6 to 8 weeks.

Shawn Webster – JP Morgan

Okay and the linearity of your orders.

Mohan Maheswaran

In Q2 the linearity that the booking were higher in the second half of Q2 as what we have expected and kind of that’s the same quarter we expect in Q3 as well.

Shawn Webster – JP Morgan

Okay. And for the fire, so you have $1 million of revenue impacting roughly in Q3 and then $2 million to $3 million in Q4, is that versus your plan or is that should we think about that is sequential declines each quarter in that business unit?

Emeka Chukwu

The $1 million softer impact is obviously versus our plan, our internal plan.

Shawn Webster – JP Morgan

Okay, are you expecting growth in the back half of the year for the segment?

Mohan Maheswaran

Yes, we’re expecting that business unit to continue to grow as we increased our manufacturing capacity over there.

Shawn Webster – JP Morgan

Okay and is there any color you can provide on the communications segment weakness in terms of specifics or geographies?

Mohan Maheswaran

Communications was really our historical Sonnet based communications products, what used to be our Acapella product line. It’s really the historical infrastructural communications stuff versus the new base station type of products we have designed into. So, that’s really where most of the weakness was.

Shawn Webster – JP Morgan

Okay and I’m sorry. Last one on the gross margins flat to down a 100 basis points, what’s – what are is it mostly the recoveries from the fire that swings out a 100 basis point around in terms of what you are expecting for Q3 or what are the moving parts that will move it to one side or another of that?

Mohan Maheswaran

Well, I think the best way to answer the question is out of the 100 basis point reduction. I think 70% to 80% of that is because of the fire and the remainder it’s just due to revenue mix.

Shawn Webster – JP Morgan

Okay, thank you very much.

Operator

Your next question comes from the line of Rick Schafer with Oppenheimer.

Rick Schafer – Oppenheimer

Hi, guys I just had a couple of questions. First on just back on the fire for a second I guess what’s your level or can you give us an idea of your level of confidence that the fire is only going to have a real second half impact on revenues and margins here and then maybe give us a little more color on why that impacts actually bigger in the fourth quarter I mean is that just inventory being bled off or what’s going on there?

Mohan Maheswaran

Well, so, let me answer the second part first Rick. I mean the fire well, it was a mostly in the fab area in fact pretty much contained to the fab area. So, the back end operations were pretty much unaffected, which means obviously that we have to get the building, fab building back in operation and get new equipment back in operations. So there is an impact to the Q4 number, which is greater than the Q3 number obviously because we had material already in the back end.

So, that I’ll answer the second question. In terms of confidence level, we’re making good progress in terms of the recovery. It’s going very well, it’s on schedule and we almost have the building that was impacted pretty much 80%, I would say we don’t know, so it’s question of getting new equipment in the reinstalled and materials flowing again and so, we expect nobody end of this quarter that will be back where they fully functioning operation and then the question is, how was the yields like and nor that some stuff, which we will really only be able to quantifying Q4.

Rick Schafer – Oppenheimer

But, you still feel pretty good that, I mean just going to be limited about a $3 million to $4 million total impact for this…

Mohan Maheswaran

Yes, at this point yes.

Rick Schafer – Oppenheimer

Okay and is it possible, I know this business is pretty sticky for you guys, we need a possible to lose some of that, some share I guess in the third and fourth quarter. I mean could you lose sockets or lose any business there?

Mohan Maheswaran

I don’t think we’re losing sockets, but the revenue that we had planned on – it’s likely that that will be lost.

Rick Schafer – Oppenheimer

Okay and then the second question, I know you talk about a Protection is a primary top-line growth of you guys. I think you also pretty open that it’s one of your lowest margins, entire lowest margin business. I guess it’s kind of looking at your story like for next year as a margin expansion story. I mean I guess the key part of that would be getting Power Management margins up, I mean can you give us any color and how that’s going to be accomplish or even on target area.

Mohan Maheswaran

So, let me clarify Rick, you said Protection, but I think in a Power Management right?

