The Daily Magic Formula Stock for 11/04/2008 is Intersil Corp. According to the Magic Formula Investing Web Site, the ebit yield is 16% and the EBIT ROIC is 50-75 %.
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We are a global designer and manufacturer of high performance analog integrated circuits (âICsâ). We believe our product portfolio addresses some of the fastest growing applications in four end markets: High-End Consumer, Industrial, Communications and Computing.
Our business strategy emphasizes the following key elements:
Focus on High Growth Markets . We focus our investments on markets with the potential for high growth. We believe that the demand for ICs in our focused markets will be higher than that in the overall semiconductor industry.
Broaden our Product Portfolio . We intend to increase our investments in the design of general purpose proprietary products and continue to develop application-specific standard products for high-growth vertical markets.
Maintain Technology Leadership . We have almost 600 research and development employees working on innovative solutions for analog architectures. In conjunction with these efforts, we continue to expand our strong intellectual property position by seeking to increase our existing portfolio of over 1,000 patents.
Maintain Quality Customer Service . Quality customer service is critical to our customer retention and sales growth. Through our customer relations initiatives, we believe we distinguish ourselves from our competitors. Additionally, our sales force, authorized representatives and distributors provide customer information programs and support for our comprehensive, global customer service efforts.
Partner with Leaders in Semiconductor Markets, Products and Services
Partner with Leaders in our Target Markets . We partner with industry leaders in each of our target markets to deliver advanced technology for rapidly emerging applications. Our customer base of industry leaders illustrates the acceptance of our products to date, and we continue to partner with these customers and others to develop and market our next generation products. Our applications and design engineers support our customersâ end product development.
Utilize Specialty Expertise in Manufacturing Services. We employ high-volume and specialty suppliers of products and services in our industry. We source a substantial portion of our wafer needs as well as assembly, test and packaging requirements from those who provide those products and services on a merchant basis, specialize in those products and services and deliver them at reasonable cost. This reduces our capital requirements and enhances our flexibility in managing our ever-changing business.
Our mission is to provide differentiated, high-performance analog ICs that meet our customersâ needs and exceed their expectations. Our objective is to grow our revenues and earnings faster than our peers. We were formed in August 1999 when we acquired the semiconductor business of Harris Corporation (âHarrisâ) and began operating as Intersil. We began our transformation into a high-performance analog company in 2002 with the acquisition of Elantec Semiconductor, Inc. (âElantecâ), followed by the divestiture of our wireless networking business in 2003 and the 2004 acquisition of Xicor, Inc. (âXicorâ) and the 2007 acquisition of Planet ATE, Inc. (âPlanet ATEâ).
Our internet address is www.intersil.com . We post the following filings on our website as soon as reasonably practicable after they are electronically filed with the Securities and Exchange Commission (the âSECâ): our annual reports on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K, the filings of our officers and directors pursuant to Section 16(a) of the Securities Exchange Act of 1934, our proxy statements on Schedule 14A related to our annual stockholdersâ meeting and any amendments to any of those reports or statements filed or furnished pursuant to Section 13(a) or 15(d) the Act. All such filings are available free of charge on our website. We have adopted a Corporate Code of Ethics, which is applicable to our Chief Executive Officer and principal financial officers. A copy of the Code of Ethics is available on our website or free of charge upon request. The content on any website referred to in this filing is not incorporated by reference into this filing unless expressly noted otherwise.
The public may read and copy any reports filed by us with the SEC at the SECâs Public Reference Room at 450 Fifth Street, N.W., Washington, DC 20549 and may obtain information on corporate reports by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov .
Products and Technology
Our product strategy is focused on broadening our portfolio of Application Specific Standard Products (âASSPâ) and General Purpose Proprietary Products (âGPPPâ) which are targeted at four high-growth markets: High-End Consumer, Industrial, Communications and Computing.
Our high-end consumer products include our optical storage, displays and handheld products. These products target high growth applications such as DVD players and recorders, MP3 players, GPS systems, liquid crystal display (âLCDâ) televisions, cell phones and digital still cameras. The high-end consumer category represented 29% of our sales in 2007.
