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Xilinx, Inc. (XLNX)

Q4 2006 Earnings Conference Call

April 26th 2006, 5:00 PM.

Executives:

Lori Owen, Investor Relations

Jon Olson, Chief Financial Officer and VP of Finance

Willem Roelandts, Chairman, Chief Executive Officer and President

Analysts:

Michael Masdea, Credit Suisse First Boston

Glen Yeung, Citigroup

Christopher Danely, JP Morgan

William, Harris Nesbitt

David Wu, Global Crown Capital

Mark Edelstone, Morgan Stanley

David Wong, AG Edwards

Seogju Lee, Goldman Sachs

Steve Iliescu, UBS

Quinay Laharia, Deutsche Bank

Jeff Palmer, Friedman Billings Ramsey

Gurinder Kalra, Bear Stearns

Operator

Good afternoon. My name is Richard, and I will be your conference facilitator today. I would like to welcome everyone to the Xilinx Fourth Quarter 2006 Fiscal Year Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer section. Operator instructions

I would now like to turn the call over to Lori Owen.

Lori Owen, Investor Relations

Thank you and good afternoon. With me are Wim Roelandts, CEO; and Jon Olson, CFO. We will provide a financial and business review of the March quarter and then we will open the call for questions. I will then end the call with a few housekeeping items.

During today's call we may make projections or forward-looking statements regarding future events or the future financial performance of the company. We caution you that such statements are predictions based on information that is currently available. Actual results may differ materially. We refer you to our SEC filings which are posted on our website. These documents identify important risk factors that could cause actual results to differ materially from statements made today.

In the event non-GAAP statements are made during today's call, the respective reconciliations will be published on the Investor Relations website. This conference call is open to all and is being webcast live. It can be accessed from our Investor Relations website. Let me now turn the call over to Jon.

Jon Olson, Chief Financial Officer and VP of Finance

Thank you, Lori. Revenues in the fiscal Q4 increased 5% from last quarter to $472 million, compared to the same quarter a year ago, revenues were up 21%. Fourth quarter net income was $110.7 million or $0.32 per diluted share including a $4.5 million acquisition related charge. The tax provision for the fourth quarter includes an $8.9 million or $0.03 per diluted share benefit related to prior year adjustments driven primarily by an over provision of state taxes. This is compared to net income of $81 million or $0.23 per diluted shares in the prior quarter.

On a fiscal year basis, revenues were $1.73 billion, up 10% from $1.57 billion in fiscal year '05 and operating income increased 11%. We exited the fiscal year with $1.6 billion in cash. Operating cash flow for the year was $489 million, up from $275 million last year and free cash flow was $422 million, up from $214 million in the prior year.

Our cash balance coupled with continued strong free cash flow generation led to the Board's recent decision to increase our quarterly dividend to $0.09 per share, up from $0.07 per share in the prior year and up from $0.05 two years ago when we first initiated the program.

In fiscal year '06, we repurchased 15.1 million shares for $400 million, up from 4.4 million shares for a $135 million in fiscal year '05. We also paid $97 million in dividends, up from $70 million in the prior fiscal year. We remain committed to both dividend and repurchase programs.

Gross margin of 62.3% was a decrease from last quarter's 63% and lower than expected. This is almost entirely due to product mix. Our new products category was stronger than anticipated with better than expected strength coming from nearly every product in this category. As a result, the percentage of sales from new products increased by over 4 percentage points from just under 33% in the third quarter to slightly more than 37% in the fourth quarter.

This mix shift is more than what we typically see and more than what we were expecting in the March quarter. At the same time, sales from mainstream products declined 5% sequentially, dropping 4 percentage points to represent 43% of total sales.

We knew going into the March quarter that we would be impacted by mix shifts of new products but the magnitude was greater than expected. Also during the last month of the quarter, the customer mix of new products was more concentrated towards a large volume deals than anticipated, which contributed to the slightly lower margin than forecasted.

On the positive side, we are exceptionally pleased with our new product momentum, particularly what we are seeing from Virtex-4, while we are expecting continued mix shift to new products, 90 nanometer yield improvements should more than offset any product mix shift resulting in overall gross margin improvement.

Operating expenses for the quarter were up 7% sequentially including an expected $4.5 million in process R&D charge related to our acquisition of AccelChip. This was in line with the guidance we provided going into the quarter.

Other income for the quarter was $10 million, in line with our guidance and share count was 350 million shares versus our guidance of 351 million shares.

Tax rate for the quarter was 13% and included an $8.9 million benefit related to prior year adjustments driven primarily by an over provision of state taxes. In addition, the underlying tax rate prior to these adjustments was slightly lower than forecasted largely due to the actual mix of geographic profit.

Let me now comment on the balance sheet. Cash balance of $1.6 billion decreased $27 million due primarily to higher receivables exiting the quarter. Day sales outstanding increased eight days to 37 days, a result of our strong shipment profile at the end of the quarter.

