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Cypress Semiconductor Corp. (NASDAQ:CY)
Q3 2009 Earnings Call
October 15, 2009; 11:30 am ET
T.J. Rodgers - President & Chief Executive Officer
Brad Buss - Chief Financial Officer
Dinesh Ramanathan - Executive Vice President of Data Communications Division
Norman Taffe - Executive Vice President of Consumer & Computation Division
Chris Seams - Executive Vice President of Sales & Marketing
Harry Sim - Chief Executive Officer of Cypress Envirosystems
Tim Luke - Barclays Capital
Jay - Citigroup
John Pitzer - Credit Suisse
Chris Danley - JP Morgan
Jeff Schreiner - Capstone Investments
Doug Friedman - Broadpoint AmTech
John Barton - Cowen & Co.
Sandy Harrison - Signal Hill
Suji De Silva - Kaufman Brothers
Adam Benjamin - Jefferies
Vijay Rakesh - ThinkEquity
Welcome to Cypress Semiconductor third quarter earnings release conference call. Today's conference is being recorded. If you have any objections, you may disconnect at this time.
I would now like to turn the call over to Mr. T.J. Rodgers, President and CEO of Cypress Semiconductor. Sir, you may begin.
T.J. Rodgers
Good morning. We're here to report the third quarter. We'll do it standard way, starting out with Brad Buss, CFO, talking about the financials.
Brad Buss
Thank you, T.J. Thanks, everybody for joining us today. Just a couple of quick things before I go into the details, obviously everything we're talking about is our preliminary unaudit results. We'll be filing our 10-Q on schedule and we encourage you to take a look at that including the risk factors that we have in that document, as well as in our press release.
One more little bit housekeeping before I kick off. You'll notice in the table in the press release, we've renamed our other bucket to reflect really what the group is, called emerging technologies, there's been no changes to the components that are in there, and there's been no historical adjustment at all.
When we've also added a simple subtotal of our three reportable divisions, MID, CCD and DCD, so that you can kind of see what the core semiconductor business is doing. You can see the impact of the emerging technology group has on our consolidated results and then you can properly reflect and value each one of them as you remember, SunPower and feedstock used to be part of what we used to call emerging technologies as well.
We have a pretty good track record and that's giving you a call option in our opinion on some future value and growth. So, if you have any questions on that, I'd be glad to follow with up, but just some simple changes there. As far as Q3 results, I'm very pleased and my body language reflects it, doesn't. That we had better revenue, gross margins, net income, EPS and cash flow than we originally expected.
This exceeded our prior guidance and also beat the street consensus as of the end of the quarter. We, again demonstrated very strong operating leverage in our business model, and we expect that to continue well into 2010. For Q3, we reported $178.7 million, which is a 15% sequential increase and a decrease of 20% on a year-over-year basis.
Revenue for the quarter exceeded the top range of guidance due to strengthen CCD and MID, by division, MID increased 8% versus the prior quarter, to by strength in our SRAM business due to market share gains and an increase in communications and demand. DCD was basically flat, as we expected due to lower end of life military shipments.
In CCD, they grew 20% sequentially in Q2; they not did up again in Q3 and grew 26% sequentially, driven by better than normal seasonal growth, as well as continued strong growth in our TrueTouch touchscreen solutions portfolio. TrueTouch continues to grow very rapidly as we continue to add new customers and additional handset models into volume production and we expect very strong sequential growth again in Q4.
As a reminder, I've said that I expect TrueTouch to be our fastest growing programmable product line to reach 100 million accumulative revenue and we also expect TrueTouch to be one of our top five revenue generating product lines by the end of this year. Again, very stronger results for a very new product that's very hot right now. In addition in the quarter, we also benefited from strong USB sales in a seasonally strong PC quarter, as you've been seeing from some of the earlier results.
On a GAAP basis, we posted a net loss of $19.7 million or $0.13 a share, which was driven primarily by non--cash charges for stock-based comp of approximately $31 million, another 80-ish million in additional restructuring activities and just under a million in historical acquisition-related expenses. This is down significantly from the net loss of $0.32 per basic share in Q2.
Non-GAAP net income was $19.2 million, resulting in earnings per fully diluted share of $0.10, which was better than the $0.05 to $0.07 I guided, even with a slightly higher share count. EPS strength came from internal operating leverage, which again was the higher revenue we had stronger gross margins and we continued to have very tight OpEx controls and again this was a significant increase from last quarter's diluted net loss per share of $0.03 cents.
Margins very pleased obviously where they came in and you saw our consolidated non-GAAP gross margins at 51.9%. That's up a full 7.7 percentage points from the prior quarter and was above our guidance. This was driven by our internal utilization moving up. We also achieved record wafer starts from our foundry partners and obviously had a favorable product mix with a higher mix of CCD revenue. This is the highest non-GAAP gross margin we've posted since 2004, and we've exceeded our 2008 peak gross margins, even on a substantially lower revenue base.
Our core semiconductor gross margins again, which includes the impacts of emerging technology division, were an impressive 53.7%. Our average utilization based on wafer starts in the quarter and our historically installed capacity, which I'll explain later, was 69% for Q3, up a full 10 percentage points from our Q2 utilization rate of 59.
However, if you look at how we're looking at it based on our current staffing levels, which are reduced and we've adjusted our equipment capacity, our real utilization in Q3 was 78%, up 12% from Q2, and I expect to be in that range again in Q4. Again, we're going to start reporting on this adjusted utilization rate going forward, because that more properly reflects what we're doing and what you can expect.
As we have been discussing pretty heavily over the last year or so, our move to a flex fab strategy is continuing to pay off, approximately 38% of our wafers made came from our foundry partners in the quarter, a record amount, and we expect that we'll be at approximately a 50/50 split within the next two years, as we do not plan any substantial footprint increase in our one remaining fab.
Product margins remained relatively stable as approximately 80% of our revenue is proprietary and programmable. Our average ASPs in Q3 have increased year-over-year by 3%, which has been very encouraging in this economic environment. They decreased 5% sequentially to $1.32, and that was really mostly due to a higher level of CCD revenue in Q3. The vast majority of our main product lines had ASPs that were flat or slightly up, so we've been very pleased with what we call our product margins have held in.
On the OpEx front, our non-GAAP operating expenses increased by $1 million sequentially in the report and that totaled $75.8 million, but as you know, that included a $2.3 million non-cash accounting charge relate to the valuation of our deferred comp plan, and you can see the breakout of that in the face of the press release on the income statement. When I do my guidance, I don't assume any movement in the deferred comp plan, because it's so hard to predict.
So if you look at it on a comparable basis, we actually reported $73.5 million versus my guidance of $73 million to $75 million. So we came at the lower end of our OpEx and that's due to our continued focus on cost containment. Just to put things in perspective, our non-GAAP operating expenses, which include any of the deferred comp charges and/or benefits, which can happen in certain quarters, decreased 18% year-on-year and we continue to push forward with a lot of our cost containment efforts well into 2010.
Just a quick note on headcount in Q3, our worldwide headcount totaled approximately 3,600 people, and that's a decrease of 19% since our peak in Q3 '08. Pay cuts are coming back in Q4. In Q3, we turned our bonus plans back on and any accrual related to that was already in the reported numbers.
So even as we're turning back some of the temporary expenses, we're still managing to keep the OpEx very low and just as a side note, none of the executive staff are having their pay cuts restored until we hit a 15% non-GAAP PBT. So, again, another part of our demonstration of our commitment to drive the operating leverage further into 2010.
Our other operating income was a gain of $3 million, and again, the other $2.5 million for the deferred comp was a benefit in there. The real cash impact was half million dollars in interest income. The taxes were inline with my guidance of about 900K. Our basic shares came in at $152 million, consistent with my guidance. Fully diluted shares were $198 million, and that was slightly above my guidance due to a higher average stock price and some increased option exercises and I'll go into the share count more when I give the guidance.
On the balance sheet, our cash and cash equivalents remained very strong at $246 million and was flat with Q2. Our total cash and investments, which include the auction rates of about $35 million, which are classified as long term investments, totaled $281 million. So, we actually slightly grew cash in the quarter, even after we paid out $48 million to settle the remaining convert call spread.
We achieved operating cash flow of $24.3 million in Q3 and again just to put that in perspective, that was 2X what we did in Q3 '08 before the downturn began. I expect to grow net cash investments by approximately $50 million in Q4 before any potential share buybacks, due to positive operating cash flow, some normal option proceeds and we're probably going to get in close to $20 million in tax payments.
We've got our IRS refund coming and our friends at SunPower mind it's been one year since the split and we're still talking and they also around $15 million as part of a tax sharing agreement. So, that will push our total cash and investments for north of $300 million and to approximately $2 per share.
