Integrated Device CEO Discusses F2Q11 Results - Earnings Call Transcript

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Integrated Device Technology, Inc. (NASDAQ:IDTI) F2Q11 (09/26/2010) Earnings Call October 25, 2010 4:30 PM ET


Ted Tewksbury - President and CEO

Rick Crowley - CFO


Tim Luke - Barclays Capital

Sandy Harrison - Signal Hill

Glen Yeung - Citi

Sukhi Nagesh - Deutsche Bank

John Barton - Cowen


Good afternoon and welcome to the Integrated Device Technology Incorporated fiscal second quarter 2011 financial results and conference call. (Operator Instructions)

With that said, here with opening remarks is Integrated Device Technology's Chief Financial Officer, Rick Crowley.

Rick Crowley

Welcome to our fiscal second quarter 2011 earnings conference call. I'm Rick Crowley, IDT's Chief Financial Officer. Presenting with me on the call today is Ted Tewksbury, our President and CEO.

Our call today will include remarks about future expectations, plans, and prospects for IDT, which constitute forward-looking statements for purposes of the Safe Harbor provisions under applicable federal securities laws. Actual results may differ materially from our forward-looking statements as a result of various important factors, including certain risks, which are detailed in IDT's most recent Annual Report on Form 10-K as filed with the SEC.

IDT does not intend to update the information provided in today's call and expressly disclaims any such duty except as required by law. In addition, pursuant to Regulation G, any non-GAAP financial measures referenced during today's conference call can be found in our press release posted on our website at, including a complete reconciliation to the most directly comparable GAAP measures.

Also, we have made selected financial information available in webcast slides, which can be found in the Investor Relations section of our website.

Now, I'll turn the call over to Ted who will provide some second quarter highlights, and then I'll return to give you more specifics on our September quarter results and our outlook for December. Ted?

Ted Tewksbury

Thank you, Rick, and thanks to all of you joining us today. Our results once again came in better than expected in Q2, validating our strategy and highlighting the significant leverage in our operating model.

Revenue was up 5% sequentially to $166.9 million, driven by a 22% increase in new products combined with growth in our core consumer timing, communications timing, and DDR3 memory interface businesses. Our deliberate efforts to shift the mix to higher value-added products resulted in a non-GAAP gross margin of 57.3% and our highest GAAP gross margin in a decade.

During the quarter, we generated almost $40 million in cash from operations, or 24% of total revenue, and we bought back almost 6 million shares of our own stock.

As always, let me begin with an overview of our new products and design win activity for our consumer, computing and communications end markets for the September quarter. In addition, I'll talk about the four secular forces that are driving the growth of our businesses; video, mobility, cloud computing and fourth generation wireless infrastructure.

In the consumer end market, we experienced 17% growth in the September quarter. New product revenue from video solutions was up over 50% sequentially, driven by the ramp of HDTV timing controllers and seasonal increases in consumer timing.

Overall, consumer sales represented 19% of total revenue, up from 17% in the prior quarter. Video and mobility are the key secular drivers that are driving growth in our consumer business. John Chambers has called video the killer app that will account for 90% of all consumer IT traffic by 2013.

IDT is riding this trend with our timing, video post processing, frame rate conversion and power management products, all of which continue to gain design win traction in new 3D and IPTVs, set top boxes, video conferencing equipment and mobile consumer electronics. As an example, during Q2 we announced that Yamaha had selected our Vida video post processor for use in their new Aventage Audio/Video receiver.

IDT's Emmy award-winning Hollywood-quality video technology allows Yamaha to deliver an unrivalled home entertainment experience to its customers.

In the computing end market, we experienced a slight decline in revenue quarter-over-quarter. PC-related revenue decreased about 5% sequentially, with 40% growth in DisplayPort Timing controllers, offset by soft audio codec sales and lower shipments of PC Clocks as we continue to steer from capacity towards higher gross margin products.

Server-related revenue was roughly flat quarter-over-quarter, with moderate PCI Express growth offsetting a slight decline in memory interface sales. Altogether, computing represented about 35% of total revenue, down from 39% in the prior quarter.