Combined inventory as Xilinx and distribution decreased by 10 days to 134 days. Internal inventory levels decreased by 13 days while distributor inventory days increased by three days. While we are at the upper end of our stated inventory target, our efforts to lower days of inventory continue. I will now turn the call over to Wim to comment on our business and products.

Willem Roelandts, Chairman, Chief Executive Officer and President

Thank you, John. Good afternoon and thanks for joining us today. I will start off today's call with a brief recap of the fiscal year and then turn to a discussion of the March quarter. For the fiscal year, our sales were approximately $1.73 billion, up 10% from last year. The revenue delta between us and our nearest competitor is the largest that has ever been. And we estimate our current PLD market segment share at the end of the March quarter to be approximately 53%, up from just over 50% in the same quarter one year ago.

Within the PLD market, we estimate our FPGA segment share at the end of the March quarter to be approximately 59%, up from 57% in the same quarter last year. And our share of the CPLD market segment will be over 28% in the March quarter, up from 27% in the same quarter last year and a record high.

The distribution of our revenues by geography and end markets for fiscal year '06 was the most balanced in our history. Combined sales from the industrial and other category and the consumer and automotive category, the two end market categories we consider non- traditional increased 21% in fiscal year '06, reaching a record 40% of sales, up from 36% in the prior fiscal year and up from just 8% five years ago.

Communications, our largest end market increased 7% in fiscal year '06. This market has been relatively flat at around 50% of revenues for the past three fiscal years. However, entering fiscal year '07 I expect communications to grow as a percent of our total revenues based on increased design win activity in high-growth areas such as IPTV, next generation wireless, for instance, HSVPA and Wimax and Metro and Core Access.

Sales from all our geographies increase in FY06, with the strongest region being Japan which increased 12% to represent 15% of total sales. Asia Pacific increased 11% and represents 24% of sales. North America increased 9%, representing 41% of sales. And Europe increased 8%, representing 20% of total sales.

In fiscal year '06 our customer base exceeded 21,000. It was just under 15,000 five years ago. It has consistently climbed in each fiscal year, primarily due to the strong customer adoption of the Spartan family. Our customer concentration remains low. And in fiscal year '06 our largest customer represented only 6% of total sales.

Now let me turn to a discussion of the current quarter. Record revenues of $472.3 million in the March quarter was slightly better than expected, up 5.1% sequentially at the high end of our guidance to the Street.

Versus the same quarter a year ago, sales were up 21%. Bookings for the months of January and February were better than expected while March bookings were slightly stronger than anticipated. The bookings for the quarter were 55%.

New products had another impressive quarter, growing 18% sequentially and representing 37% of total sales, up from 33% last quarter and up from 22% in the same quarter a year ago. I am particularly pleased with the strong growth of Virtex-4 and Virtex-II Pro during the quarter. Both of these products offer significant embedded functionality differentiating them from competitive offerings and enabling them to pioneer new opportunities above and beyond the traditional FPGA space.

Virtex-4 showed phenomenal growth during the quarter with sales increasing north of 70% sequentially. If you look at the composition of the Virtex-4 by domain family, LX is the largest in terms of sales, representing 75% of the total family sales. Part of this, of course, is a function of the fact that LX was introduced first, and has the most devices shipping. The second largest family is FX, followed by SX. Combined sales from FX and SX products represent approximately 25% of total Virtex-4 revenues. I expect this percentage to increase overtime, however, based on current design win activity for these families.

Virtex-4 sales are easily exceeding Virtex-II Pro at the same time of product life and we continue to be optimistic about its prospects going forward. Virtex-II Pro, Spartan 3, and CoolRunner-II also reached record revenues for the quarter. And I would like to discuss each of these families in more detail. I will start with Virtex-II Pro.

The momentum behind Virtex-II Pro continues to exceed our expectations. After the slow start, this family has become the industry's largest FPGA family on 130 nominated process technology with a diverse and growing base of customers.

Virtex-II Pro is unique in the industry because of the only FPGA besides Virtex-4 FX with hard embedded processing capabilities. And it is increasingly because of the processor that customers are choosing Virtex-II Pro and Virtex-4 FX over competitive offerings.

I am often asked how the processor is used within customer applications and how we measure the success. You can certainly point to the sales growth of Virtex-II Pro and Virtex-4 FX to measure success. I would also like to highlight a few customer applications.

First, let's take the case of a large video IO digital switching application. By using the embedded processors in Virtex-II Pro this customer was able to eliminate over 50 discrete ICs, reduce the form factor of the main board and eliminate cards. This particular product is one of the most innovative products of NAB and this customer will be using Virtex-4 FX in their next generation designs.

Another case a customer designed a core network switch router using both embedded PowerPC processors to manage look-up tables. Without Virtex-II Pro and the PowerPC processors, this customer would have to add several additional devices to accomplish a similar task including both the time to market and cost of the overall solution.

A recent secured application uses dual PowerPC processors, in a packet processing engine to secure and clear data paths enabling them to reduce the complexity of encryption management. Some customers, like Raytheon, who developed an advanced communications system use both the embedded processor within Virtex-II Pro as well as our MicroBlaze soft processor. In these particular applications, Xilinx MicroBlaze soft processor offloads those paths from the PowerPC processor allowing the overall clock frequency to remain low while significantly decreasing power consumptions.