Our industrial products include our operational amplifiers, bridge driver power management products, switches and multiplexers, and other standard analog and power management products. These products target end markets including medical imaging, energy management, automotive, solar generating devices, military and factory automation. The industrial products category represented 23% of our sales in 2007.
Our communications group is made up of our line drivers, broadband and hot plug power management products and high speed converters targeted to applications in markets such as DSL (Digital Subscriber Line), home gateway, satellite, VOIP (Voice Over Internet Protocol), networking, cellular base station and networking/switching equipment. The communications category represented 21% of our sales in 2007.
Our computing category includes desktop, server and notebook power management, including core power devices and other power management products for peripheral devices. The computing category represented 27% of our sales in 2007.
Bridge driver power managementâ a bridge driver is a device that supplies (i.e., drives) or accepts power in the form of voltage and current into a circuit that consists of a load connecting (i.e., bridging) two or more
switching elements. An example of a bridge driver is a device that opens and closes switches arranged to cause a motor to start, control speed, stop, and reverse direction. Power management from/to those devices is an element of the technology.
Broadband power managementâ Broadband is a term which refers to a signaling method which includes or handles a relatively wide range of frequencies which may be divided into channels. Power management from/to those devices is an element of the technology.
Cellular Base Stationâ consists of transmission and reception equipment, including the base station antenna, which connects a cellular phone to the network.
DVD (digital video disc) recorderâ also known as a DVD burner, is an optical disc recorder that records video onto blank writable DVD media.
GPS (Global Positioning System) systemsâ devices that use the Global Navigation Satellite System, which is comprised of more than two dozen GPS satellites in medium Earth orbit, transmitting signals allowing GPS receivers to determine the receiverâs location, speed and direction.
High speed (power) convertersâ a circuit which converts a source of direct current from one voltage to another. Converters are important in portable electronic devices such as cellular phones and laptop computers, which are supplied with power from batteries. Such electronic devices often contain several sub-circuits with each sub-circuit requiring a unique voltage level different than that supplied by the battery.
Hot plug power managementâ hot plugging, also known as hot swapping, is the ability to remove and replace components of a machine, usually a computer, while it is operating. A well-known example of this functionality is the universal serial bus (USB) that allows users to add or remove peripheral components. Power management from/to those devices is an element of the technology.
Line driverâ an amplifier used to improve the transmission reliability of a digital signal over a metallic transmission line, to longer physical distances, by driving the input to the line with a higher than normal signal level.
MP3 playersâ devices that play digital audio in the MPEG-1 Audio Layer 3 format, more commonly referred to as MP3, which is an encoding and compression format designed to greatly reduce the amount of data required to represent the audio content.
Multiplexerâ also known as âmuxâ is a device that combines several input signals into a single output signal in such a manner that each of the input signals subsequently can be recovered.
Operational amplifiersâ usually referred to as an âop-amp,â captures weak signals from various inputs and amplifies them for processing. Op-amps are among the most widely used electronic devices today, being utilized in a vast array of consumer, industrial, and scientific devices.
Geographic Financial Summary
We operate exclusively in the semiconductor industry and primarily the analog sector of that industry. Substantially all revenues result from the sales of semiconductor products. All intercompany revenues and balances have been eliminated. The revenues noted in this section are based on shipping destination.
Three distributor customers and two original equipment manufacturer (âOEMâ) customers, each accounting for at least 5% of the Companyâs revenues, totaled 43% of revenues in fiscal 2007. Two of the distributors represented 11% of revenues each during fiscal 2007 and 21% of aggregate net accounts receivable at December 28, 2007. The loss of any one or more of these customers could result in a materially negative impact on our business.
Sales, Marketing and Distribution
In 2007, we derived 50% of our revenues from OEM customers, original design manufacturer (âODMâ) customers, and contract manufacturers. We derived 50% of our revenues through distributors and value added resellers.
Our sales organization is supported by customer service and logistics organizations throughout the world. Product orders flow to our fabrication facilities or to foundries where the semiconductor wafers are made. Most of our semiconductors are assembled and tested at the facilities of independent subcontractors. Finished products are then shipped to customers either indirectly via third parties or directly via internally-owned warehouses in the United States, Asia/Pacific and Europe.