Our diversion of R&D investment and FAB capacity away from low gross margin products like PC Clocks has paid off handsomely in gross margin expansion. I'd like to emphasize however, that we continue to participate in mobile computing platforms such as notebooks, netbooks, tablet PCs and embedded applications, where we can add value with differentiated higher gross margin products.

For example, we recently announced the industry's first single chip power management solution for LCD displays and portable consumer devices. This new product integrates an LVDS timing controller together with power management and a 4-channel driver for LED backlighting. This highly integrated solution exemplifies our strategy of combining power management with our core timing and digital expertise to simplify our customers' system designs. We also continued to see strong adoption of our DisplayPort timing controllers in the notebook segment as Intel continues to promote this standard. We recently announced a new Multi-Monitor controller which is the world's first DisplayPort based device that allows users to connect up to four monitors to a single port.

Finally in audio, we just introduced the world's first family of high definition PC audio codecs that feature DDX-based class-D modulation technology which extends battery life, eliminates pops and clicks and reduces electromagnetic interference from PC audio systems.

In our enterprise computing business, the killer app is cloud computing. Intel noted in its most recent conference call that shipments into its cloud computing segment were up 200% from a year ago, and up 50% from last quarter. As enterprises shift computing and storage to the cloud, datacenters will need more servers and storage devices with higher performance, lower power and more virtualization.

IDT is capitalizing on these trends by combining our leadership in timing, serial switching and memory interfaces with our new analog and power management capabilities to deliver the industry's most comprehensive portfolio of mixed signal solutions for data centers and the enterprise.

IDT continues to defend and grow our number one position in memory interfaces. Our DDR-3 memory interface revenue was 95% year-over-year exceeding the 30% annual growth rate reported by Intel in their server segment.

Another very exciting new growth area for IDT is enterprise computing division is solid state drives. PCI Express is rapidly replacing SAS and SATA in SSD interfaces due to its higher performance, lower latency and lower power. Gartner estimates that PCI Express based SSDs will represent over 40% of the enterprise solid state drive market by 2013 opening up a $100 million sale for IDT.

We're leveraging our PCI Express expertise as well as our partnership with Micron to lead this disruptive technology transition. In Q2, IDT demonstrated the world's first solid state drive using the enterprise Non-Volatile Memory Host Controller Interface Standard at the Flash Memory Summit in the Intel Developer Forum. The NVMHCI standard was defined by IDT and other industry leaders to enable the development of standard software drivers and features for PCI Express based SSDs and to catalyze the widespread adoption of this technology.

Our power management solutions also continue to gain traction in advanced computing applications. During the quarter, we started shifting voltage regulators modules to SGI to power their Altix UV, the world's fastest supercomputer. The Altix UV utilizes IDT VRMs for microprocessor, ASIC and memory power requirements.

Moving on to communications, our revenue increased 9% sequentially on strength in RapidIO, timing and standard products; this marked our sixth consecutive quarter of growth in communications representing 46% of total revenue up from 44% in the prior quarter.

The explosion of IP traffic driven by cloud computing and video and mobility is spurring demand for higher speed, higher capacity, wireline and wireless infrastructure. As speeds and performance levels increase, the need for higher accuracy, lower power and lower jitter timing solutions increases proportionately.

To address these requirements, IDT recently introduced the worlds most accurate all silicon CMOS oscillator. It achieves 100 parts per million of total frequency error across temperature, voltage and other parameters. This, my friends, is a breakthrough. It enables crystal based oscillators to be replaced with a single monolithic silicon IC.

Our continuing penetration of the $700 million crystal oscillator replacement market underscores IDTs commitment to defending and growing our world leadership position in timing. No other company in the world offers the breadth, performance and flexibility of IDTs timing portfolio. In Q2, our communications timing revenue grew 10% sequentially spanning broad based applications in datacom, telecom and wireless infrastructure.

And that brings me to the fourth major trend driving our business, which is 4G wireless infrastructure. Virtually all LTE and HSDPA base stations use RapidIO switches, and IDT is the sole provider of these devices in the world today. The accelerating deployment of LTE base stations is driving growth in both our timing and our RapidIO businesses. As you know during the quarter, Verizon announced that it will turn on its 4G LTE network in 38 markets by year end and will cover two-thirds of the U.S. in the next 18 months.