Inventory management was another bright spot I think in the quarter. Our net inventory was $84.6 million, basically just slightly up from the prior quarter and our inventory remains at the lowest levels that we've seen in quite a while. As well, I think you can see some of the detail, the $84.6 million includes almost $6 million in capitalized non-cash stock-based comp charges and there's almost another $15 million for the last time buy that we did as part of the closure of the Texas fab.
So, if you subtract those two our normalized to operating inventory is really only around $64 million. We seen our justice, finally increase inventory, it's been a long time since that happened. The vast majority of that happened in our Asian distributors and again, most of that is all of the just increase of that book cost, which actually gets debited down pretty heavily.
About 63% of our business went through distribution and again, as a reminder, we don't recognize revenue on all of our distributors until the product is resold. From our perspective, we've seen no substantial inventory restocking going on in the channel and we still believe the channel inventories remain low. We expect to see our internal net inventory to be flat to grow slightly, as we need to bring up some of our internal profiles for new products.
Turning to accounts receivable, they totaled $103 million. They were up about $18 million consistent with revenue and the increase in the distributor deferred income. DSO was up slightly just based on timing of revenue and our aging continues to be excellent. CapEx was $6.8 million for the quarter, depreciation was $12 million and that's down 28% year-on-year just as a side note.
Just to go back on the debt and call spread maturity at the end of Q2, at $28 million in principal amount of the convert outstanding. On September 15 we paid off the note. We settled the call spread and like I said we paid out net of all of that about $48 million. So we're totally debt free and we have no call spread outstanding, no other derivatives as well.
In Q3 the convert and call spread warrants impacted our fully diluted share count by 3.5 million shares and that will obviously go away in Q4, as neither of those remain. So, for share count, since we returned to non-GAAP profitability, we also now report fully diluted shares.
Our weighted average basic shares for EPS were 152, up from Q2 due to an increase in employees exercising options, or issues vesting and the closing of an ESPP period. The outstanding shares at the end of Q3 were $155 million. The fully diluted share count was 198 and was driven by the increased average stock price. The call spread warrants and in the money options and just as a side note.
The average stock price for Q3 was 1020, which was up 28% from the Q2 average stock price of 795. For GAAP EPS, you continue to use the basic share count. Since on a GAAP basis, will remain a loss and again we remain very proactive and managing dilution through our stock awards, and I expect that for 2009, our net burn rate will be zero or slightly negative.
I'm now going to turn to guidance. As you saw in the release, we were pretty encouraged by our strong book-to-bill of 1.21, which historically is never above one at the end of Q3. All divisions are above 0ne with MID & CCD being the strongest and we also have higher backlog than we did at the same time in the prior quarter. The customers continue to remain cautious and the Christmas sell-through can and then we'll have a major impact in our Q4 and potentially Q1 results.
So, again, after growing 12% in Q2, 15% in Q3, we're pleased that we're forecasting continued growth into Q4. We expect revenue to be in the range of $180 million to $185 million, which is up 1% to 4% and like I've said, which could vary with the holiday sell-through results.
Q4 is a 14 week quarter and the extra week is not projected to have a material impact due to the holiday period, of which that week falls. So, basically our Q4 will end on January 3. Our historical Q4 sequential revenue growth rate has been a negative 3% for the period 2005 to 2007. So we're actually guiding well above normal seasonality. I didn't include Q4 '08 in there since that was the start of the monster downturn, and I don't think is really reflective of the environment that we're in.
We expect growth in MID and flat to slight growth in CCD, which is very impressive since CCD normal goes backwards in Q4 and I think the continued strength in TrueTouch will offset any consumer slowdown in CCD. In addition, based on data to date and expected new design win ramp, we expect to have a better than seasonal Q1, which, again, for the same period of 2000-2007 has declined an average of 6%.
We're not giving any formal guidance, but we expected the question, I wanted to share some of our thinking and obviously that could change between now and when we give formal guidance in January. Gross margins improved very strongly and we're happy we can keep them at the same levels. So I'm estimated gross margins holding around 52%, give or take a half a point.
Obviously, this excludes any non-planned inventory charges, standard changes, or scrap. We're also assuming factory utilization of 75% to 80% based on the adjusted capacity method I explained earlier. We plan to hold OpEx again in the range of $74 million to $75 million, and again, that assumes there's no major fluctuation in the deferred comp plan.
Figure on OIE of about $400,000, and a minority interest benefit of approximately 200K due to our subsidiaries that we talked about in our emerging technologies bucket. Taxes for Q4 should be about 900K. We'll return to our 10% level in 2010.
CapEx of about $12 million, depreciation of about $12 million, and I would look for the share count on a basic basis to be around $157 million to $159 million, and on a fully diluted basis of about approximately $198 million, give or take $1 million, and obviously that will fluctuate with the stock price. Any stock repurchases exercises, et cetera. If you wrap all that together, you get a non-GAAP EPS in the range of about $0.10 to $0.11, which is above our current street consensus of $0.09.
So, again, very pleased with where the quarter ended. I'm very happy where it's going. We have very strong product cycles that we'll talk about a lot in the call, and I'll turn it over to Chris for a discussion of our end market.
Chris Seams
Thanks Brad. Let me get some of the usual indices. In terms of revenue splits by geography, relatively unchanged from the second quarter. Asia-Pacific was 56%, slightly up, North America 23%, Europe and Japan 11% and 10% respectively. With the revenue growth units increased dramatically in the quarter up to $136 million units. Brad gave you ASP numbers already and relatively the same environment as we had in the second quarter, are fairly stable pricing environment.
All of our end markets grew in the third quarter. Let me say, the growth was led by computation followed by handset within the consumer segments. Brad gave the overall book-to-bill since I anticipate, I will get asked later in the question session or by division, let me give it to you now. CCD was 1.17, MID was 1.32, and DCD, 1.06, all three divisions above unity.
Our backlog rose above the $200 million mark to $207 million and again, that's a six-month semiconductor backlog window. We entered this fourth quarter book 72% to our guidance. Last quarter, the number was 66%, so it is a stronger signal than we had last quarter. Brad talked about some of the Christmas sell through conservatism that we're looking at now that's probably why we're a little bit muted although our booking signals are a little stronger.
Two weeks into this quarter, we continue to see bookings patterns that will support that guidance. While I have heard regular reports from our customers about spot shortages in the industry, very few of them have been from Cypress, our lead times remain attractive from between four and eight weeks.
We've done a great job of ramping back capacity as our business has comeback and our checks by account we do a fairly detailed check on a monthly basis with each of our accounts for us at least suggest at this time we still don't see any signs of double bookings in our backlog.
With that said, let me turn the call back to T.J. for more details on the quarter.
T.J. Rodgers
First of all a little bit more detail on the division. We have reported revenue by division and gross margin by division and we used to report revenue, gross margin and contribution EPS by division. We received a letter from the SEC four, five years ago saying that it was difficult to calculate EPS by division therefore; we shouldn't do it so we stopped reporting it.
So I'll tell you what I'll call allocated EPS that is when we divide the company up and allocate all of our costs to only the divisions, what their contribution to EPS was, MID at 48% gross margin on $71.7 million and contributed $0.07. Data com at 68.8% gross margin on $25 million and contributed $0.03 and CCD at 54.1% gross margin on $78.8 million, our biggest division and contributed also $0.03.
That means our semiconductor division, which is not our fully reported number, which I'll get to in a second, add gross margins is 53.7% and had EPS of 13. That is subtracted from by what we used to call other and we realized, it was probably unreasonable to call SunPower, quote other, unquote and we've got some pretty good start up companies in that category right now, like Cypress Envirosystems, for example and that group posted $3.1 million in revenue, had negative gross margin and a $5.9 million or $0.03 per share loss taking the corporation to $0.10.
So that's just a little bit of color on the breakout. The main reason the emerging technologies losing money is that they spent $3.4 million in R&D, before $3.4 million in revenue, which is kind of like what you would expect for a startup. On the highlights, we can't programmable and proprietary products those, which only we make which when we have a socket we own it.
We don't have to bid for it. That's group contributed 82.8% of our sales. That's the category we've been pushing, up from 79% and that's our index of having transformed the company from second source or multiple source RAM Company. The biggest news of the quarter and frankly for Cypress the biggest news since 2003 since we introduced PSoC 1, was that we introduced PSoC 3 and PSoC 5 I was given the key note address at the embedded systems conference in Boston.
I will sure that we're giving another key note address of the arm develop this conference here in Silicon Valley and we use that opportunity or vice versa, we got the opportunity because we introduced PSoC 3 and PSoC 5. Our PSoC 1 product as a microcontroller is fairly anemic in performance. This enables microcontroller with a proprietary design and only four Mbps or mega instructions per second our performance.
On PSoC 3 contains an 8051 and 30 missed the performance at 7.5 times higher and PSoC 5 is a lot like PSoC 3, but contains the 32-bit arm M3, cortex M3 processor with 100 Mbps of performance that's 25 times faster than PSoC 1. In addition, based on our customers' in put, we improved the A to D, the analog in general, specifically the A to D in the products and PSoC 1, for example, we had 8-bit A to D converters that did sampling 31,000 times of second, 31,000 kilo samples per second. That's fast enough to measure a thermometer, something like that. It's not fast enough, for example, to look at the voltage on a motor and adjust the current and the windings on a motor.