Other application using our embedded processor include multi-channel radio systems, packet processing engines in control planes, smart camera preprocessors, handheld military radios, and wireless base stations. We believe that the majority of customers purchasing Virtex-II Pro and Virtex-4 FX are using the embedded processor either as a standalone processor, a companion/background processor to the customer's main processor, or in conjunction with our MicroBlaze soft processor.

In fiscal year '06, sales from Xilinx's Spartan families increased for the eighth consecutive year and now represents 24% of total revenues, up from 21% a year ago and up from 8% five years ago. In 2005, we gained share of the high-volume FPGA market segment. It doesn't matter how you measure it, by looking at the Cyclone versus competing Spartan families or by looking at the combined sales of all low cost FPGA products.

Most of the share gains are due to the success of the Spartan-3 family, which posted record sales in the March quarter. Sales from this family have tripled versus the same quarter a year ago. Our newest low cost FPGA offering is Spartan-3E, which is our most cost-optimized family to date, offering price points as low as $2 per device in high volumes.

Spartan-3E sales increased significantly during the quarter with design wins in high-volume markets such as low-cost networking, computing, automotive and consumer. With every new generation of the Spartan family, as we read the benefits of price elasticity for in new applications and addressing higher volumes. The number of customers designing with Spartan today is 60% higher than it was five years ago.

CoolRunner-II sales also reached a peak sales during the quarter. In fiscal year '06, CoolRunner-II consumer business grew 44%, led by success in portable consumer electronics. In the March quarter, for the second quarter in a row, the largest customer for CoolRunner-II was the handset customers.

CPLDs are really a phenomenal success story for Xilinx. Since 2001 we have more than doubled our CPLD market segment share while consistently increasing their gross margin contribution.

For the total quarter, Spartan sales represented 24% of revenue, Virtex 53% of revenue, and CPLDs 9% of revenue.

Let me now turn to a discussion of sales by geography and end market. From a geographic perspective, Europe was our strongest geography with sales growing 15% sequentially. Much of this growth was due to increased activity in both wireless and wireline communications, the Test and Measurement and audio video broadcasts were also strong.

Asia-Pacific and Japan were also up sequentially with strength coming primarily from Communications, Consumer, and Test and Measurements. North America, as expected, was the weakest geography with sales essentially flat as increases in communications were offset by decreases in defense.

From an end market perspective, consumer was the strongest sector increasing 14% sequentially, and representing 15% of total revenues. Most of the strength from this category came from audio/video broadcast with consumer and automotive applications were also up.

Communication business was up 5% sequentially driven by wireless sales. Wireline sales were flat sequentially but impacted by a large expected easy transition during the quarter. Storage and service was flat in line with expectations, industrial and auto was up 3%, more than anticipated due to strength in industrial, scientific and medical applications, as well as less weakness than anticipated in defense.

Fiscal year 2007 is shaping up to be a productive year for Xilinx. We will be making a number of exciting product introductions during the year. In fact, you may have seen that we recently announced work in 65-nanometer silicon from both family partners for our next generation Virtex family. We have delivered software and engineering samples to early access customers and general silicon availability will be ramping in the second half of the year.

Let me now turn to the guidance for the quarter. We ended the June quarter with backlog that is up in single digits sequentially. Inventory levels at our end customers remained relatively lean and internal inventories at Xilinx are significantly improved. The lead times remain extended for certain products but we believe that we have secured appropriate capacity to address continued back end capacity constraints.

On the other side, we are concerned about the growing energy prices and the ongoing consolidation in the telecommunication industry, which could cause some short-term disruptions. As a result, I am guiding revenues up 1% to 5% sequentially.

From an end market perspective, I expect sales from communications to be up sequentially driven by wireline applications. We're forecasting sales from industrial and other to be slightly down sequentially driven mostly by declines in test and measurement, which has been exceptionally strong over the past two quarters. Coming off of a strong quarter I expect consumer to be flattish, and storage and service should be slightly up, driven mostly by server applications.

From a geographic perspective, I expect sales from all regions to be flat or up sequentially. Now let me turn the call back to Jon for some final remarks.

Jon Olson, Chief Financial Officer and VP of Finance

Thank you, Wim. To achieve the midpoint of our revenue guidance, we will require turns of approximately 55%, flat with the prior quarter. Gross margin is expected to be approximately 52.5%, including $4 million of equity-based compensation. This is an improvement over the previous quarter's gross margin, which did not include equity compensation. We expect our mix to continue to trend toward new products, albeit at a slower rate.

Additionally, we expect to benefit from continued yield improvement on 90 nanometer technology. Days of inventory are expected to be approximately 130 days. R&D expense will be approximately $100 million, including $12 million of equity compensation. SG&A will be approximately $96 million, including $11 million of equity compensation. Amortization expense will be approximately $2 million. Other income is expected to be $13 million. And the share count is expected to be 348 million shares. Let me now open the lines for your questions.