Rick Schafer – Oppenheimer

I apologies yes, Power Management.

Mohan Maheswaran

So, Power Management I mean the story with powers is been clear, since I joined the company really the company had focused a lot of it’s Power Management products on the computing space and I didn’t think as I came into the company that was a great space for us especially the desktop complete computing and the notebook computing and we have had a strategy over the last couple of year to kind of the emphasis that put more of the investment into general purpose products and to the segments, which I believe we’ll generate high gross margin our us.

You get new general purpose power products that fit quite well with some of the computing requirements, but in general they can be targeted at many other different areas. So, I think that as we getting those new products out and they start to gain traction, which they are now and when they really start to generate revenue, we will see both gross margin expansion and revenue growth from the power business. In addition to that I expect Protection business to continue to growth as I mention.

Our advanced com and sensing business is most people know it was three acquisitions we brought together and we have a lot of new product platforms coming out there, which will not only enable us to get more traction in the consumer analog sector, which we have – sorry we participated in, but in some new areas like the Timing Synchronization in Packet, Packet-based networks for example that should also drive gross margin expansion and growth and then once we get our Power Discrete some operations back inline I expect to continue to gain share in that market. So those are all areas that I think help us to grow in both the top line expand gross margins and get leverage on the bottom line.

Rick Schafer – Oppenheimer

Got it and then a follow-up on the Power Management question I mean is that safe to assume that were sort of at the bottom here we have kind of bottom down on Power Management margins and maybe which we thinking about possibly just been a 50% margin business going forward at all?

Mohan Maheswaran

No, it does take time to get the new products, which are getting designs now into to real revenue and generating the type of revenue that can offset the notebook industrial revenues that are little bit larger because of the volumes, but I think we have probably reached a low point in the second half year, of Power Management gross margins and my expectation is that we will start to see that increase. As I mentioned in the script, that computing business now, just about 17% of the revenue that’s kind of device evenly between Power Management and Protection. So, Power Management is relatively small part now of the total company the computing part out of that.

Rick Schafer – Oppenheimer

Got it, thanks.

Operator

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

Steven Smigie – Raymond James

Great, thanks for taking my call and my question. Just a question on, a couple of weakness in the quarter what use to be in the SONET? How long would you expect to see that weakness continue could you see that going to future quarters as well or is that more one-time thing?

Mohan Maheswaran

On the comp side, Steve.

Steven Smigie – Raymond James

Yes.

Mohan Maheswaran

I think that was more just relates to the marketplace, I don’t think there is anything specific no design losses or any of that type thing. Its just the market was a little bit softer in Q2, we don’t anticipated to be a major issue for us. Second Q3 is typically a little bit softer I think, but we expect it to comeback.

Steven Smigie – Raymond James

Okay, all right and then just as I look out the fiscal fourth quarter excluding the impact of the fire would you characterize that has being over would you characterizes being seasonality typically for that quarter or you have launching new products so I just could [ph] see seasonality in that quarter.

Mohan Maheswaran

Q4, I mean typically what we would see is that on a consumer, which still be quite strong and then because that quarter goes into January, there maybe some pick up in industrial and communications in that quarter.

Steven Smigie – Raymond James

Okay. So it should be a excluding the impact of the fire, should be a growth quarter?

Mohan Maheswaran

That’s what the current expectation we’ll not give you guidance for Q4, at this point.

Steven Smigie – Raymond James

Okay and then in terms of the overall opportunity for gross margin expansion, I’m just curious, your thoughts over the next year as these products rollout what’s may be a range of potential gross margin expansion you could see, obviously there is certain products may work versus certain that won’t so I’m just curious on that?

Emeka Chukwu

Well Steve, our expectation here is that a lot of that new product design wins that we are seeing right now should really be producing revenue fiscal year 2010. So, it’s kind of hard for me to quantify the range of gross margin expansion, but I’d really expect us to really to see some decent expansion of gross margins or something in the order of a 100 basis points and above.

Steven Smigie – Raymond James

Okay, great. All right, thank you very much.