With PSoC 3, we've increased that performance by 12X to 384-kilo samples per second and by 30 times to a million samples per second in PSoC 5. We're finding that the bigger value in PSoC is not the micro controller, the category we get lump into for lack of a better place to be put in the standard set of categories, but the analog, where we sell the value of PSoC and say, by the way, it also has the micro controller in it.
We've also brought the analog to digital up to 20 bits of accuracy, just for non-technical, 10 bits is a million, is about 24, rather, and therefore 20 bits is 1024 square to million. So our newest analog to digital conversion capability is one part per million accuracy in reading; meaning that it can read a one volt signal to a micro volt of accuracy. PSoC 1 had 2,000 gates of programmable logic. We've increased that by effective 10 in PSoC 3 and PSoC5 to 20,000 gates programmable logic.
Furthermore, we rearchitected the logic to be much more efficient and get much more capability per equivalent gate. Finally, PSoC 1, despite its performance, consumed 48 mill watts of power, which is still relatively low. PSoC 3 at 7.5 times more horsepower consumes only 1/8th of the power six volts and PSoC 5, with 25 times the power consumes only 135 PSoC 3, a 14 megawatt powers at the same frequency. So what we've done is take our big win in PSoC 1 and try to broaden market.
PSoC 1, being a relatively modest performing micro controller only addresses the bottom half of the 8-bit micro controller market. If you think about the micro controller market, it's got three segments, 8, 16 and 32-bit. Each segment is $5 billion of TAM, so it's $5 billion, $10 billion, $15 billion TAM and PSoC 1 covered only the bottom 30%, or the bottom $1.5 billion of the lowest rung of the $15 billion micro controller market. So we only had emphases with that, we got 30% penetration. So we had a spectacular success on a very narrow part of the market.
Whenever we got up against the design packages typically one the reason we lost, and we lost more than we one even given our success is that PSoC 1 didn't have enough analog or more powerful enough computer or enough programmable logic on it to carry the date. So what we've done now with PSoC 3 and 5, as we now cover all of the $5 billion 8 bit market, all of the $5 billion 16-bit market sand about half of the 32-bit market.
We don't cover the real screaming micro controllers, for example, that come out of, let's say renaissance and Japan they are used for automotive engine controllers. So our TAM, including not only the, enlarged micro controller market, but also the analog market are covering has increased from $1.5 billion TAM for PSoC 1 to $15 billion for PSoC 1 plus 3, plus 5. We call that our 10 X plan, and we're actually asking our distributors to give us the 10 X plan. We want equivalent penetration 10 times bigger market, and we want to see that growth.
Final point, and I'm spending most of my time this morning on PSoC 3 and 5, because it's the biggest deal is that, we've moved the software in PSoC 3 and 5 to a new level. I've shown most of you, any of you who have come to a conference probably seen me demonstrate the software from PSoC 1 and it is, basically the ability to create your own custom micro controller with your own custom digital and analog peripherals in less than an hour with dragon drop kind of graphical user interfaces.
PSoC 3 and 5 software moves designers up to the next level of extraction and even relative to the higher chip performance I've described over the last few minutes, I think the draw of PSoC 3 and 5 will be more on the software side even than on the hardware side.
The next level of extraction makes the chip invisible to the designer and for those of you who come to our analyst conference in November, I will demonstrate that software. I'm demonstrating, by the way, live at both the key notes because the software is quite stable enough to go do a demo in front of people and what it does is you design by dragging out of block.
So for example, if you want an analog to digital converter, you go to a menu, you click on analog to digital converter and you bring out of block and you hit a button in down and then menu pops down and then you can configure the block to be high or low power, they have anything from 12 to 20 bits of accuracy. As you move up in the accuracy, you move up in power consumption and you move down a sample rate, you retarding off, etc.
So you spend on the order of 30 seconds picking the A to D converter you want and needs that, the machine decide what's your sources on the PSoC chip that you don't have to look at or used and configures them for you. So the first software, configuring software that I described earlier is actually, the function of it, it actually embedded in the new software and I would say based on my interaction with customers, the strongest, most positive interaction I've had is how cool the new software is.
So to summarize and end this section, we've introduced PSoC 3 and 5. We're getting key notes because of its importance. Its power is 10 to 25X in both processing analog and in logic, the power of PSoC 1. It magnifies the market from $1.5 billion TAM to $15 billion TAM, and we've got very good software that's being well received.
I might point out that we got the very good software, because we were once in the CPLD business and we invented software that's very well received by our CPLD customers called warp and that framework and that graphical user interface existed in the company and therefore the creation of our new PSoC software was to embed extra analog and processing functions into what used to be just a programmable digital software suite. So we ended up reusing a major investment from the past.
Okay, a couple more things, then to questions. We've introduced in the language in the press release, the family of new high-accuracy, multi-touch, all-point TrueTouch touchscreen solutions and so in the marketing jargon gets so long. It's hard for me to even understand.
What that means is touchscreen and the differentiation of the family, which is called TMA300, is that unlike touching a single point and pressing a button, and unlike even gestures like the Apple, iPhone where you can move your fingers and swipe them and cause the phone to do things. This is the next step where you can have up to 10 fingers on the screen and you can do complicated gestures which are programmable. That is the most advanced touchscreen product in the world. We call it the TMA300, obviously underneath the hood, if you look, it is PSoC technology.
A couple of big wins in the touchscreen area, Samsung picked us for their Omnia HD mobile phone, which is a high volume phone. Another big one was the, China's Media company put us in a microwave oven. In this case, they're looking at a different aspect of this concept. They needed water in a kitchen, you're going to have water on your finger and you may have water dribbles over the touchscreen.
So turns out if you have a PSoC as opposed to a fixed chip, you can go into an environment, you literally and we do this, dribble water on the board and then adjust the analog circuitry to deal with that extra interfering signal. So we've won that water resistance slot in high volume business consumer products.
We won an award from designers, it's called Golden Mousetrap and nifty little award literally got a gold plated mousetrap on a plaque and it's something the engineers appreciate, I did and it was for our power PSoC family, which is beginning to take off that PSoC with 36 full one ample transistors on it so we can start controlling power, for example, light-emitting diode.
In that same area, company for WSE lighting in North Carolina has put us into our EZ-Color Controllers, I'll explain that in a second, into a pallet with brake system. So I think about the lights that are under your cupboard in the kitchen and instead of having little bulbs that burnout, like Christmas tree strings, you have a tape and embedded in the tape are small light-emitting diode and furthermore, they are not white light-emitting diode to red, green and blue, it alternating red, green and blue.
So, now I need your covered lights and you can change the color all the way from pure red, pure green, pure blue, to white, its a mixture of them and you can do that so I think house accent lighting is going to change. It's going to go to LEDs and it's going to become more complicated that's driven by DC current not AC and that's where PSoC plays, that's a easy color solution for those of you who have been to any of our conferences, I've demonstrated that several times.
Moving to the RAM group, we introduced the 144 megabit, 950 million transistor Static RAM, which we call the Quad Data Rate Static RAM. Quad Data Rate means that is got input port and the input port accepts an address both on the up tick and the down tick of the clock, doubling the speed of data for a given clock frequency. It's got an output port and data can come independently out of the output port.
Also both on the up tick and down tick. So we have two ports moving data in and out and both ports move up and down tick of the clock, two times two is for enhance Quad Data Rate. That is designed to move data quickly, not to block the output of the RAM with the inputs being used and if you ask what is that created to do the answer is routers. That RAM, which is the biggest in the world, we've heard it cannot the sample yet that renaissance might have an equivalent size.
It's done in the 65-nanometer technology at UMC. It runs at 500 megahertz. So that means that the effective clock rate of the RAM for moving data is 1gigaahertz and that means the RAM can move data in and out at 80 gigabits per second. So, this if you want to think about the pipes and internet getting bigger and bigger the data flow gets larger and larger that RAM will be in the routers of virtually every important router company in the world and pretty much everything you do at one time or another will go through that RAM or one of its cousins.
We've introduced the family of nonvolatile static RAMs but these are RAM that act like RAMs, but when the power goes off, they store the data on a bit-by-bit basis so they are black boxes, if you will, fail safe memories, that's it hole data in key positions in circuit in the boards, for example, in black boxes, I think about in the Airplane, the Black Box holds data during a crash, black boxes are going into cars.
We see one application of a nonvolatile static RAM. We like the static RAM market and we've got a start up in the other market called the Agiga Tech. In the Agiga Tech makes on board it make nonvolatile RAM functions. They do it with chips and control circuitry, but they use commodity NAND flash and commodity DRAMs in order to memory.