Back to you, operator.

Question-and-Answer Session

Operator

Operator Instructions Your first question comes from Michael Masdea with Credit Suisse.

Q - Jeff Loff

Hi, it's Jeff Loff for Michael. In your commentary on the last fiscal year, you talk about revenue growth of 10% and operating profit growth of 11%. Just curious as you look at it over the course of this year, what do you expect those lines to trend in terms of the operating leverage that's in the model for you?

A - Jon Olson

Jeff, I am not sure I understood your question. Is it about fiscal ‘07?

Q - Jeff Loff

Yes. It's about fiscal '07 and how operating expense would grow relative to revenue because it doesn’t look like there was much leverage last year. So I'm wondering what the outlook is this year.

A - Jon Olson

I understand your question now, thank you. As we've talked about in the past, we have been committed to get to our operating model percentage goals by holding back some spending. So throughout the year we did add some things and add some spending in specific areas, particularly shoring up some of our new initiatives in DSP and embedded processors and also some sales changes relative to the merger between Avnet and Memec, the two primary distributors we had a year ago. So that added some additional below the line expenses that we won’t have growing at the same rate next year. That is kind of one point. I think also that we are, again, trying to hold back our spending and keep ourselves in a very fiscally controlled model while we let the topline grow. As you've seen in the last couple of quarters our revenues grew quite briskly. And we -- while our guidance is pretty much in the historic area going forward, we still feel good about next year's revenue growth. So we expect our operating margin leverage to improve and grow at a faster rate than it did in the previous year.

A - Willem Roelandts

Next question, please.

Operator

Your next question comes from Glen Yeung with Citigroup.

Q - Glen Yeung

Thanks gentlemen. I am looking at some of these metrics where your backlog coverage is the same as it was last quarter, and your guidance kind of seasonal growth looking into the second calendar quarter. But I wonder if looking at the trends you saw in bookings for example in the first quarter and some of the trends we've seen in the end market, just whether or not your level of confidence in the second quarter visibility is better, worse, the same than it was as you entered the first quarter? First calendar quarter.

A - Jon Olson

I would say, Glen, I think the visibility is -- we feel about the same. I think looking at the pattern, April and May are typically pretty strong months for us in terms of bookings, turns and what the backlog says. And in the previous quarter, the pattern was a little bit different, it was a little bit weaker in the beginning and stronger towards the end. So the patterns are a little bit different. Though we feel pretty good about where we are going into April, to be the strong end. So again, we are a little cautious about the month of June which has had a lot of variability for us than in past quarters.

A - Willem Roelandts

Next question, please.

Operator

Your next question comes from Chris Danely with JP Morgan.

Q - Christopher Danely

Thanks guys. Good quarter. Nice to see the com business finally coming back. And Wim, can you just talk about the communications end market and what you see? I guess I saw your comment interesting that there might be some delays out there with consolidation. Have you seen any effects in the end markets because of the consolidation?

A - Willem Roelandts

Chris, no, we have not seen any delays. But when companies consolidate or merge, there is always the first couple of quarters always disturbance and project gets canceled, putting question at least or delays. And that’s what we are kind of a little cautious about. At this moment we have not seen anything of that matter. And as you know, I am pretty optimistic about the communications market because I think there is a lot of new capabilities coming on line or at least people are preparing for it. And that is why we are positive on the market. It is just one of these clouds on the horizon, you do not know if it is going to hurt you or not but we just want to be cautious. We want to make sure that our investors know about it.

Q - Christopher Danely

Thank you.

A - Willem Roelandts

Next question, please.

Operator

Your next question comes from Ambrish Srivastava with Harris Nesbitt.

Q - William

Hi. Good afternoon. It's William for Ambrish. A question about inventory. I just want to get an idea in terms of the makeup of inventory at a more heavily weighted toward with finished goods, and also in terms of the date of inventory, I guess you guided to 130 days for next quarter versus long-term target of around 120 days that you talked about in the past. So just if you can comment on your confidence level of the current levels, and when do you expect to bring that down closer to your target of 120 days? Thanks.

A - Jon Olson

The mix issue, in the previous couple of quarters we moved a little bit more towards finished goods. We bought some extra piece for us to be able to lift through some of the tightness that's been going on in the backend. So we continue to carry a little bit more in finished goods than we normally would, however, we bled some of that off already even in this last quarter so I would not call it a very significant swing towards finished goods but we back off a little bit, but that is one point. So not a lot of change there but a little bit of positioning or posturing relative to the finished goods. With respect to the days, one of the things that has really been hurting us in the days area has been the strength that we have been seeing for Virtex-4. So when we have so many new individuals SKUs with a three headed family like we do Virtex-4, SX, LX and FX that we end up having a lot of strength, the cost of those products are still relatively high, meaning they are not at the corporate model yet. So they carry a very higher cost. And therefore that pushes our inventory in the face of forward-looking demand that we've had some strong demand we've been preparing for that and that has driven our days up. And now you are starting to see some of those things moderate and come down in addition to the fact that we have taken some steps to try to push our inventory down because we have not been very comfortable with how high it is. So I'm not going to give you an exact date on when we're going to get to 120, but I am going to tell you that we're going to continue to focus on it. As you see, we have taken 10 days out. We're going to take another four or five days out in the next quarter and we are going to continue to try to work that down a little bit more and get closer to our 120 target over the coming quarters.