AT&T has also announced that it plans to roll out LTE in the U.S. in mid-2011; all of these will have IDT inside. In Q2, our revenue from Serial RapidIO switches grew over 60% sequentially. And the LTE growth ramp has only just begun.

Let me now provide some color on our markets relevant to the December outlook. IDT's overall revenue grew by 21% in the six months between March and September, driven by robust demand, new product ramps and share gains. However, increasing macroeconomic uncertainty led to weakening order patterns as the summer progressed.

Our book-to-bill ratio declined from greater than one when we entered Q2 to less than unity when we exited. Despite lower sequential shipments of PC-related products in Q2, end of quarter channel inventories exceeded target levels, driven by weaker than expected resales in the month of September. We are proactively reducing PCI or/and timing shipments this quarter in order to meet balance channel inventories. In addition, ODMs and distributors are reducing their inventory levels ahead of Intel's Sandy Bridge ramp.

These factors present headwinds for the December quarter. In the PC end market, we expect continued below normal seasonality for the reasons just described. In the consumer end market, we expect revenue to decline, driven by global demand weakness. In communications, we expect the December quarter revenue to be slightly up, fueled by continued rollout of wireless infrastructure worldwide.

Overall, for our third quarter of fiscal 2011, we expect revenue to be $153 million plus or minus $3 million.

IDT, our customers, and many other semiconductors are currently weathering a highly uncertain demand environment. Nevertheless, we remain focused on outsized long-term value creation for our shareholders. IDT has built three cornerstones for sustained value creation, and these are the key points I hope you take away with you today.

First, IDT is tapping into powerful market forces that will drive secular growth in the coming years; video, mobility, cloud computing and 4G wireless infrastructure. Second, IDT has the new products to capitalize on these trends. Our new product engine is cranking out a continuous stream of world's first, and doubling new product introductions year-over-year.

In Q2, our new product revenue was up 22% quarter-over-quarter, and up 80% year-over-year. Third, IDT has the operating model to parley revenue growth into profitability growth. During Q2, $0.83 out of every incremental sales dollar dropped to non-GAAP operating profits, clearly demonstrating the leverage in our model. So, IDT has the growth drivers, the new products and the operating model to outperform the broader markets on a sustained basis once we get through this temporary low in demand.

Before I turn the call over to Rick, I'd like to personally invite each of you to attend the first analyst day we've hosted since I've been with IDT. It will be held on December 7 at our corporate headquarters and will be an excellent opportunity for you to meet with our general managers and hear firsthand how each of their business units is capitalizing on the growth vectors in video, mobility, cloud computing and 4G wireless infrastructure.

I guarantee that you'll come away with a deeper understanding, an elevated sense of excitement and increased confidence in the new IDT. So please contact Mike Knapp. And we look forward to seeing you there.

With that, I'll turn the call over to Rick to expand on the financials and our guidance for the December quarter.

Rick Crowley

Let me start by going over our non-GAAP results for Q2, which reflect another quarter of exceptional execution. As Ted mentioned, total revenue of $166.9 million was up 5% quarter-to-quarter and above the midpoint of the range we provided in July, driven by growth in both core and new product launch.

Fiscal Q2 gross margin was 57.3%, up 170 basis points from the prior quarter, represented a four-year high for the company on a non-GAAP basis. The quarter-to-quarter improvement was largely due to better product mix as we reduced our exposure to PC Clocks and increased our manufacturing of higher, value-added solutions. The FAB is running at full capacity, and we continue to have great success optimizing our product mix to achieve greater profitability as is reflected in our September results.

We limited total operating expense growth in Q2 to $64.7 million, up only $500,000 or 1% from $64.2 million in the previous quarter. The quarter-to-quarter increase was primarily the result of variable compensation expense items related to improved business trends. R&D spending during the fiscal quarter of $41 million was approximately $1 million less than the midpoint of our guidance, due to lower outside service expense and material purchases for new product prototypes. Some of this R&D spending will be incurred in the current December quarter.