Operator

So, our next question comes from the line of Sumit Dhanda with Bank of America Securities.

Sumit Dhanda – Banc of America Securities

Yes, hi a couple of questions so just to that I' m clear on this Mohan or Emeka. There is a cumulative impact from the fire in Q3 and Q4, is the $2 million to $3 million in Q4 incremental to what you see in Q3 that’s the first question, and then secondly, do we expect the reversion back to the levels you are running at in the April quarter, as you ahead into fiscal 2010 given the supply constraints in the business or does the loss of business in the back half of the year flow through in subsequent quarters in fiscal 2010.

Mohan Maheswaran

So, the answer to both of your questions is yes. Sumit, I mean we first of all the Q3, Q4 impact is cumulative, so $1 million in Q3 and then additional $2 million to $3 million in Q4 and then going forward, once we have the operation back in running, because its supply constrained, our expectation is we’ll get back to the type of revenue level that we were at and my expectation is we’ll still be able to continue to grow that business and gain share, which is what we were doing in the first place. So, that’s the expectation.

Sumit Dhanda – Banc of America Securities

Okay, and the second question I have for you or Emeka, your margin targets were 55 to 60 in the back half of this fiscal year and 25 to 30 on the operating margin side. Even if we account for what's happening within your Power Discrete business because of the unfortunate fire it doesn’t seem like you’re close to that target and so, I guess my question is, as your new product ramp unfolding slower than anticipated and if so what's really the reason for that?

Mohan Maheswaran

So, the gross margins, we had set a target of exiting this year at the mid range of our gross margin model and at the lower end of our operating margin model so 25% operating margin and then mid range of the gross margin model I think we still today look at it and say well had we not at the fire we would have been put maybe not quite there in the mid point of gross margin model but maybe 56 percentage and so we would have still exit of the year at a pretty good and gross margin and we still feel and then continue to feel that they low end of the operating margin model is achievable.

So the product attraction a new platforms I think where the disappointment is in the new platforms in new market so markets like WiMAX and GPON and some of the 3G, 4G infrastructure I preview that is more of a macro economic issue versus a product issue in Power Management I think we recognize that we can still do better from an execution standpoint its one of the reasons I hider new general manager and I still think we can do better than but in general I would say that we quite please with the new product platforms coming out and the gaining design wins the design win momentum is quite good its turning those design wins turning into revenue that hasn’t yet materialized.

Sumit Dhanda – Banc of America Securities

Okay and then perhaps my last question here. On inventories I think Emeka last quarter when the inventories had gone up you said that entering the July quarter that be flat to down on a sequential basis in the July quarter and that’s on a days basis seems like they were up slightly, can you help us understand, given that your hit your sales target why that inventory profile didn’t match your initial expectations.

Emeka Chukwu

If you look at our demand forecast for the second half its typically been a very strong second half for us and as we went through the quarter and continued to look at the demand we felt that we needed to have the inventory in place on in and one thing to observe is that that inventory increase in the second quarter was much lower than the increase in the first quarter, so I think we did make a reasonable effort to bring inventory down our expectations are as that we go through the end of the October quarter that we should start to see inventory are come down.

Sumit Dhanda – Banc of America Securities

It maybe just one follow up on that, I know you’re saying that the build is in anticipation of demand, but even if we adjust for the $1 million loss and the October quarter because of the fire, it doesn’t, it would have been up 3% at the midpoint of your guidance. While that’s not bad it’s certainly not suggested of a very strong demand trajectory. So I am having a little bit of a hard time reconciling, your opinion that for two consecutive quarters you said that partly the increase in inventory outside the supply disruption that you saw in the previous quarter. Is an anticipation of better demand, but it doesn’t seem to be reflected in your outlook for at least the October quarter revenues.

Emeka Chukwu

As you build inventory you are now just looking one quarter, you are looking at more than a quarter right and if you look at our demand you also have to be aware of the mix of where the demand is coming from. You also have to take into account the supply lead times. So taking all those into accounts on the history that we’ve had in the past with delinquencies we felt that we needed that inventory I say in the right level where we wanted to be.