A - Willem Roelandts

Maybe just one additional comment. We have two product lines ramping. So in days of inventory looking backwards, we have to put inventory days looking forward. And when you have very strong growth, you have to put a little bit of inventory in place just to be able to handle the next quarter's demand as maybe I should comment. Next question, please. Hello.

Operator

Your next question comes from David Wu with Global Crown Capital.

Q - Han Lee

Hi. This is Han Lee for David Wu. Regarding your gross margin, for the next quarter you’ve guided 62.5% with a $4 million stock option expense charge. And I am wondering what is that in terms of pro forma basis. And also, I have some question about the tax rate because if the tax rate going to stay at 22% or is it due to the shift in revenue, even different to different regions?

A - Willem Roelandts

To answer your first question, we provided you the information relative to what the dollar amount is of the equity-based compensation. And so we aren’t publishing pro-forma financial statements at this time and we are still evaluating exactly what we want to do there. So I'm not going to give you the arithmetic answer. But I think you can figure out how the percentages and the guidance in your model. Relative to the tax rate, our tax rate forecast is at 23%, which is relatively flat from what we had been forecasting last year plus or minus a point or two. While we are continuing to rebalance our shipments from a global perspective, there won’t be a huge mix shift around our various entities that we are forecasting at this point in time, which yields the same 23% we have been forecasting.

Q - Han Lee

Thank you.

A - Willem Roelandts

Next question, please.

Operator

Next question comes from Mark Edelstone with Morgan Stanley.

Q - Mark Edelstone

Good afternoon, guys. I had two relatively brief ones if I could. The first one is Wim, when you look at the mainstream products and look out for all of fiscal 2007, can you give us a sense of what you think those products do? Do we get growth off of those or are we at a stage where you would be happy to if they just hold relatively flat as we go through the year on a combined basis? And then we have seen across the landscape we’ve seen distribution inventories increasing for almost every company. And I was curious to know your perspective on how you do see distributors basically viewing the Xilinx portfolio right now going into the second quarter. Is that just confidence level in the business or are people finding that they just let their inventories get too low and it's kind of reversion to the mean here in the March quarter?

A - Willem Roelandts

So let me answer your first question, Mark and then Jon will answer your second. No, my expectation is that the mainstream products will continue to grow for next fiscal year. I think they were down this quarter because they were extremely strong in previous quarter. So it is just kind of little of an overshoot last quarter that's been corrected. But my expectation is that the mainstream products, we've got the bulk of products in production. That they will continue to grow overtime, absolutely.

A - Jon Olson

On a dollar basis.

A - Willem Roelandts

On a dollar basis. On a percentage basis, of course, that could change because the new products will grow faster. But then after a while, we reclassify the new products so it's shifting around.

A - Jon Olson

Yes, on the inventory issue, Mark, we have been watching that pretty closely. And its actually focused on just a couple of two or three different situations that we had where distributors built up in, I would say earlier in anticipation with some large customer business and we’re in the process of correcting that overtime. So I don’t view it as a broad-based inventory buildup. It was actually a very specific focused thing that we need to modify a little bit by a day or two, bring it back down to our 30-day model.

Q - Mark Edelstone

Okay. Thank you.

A - Willem Roelandts

Next question, please.

Operator

Your next question comes from David Wong with AG Edwards.

Q - David Wong

Thank you very much. Wim, your consumer and automotive as well as industrial segments show really good year-over-year growth, 31% and 47% respectively. Can you help us parse out what extent this year-over-year strength is because of industry correction last year versus strength in the end markets this year and also any Xilinx specific items, perhaps Spartan is doing well in these segments? Can you give us an idea of where all this growth comes from?

A - Willem Roelandts

Absolutely David. I think the growth comes mainly because of the long-term effort that we’ve started seven years ago to grow our business in these areas. Like I mentioned, five years ago in 2000, this whole combined category: consumer, automotive, industrial, and then the remaining business was only 8% of our revenues. Today it is 40%. And if you look back it really has compensated for the decline in the communication market after the 2000 bubble. So this is really the long-term effort that Xilinx did and we are committed to that. And I believe that this business will continue to grow. Automotive is very early. We are still very early in that industry. We have only been focused on that for the last three or four years so we have plenty of growth there and consumer the same thing. So now, this is really the effort that we have been working on to diversify. One of the lessons I learned after 2000 that we were way too focused on the communication industry or way too concentrated on the communications industry, let's say it like that. So I made a strategic decision that we have to be more diversified and in fact it's already started in '98. And the key driver for that, of course, is on one side Spartan. Spartan is a product that started in '98 and has been doing extremely well going from zero to 24% of our revenues now, but also CoolRunner. CoolRunner was acquired for the original technology was in acquisition but for us, it allows us to get into the handset market, the portable device market. And it is really doing very well. So these are the two families that we are pushing in this consumer space, automotive space and that is why we are growing so much. Next question please.