SG&A expenses of about $24 million came in as expected and were flat quarter-to-quarter. Our operating profit increased sequentially by 30% to $31 million from $23.8 million in Q1 due to higher revenue and gross margins. The intrinsic leverage in our business model was evident in Q2, as $0.83 of every incremental sales dollar dropped to operating profit. This resulted in operating margin of 19%, up from 15% in June.

Interest Income and Other was about $600,000, up $200,000 from the prior quarter. For Q2, we reported non-GAAP net income of $30.4 million, or earnings of $0.19 per share. This was up $0.05 from the June period and was $0.03 better than the midpoint our expectations provided in July.

Now, let me summarize our results on a GAAP basis. We reported GAAP net income of approximately $20.2 million, or $0.13 per diluted share in the September quarter. This is up $0.07 from the $0.06 per share recorded in the June quarter excluding the one time gain due to the sale of our network search engine business in the year ago period, Q2 marks the highest quarterly GAAP earnings per share level for IDT in ten years. The difference between our GAAP and non-GAAP results nets out to about $10 million, or $0.06 per diluted share.

Fiscal second quarter 2011 GAAP results include approximately $5 million in acquisition and divestiture related charges, $4 million in stock-based compensation, and $1 million in restructuring related charges. For further information, including a detailed reconciliation of GAAP to non-GAAP results please see the financial tables of today's press release which can be found on our website

Now, I will turn to our balance sheet. Cash and investments totaled approximately $339 million at the end of the September quarter, a sequential increase despite a higher level of share repurchase during the quarter. We generated approximately $40 million of cash from operations, received $2.4 million from the employees stock purchase program and used $31.4 million to repurchase $5.8 billion shares of common stock. Capital expenditure were about $4 million in the second quarter. Free cash flow, defined as cash flow from operations minus capital expenditures was $36 million in the second quarter.

Net inventory was about $53 million in September, up $3 million sequentially while days of inventory increased to 68 from 64 days in the prior quarter. Our trade accounts receivable decreased approximately $1 million to $74.3 million in September while DSO also decreased moving to 40 days from 43 days in the prior quarter.

I'll now turn to our forecast for the December quarter. The uncertainty surrounding the rate of global economic growth during the summer caused many of our customers to reduce the forecasted demand for their end products. This translated into lower order rates during the September quarter.

The fiscal Q2 IDT to bookings declined sequentially, and our book-to-bill ratio for the quarter was below one.

Ted, provided information regarding various factors impacting our December quarter revenue outlook in his remarks. To reiterate, we currently project revenue for our fiscal third quarter 2011 to be $153 million plus or minus $3 million. On a non-GAAP basis, we project gross margin to remain roughly flat quarter-to-quarter at 57.3% plus or minus 50 basis points depending primarily on the revenue range and product mix. We anticipate utilization in our Oregon wafer fab will be about 95% in the third quarter.

We currently project operating expenses in the December quarter will be in the range of $65.5 million plus or minus $1 million dollars. R&D is expected to be approximately $42 million as some of the development expenses previously forecast for Q2, pushed into fiscal Q3. SG&A spending is projected to decrease to about $23.5million.

We currently anticipate interest and other income to be about $400,000 and we expect our fiscal Q3 tax provision to be about $900,000 as we continue to benefit from tax credits accumulated in previous years. We project Q3 share count to be about $157 million on a diluted basis and project our non-GAAP EPS to be about $0.14 at the mid point of our revenue guidance.

On the balance sheet, we expect to generate approximately $20 million in cash from operations during the December quarter. Our on-hand inventory and days of inventory are expected to increase sequentially as it begins to build bridge inventory for a wafer fab transfer. We project that cash balance at the end of December will be approximately $360 million, which does not include any impact from share repurchases during the quarter.

In summary, we continue to successfully defend and grow market share in our core business lines. While we expand our available market through system level analog and digital solutions.

While we see weaker than seasonal revenues for the December quarter, exacerbated by inventory reductions in the computing end market, we believe we're well positioned to benefit from long term secular growth divers. And remain confident about out ability to maintain above market growth rates over the long run. Our second quarter financial result demonstrate the strength of our financial model, IDT is much better positioned to weather the current slowdown in demand that we were two years ago.