To serve our customer base, we maintain a highly focused sales team, which focuses on those major accounts that are strategic to our marketing and product strategies. We also have direct geographical sales organizations selling products in regions throughout the world. The geographical sales force works closely with a network of distributors and manufacturersâ representatives, creating a worldwide selling network. We have dedicated direct sales organizations operating in the North American, European, Japanese, and Asia/Pacific markets. Sales offices are strategically located near major OEM and ODM customers throughout the world. The technical applications organization is deployed alongside the direct sales force, ensuring both applications and product/customer focus. Our dedicated marketing organization supports field sales and is aligned by specific product group.
Manufacturersâ representatives generally do not offer products that compete directly with our products, but may offer complementary items manufactured by others. Manufacturersâ representatives do not maintain product inventory; instead, customers place large quantity orders either directly with us or through these manufacturersâ representatives. Smaller quantity orders are typically placed through distributors.
Distributors handle a wide variety of products, including products sold by other companies that compete with our products. Some of our sales to distributors are made under agreements allowing for market price fluctuations and/or the right to return some unsold merchandise. Some of our distribution agreements contain an industry standard stock rotation provision allowing for minimum levels of inventory returns or scrap. In our experience, these inventory returns can usually be resold. We recognize revenue shipped to North American distributors when the distributor sells the product. Sales made to international distributors are recognized when product is shipped to the international distributors and provisions are recorded on those sales for expected price fluctuations and returns.
Research and Development
We believe that the continued introduction of new products in our target markets is essential to our growth. We incurred costs of $118.3 million, $126.5 million and $134.4 million on research and development projects for 2005, 2006 and 2007, respectively, including share-based payment expense. In 2007, we introduced over 250 new products for our target markets. We believe that we must continue to innovate, enhance and expand our products and services to maintain our leadership position, and we intend to achieve this through in-house research and development and, occasionally, selective acquisitions. At December 28, 2007, we had almost 600 employees engaged in research and development.
We sell many product types that utilize silicon wafers containing integrated circuits. Our business is dependent upon reliable fabrication, packaging and testing of these wafers. We fabricate wafers of integrated circuits in our Florida manufacturing facility. We also have wafers of integrated circuits manufactured by leading foundry suppliers such as IBM Microelectronics, Taiwan Semiconductor Manufacturing Company, United Microelectronics Corporation and AMI Semiconductor. We believe that our strategy of employing internal and foundry suppliers provides an increased level of flexibility and capacity to meet production demand. In addition, this strategy significantly reduces the ongoing capital investment required to maintain our production capabilities. During 2007, we internally produced approximately 26% of our wafers and sourced the remaining 74% from foundry partners.
Following fabrication, wafers are subject to packaging and testing processes. The majority of these processes are performed by independent subcontractors located in Malaysia, China, Taiwan and the Philippines. However, we maintain assembly and test capabilities for certain products in Florida and California.
Historically, certain materials, including silicon wafers and other materials, have been in short supply. In the recent past, we have not experienced delays in obtaining such materials, which could have adversely affected production. However our reliance on foundry partners for silicon wafers, the building block of our products, is critical and the relative importance of this part of the supply chain continues to increase, increasing our risk of incurring a production-limiting shortfall. As is typical in the industry, we must allow for significant lead times in delivery of certain materials. The production of integrated circuits, from wafer fabrication, through packaging and final testing, may take from eight to sixteen weeks. We manufacture thousands of product types and our customers typically require delivery within a short period of time following their order. To consistently meet these requirements, we maintain a substantial work-in-process and finished goods inventory.
Manufacture, assembly and testing of integrated circuits is a complex process. Normal risks include errors and interruptions in the production process, defects and shortages in raw materials and disruptions at supplier locations, unexpected demand, as well as other risks, all of which can have an unfavorable impact to production costs, gross margins and our ability to meet customer demand.
Our product sales are made pursuant to purchase orders that are generally booked up to six months in advance of delivery. Our standard terms and conditions of sale provide that these orders become non-cancelable thirty days prior to scheduled delivery for standard products and ninety days prior to scheduled delivery for semi-custom and custom products. Backlog is influenced by several factors, including market demand, pricing and customer order patterns in reaction to product lead times.