The other thing we also need to take into account is the fact that channel inventory is down sequentially so if you look at in the aggregate as just one pull off inventory. Your probably consider our overall inventory both the channel internal and our inventory it’s actually flat to down as of the July quarter.

Sumit Dhanda – Banc of America Securities

Okay, thank you.

Operator

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

Harsh Kumar – Morgan, Keegan & Company

Guys, a couple of question. Mohan if I heard correctly I think you said your PC business was slightly down percent or so, this seems to be a little bit contrary to what we hearing in the marketplace from some of the other vendors. Could you maybe clarify what’s behind that just maybe makes your products and anything that’s special going on with your business relative to the market?

Mohan Maheswaran

I think it’s partly our strategy which was to turn away some very low-margin desktop notebook business in some new platforms. We made a specific attempt to do that and, that’s probably why the Computing Power business in Q2 was little bit lower than one may have anticipated, but I think its not a huge decline, its relatively modest and I think Computing for us was still be strong in the second half.

Harsh Kumar – Morgan, Keegan & Company

Okay and I think that that actually looking to my next question on power. Its seems like it’s a little bit more delay then we’d previously though Mohan, could you maybe try to solidify, for us when you think that might comeback for you and a sort of lastly throughout the 2010 estimate, but is there any indication either ways earlier back half, first half anything like that?

Mohan Maheswaran

I think we should see improvements in the both the top line in specific markets in the first half and that should help us in the gross margin front, but again it depends on, which segments within the power area, which markets that we’ve kind of take off. So for example, WiMAX infrastructure and GPON infrastructure and some of those new markets that we’ve got designed wins in, UMPC displays, how they roll out in the year is the question. I would say that I think that many of new products we have very are good and I think that the design win momentum is very encouraging.

Harsh Kumar – Morgan, Keegan & Company

Okay. Fair enough. That’s helpful and then once you get past let’s say you get to the January quarter and your at the end of that in your past there are no sort of impact and you’re still sort of growing revenues that are at the marketplace are better. Would you then think, Mohan that your gross margin target and operating margin targets are then achievable next year, perhaps? Once you’re past all these sort of one time fire issues?

Mohan Maheswaran

Yes, absolutely, I mean I think if we look at our advanced com and sensing products and the momentum we have there, that should be well within the range our target model and to the high end of that. I think our new Power Management products will be in the range perhaps at the low end of our target model, but in the range. Protection continues to be in the range and Power Discrete certainly will be in the range obviously once we get that back and growing, I think we’ll expect that that will be the expectation, so yes.

Harsh Kumar – Morgan, Keegan & Company

That that’s helpful thanks guys. That’s it for me. Thank you.

Mohan Maheswaran

Okay.

Operator

Your next question comes from the line of Manoj Nadkarni with Chip Investor Group.

Manoj Nadkarni – Chip Investor Group

Hi, good afternoon and congratulations on the solid quarter and record results.

Mohan Maheswaran

Thank you.

Manoj Nadkarni – Chip Investor Group

Yes. Can you please give more color on the end markets where you’re seeing growth for your Protection and Power Management businesses kind of recap for us?

Mohan Maheswaran

The end markets within high end consumer Protection and Power are doing very well in the handheld space and then other high end consumer products like TVs, set-top boxes, general purpose consumer equipments is a very broad range of equipment and even within handheld actually there is a lot of different submarkets within that category, including cell phones and smart phones and media players and which we’re really getting very good traction in all of those areas both in Protection and then increasingly so in power as well.

Manoj Nadkarni – Chip Investor Group

Okay. So the strength that you’re seeing in the Protection business, is that primarily because your available market is growing or you think you’re gaining share versus competition?