Despite near term inventory corrections in customer demand fluctuations, we remain committed to deliver solid profitability and cash flows while continuing to invest for future growth.

With that summary, I will turn the call over to the operator for the Q&A portion of the call.

Question-and-Answer Session


(Operator Instructions) First we'll go to the line of Tim Luke with Barclays Capital.

Tim Luke - Barclays Capital

It looks like your gross margin going forward, is holding up well, despite a somewhat lower revenue guide. Can you talk about some of the factors that are contributing to a flat gross margin despite any decline in the revenue? And as you think about it going forward, it seems that your utilization is staying pretty high. How should we think about that? And how should we think about your plans relative to the inventory level on hand as move through the December quarter?

And then if I may, could you give us some sense of how you feel that the Sandy Bridge ramp may impact the computing business as we look into the calendar first quarter?

Rick Crowley

Okay. Tim, it's Rick. With respect to the gross margin as you saw in the recently completed September quarter results here, the mix is definitely helping our gross margin. And we anticipate that the mix will continue to be favorable in the December quarter with some of our lower margin businesses declining and the comp business holding up pretty well. That's just one aspect.

As you noted, revenue is down. So there is less revenue to spread across the fixed cost which creates a bit of a headwind. And the fab utilization in the factory aspect is about the same quarter-to-quarter. So you have improving mix helping us offsetting the lower revenue, basically creating what we see approach us as we sit here today.

With respect to your second question on the inventory utilization going forward, we're still holding to our model that we articulated last time, walked over 54% to 56% gross margin only from the standpoint that we do see some of our growth lines overtime rebouncing the mix. But in the near term, the mix is positive. And the capacity utilization and inventory build; as I mentioned, we're just beginning to build our bridge inventory for the fab transfer, something that the strength and demand in, so far, the first nine months of the year has actually prevented us from doing. So we're taking advantage of that this quarter, still seeing fast utilization come off the CAD, but that's more holiday related than anything else.

As we move into the first half of the next year, we'll continue to need to build inventory. So you will see our days continue to move up. But ultimately, the utilization of the factory is going to be dependent on end-customer demand, not the bridge build for inventory for the transfer. And because of that, it's really difficult to predict what the utilization is going to be as we get into March and June at this point, because we're only guiding one quarter of a time and we have to see how bookings move from there.

I think Ted will speak to the categories question.

Ted Tewksbury

As far as the Sandy Bridge aggregation is concerned we talked pretty extensively about that on the last earnings call. And at that time, we said that PC clocks represented about 10% of our revenue and about half of that was exposed as a result of the clock integration on Sandy Bridge. And we're still sticking by that.

What we're seeing right now is that some of the distis and the ODMs are starting to take down their inventory in anticipation of the Sandy Bridge launch. And we're also doing the same as far as reducing our shipments in order to reduce our exposure.

Tim Luke - Barclays Capital

It looks like your comp business seeing a good strength, you talked about the consumer being slightly lower due to the global demand. What were the areas within the consumer that are somewhat softer may be sequentially than you might have thought?

Ted Tewksbury

We see rather inconsistent behavior in our consumer market from year-to-year. Typically it tends to be flattish from September to December. Sometimes you see gaming go up; sometimes we see it go down a little bit. This time around, we expect to see gaming reduce a little bit because of the demand weakness. And then also, as I think you are well aware, there has been weakness in the flat panel display of high definition TV segment which impacts us.


Next we'll go to the line of Sandy Harrison with Signal Hill.

Sandy Harrison - Signal Hill

We started to talk a little bit about the fab transition on the prior question. How is that coming from an execution or a mechanic stance? And then as we look at that transition, how should we be thinking about longer term model and what its potential impact is on sort of building out next year?

Ted Tewksbury

The fab transition is right on schedule. In fact, Q2 is the first quarter that we started shipping production wafers out of KSMC. So that was a major milestone. We're still on target to complete the transfer by the end of calendar year 2011.