Additionally, we believe backlog can fall disproportionately to consumption rates in periods of weak end-market demand since production lead times can be shorter. Conversely, we believe backlog can grow faster than consumption in periods of strong end-market demand as production and delivery times increase and some customers may increase orders in excess of their current consumption to reduce their own risk of production disruptions.
Our six-month backlog at December 28, 2007 was $176.4 million compared to December 29, 2006 of $117.7 million. Although not always the case, as discussed in the foregoing paragraph, backlog can be a leading indicator of revenue performance for approximately the next two quarters.
See âBusiness Outlookâ elsewhere in this Managementâs Discussion and Analysis of Financial Condition and Results of Operations relating to expected revenues in the near term.
The high-end consumer and computing markets generally experience relatively weak demand in the first half of each year and stronger demand in the second half of each year.
The high performance analog market is extremely competitive. We compete in our target markets with many companies that have significantly greater financial, technical, manufacturing and marketing resources than us, including but not limited to Texas Instruments, Analog Devices, Linear Technology, and Maxim Integrated Products. We compete on the basis of technical performance, product features, customized design, price, availability, quality and sales and technical support. Our ability to compete successfully depends on elements both within and outside of our control, including successful and timely development of new products and manufacturing processes, product performance and quality, manufacturing yields, product availability, intellectual property protection obtained by us and our competitors, customer service, pricing, industry trends and general economic trends.
David B. Bell, Chief Executive Officer, President, and Director. Prior to his appointment as Chief Executive Officer on February 13, 2007, Mr. Bell served as President, Chief Operating Officer, and Director of the Company since April 2007. Prior to joining the Company, Mr. Bell was employed for 12 years with Linear Technology Corporation (âLTCâ), most recently, from June 2003 to January 2007, as its President. Prior to becoming President of LTC, from January 2002 to June 2003, Mr. Bell served as LTCâs Vice President and General Manager of Power Products and, from February 1999 to January 2002, as LTCâs General Manager of Power Products. From June 1994 to January 1999, he held the position of LTCâs Manager of Strategic Product Development. Mr. Bell has a B.S. degree in Electrical Engineering from the Massachusetts Institute of Technology. Age: 51
Robert W. Conn, Director. Dr. Conn has been one of the Companyâs Directors since April 2000. Dr. Conn has been Managing Director of Enterprise Partners Venture Capital since July 2002. From 1994 to July 2002, Dr. Conn was the Dean of the Jacobs School of Engineering, University of California, San Diego, and the Walter J. Zable Endowed Chair in Engineering. Dr. Conn served on the Board of Directors of ChipPAC, Inc. from 2002 through 2004, and on the Board of Directors of STATS ChipPAC, Inc. from 2004 through 2007. Presently, he is a member of the National Academy of Engineering and also serves on the Board of Directors of several privately-held companies. Age: 65
James V. Diller, Director . Mr. Diller has been one of the Companyâs Directors since May 2002. Mr. Diller is a retired Chairman of the Board of Elantec Semiconductor, Inc., a post he held from 1997 to May 2002. Mr. Diller served as a director of Elantec Semiconductor, Inc. beginning in 1986. From November 1998 to July 2000, he served as Elantecâs President and Chief Executive Officer. Mr. Diller is a founder of PMC-Sierra, Inc. and was its President and Chief Executive Officer from 1983 to 1997; he is currently Vice Chairman of the Board of Directors. Mr. Diller was a director of Sierra Wireless, Inc., a provider of wireless data communications hardware and software products from 1993 through 2003. In addition, Mr. Diller also serves on the Board of Directors of several privately-held companies. Age: 72
Gary E. Gist, Director . Mr. Gist has been the Companyâs Chairman of the Board since May 2005. Prior to this Mr. Gist served as a Director since the Companyâs inception in August 1999. From 1995 to present, Mr. Gist has served as the President and Chief Executive Officer of a privately-held company that focuses on designing and manufacturing electronic products. Age: 61