The laser biggest nonvolatile static RAM is 8 megabits right now, these guys have nonvolatile RAM boards, small like 2 by 3-inch boards. They go up to 2 gigabytes of nonvolatile RAM equivalent and that's one of our plays in our emerging technologies group. Cypress announced shipment of its 1 billion USB controller. We've been shipping USB since 1996.
We feel we are the market leader and we just crossed the billion-unit market. We also introduced a couple USBs into automotive call. USB is become extremely cheap you can put a USB port at pretty much anything for less than $0.50 and therefore the automotive industry, in addition to standard bus, which are is starting to use a USB as well. Those are the major technical events for the quarter. I'm going to stop there and turn it over to questions.
Question-and-Answer Session
(Operator Instructions) Your next question comes from Tim Luke - Barclays Capital.
Tim Luke - Barclays Capital
Just with respect to the DCD area could you just talk about how you – we should think about going forward and maybe with respect to the guidance, Brad, as you model how you just see at the different segments to be and then going forward, could you just give some color on you said that you thought that the first quarter might be down slightly less than seasonal. What are some of the elements that might support that? What's the impact of the differentiation in the weeks to that?
Brad Buss
If you look at the current guidance, the ones before, and like one before us, which again, far better than normal seasonality, which we're glad to see. I think you will see MID growing, DCD kind of flattish, maybe up, and I think CCD kind of probably flattish to up with more of a bias to being up at this point, which again that's a big deal. We've never seen CCD be flat in the Q4. Again, a lot of it will be on the sell-through, right, which is kind of early to tell. Right now we feel like it's been pretty good, but it's still early to call and there could be a bias to it, being up a little higher than where it's at.
So we're actually very pleased where that's came in. The Q1, we expected the question, and I think the key thing there is, we still see TrueTouch growing sequentially. I mean it's going to grow big this quarter and it will grow sequentially again in Q1, which is an awesome feat and that will temper some of the normal seasonal downtrend.
So, we're not in a position to give you any guidance on it, of whether it's down X or up Y or flat at this point. We just have a pretty good handle that it should be better. Also, in other design wins that we have in the pipeline in the company, we continue to do very well in the SRAM end of it and we have new customers coming in. So, it's a very good position to be in and a lot of it will depend on the sell-through and I'll flip to over to Dinesh, specifically in DCD.
Dinesh Ramanathan
We are expecting West Bridge to remain flat to maybe slightly down in Q4 and typically Q4 is a down quarter for the West Bridge group, primarily because it depends human related device. So that is where we think it's going to be.
Tim Luke - Barclays Capital
Maybe you talked associated with TrueTouch that in the release that you had Samsung using the offering. Can you talk about some of the other where you are in terms of number of major handset OEMs endorsing and using the product, and maybe, Dinesh, give separately just a little bit more color on what you see happening with West Bridge and DCD next year?
Norman Taffe
Relative to TrueTouch to your question, as I think I said last quarter, actually we really have active designs at 100% of the top five mobile phone suppliers in the world than we expect to see continued share growth in terms of phones going into production. We are only talking specifically certainly about one that have been announced, like the Samsung phone we announced earlier today, but I think you'll see more press releases, more announcements, as customers that are okay with that.
Some of the customers don't want that announced and you can kind of learn from teardowns, but we've had tremendous success and we're thrilled with the, how well the product is being accepted. We announced what's called TMA300. I think it's important to remember that's our third generation TrueTouch product. Really with the volume we've been shipping, with the 100 and 200 series have ramped significantly.
This quarter, we will see our first significant volume on the 300, which first customers we're getting about four or five months ago, but it's going to start to really ramp. That's going to ramp significantly in Q1 and Q2 to address, what Brad said about the continued growth.
Dinesh Ramanathan
I think the key thing that we've been encouraged on, is you're seeing multiple handset design wins and many of these customers. Then I think like Norm said, the sample response on the next gen has been pretty big, pretty much pick a cell phone guy and they're sampling that product right now.
So that's a very strong future indicator of where we look at it going and we continue to add guys into that group, literally every couple of weeks to support the demand. I think the other big thing that Norm hasn't talked on it, is we're also seeing designs outside of the big guys and into other end markets that quite frankly as we catch our breath from reeling in the big fish, we're starting to move down to the next year.
T.J. Rodgers
What we do and that comment on the technology of TrueTouch, is we usually enter the market by programming PSoC to give the desired response and then we learn and one of the things you can do since you are programming PSoC with firmware, and you can do a rev per every other day.
So in a month, you can do 15 revs and this really does happen this way. You have very rapid learning. Then the customer says, "Okay, thank you very much for getting me into the touchscreen market rapidly, but I want my costs to go down and I want more channels or whatever".
This takes quarters, but over the next few quarters, we then make a derivative product, which we call ASSP application specific standard product, which is basically a PSoC, having jetson the blocks and the PSoC that are needed for the TrueTouch application for us, enhancing one of the blocks for better analog gain or something like that.
Then we bring on a second generation product, like the TMA300, which looks a whole lot like PSoC inside, but it's really a specific product for specific markets that tuned up. We've done that with a whole family of cap sense products based on the PSoC 1 family. We're now doing it with TrueTouch products based on both PSoC 1 and PSoC 3. So we have the benefit, when PSoC is getting into the market and learning very rapidly and then we go hammer out a super cheap ASSP.
Tim Luke - Barclays Capital
West Bridge?
T.J. Rodgers
Yes, so we are right now in our annual planning cycle and I don't want to sort of throw out what I think the numbers for next year are going to be. I will when we get you next call.
Tim Luke - Barclays Capital
Then last, I guess for me, Brad, gross margin at 52% and you're guiding it kind of flat. What are the thoughts on next year? What maybe the variables and how should we think about it?
Brad Buss
I think we'll continue to see it move up. Like I've told you guys before, I think we have a very good plan to be able to get to that 55% range kind of over the next few years. I'm hoping it can happen quicker. You saw a very good result this quarter, part of its mix, part of it's been the factories did a superb job of ramping back where they are at and we'll continue to do more business through the foundries as we continue to ramp up. So, I'm comfortable seeing it probably ticked up another good point into next year.
Your next question comes from [Jay] - Citigroup.
Jay - Citigroup
This is Jay, for Glen Yeung from Citigroup. Brad, just wondering when you discuss the supply chain inventories being low, can you quantify how many days do you think that supply chain inventories need to be filled, I think most recently, you had said about 3 to 7 days?
Brad Buss
Yes, I think again, from our perspective what we're seeing with our end customers and Chris and his team, and our ops guys, like I think most companies get better and better every year and every down cycle. We're talking to customers more. We're getting triangulated forecasts from them and the CMs or ODMs who are in the middle. We're talking more and more distributors. I think the 3 to 7 probably still holds, on average. There's probably some products that's better or worse. So again, I think from our end of it, we still expect to see that need to increase to more of a normalized level.
Jay - Citigroup
I think you'd mentioned that had been building some inventories. Does this continuing to build inventories in the December quarter?
T.J. Rodgers
It's hard to say. As I guess right now, I would say probably no. I think for us, the fact that it increased at the end of the quarter is a reflection of, again our Q4 being up, which normally it isn't. So I think they were just taking inventory to kind of support the short term needs of what gets done.
I have a theory that, most companies including the dustiest like to do a level of balance sheet dressing at the end of the year. So I think it will depend on the sell through and I think they're going to continue to try and remain as lean as they can as part of their business model as well.
Chris Seams
This is Chris. Let me make one comment. If you look at the increase relative to days or weeks of sales, it was about on par with the revenue growth that we've seen and are expecting in our guidance. So it's not out of line to service the business.
T.J. Rodgers
The other big thing is we move more and more to programmable. Our programmable proprietary kicks over 80%, right. We need and they need the full inventory to make sure that our customers aren't cut short and that we can supply upside that they may not forecast within lead times so.
Another reason, why I think they're going to need to see them, and others take inventory up for the next couple quarters, but I think it will be slow. I don't expect any big bounce back and that's why it gives us a lot of comfort in the double ordering concerns that I know a lot of people are flinging around. We don't see it and we've done a lot of work in that area to make sure.
Your next question comes from John Pitzer - Credit Suisse
John Pitzer - Credit Suisse
Just Brad, can you share with us are you want to share with us a dollar amount for TrueTouch in the quarter and I guess, help me understand, great job sizing the PSoC 3 and 5 markets. Help me understand what kind of time you're looking for on TrueTouch. Are we seeing it get into other than very high future phones yet and if you look at the sequential growth, are you expect in Q1, is that still mainly from handsets or are we starting to see some penetration into PCs with touchpad?
Brad Buss
Yes, I mean we're not willing to give out any numbers, including T.J. on that. Obviously from a competitive reason, I think, with the growth that you saw look at just put it in perspective, CCD group grew 26% and pay our clock business isn't growing 26% sequentially.