Rick Crowley

I think on the gross margin standpoint, Sandy, ultimately, we believe that we'll get fully out of the fab. If you look at calendar 2012, the first main point there is that we do have potential gross margin upside from our current margins. And that we do believe we'll be able to obtain better wafer pricing from the foundry than we can get even at fully utilized rates in our fab in Oregon.

So that's good. As I mentioned in the call last summer, we'll update our gross margin model as we get closer to that event. In the meantime, I think in the near term, eventually quarters we'll manage the outlook and capacity utilization as we would normally. But certainly in the December quarter of 2011 right now, our fiscal third quarter next year, we probably will see a margin decline as that's the quarter we expect our last wafer out of the fab and ramped down to occur.

And at this point, I can't give you some guidance there with respect to what we see, but we certainly should model in some gross profit deterioration in that quarter, albeit it will be transitory in nature.

Sandy Harrison - Signal Hill

Hearing a lot more talk in your prepared remarks and seeing some additional activity in the industry about the RapidIO product and them using the PCI Express scenario other than what it originally started out. What's your view on how you expect to see that roll out? And right now you guys are talking about being the only one shipping. I guess an FPGA guy talked about having some RapidIO stuff and sort of what's the difference between sort of an FPGA based solution versus what it is you guys have dealt with and seem to have had some design wins with?

Rick Crowley

The FPGA guys that are talking about having RapidIO, they're talking about the interfaces themselves, the end-point IP. They don't have the switches. The switches are really the high ground of RapidIO design. And there is nobody else out there to our knowledge today that has that including all of the FPGA vendors.

And so those products are already shipping and you will see revenue continue to increase in our RapidIO business over the next several years as RapidIO ships in the fourth generation infrastructure. You've already seen very strong quarter-over-quarter growth in that business. This quarter it was 60%.

As far as the PCI Express switches, we don't see that as being a viable competitor for the 4G base station, simply because of performance requirements, latency requirements and so forth, which can only be addressed by RapidIO. However, we do see PCI Express moving into other communications applications in telecom and datacom, and moving beyond to server-specific applications for which we originally designed those products.

So PCI Express, I don't know if I mentioned that. I guess I talked about PCI Express growing; it actually grew about 4% this quarter. We see continued growth in that business. And our third generation PCI Express switches are in development now and coming along very well. So that will be another growth vector in the PCI Express area.

Sandy Harrison - Signal Hill

Last question on the new products. It looks like they're probably somewhere around 17% and actually the total revs up from what's like 15'ish, 16% last quarter. Do we still think we can put up 20% of total revs in the December quarter, or what sort of are you thinking on that milestone?

Ted Tewksbury

So this quarter new products composed 17% of our total revenue, so roughly flat with last quarter. We expect that by December we'll hit probably 18% of total rather than the original 20% of the total. And the reason for that is actually a good one; it's simply that our core products have grown more quickly than we anticipated when we put out that estimate over a year ago.

And I think that estimate has been remarkably accurate when you think about it. But we made that forecast a year ago when new products were only 5% of our total revenue. So right now we're sharpening our pencils and we're going through that calculation again. And we will, during our analyst day in December we'll report a new target for new products for the next year.


And next we'll go to the line of Glen Yeung with Citi.

Glen Yeung - Citi

Revenues in the fourth quarter will fall relatively substantially. And I think that's (relatively) so given that they're typically slightly up in the fourth quarter. What's your confidence level that we can get back to 165 plus kind of revenue number sometime in the next quarter or two? How do you think the inventory situation will progress?

Ted Tewksbury

As typical in the summer, your inventory cycle, it will last a quarter or two. I think that virtually all of the decline in revenue here we're seeing, almost all of it this quarter and the December quarter outlook is somewhat related to inventory, the customers' inventory and reduced lead times and bringing their inventories down or us bringing our channel inventories down.

So I think we have a high degree of confidence as, once we get to the seasonal March quarter, we can get back up to the revenue we just posted in the September quarter, assuming that the macroeconomy is growing at reasonable level, and we get through this inventory build and (drain) that doesn't seem to be overly bad. It's not like two years ago, I think. So I think we have a high degree of confidence that we can get back to a reasonable level of revenue after cleaning up the inventories.