Q - David Wong

Thank you.

A - Willem Roelandts

Next question please.

Operator

Your next question comes from Seogju Lee from Goldman Sachs.

Q - Seogju Lee

Thank you. Just on the gross margin, I wanted to explore a couple of things. One, on the new products, can you talk about where you stand on the cost curve? As you had a couple of issues on the yield side earlier in the lives of products like V-II Pro. And also, just as you are ramping up the dual supplies strategy, just how you look at where you stand on the cost versus where you traditionally stand on cost curve at this point? And then secondly, in terms of gross margin improvement in the June quarter, can you help us understand what is driving that on a sequential basis? Is it recovery and mainstream or is it a function improvement on the cost on the advanced product? Thank you.

A - Jon Olson

It's actually the new product composition, most of the new products with the exception of Virtex-4 are very close if not above the corporate model at this time. So we're doing very well there. V-II Pro has been in the market for quite some time and those issues that were historic are now well behind us from that perspective and V-4 is tracking really right on target to where we anticipate it, below corporate model. I think that some of the reason we talked about relative to the margin this time is that we had such a strong revenue growth rate out of there that drove this down a little bit. But again, the margins are positive. They are just not at the corporate model yet. And the one particular issue we had on yield with FX, we have just come out of that and while we still have some older inventory that we are moving through the system, those yields have improved, grew substantially and the costs are starting to come down on that also very nicely, albeit later, behind the SX and LX cost curves. Relative to the June quarter driver, I would say there are certainly some yield improvement numbers that we're counting on from the new products. I would say that's about half of it. So I think the other half of it is related to I don't know if I would call it a comeback of the mainstream but a slower growth increase of the new products relative to how we did in this past quarter. So that helps to naturally bring the margin up a little bit.

A - Willem Roelandts

Next question, please.

Operator

Your next question comes from Steve Iliescu (phonetic) with UBS.

Q - Steve Iliescu

Yes. This is Steve Iliescu in for Tom Thornhill. On options expenses, it looks like you have been around 21 million net of tax, and I guess your guidance is in line that. Going forward, should we think of option expenses trailing off or holding flat at this level? And if you could you give an update as far as your stock options policy? Thank you.

A - Jon Olson

So, for this year, you should think of it as being relatively flat around that number. There won’t be any huge moves to that because essentially the expense is created from layers that were created in previous years and those layers are coming forward. So the new options from this year will not hit us until the July timeframe. And that will add some incremental to it. But there is also some things some shares falling off of that. So we look forward and say that is a pretty good number to use on a quarter-by-quarter basis for now. And I will let Wim answer the policy question and what we're thinking about.

A - Willem Roelandts

Yes, Steve. From a stock option point of view, of course we are rethinking our whole approach to stock options and trying to minimize the impact that the expensing of stock options has on our P&L. Of course these things will take time like Jon explained. We are paying now for the last 10 years of stock options kind of over the last four years, rather, of stock options. So it is going to take a while before you see this have any impact. But we're going to move to a mix of stock options and restricted stock. We are also planning to reduce or trying to minimize the impact to some other factors. So that is the direction we are moving. Try to minimize the impact of stock option expensing but at the same time maintaining a relatively broad base of the ownership amongst our employees, because I believe that is what drives employees to work extra hard that is needed to really bring these outstanding products into the market. Next question, please.

Operator

Your next question comes from Quinay Laharia (phonetic) with Deutsche Bank.

Q - Quinay Laharia

Hi, this is Quinay Laharia for Ben Lynch. For many years, you guys have been talking about reducing reliance on communications business. And now if I heard Wim right, this segment might actually grow as a fraction of revenue in fiscal '07. Just was wondering if this is a kind of surprise for you guys and if it is really still realistic to expect you guys to be reduce reliance on communications?

A - Willem Roelandts

Yes, I can easily answer that. We have in fact reduced our reliance on communications. It is now down to slightly below 50% of our revenues from I think our peak was close to 80% in 2000. So we have significantly reduced. What I really want to say is that if you look at the last four years, our growth rate has been in the 10% to 15% range, which is well below our corporate average. And what you look at here is really a combination of two things. The communication industry is declining on one side, on the other side our growth in these new markets: consumer, automotive, industrial has kind of compensated each other. What I believe is now happening is that we are entering a phase where communication could start to grow a little stronger than in the past and I believe we will continue to see the growth continuing in the other areas. So although we are talking about communication growing a little bit as a percent, we're talking a few percentage point mainly in the short-term. In the longer-term, if you talk about three to five years or two to three years in the future I have no doubt that the communication will be a smaller percent of total revenue mainly because the other parts are growing so rapidly. So it is more a shorter term effect rather than in the long-term. But its good to see the two big parts of the company, on one side communication is 50%, and the other side we have the consumer, industrial, and so on, automotive at 40% but both of them will be growing in over the next year or so. And that is different from where we have seen it in the last five years. Next question, please.