So obviously PSoC and TrueTouch are growing much bigger than that 26%, which is pretty amazing, if you put it in perspective. The fact I said it will be one of our top five product lines exiting the year can give you a feel and again, we've talked on being around, $100 million team revenue faster than anything else and most likely that number for next year, you can kind of start backing into it.
T. J. Rodgers
If you think about where touchscreens are going to go, they have been limited, because of touchscreens that exist today are resisted and what resist of cote means is there's multiple layers built under a piece of plastic, which is flexible. When you push your finger down, you press on conductors and there's a gap and you press two conductors together. Resistive conductors such that you can measure resistance and figure out where your finger is the problem is touchscreens
If you have ever been and go to any joint that's got a cash register that's resistive, you go in and you look and you can see where on the screen and they wear out. So when you bring our capacity touchscreens, you can have a piece of glass over it and you're measuring with an electric field that so capacitor has through the glass and all of a sudden they are fast and they are highly reliable and they are durable. So where are they going to go cell phones and PCs. What fraction cell phones have a touchscreen in them now?
John Pitzer - Credit Suisse
Today it's less than 20%.
T. J. Rodgers
Today its less than 20% later.
John Pitzer - Credit Suisse
Less than 10?
Brad Buss
I think about that level.
John Pitzer - Credit Suisse
Okay. So you got 1.2 billion or so cell phones per year and right now you got 120 million of them with touchscreens. As touchscreens get cheaper, people are going to look at buttons, kind of like reestablish its going to be, World War II technology. So there will be ever increasing penetration into cell phones.
The next thing that's going to come is PC the barrier to personal computing touchscreen right now is that the bigger screen also has pretty good resolution. So, you don't just have bigger pixels, the same number spread out on a bigger screen. You have many more pixels. That means you have more rows and more columns. That means you have to have more chips or channels at least in order to scan a bigger screen. So the next level's going to be touchscreen and PC. Windows 7 is coming out soon when is the date for that?
Brad Buss
They have already got off engineering stuff I saw a demonstration yesterday and all sudden running our personal computer is going to look like what was the Tom Cruise movie where the guy left around?
T. J. Rodgers
Minority report.
John Pitzer - Credit Suisse
Minority report and I saw yesterday that it working place how minority report but you could see the beginning other. So, you take PCs what's the yearly volume of PCs, 250 million?
T. J. Rodgers
Do so you got another 250 million and overtime and they are going to convert to touchscreen, so the opportunity is huge. Problem is that stuff I'm talking about is hard from an engineering point of view and therefore we're in a very rapid learning mode and fortunately for us our learning mode is firmware based as opposed to make a chip and see if it works old fashioned the way the industry's always worked, so I'm giving you that in move of giving specific numbers to give you a feeling for the opportunity. That's the price.
John Pitzer - Credit Suisse
T.J. specifically on the PC market, I understand the touchscreen opportunity. Are you guys focused at all on the touchpad opportunity for the mouse?
Norman Taffe
Hi, John, this is Norm. We already sell into touchpads today with our capacity stuff and I think you'll see more of that going forward. So that is part of our solution that we offer. I think to also answer your question earlier about other markets, while we talk about the mobile handsets, the fact is we also quite a few designs and personal navigation GPS systems that I think are going rapidly toward touch and prefer to go to capacity versus resistive.
Digital-still cameras, we announced our first digital-still camera and even the automotive space has going heavily towards having touchscreen as well. I think the breadth of the market is quite significant.
T.J. Rodgers
I think couple years out, John, you could probably see just as many, if not more non-handset units than handsets.
Dinesh Ramanathan
T.J., going back to your allocated EPS, I appreciate it, because it reminds us that the MID business is pretty leveragable. If you look at the router end markets, cyclically it's one of the most depressed piece of the far go end markets out there in the market right now. What are the yards given you're experiencing that business they were at the cost of [soda]. The beginning of the cyclical recovery that could be stronger than we think?
Dana Nazarian
We see slow, steady demand progress in that sector. So we don't see as much radical movements up and down. It's slow. It's steady. It's improving. The bottom line is people need to move data faster and faster and the new systems that are being designed right now require much bigger bandwidth and much deeper densities. So it's just a typical progression in that space. I predict high single-digit trigger for the next couple years.
Dinesh Ramanathan
Is that particular business doesn't flop up and down like consumer business. You got Christmas fell, bunch of new cell phones. The routers today, it is a catastrophe it's rather for the router corrupts data. So they're under the luck from there in customers the service providers. There under extreme pressure for ultra reliability. That's the products they get, model if you want to think about it is sort of like, 20 years ago qualifying a chip for an IBM mainframe.
Ultra liable yes, we go through significant qualifications to get in and that kind of model of ultra liability infrastructure equipment doesn't flop around real fast. So we're in the process of taking share in that market and it will be a nice sort of rising tide, fully rising tide that come rest of the company right around and the rest of the companies and businesses that move up and down faster.
That's beyond the end market stuff, John, don't forget, he's picking up more market share, on a fairly continual basis. Then like I've mentioned, as he converts the sync portfolio into 65-nanometer, he gets a click in margins as well. To your point, you are going to see nice, steady leverage in that group into the next year and we expect all the groups to steadily improve their leverage as well. I mean we're going to be marching very close to those 20% operating margins.
John Pitzer - Credit Suisse
Then, guys, my last question on the PSoC 3 and 5, T.J., or could you guys help me understand the design cycle life and if you guys start looking at revenue milestones, how we should think about that for those two products?
Norman Taffe
From a milestones' perspective, we just did the formal announcement, as you know, last month at the embedded systems conference. We've had a lot of lead customers with products for PSoC 3, since kind of March timeframe. We will actually ship our first revenue shipments this quarter, but this is a longer designed cycle. It's not like TrueTouch the way it will grow. It's more of the traditional base. It's actually more of your industrial/medical, those kind of accounts.
So from a designed cycle, it's more the traditional 12 to 18 months to ramp to significant volume. Frankly, this will be the base for all the way for probably a decade of revenue for the company. So it's really long term strategically critical step forward, but it's not something that ramps real quick like TrueTouch.
The PSoC 1 family came from Cypress Microsystems, which is one of our emerging technologies companies. It was a consumer of EPS between 2000 and 2003 we introduced the first PSoC 1 in 2003. The TMA300 is based on that same technology, although specialized chip, PSoC 1 has got the same processor in it for example, that we just introduced that's going to take off.
So I believe we will be getting design wins from PSoC 1 in 2013, a full decade after the introduction of the first part. So one thing we like about them, of course, they're really belong with part and you're not in and out like normal consumer electronics where if you miss a cycle, graphics, accelerator, something like that and your finances.
Your next question comes from Chris Danley - JP Morgan.
Chris Danley - JP Morgan
Brad, you talk about how you expect gross margins to trend up gradually next year. Can you talk about, how you expect operating expenses to trend after Q4?
Brad Buss
Yes, we've got very, very tight cost controls and we continue to evaluate businesses, where we're investing, how we're reallocating, we're very big proponents of stuff offshore. We continue to do that. So I think you'll see them move up in Q1, like they normally do. You've got the FICA resetting.
You got your big audit fees coming in that, where it's a lot of that kind of Q1, onetime seasonal stuff that will bring it up, but then, I'd expect to see it kind of flattish to maybe up slightly or put in a bigger way. I'd like to see at least 70% to 80% of the incremental GP dollars fall right through to the bottom line and we're pretty committed to making that happen. We're not happy with our kind of really our SG&A end of it and we plan on making that move up.
Chris Danley - JP Morgan
By the way, you said OpEx should be roughly flat for Q4, right?
Brad Buss
Chris Danley - JP Morgan
Then just on the guidance for Q4, with an extra week, if we take out the impact of the extra week, are you guys guiding to basically a seasonal quarter, or a little better than seasonal?
T.J. Rodgers
It would still be better than seasonal, because normally we would have been down a couple points. The extra week in our view is a couple million bucks because of the way it straddled the holiday, New Year's and shutdowns in that. So even without it, I think we would have been flat to slightly up.
Brad Buss
As a cost saving measure, we've got an extra shutdown during the period. So we're pretty much trying to get the quarter done and save some money in that 14 week.
T.J. Rodgers
Then, Chris, just to add on, when I look at Q1, it's even more encouraging, that I can be better than seasonality, because I'm actually losing some of that into the prior quarter.
Chris Danley - JP Morgan
Then as far as the gross margin drivers for next year, would you say it's equal between mix and increasing utilization rates, or is there something else in there?
Brad Buss
So there are two primary drivers for gross margins. One is bringing our Fab 4 to full capacity. Right now, Fab 4 can't start any more wafers. They are at current full capacity, but over a longer period of time like six months, you can jam more wafers in and the extra wafers are very cheap. So there'll be a slowly improving utilization of Fab 4.