Rick Crowley

Glen, just to amplify, I've got a very high level of confidence. We've got to get through December. And of course March tends to be a seasonally weak quarter. But based on the number of new products that we've got introducing, and the underlying strength of our business model, I have no doubt that we're going to bounce back to those levels relatively quickly once the demand comes back. And there's more certainty in the global economic situation, and the inventories get back to a balanced situation.

But let me just provide some perspective on the December guidance. Typically, we guide roughly flattish from September to December. It's not usually dramatically up or dramatically down, it tends to be relatively flat. I think if you look at where our peers are guiding, most of them are sub-seasonal; a lot of peers are down. And as you take all of that into account, with the inventory work-down and the overall global weakness, I think the guidance that we're providing really is not bad in the grand scheme of things.

Again, to give some perspective, as I mentioned in my prepared remarks, the six months from March to September, we were up 21%, which was well above our peer group. If you take into account our guidance and look at the nine month period from March to December, we're up 11%. And we did a quick analysis based on the mixed-signal peers who had reported today, and the group was up about 8%. So we're actually in line or better than where the peers were coming up.

So I think the weakness that we're seeing in December is not outlined with the other reports that are out there, and I think we'll very quickly come back to the 165 to the 170 level.

Glen Yeung - Citi

Can you give a stat as to the progression of lead times for you? And obviously they were tight for a while, loosening up now. When do you think lead times kind of get back to the sort of core normal levels and stabilize from there?

Rick Crowley

We're still seeing lead times generally in kind of the 8 to 12 week range. So I think since it's a (lying) indicator in the supply chain, it will take through the March quarter is my view to get them back into the mid-single digits again with the high single digits.

Glen Yeung - Citi

You might have said this earlier, I'm not sure I caught it. But just to understand, the weakness in the fourth calendar quarter is predominantly PC-related. Is that right?

Ted Tewksbury

You see it in consumer.

Glen Yeung - Citi

At consumer, okay.


Next we'll go to the line of Sukhi Nagesh with Deutsche Bank.

Sukhi Nagesh - Deutsche Bank

Just a follow up on the last question, Ted. Which one do you expect to be weaker for the December quarter, computing or consumer?

Ted Tewksbury

The weakest segment in the December quarter is PCs.

Sukhi Nagesh - Deutsche Bank

And then just in terms of your OpEx, $65.5 million is what you guided to Rick. R&D at $42 million is higher than what we you'd expected. How much of that increase do you think maybe capered back down in the March quarter? I think if you remember last time, you had expected the December and March quarter of this fiscal year to actually decline for the OpEx when I think you had talked about it in the September timeframe.

Ted Tewksbury

Sukhi, before I let Rick answer that question, let me correct the last statement I made. The weaker segment is actually consumer, which is down about 20%, September to December. Overall, computing is down 13%.

Rick Crowley

Sukhi, about the OpEx, we came in better in September, sort of this timing of receipt of some of the materials, the new product materials pushing from the September quarter into October. And so it's kind of moving back and forth. While R&D I think, we averaged about 25% of revenue in the first half of our fiscal year in R&D. Obviously, the guidance has it up above the 26% that we had talked about previously. We're not going to be able to adjust in one quarter.

The 26% is still a ceiling for us that we're looking to hold. So we're looking at cost reductions on how to get back into that. But as we mentioned, the only way we're going to grow is just to invest. So we've said that consistently. We're going to continue to do that. You're seeing us hold SG&A flat Q1 to Q2. Regarding that down in Q3, the answer we said, we have the lost leverage going through the year. So I think we're being consistent with that, and on the plus side we've delivered gross margins well in excess of what anyone expected so far this year. And we're continuing to guide to that in the December quarter.

So when you look at it, what we're guiding to here in the December quarter is $0.14 of the midpoint, which is what we delivered in the Q1 on $5 million higher revenues and the midpoint of revenue we're guiding. So make you seeing the fact that we're delivering good results and of course we will focus on OpEx in a weak demand environment, but we're not going to throw the baby out of the bathwater so to speak.

Sukhi Nagesh - Deutsche Bank

Just on the share buyback part of it, you spent obviously a nice chunk of cash, buying back $6 million shares. Does your share count guidance for the December quarter of $157 million include or exclude share buyback?