Mohan Maheswaran

Well, I think it’s a little bit of both, but I think its most of the first statement you made the Protection business, what’s happening there is that the demand for planned very, very good robust Protection in different equipments is increasing. More ports you have USB ports, HDMI ports and Ethernet ports, a number of ports is increasing and then as I mentioned bandwidth of those ports is also increasing. So, you got from fast Ethernet to gigabit Ethernet, 10 gig Ethernet, HDMI 1.2, 1.3, USB to USB 2, at each time there is a bandwidth increase, this I puts more of a burden on the Protection device and that also is the opportunity for us and we’re seeing that and then the green factor and the fact that we have very small Protection devices and highly efficient Protection devices is also helping us.

Manoj Nadkarni – Chip Investor Group

Okay. And regarding your wafer output, majority of your wafers or finished wafers, I should say they come from fabs in Asia, is that right?

Mohan Maheswaran

We have foundry partners in Asia and Europe mostly, yes.

Manoj Nadkarni – Chip Investor Group

Okay, so this Mexico facility that’s only a small portion of your total output?

Mohan Maheswaran

Yes exactly, but the Mexico facility is the only one that we own, when we run that, we manufacture our own – that’s our own manufacturing there are own foundry, our own wafers and our own back-end.

Manoj Nadkarni – Chip Investor Group

I see, okay. Well, again congratulations on a sold quarter.

Mohan Maheswaran

Thank you.

Operator

Your next question comes from the line of Craig Ellis with Citi.

Craig Ellis – Citigroup

Thanks for taking my questions. I’ve just two clarifications, one of the gross margin impacts to the fire. Given that the revenue impact is increasing about 2 to 2.5 – in the fiscal fourth quarter, is the gross margin impact increasing commensurately or is there no real incremental negative impact in the fourth quarter?

Emeka Chukwu

Craig, this is Emeka. Yes, we do not expect any incremental negative impact in the fourth quarter and the reason is that we are seeing something benefits from the traction from some of our new products. So, we are expecting to get some help from the mix of new product revenues in the fourth quarter and we’re thinking that that should be decent enough to offset any lingering effects of our revenue that we’re losing from the Power Discrete.

Also in addition because the Power Discrete facility is going to be backup to full operations we believe by the end of – by the start of Q4. The absorption that we’re going to be losing in Q3, we should not have that reoccur in Q4. So, a combination of all those moving parts allows us to believe that we should not see any incremental negative impacts on our gross margins in Q4.

Craig Ellis – Citigroup

Okay and then somewhat relatively with regard to the potential insurance recovery what you need to do to capture that and when you get it where is that booked?

Emeka Chukwu

Well, in general, when you get the insurance recovery, you book it into the same line where you book the expense and we are definitely. Our – the ideal situation is for us to get the insurance recovery as quickly as possible. We’ve modeled some recovery in Q3, we should also see some in Q4, but the one thing to just emphasize is that impact of the fire both in terms of the insurance expenses and the additional expenses and the insurance recovery has been modeled into the guidance that we get.

Craig Ellis – Citigroup

Can you quantify how much insurance recovery you’re expecting in the guidance that you gave for the third quarter?

Emeka Chukwu

No, I can’t quantify the amount of the insurance recovery that I’m expected. I do believe that there is going to be a net; I don’t expect that insurance recovery is a great to completely offset the additional expenses that we are going to see in this quarter because of the fire.

Craig Ellis – Citigroup

Thanks, Emeka.

Operator

You have a follow-up question from the line of Sumit Dhanda with Banc of America Securities.

Sumit Dhanda – Banc of America Securities

Yes, hi, just a couple of quick follow-ups. Mohan or Emeka so, in light of whatever has occurred both really mainly on the fact that some of the new markets haven’t panned out as quickly as anticipated plus the Reynosa fire, if you had a reset when you would be hitting your target margin models, would you say that’s first half of ’09? Is it second half of 09? Are you willing to put a service stake in the ground on that?