Second thing is we're going to grow faster than we could possibly increase Fab 4. So that to me is a biggest benefit of our flex fab strategy that we can go get more wafers and get them quickly. As we move a larger fraction of our wafers to the very low cost foundries in China, which is what we've chosen to off load our PSoC technologies, our weighted-average wafer cost will go down. So fab wafer costs will go down and then the weighted-average between the two types of fabs will go down, that's one big lever.
Second big lever is we have a machine called an auto line. It is a 75 foot long machine that takes in wafers at one end and puts out tape and reel fully tested product at the other end. It breaks the paradigm of having front end area where the grind wafers, front end of the assembly where you touch a wire about a mold room, the back end of assembly where a different place and then a test area and then the QA area.
So if you look at a typical assembly and test plant, there's like five or six areas where you park inventory, keep inventory, and then it takes weeks to get through all of that. In an auto line, it takes approximately four hours for a wafer to turn into a finished part and so soon it makes all of those areas go away.
We have nine auto lines now and we are putting a bigger and bigger traction of our production on them and they're very, very cost efficient. They also have very much higher quality, since there's no handling and moving of material not human intervention. So, we're now at the rate of 50 million of our 135 million units around the auto line and we're rapidly ramping that.
So, getting on the auto line in the back end and it will make us faster, we'll decrease our inventories, improve our quality and it's a big lever for the gross margin improvement. So you ask let's see, new product, always and obviously and then those two manufacturing things, flex fab and auto line.
Chris Danely - J.P. Morgan
Can you guys just put a little perspective on your Asian distributor inventory comments? Maybe could you just talk about what they are and sort of the normal environment and how low they got at the beginning of the year and then where they are right now?
T. J. Rodgers
I don't have the exact numbers.
Brad Buss
Yes, I don't have the exact, but they are still down kind of from a year ago, to put that in perspective obviously and business is down, our just these group back direct guide in Q3, so their growth rate was higher than the 15%. Most of it is a lot of them took product down to, like extremely low levels, we do a lot of PSoC, and the TrueTouch obviously through these guys.
Its down just taking it back up to fit the demand, we don't see them taking weeks or days of inventory up at all. If anything, they are still down and they want to remain down to the point where, we're taking a hard look at our margins we pay them, to fill inventory, which assumes that's amount of inventory you carry and if you don't want to carry it, we'll carry it and tie bank, use our auto lines to our advantage, but I'm going to take margin away from himself.
T. J. Rodgers
We will put some data on the web for you, but the concept of inventories going up, what happened was inventory in one geographic area, Asia went up primarily in one area, USB, because there's a big rush on USB chips last quarter, with regard to days and we will quantify this. The days of inventory and distribution in the third quarter were approximately flat with days of inventory in the second quarter and those two numbers are as low as their distributor inventories have been in years. That's where we are, low not high.
Your next question comes from Jeff Schreiner - Capstone Investments
Jeff Schreiner - Capstone Investments
Brad, I was wondering if you could help us a little bit with maybe the levers on, you know, end demand and how the holiday season plays out and how might somewhat, maybe a 5% lower utilization rate, if you have to slow down any builds, impact your focus on your prior guidance you kind of gave on where you expect to be for gross margin in the next year?
Brad Buss
I don't think it would be anything big at all, Jeff. Like T.J. said, a lot of it through our flex fab, so we're able to basically keep our guys I think fairly consistently loaded. That's obviously a big benefit of them, if we look at kind of the throughput where to date, things are running very well.
So I don't see it swing the needle much at all I mean there's always that's fill my guidance you can always be a half point one way or the other. It's not a precise science, so I'm not concerned one bit and also our own internal inventory level are so low the other big thing that swings go lot of people its talking inventory reserves and those have been moving down nicely for us because we just quite frankly don't have the inventory that can age or needs to get written off. So, I'm not concerned at all on that.
Jeff Schreiner - Capstone Investments
Okay. Just want to also wonder a little bit about guidance about capital expenditures and it going to be trending down a little bit and I think you guided flat, if I'm correct in my statement for Q4 and just wondering are these levels sustainable or do you think you can even go lower as you move to your more flexible manufacturing model?
Brad Buss
Yes Jeff, just to clarify, the CapEx for Q4 was up from Q3, but if you kind of look at where the whole year will end up, it's roughly 30ish million dollars, which is pretty consistent with what I guide and to your point, that's a very low number for a company that has a front end and a back end I think a lot of fables guys and actually spend very similar amounts so as a percent of revenue, we're probably better than most and like we said before, we don't see any big need to do any capacity footprint.
We're going to leverage our foundries Dan moving is same to 65-nanometer UMC. Grace is a big partner. So we got to add testers. We're doing a few pieces of equipment to support our next gen of TrueTouch and PSoC 3 and 5, but nothing substantial. So I think at $30 million, $40 million range is more than sufficient and we've got our emerging technology group that will add a little bit of CapEx, but I think we'll stay within that in that realm pretty nicely.
Jeff Schreiner - Capstone Investments
Just one last housekeeping question, thank you for your time, what direction should we see if dot-com going in the fourth quarter? It's been trending down sequentially in 2009. Where should we expect that maybe in Q4?
Brad Buss
It will continue to go down. Remember, a large portion of that nut was due to the spent, and we had to take a comp charge related to that, so we see that number going down really every quarter for probably the next year or so. I think you could Take $5 million dollars off the reported Q3 number as a rough estimate, because I think the other key thing to my other point that's important for you to understand, our grants and cancellations are pretty much zero, right?
So we're not issuing a lot of stock and the pro and the con in stock-based comp is our stock's done very well, right? So that even though I could give out the same number of shares, my stock's up a lot more than it was in prior years. So the number will keep moving down and I think eventually will settle in kind of the low 20s.
Your next question comes from Doug Friedman - AmTech.
Doug Friedman - Broadpoint AmTech
I've noticed there's some talk going on out there about changes over in the China foundry and you guys are increasing your outsourcing. Any impact expected if there were some between Grace and HHNEC and what you're seeing out there as far as wafer supplies?
Shahin Sharifzadeh
We don't expect any changes. We work with Grace very closely. We actually work with HHC very closely as well. As you remember, we did an agreement with HHNEC in 2006 transferring our Micron Technology, actually merger, going to be a lot better for us, we're going to have a stronger partner in China and we took of the companies merge.
We were dealing with both and their merger will not make us a more important customer. It's not a big deal for us we know the management teams of both sides.
Doug Friedman - Broadpoint AmTech
Any thoughts on what's happening as far as pricing in the foundry industry these days?
Shahin Sharifzadeh
For us the foundry prices have remained flat and we expect them to go flat to down next year. It's China. It's China and they are extremely cost efficient and we got a deal for continuous improvement in cost, as the condition of signing up to begin with.
Norman Taffe
Doug, I think the other thing to remember, a lot of what we're doing as older technology, right, you're kind of 0.13 and older. There is a very big amount of capacity out there. So we're kind of in the sweet spot, we don't see issues with not getting capacity and we don't see any pricing pressures that would move upwards. It continues to be substantially lower than what we're doing internally on a wafer basis.
Doug Friedman - Broadpoint AmTech
A lot of questions have been asked already on the distribution levels. Without going there, can you talk to me about what percentage of your sales are being supported through distribution right now and what change you might expect to see on that next year?
Norman Taffe
With 63% in Q3, we normally bobble around 60% to 65%, just depending on the quarter. As far as next year, it's hard to say. I mean T.J. mentioned that explained concept. We are pushing distribution very heavy, in these advanced products. It's perfect for their world, and we expect to see it probably move up over time, but I don't expect any dramatic jump next year, but I would think, again, just slowly moving up really every couple years, which is obviously good for us, because gross margin wise, that's another big benefit. Our gross margins run substantially higher than the reported margins that we showed you today.
Doug Friedman - Broadpoint AmTech
My last question, you've already commented on sort of your ASP trends that you've seen year-to-date. Any expectations on what you're seeing presently sort of in bidding for new business, how aggressive the marketplace is, and what you're seeing as far as ASP trends, going forward? What are you expecting there?
Chris Seams
Doug, this is Chris. Obviously in the nonproprietary part of our business, we have to compete in a commodity oriented world in some of our memory products there and that goes more towards Moore's law and some of the advanced products, but in some of the legacy products, we actually expect prices to flatten and maybe go up overtime.
So where we play in those markets, we're not too concerned about price erosion and as the discussion today indicated, we believe that we've got internal cost reductions that will keep our competitiveness either at or improve where it's at today.
In the proprietary world, frankly I expect pricing to increase overtime. As we go out to market with PSoC 3 and PSoC 5, those are much more value added proposals to our customers and we expect to share that value with them, but along the way, we're going to get much higher pricing on a unit basis than we're used to today and we're already seeing that at the forefront of the PSoC 3 opportunities and frankly we're seeing it in some of our more advanced touch opportunities as well.