Rick Crowley

It includes the averaging of the share buyback we did in the September quarter. Here, the cash balance nor the share count takes into account any share repurchase activity for the December quarter that will factor into those numbers.

Sukhi Nagesh - Deutsche Bank

And one final question from me. Obviously down 8% for the September quarter, is slightly worse than some of the other analog mixed-signal peers. If that's the case, should we kind of expect a better than seasonal March quarter? How are you looking at March?

Rick Crowley

Well, we only guide one quarter a time, but when you look at the seasonality, as we touched on I think in a previous answer, in March it's typically consumer and PCs. And clearly, in this December guidance we've got PC's down, we've got Consumer down. So we're hopeful that we'll see a less than seasonal impact in the March quarter than we normally might see because of that. But it's unclear at this point in terms of how the bookings come into the rest of the quarter and what our customers do. So we're hopeful that these are leading indicators of a lesser seasonality in March that we just don't know yet.


Next we'll go to the line of John Barton with Cowen.

John Barton - Cowen

Ted, you'd commented about the proprietary position you have in RapidIO switches, in particular compared to the size. Going forward, what do you expect that competitive landscape to look like?

Ted Tewksbury

It impossible to say, John. It's impossible to predict what the competitive landscape is going to be, but I strongly believe that we're going to maintain the dominant position in that particular application simply because it takes an enormous amount of R&D and enormous amount of time to develop these products, not to mention developing the tight relationships and the confidence and trust of the customers who are designing these into infrastructure boxes that are going to be around for decades. So it's a very, very high barrier to entry and we don't see anybody else on the landscape right now who's even got a shot.

John Barton - Cowen

Could you give us some glimpse into the magnitude of that business for you, percentage of rev et cetera? And then what you think about the growth prospects over the next year plus?

Ted Tewksbury

I really like to get away from divulging the details on a product-by-product basis. When I started here two-and-a-half years ago, our video business was just a display port business. Today it's a business that includes host processors, frame rate converters, power management. We have a whole display and video business. And I prefer to report it in that context rather than go down to the nitty gritty ton a product-by-product basis.

What I can tell you is that on a growth basis, the display port products continue to gain traction. We were up over 40% in the September quarter. And we expect to see more strong double digit growth for the December quarter.

John Barton - Cowen

If you could just comment on M&A strategy going forward.

Ted Tewksbury

We continue to monitor potential acquisition candidates that would be a good strategic hit as well as be accretive and carry a long-term profitability for our shareholders and also to fill technology gaps that we have. And at the present time, most of those gaps have been filled and the emphasis is really more on executing on the price that we started.

And so we don't have any immediate targets for acquisitions. We don't have anything that's on our radar screen right now. And as I said, on the last call, and I still strongly believe, the best use of our cash right now is buying back our own stock. I really believe that IDT is the best value out there right now. So that's really the guide that we're going down.

John Barton - Cowen

Just a glimpse into the tax strategy going forward and how it hits the income statement over the next year or two?

Rick Crowley

Well, probably the biggest wildcard is what the governments can do. But, putting that aside, I won't speculate on that. Obviously, we're taking good progress at real solid GAAP earnings this quarter. The setback continues into next year of our valuation allowance and so forth. And expect that probably or now in middle of next year. Sometime it will have to take the tax rate up to about 15% from cash tax basis today and I'm not speaking now for non-GAAP basis.

That's what guidance I would give from modeling at this point.

John Barton - Cowen

You said about the midpoint of next year?

Rick Crowley


John Barton - Cowen

In the midpoint of fiscal next year?

Rick Crowley



Because there are no more questions in queue, I will turn it back over to you for closing remarks.

Rick Crowley

Thank you very much for joining us today. We appreciate your interest in IDT and look forward to meeting with you on our marketing trips this quarter and on our next call. We would love to see you on our analyst day on December 7. Please contact Mike Knapp for details.

In addition, we will also be attending the Citi and Barclays investment conferences as well as the electronic trade show this quarter. We look forward to seeing you at one of these events. Good bye.


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