Operator

Your next question comes from Jeff Palmer with Friedman Billings.

Q - Jeff Palmer

Hi, gentlemen. Wim, do you think you could give us your thoughts on when you would see peak revenue from the Virtex-II Pro? And then as a follow-on maybe when you might see peak revenue for Virtex-4 for the product revenue since introduction?

A - Willem Roelandts

Yes, Jeff, you know the V-II Pro is really a dramatic change in strategy for Xilinx. Once we started integrated processors it really changed the decision point at which a decision is made to use these products. Traditionally, programmed logic is many be used as logic where a decision is made pretty late in the project cycle, typically 12 or 18 months before a product goes in production, people decide at the engineer level what program or devices to use on GLU logic. A decision on a processor based solution is made very early in the project cycle, typically by the architect. And that is the big change that happened with V-II Pro. That’s why V-II Pro was slow to take off because the architecture decision was made but it was two, three, four years ahead before the product was in production. So we had a slower start on V-II Pro. But my expectation is that the ramp on V-II Pro will continue for at least several years. Because of the fact that these products tend to be mainly in the communications space which tend to have very long lifecycles. As far as V-4 is concerned, they are of course we have a mix of products. We have V-4 LX, which is more a traditional FPGA and V-4 FX which is more the replacement of V-II Pro. I think at the peak revenue for V-4 is at least five years away.

Q - Jeff Palmer

Great, Wim, thank you, and just a housekeeping question, if I may, for Jon, Jon, I missed what you said about the employee stock option expense would be on R&D for the next quarter, I just couldn't type that fast?

A - Jon Olson

The R&D expense will be $100 million. And that includes $12 million of stock option expense.

Q - Jeff Palmer

Great. Thank you very much gentlemen.

A - Willem Roelandts

Next question, please.

Operator

Your next question comes from Glen Yeung with Citigroup.

Q - Glen Yeung

Thanks. Just a follow-up. Jon, I think I heard you talk about where you thought margins would go in the second quarter and no, why they would go that way. If we think about the fiscal year, can you give us a sense as to the kind of trends I don't want to pinpoint you to a number, but the kind of trends we might expect to see in gross margins?

A - Jon Olson

Yeah, I think that we had growth last year in margins as we went through the quarters. And I think if you look forward year, I think we will see less of a growth pattern, albeit, I do not think we will see a decline either. I mean the way we are modeling things out is that we will continue to get some incremental yield improvements. And depending on how the mix turns out, which could always change on us at anytime, I feel pretty good about where we are in margins. And then where it starts getting tougher is when the next generation Virtex product family gets introduced. And what happens then is that we start building wafers, those wafers in unit costs are very expensive in the beginning. And that would have a drag on our - potential drag on our margins. I wouldn’t expect you to see that coming until the December or March quarter. It's really depending on how the launch goes and the timing of things.

Q - Glen Yeung

Thanks.

A - Willem Roelandts

Next question, please.

Operator

Your next question comes from Chris Danely with JP Morgan.

Q - Christopher Danely

Thanks guys. Hope since we're cycling through I can sneak two in. The first is a quickie. When do you expect the back end constraints to ease? And the second one is a little more big picture. Certainly the Spartan products have grown fairly well. The various piece are 1/10th to 1/20th of that of the Virtex products. So do you guys see any cannibalization of some of the high-end router products that used to go to, say the Virtex or your high-end FPGA line going to the Spartan? Thanks.

A - Willem Roelandts

First of all, with the backend constraints, Chris, I think it's going to be there for quite a while. The reason is first of all there is a concentration now in the back end companies, that is before big companies are pretty much in control of the market. And none of these companies have made much profits over the last four or five years. So I think that you were going to see is that we're going to be reluctant to invest until their profit margins are a little bit higher. And so it could take a while before that is the case. Now for Xilinx, we have foreseen this and so we have taken agreements with these customers mainly in the form of APAs to guarantee a certain capacity. So that's why we had outstanding on time delivery performance this quarter. And we expect that to continue over the quarters to come. So, we are in pretty good shape as far as that is concerned. Secondly, about a cannibalization of Spartan and Virtex, clearly, some of that will happen. However, Spartan is much lower performance than Virtex and is really targeted for a different market. The consumer and the automotive markets. Although Spartan is used in some of the routers and mainly as what I call GLU logic, it is Virtex was really the main product that they use to do the heavy-duty work and that is really replacing the core of the design. So when you look in the past, all of the programmables were used and GLU logic in the core of the design were A6 processors with ASSPs. Today we see Virtex taking more and more of the place of the core of this design as our Spartan is used in some cases of GLU logic. Of course, Spartan's main business comes from the consumer markets. Where there is a very huge volumes. We receive now on the regular basis orders that exceed 100,000 units a month for instance. And that allows us also to work down the learning curve and increase the yields and the profitability for the whole product line. So it's Spartan that sells to a communication customers at low volumes at a very different price from a Spartan that sells 100,000 units a month to the consumer market, even though it is the same physical product. I hope that answers your questions.