So on an aggregate basis, I expect in commodities we will have to go down some for our customers overtime to compete, but in the value add proprietary world, I would expect our ASPs to increase overtime.
Your next question comes from John Barton - Cowen & Co.
John Barton - Cowen & Co.
Brad, if I could go back to your comments on OpEx. If I understand you correctly, December quarter basically flat sequentially. March quarter basically flat if you would have back out FICA, audit, etc., but yet we go 13 weeks, 14 weeks, is the reason we're not seeing a 7% increase and then decline because you're doing a forced week of time off and just burning out that accrued vacation time? Am I thinking about that correctly?
Brad Buss
Yes, that's definitely a part of it for sure, but again on the other hand, we still are taking costs down, right. If you just look at the Q3 number we posted, right. I mean that was barely, barely up from the prior quarter and we've got additional accruals related to bonus plans in there. So obviously we had to take other costs out to remain flat and it's just part of our efforts.
There's certain things we've announced that will roll off. There's other things we'll do that will roll off and it's basically canceling each other out. We have a very, very big focus on OpEx and operating leverage. I think you'll all be pleased as we progress into 2010. To the point that we're willing to put our pay cuts up, as I mentioned before. Weren't we, guys?
John Barton - Cowen & Co.
T.J., you talked about all the attitudes of different family of PSoC. You talked about kind of how you address the TrueTouch market, programmability and that kind of a fixed solution, etc. Could you talk a little bit about the competitive landscape in TrueTouch and as you're looking at the FAE reports, why are you winning the sockets you're winning, and maybe even more importantly for those that you don't win, why aren't you winning, and what do you think this competitive landscape looks like a year or two out? Obviously, huge potential TAM, what percentage of it that you think, you have and then how is that competitive dynamic play over the long-term?
Norman Taffe
As far as why are we winning, I think a couple strategies have paid off very well for us. In addition to what T.J. said, the base programmability of our solution, which is kind of core advantage we brought to this market. We also made a strategic decision to partner early with the people developing the ITO glass film, and the LCD suppliers.
Our view was, and I think it's proving out that the handset suppliers were not going allow this to be an aggregated solution in general and by partnering with them, providing them the capability, so that those large companies like the TPK is the world could provide a solution based on our technology, I think is proving to be very, very successful.
We even today, the newer product, we have over 20 partners doing designs with our latest generation TrueTouch solutions. So that is the model we think, the model that's winning and going to continue to win in this industry and I think that's been one of the key strategies that allows us to win.
Secondly, we can talk about chips that came out and we were certainly the first to deliver multi-touch solution. So that was kind of a key first to market piece that got us in the door. So I'll tell you, on the ground its big customers, its software plus the product, that wins and so we've also been first to enhance the solution with capability.
I can talk about some of them like proximity detection or that rejection of things like your face when you bring the phone up so it doesn't detect that as a touch, for example and more like what T.J. pointed out, waterproofing. Those kind of capabilities delivered in firmware on the solution really differentiate and are what the handset suppliers are looking for and I can tell you there's more of those coming and that allows us to continue to have competitive advantage to those customers with the products.
So, its relative to your question about how they should landscape changing, I think we're going to see a continued change toward silicon-based solutions or partner-based solutions as opposed to strictly modules. There is some portion of the market that prefer to stay module oriented but we think that shift is already well underway for this aggregating that portion of the business.
John Barton - Cowen & Co.
So longer term and what do you think is reasonable expectation for market share?
Brad Buss
I can tell you right now, in the Capstone space, which I think it follows a very similar model, which we became the number one supplier of Capstone solutions, we reached 30% and have stayed around the 30% level in Capstone I think we have similar expectation and target in this space.
John Barton - Cowen & Co
Then, Chris, couple different points of this call, it's been referenced to the fact that a lot of the future is going to on how the consumer shows up for Christmas and I would argue that the important metric is, relative to what the supply chain is preparing for, what does the consumer buy, because that will define inventory overhang. In your discussions with your customers, do you have any sense for what magnitude of Christmas spending they are building to on a year-over-year basis or any other way that you would quantify it?
Brad Buss
The answer is by account obviously we could go into how many units of this product this revision versus what it was last year. My most aggregate indicator is that we are 20% down from last year on a revenue basis Q3-over-Q3 and that would be my best indicator of what the consumer is going to do this year.
John Barton - Cowen & Co.
Best indicator anticipating the consumer to do, is that a fairway to say it?
Brad Buss
That's what they are building to.
Your next question comes from Sandy Harrison - Signal Hill
Sandy Harrison - Signal Hill
Could you catch us up on some of other things going on in other areas it seems like that segment outside of the core three seems to be really making some strides. You had talked about it a year ago as being a real opportunity and had some, had some opportunities in Santa Clara there with some buildings and maybe you could spend a second talking about what's going on in that area, because it looks like those are things that could really drive growth outside of other products you've talked about on the call.
Brad Buss
That would be Cypress and biosystems, Harry Sim is the CEO let him address the question.
Harry Sim
We've continued to see very positive response to our products. This last quarter, we had some fairly big name customers, like Kaiser Hospital, Kaiser Permanente you mentioned Santa Clara County already, which is the county within where Silicon Valley is based. Some of these customers have actually applied for utility reimbursement incentives, so PG&E, local utility has paid for 100% of the costs for customers like Kaiser, so that's very positive for us.
In addition, another notable development is we had a joint prior strategic project with Honeywell. So, that's a very big player in this space and we won the project at university of Missouri in Kansas City, so we expect a lot more to go on with Honeywell. In this coming quarter, what we see is the stimulus funding from the federal government starting to flow out.
So that we expect to be a boost overall for our retrofitting old buildings, old industrial plans for energy efficiency. We've actually expected this stimulus funding to come earlier and it's been delayed and we're finally starting to see some of that trickle up this quarter, probably next quarter. So we're keeping a close eye on that we have our sales stimulus funding proposal that went in that we're expecting here in November, so we're hoping this will be additional boost to the market.
Sandy Harrison - Signal Hill
Then there's been a number of conversations out there along with the stimulus plan about smart grid and there's been a number of companies who sort of popped up here of late, talking about smart grid and the opportunity with it. Where do you guys plan in the smart grid and how does that whole thing, how do you see it unfolding?
Harry Sim
The smart grid, there's been a lot of focus in terms of making the grid itself smart, but one thing that is increasingly getting a lot of awareness is that, if you have dumb buildings and dumb plants, they can't talk with a smart grid. So unfortunately, a lot of the dumb buildings, it's very hard to retrofit them. So what we do is provide products that make it very easy, they retrofit in minutes, the cost is 80% less than traditional solutions. So our focus is very much on the buildings and plant site to make them able to talk with the smart grid. That's where we play.
Sandy Harrison - Signal Hill
Then, Brad, just to kind of the question about 13 weeks, 14 weeks and all of that back and forth. I mean, is it a fair assumption to say that the additional week, the impact of it is basically muted in the sense that you are having a plant shutdown, which cuts your expenses and that's the time when basically you're not going to do a whole lot of revenues anyway, so net-net, it's a neutral?
Brad Buss
Basically, from our opinion yes. I mean it's…
Your next question comes from Suji De Silva - Kaufman Brothers.
Suji De Silva - Kaufman Brothers
In talking about the businesses for staff spending above the seasonal, is it really PSoC touched the driving that or are there other elements you could specifically talk about that are helping drive above seasonal first half '10 or conversely, are the rest of the businesses essentially seasonal?
Norman Taffe
PSoC touch they use driver Q4 being a backwards quarter, and we anticipate today's barring unforeseen circumstances will also keep Q1 from being a backwards quarter. The SRAM business is the very high performance SRAM business is driving us also. As we take market share, we are now the largest SRAM supplier in the world. Those are the two big ones. Am I missing something? Those are the events for us in the next six months.
Brad Buss
Yes and just to be clear, like the PSoC 3 and 5, you won't see any revenue on that in the back half of the year, late in the year. So there's nothing that's going to impact that right now. I mean that could be a very nice driver in the Q1 of the following year, when, you know, I'm hoping that down seasonality can finally disappear for us in Q1 '11, so we'll wait and see then.
Suji De Silva - Kaufman Brothers
Then on the touch sense, on the handset market, on the competitive landscape, there was quick follow-up question, where you see modules making sense versus chips, can you talk about where that modules may still have a market versus just to understand that dynamic?
Norman Taffe
Again, this is Norm. I don't know if there's a specific area. A lot of it has to do with the sophistication of the end user and when a product's more in the front end, modules make more sense as the technology is brand-new. That's I think you saw that a year ago with the growth that one of our competitors had, but as the industry matures more, it becomes less viable for high volume. There's still a second tier of customers that may not want to ever deal with having to understand all the implications of the separate glass supplier, how to apply IPO and separate chip supplier.