Emeka Chukwu

I know we have, I have looked at that situation and I don’t want to put as stake in the ground as of now, until we see everything the Reynosa comes back to full operations like Mohan indicated before. We feel very good about where we are, by the recovery efforts, but until you start getting material through the fab and getting you will see don’t really know, but let’s assume that everything works out and we get back with course and with the revenue traction that we assume with the new products. We feel very good about seeing margin expansion in the first half of next year. I don’t know that I’m willing at this point to put a stake in the ground.

Sumit Dhanda – Banc of America Securities

Okay, and then Mohan maybe for you, some of the new markets like you said have been slower to pan out WiMAX and maybe your GPON traction has been slow to materialize. How much of the new product growth that you’ve been banging on as a function of, new platform acceptance in existing markets versus just, new platform acceptance in new markets, in other words what sort of realistically in your control versus out of your control?

Mohan Maheswaran

Well, I think it’s difficult to quantify Sumit I would say we have a lot good traction in existing markets as well. I don’t give you impression that, it’s all coming from new markets. So it handhelds we got good Power Management traction, good Protection traction, but I think the real difference make us in terms of getting acceleration on top line.

I mean you mentioned well we get 3% to 6% growth here and there, but to really move the top line and to really move gross margins. I think we also need the additional emerging applications to come home for us. I mean ToPSync Timing Synchronization is an example of that. Where we have very good product technology, it’s designed in to very good customers and I mean its well above gross margin our average gross margins and, we would expect to see that starts to drive some revenue and if that materializes then I think the gross margin expansion will be clear.

Sumit Dhanda – Banc of America Securities

One last follow-up for you Emeka, you noted that your distribution inventory was down 7 days to 68, concurrently it seems like your deferred revenue or income line was up modestly. Is the counter trend there explainable because you’re carrying higher margin products and inventory in distribution inventory enhance the deferred margin or really the deferred margin number looks higher despite a lower inventory base for your assessment.

Todd German

Yes, I think is very simple so actually when you look at our distribution inventory we account for that differently right. Depending on it we just going into, if it’s going to Asia we recognized revenue upon selling. So we don’t defer anything and if it’s going into North America and Europe we do deferred revenue so if you are seeing an increase in deferred revenues probably because of high margin product, but more importantly you just miss that we do have a little bit more inventory in the North America and the Europe and China. So when you look at decrease in the days of inventory you can make the assumption that a lot of it probably came from Asia and China

Sumit Dhanda – Banc of America Securities

Okay, I understand. Thank you so much.

Operator

(Operator instructions) And you have follow-up question from the line of Steve Smigie with Raymond James.

Steven Smigie – Raymond James

Great, thanks. And something you could comment a little bit on what parts you are attacking in GPON?

Mohan Maheswaran

We have Protection Power Management products and also some communications products, but it mostly Power Management and Protection.

Steven Smigie – Raymond James

Okay and then on the ramp up of ACNS particularly on the ToPSync products, can you talk about our others specific regions where you expect to see growth sooner or expect to see more growth and both in terms of customers and then in terms of say the network where those customers might rollout these products.

Mohan Maheswaran

I mean the customers mostly in Asia and Europe and the end customer the service provider are pretty global actually North America, Eastern Europe as well as Asia.

Steven Smigie – Raymond James

Okay. Great, thank you very much.

Operator

And at this time, there are no further questions.

Mohan Maheswaran

Okay. Let me summarize by saying that Q2 fiscal year ’09 was another outstanding quarter for Semtech. Increased revenues annually by 16% to achieve our future revenue record in our 48 year history and increased non-GAAP EPS by an outstanding 39%. We also achieve the book-to-bill above one short to about core product groups grow by double-digits on an annual basis.

We also increased our cash balance by $11 million and we purchased another $10 million of our stock. Finally we are confident that we continue to grow our earnings at a faster rate then revenue as new product revenue gain traction and as we focus on improving the return on our R&D expenses. So that I would like to thanks everyone for participating in our second quarter conference call and look forward to updating you all next quarter. Thank you.

Operator

Ladies and gentlemen, this concludes today’s conference call. You may now disconnect.

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Source: Semtech Corporation Q2 2009 Earnings Call Transcript
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