Q - Christopher Danely

Yeah. That’s fine thanks a lot.

A - Willem Roelandts

Next question please.

Operator

Your next question comes from Gurinder Kalra with Bear Stearns.

Q - Gurinder Kalra

Thanks. I have a macro level question. Obviously the com ten market has been pretty strong for the first half for the PLD companies based on the guidance we've seen so far. Now the question on people's mind is where is this teaming up in the second half and without going into specifics of third quarter guidance, what other things you and we should be looking for to determine the strength of the com ten market in the second half of the year?

A - Willem Roelandts

Well, Gurinder, I believe that the strength in the communications market is really driven by a new set of obligations and I think some of you have called it a triple play, the fact that in the past the Internet was mainly used for data, data consumes eight bits per characters. Now we see more and more applications that uses Voice Over IP or Video Over IP and that of course, bandwidth that are needed and capacity that is needed is orders and orders of magnitude higher. Voice is 64 kilobits per second, video, high definition video is megabits per second and I think that's what we're really starting to see now is a shift from an Internet that is using voice communications to an Internet that is going to be voice, video and data. And that is going to require levels of investment that are driven because of the fact that the voice revenues for the telecom service companies continue to decline, they really have no choice then to go to alternate source of revenue. In other words, what today the telcos are still very much dependent on their voice revenue over switched network and that voice switching is moving away towards Voice over IP, on top of that we have video coming, so they are really looking at these new markets as a way to change the playing field. That's why you see so much talk about fiber to the home. It's really to provide the last mile so they can deliver video to the home, and the success, of course, we saw at the beginning, so it is different from country to country, but for instance, in Japan, last quarter there were 100,000 sorry, 200,000 new subscribers for fiber to the home per month, 200,000 per month. In U.S. it’s about 50,000 per month of subscribers to fiber to the home. But these fibers have to be fed and that is what we believe is going to happen. Now it’s difficult to say if it’s going to happen this quarter or next quarter or a year from now or two years from now but I believe that we really are entering a new phase of growth for the communication industry and that’s why I think you see also some of these consolidations happening and because I think that companies are starting to realize that and preparing themselves for this new phase of growth. Does that answer your question?

Q - Gurinder Kalra

Yes, it does. Thank you. I just had a follow-on question there. Obviously your inventory situation looks like a lot better ending the March quarter but prior to that we have heard of some instances of some inventory build. How do you reconcile your efforts or I guess your inventory reduction with some inventory increases and the worries out there about inventory increases in the com market?

A - Willem Roelandts

Well, it certainly is a concern and we have done our own checks throughout our supply chain and where we of course have very difficult way of measuring is in semi-finished goods inventory, in other words, finished boards, because there we lose track of our parts. We know where are parts are in the factory, we know where they are in our distribution, we know where they are in the subcontractor manufacturer, but once it's on the board then it is much more difficult to track and I cannot really, we don't have any good data there but I can tell you that the subcontract manufacturer of the distribution and of Xilinx, we feel pretty good about the inventory situation and we don’t see any excesses, even although our distribution increased by three days, it went to 31 days, which is still pretty much in our target and what we normally like to see our distribution carries, around 30 days of inventory, 35 days even. So I believe we are in good shape. What happens once the boards are assembled, much more difficult to track and there it could be some excess although we have not seen none of our customers expressed that to us at the moment.

Q - Gulrinder Kalra

Thanks very much.

A - Willem Roelandts

Thank you and next question please. Oh, sorry, last question, please.

Operator

Your final questions comes from Seogju Lee with Goldman Sachs.

Q - Seogju Lee

Hi, thanks, just back on DSOs, Jon, in terms of the tax, what sort of tax benefits should I think? And is that already embedded I'm assuming that's already embedded in the 23% corporate rate.

A - Jon Olson

Yes. It is embedded in the 23% corporate rate. So potentially I mean there is a lot of transactional activity that goes into figuring out what the rate is. We think we have fully included any impact from that. Given that we have a lot of offshore manufacturing, it is actually fairly complicated to get down into parsing out the pluses and minuses of the whole thing and when we got done with it, and all of our experts looked at it, the rate ended up being pretty much the same as it was before that. We have gone back and looked at other companies announcements to make sure that we understand it. And most of the companies we have seen, has not had such an impact as anything to their tax rates so I think we will be all right.

Q - Seogju Lee

Okay great, thanks. Good luck.

Lori Owen, Investor Relations

Okay, thanks for joining us today. We have a playback of this call beginning at 5:00 PM, Pacific Time, 8:00 PM. Eastern Time today. The instant replay will run for 48 hours. For a copy of our earnings release, please visit our Xilinx IR website. Our business update for the June quarter will be posted after the market on June 8. Our earnings release date for the June quarter of FY 06 will be Thursday, July 20 after market close. This quarter Xilinx will be appearing at the Bear Stearns technology conference on June 13. Thanks for your participation.

Operator

That concludes today's Xilinx fourth quarter 2006 fiscal year earnings conference call. You may now disconnect.

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