We intended to service that market as well, by the way. My point about the earlier, we just may service it through partners. A good example is 3M today sells products publicly that address the second tier market and they use our chips, publicly said and they deliver solutions based on that. So we'll address it secondhand, if it's more of a question just how sophisticated customer is relative to the new technology.
Brad Buss
I think what you're seeing is in the design wins and our growth, the customers have spoken and they are going to the single chip, really solutions long term and I think the norms they're working with over 30 different partners, right now. That gives you a pretty good flavor of where the market's moving.
Suji De Silva - Kaufman Brothers
One quick last question, I just that you thoughts in terms of buybacks here at no debt right now. Can you update us where you are on the program and what your thoughts over the cash balance.
T.J. Rodgers
We've got a tremendous amount of cash and like I said, it's grown pretty substantial. We would be going gung-hoe buying the stock back if we didn't have the some part of limitation we could do another 3-ish million shares and then we'd probably have to cool it for another six to nine months till we get closer to the two year anniversary to not run afoul spin issues.
So, we're taking a harder look at it to see if there's any way we can lose that up, but it's a $1.1 billion tax hit if it's not done right and T.J. and I aren't willing to run afoul of that right now, but I would spend a tremendous amount of that money right now on the stock if we could, because we're very confident where we're moving revenue, margins, operating margins over these next couple years, so 3ish million, again it's kind of the short run.
Your next question comes from Adam Benjamin - Jefferies.
Adam Benjamin - Jefferies
A couple of follow-ups for Norm; first, you mentioned shipping into all five of the top five on the handset side for TrueTouch. Basically you've only shipped one Samsung and material volume this year in Q3 and larger in Q4. Can you just, without naming names, can you talk a little bit about what you expect, given your growth that you expect for Q1, do you expect, one or two of those customers to ramp, or is it kind of gradual throughout the year as you add them and layer them in? Thanks.
Norman Taffe
As far as specific to your question, you're correct in your assumption you stated so far. Yes, by Q1 we expect at least one and probably two more to be added to the list of significant volume.
Adam Benjamin - Jefferies
Then just a follow-up, Norm, to the question earlier about the touchpad market, obviously you guys have had a lot of success moving the handset market from a module to a chip solution, as you think about the touchpad market, you mentioned some wins and have picked up other wins that you have in Tier 1s there. How do you do you expect to move that market from a module to a chip solution in the same way you've done with handsets and when can we expect some more material share in that market?
Norman Taffe
So the thing which is in pure track that in the PC space, I would say my belief is that is a market that's by and large won't move away from a module based solution. I think I don't want to indicate necessarily. We aren't against selling modules in any case where customers really demand it and there's a reason why in that space it has held on. We have had some success historically in suppliers that did choose a chip solution, but I wouldn't say that that will follow the same direction that the other spaces, like CapSense and TrueTouch have followed.
Adam Benjamin - Jefferies
Do you have every intention to go after that market maybe with better performance as opposed to just price?
Norman Taffe
Yes, we think we can apply the capabilities we have to that market as well.
Brad Buss
So the answer is yes and other parts of the cell phone down the road as well.
Norman Taffe
So if you think about the module market for a minute, think about, let's say the touchscreen, and I'm just giving you notional numbers. So let's say touchscreen is $15 and let's say the chip is $3, just to pick two numbers. The problem with not shipping chips into that market is that if we want to sell the touchscreen, we have to buy the $12 touchscreen from somebody.
We force our end customer into using a touchscreen vendor that it may or may not want to use and we then have to get a markup on the $12, which is difficult and the overall gross margin, even though we have more gross margin dollars, the overall percent gross margin is less. So it's difficult to have less than 50% of the volume and leveraging going up.
So strategy with touchscreen is that probably were we wants modules, the big I don't want large. They want to hammer on a chip price and then they're hammer on their vendors and touchscreen price and they don't want to hear about a solution from either side. That's why that market is going to disaggregate.
The better model, if you want to chip of model, is for Cypress to go to many touchscreen suppliers, sell PSoC to them and point out that they can create software differentiated products, so their hardware can be the same and they can put in different firmware and create different price points for different markets and then sell chips to them and then let them go sell modules to the world.
So that, on the sort of high end expensive module, and then of course would even be more true in the personal computer, where the glass is even more expensive and the very low end was a touchpad in PC, that product has really been commoditize and if you look at what it is.
It's a little tiny piece of plastic material is maybe two by three inches with a chip directly mounted on the flex material with chip on board technology, or flex chip technology and there, the world has become custom to at the last minute, the PC OEM will say I want a touchpad and I want so many pixels and I want such and such dimension and maybe an extra button so and they just expect that you will make the module that will work perfectly and finish show up. So all the models are going to live in a bigger, more expensive they get, the more disaggregated the market will be.
Your final question comes from Vijay Rakesh - ThinkEquity
Vijay Rakesh - ThinkEquity
Just going back to the handset side or actually in addition to the handset market, you mentioned that you are getting into the panel side, TPK, wondering which other panel guys you are working with, I guess TPK is working with Apple, too but what other panel guys you're working with.
T.J. Rodgers
You can think almost every major supplier of IT or glass we work with depending on the handset suppliers, some cases that handset supplier themselves have their own preferred subsidiary, like LG, Samsung may have a Samsung module group, so we work with those guys as well. There's also a Simko side, is with a touch module guys, semi call Simko. So all those, I would have trouble finding a single one that we haven't worked with.
Brad Buss
Vijay, we would be hard pressed for you to name one that we aren't working with.
Vijay Rakesh - ThinkEquity
Going back to the handset side, you mentioned you had design wins with all the top five handset OEMs. Do you think you will be shipping to all of them by the March quarter?
T.J. Rodgers
Everybody's asking around that question. I don't think we'll be shipping volume to them all by the March quarter. I think that comment earlier from Adam is correct, that I think between certainly two and three of them, we will be.
Vijay Rakesh - ThinkEquity
Going to the transition between module and chip, when you look at capacity handset do you think more than 50% of capacity handset is probably the OEM sub resource that chip rather than the module next year?
Brad Buss
Again, my estimate would be, yes I think that's the direction it will go more than half of them will be at the capacity that will be chips next year. I'm quite sure that will be the case.
Vijay Rakesh - ThinkEquity
Got it and where is it now?
Brad Buss
Honestly, I would have to go look I don't know the answer that's.
T.J. Rodgers
If you go back to six months, it's basically all modules.
Brad Buss
I don't know the numbers.
Chris Seams
I think out of probably the major handset designs that are shipping capacity was helpful this is Chris again. If you look at it, my guess would be less than half are shipping in module form today.
Brad Buss
If you go back before we entered the market, they were virtually all modules. So, we're in a transformation going from, nearing 100% modules to less than 50% that transition will happen over an 18 month period, as we're about six months into.
Vijay Rakesh - ThinkEquity
On the gross margin side, looks like pretty nice improvement on that line. Where do you think longer term gross margin strength, as you had a higher margin DCD and sides starts to pick up.
Brad Buss
Like I said before, we expect to be around 55%, within kind of the next year and a half, two years, and I could see it moving up another point easily next year.
Your final question comes from Srini Pajjuri - CLSA.
Srini Pajjuri - CLSA.
One longer term question, T.J., Intel is talking about this new standard for USB going forward at limits call the light peek. I am just curious as to what kind of impact, if any do you see on your USB and also the West Bridge business. Thanks.
T.J. Rodgers
That's interesting, because I was about to ask you the same question. USB Intel first USB 3 real hard there's a large infrastructure developing port USB 3 with 5 gigabits per second. There's standard set for it, there are bunch of companies working on it and USB 1.0, 1.1 and 2 have all been such great successes to me, even Intel is not going to change the world's movement to USB 3 and I'm not even sure they're trying.
After USB 3 at 5 gigabits per second, there's a slight peak, proprietary technology that's 10 gigabits per second, and it's proprietary. So there you go, proprietary Intel technology and it will be more expensive and higher performance and it's got a vision of hook up one cable and everything comes in and up through the one cable.
So I really don't know, because I don't know that much more about it. I do believe that USB 3 is going to happen. It's going to get big. For the next decade, it's going to go through a phase where it's hard to make and then it's expensive and then the price goes down and the volume goes up.
Right now, 40 megabit USB 3 sells for about $2. So right now, you can get a half a gigabit per second for $2, and five years from now you'll get 5 gigabit per second, maybe six years from now and those chain of events aren't going to change. They're too standard, too much accepted by everybody in the world and light peek, don't know. Don't have part of that action and don't have a plan to get into it.
Sir, at this time, we're showing no further questions. I'll turn the call back over to you for any closing comments.
T.J. Rodgers
Thank you for calling in. We've just reported a third quarter with good earnings and even better gross margins. We think that this well for the future and we've announced the introduction of our new PSoC 3 and 5 families, which will start driving revenue probably in early 2011. Thank you very much for calling in.
Thank you. You may go ahead and disconnect at this time. This does conclude today's conference call. Thank you for participating.
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