Mercedes Johnson, Director. Ms. Johnson has been one of the Companyâs Directors since August 2005. Ms. Johnson holds the position of Senior Vice President of Finance and Chief Financial Officer at Avago Technologies. Prior to Avago, Ms. Johnson worked for Lam Research Corporation, serving as its Senior Vice President of Finance from June 2004 to January 2005, and as its Chief Financial Officer from May 1997 to June 2004. Ms. Johnson has served on Micron Technology, Inc.âs Board of Directors since June 2005. She also served on the Board of Directors for Storage Technology Corporation from January 2004 to August 2005. Age: 54
Gregory Lang, Director . Mr. Lang has been one of the Companyâs Directors since February 2006. Mr. Lang serves as President and Chief Executive Officer of Integrated Device Technology Inc. (âIDTâ), a leading supplier of preemptive semiconductor solutions that accelerate packet processing for advanced network services. Mr. Lang joined IDT as President in October 2001, was appointed Chief Executive Officer in January 2003 and elected to the IDT Board of Directors in September 2003. IDT has announced that Mr. Lang will be resigning his positions as Chief Executive Officer and President when his replacement joins IDT at the end of March 2008. Prior to joining IDT, Mr. Lang held the position of Vice President and General Manager of Intelâs platform networking group. Previously he managed Intelâs industry leading Ethernet, storage I/O processing, home networking and broadband businesses. Age: 44
Jan Peeters, Director. Mr. Peeters has been one of the Companyâs Directors since April 2000. Mr. Peeters is Chairman and Chief Executive Officer of Olameter Inc., a meter asset and data management company, which he formed in 1998. Mr. Peeters served on the Board of Directors of Call-Net, a publicly-traded Canadian telecommunications company, from 1999 to 2002. He presently serves as Chairman of Cogeco Inc. and Cogeco Cable Inc., publicly-traded Canadian companies in the areas of broadcasting and cable. He has been a Governor of McGill University since 1999. Age: 56
Robert N. Pokelwaldt, Director. Mr. Pokelwaldt has been one of the Companyâs Directors since April 2000. Mr. Pokelwaldt was previously Chairman and Chief Executive Officer of YORK International Corporation. He retired from the Board of Directors of Carpenter Tech in May 2004 and presently serves on the Board of Directors of Mohawk Industries, Inc. Age: 71
James A. Urry, Director. Mr. Urry has been one of the Companyâs Directors since the Companyâs inception in August 1999. Mr. Urry is a Partner at Court Square Capital. Mr. Urry is also director of Lyris, Inc. and served as a director of AMI Semiconductor prior to the merger of AMI and ON Semiconductor on March 12, 2008. Previously, Mr. Urry was a Partner at Citigroup Venture Capital Ltd. from 1989 to 2006. Age: 54
MANAGEMENT DISCUSSION FROM LATEST 10K
We focus our design, manufacturing and marketing efforts on the High-Performance Analog (âHPAâ) segment of the semiconductor market. Digital and analog semiconductor components are the basic ingredient in todayâs electronic devices. In contrast to the binary nature of digital components, analog components monitor, evaluate and modify electrical signals and strengths allowing them to deal with basic and essential properties such as heat, touch, light and sound. The HPA segment is distinguished by its highly differentiated and technologically advanced products which can be building blocks for more complex circuits or highly integrated for specific applications. Historically, the HPA segment has yielded higher gross margins and suffers less competition than the digital and broader analog segments of the semiconductor market. The HPA segment requires uniquely talented and experienced designers, engineers and specialized selling and marketing efforts to address the myriad of challenges associated with todayâs complex applications.
We began our transformation into an HPA company with the acquisition of Elantec in 2002 and the divestiture of our wireless networking business in 2003. We further strengthened the transformation with the 2004 acquisition of Xicor. Our transformation has required us to report our financial performance with restructurings, impairments, discontinued operations and write-offs attendant to our acquisitions. Our first full year as a pure HPA company was fiscal 2004. Since then, our focus has resulted in revenue growth that has been very broad-based across our many analog products. We have introduced hundreds of new products in each of the last few years including several new product families that have significantly expanded our served available market. Our investments to expand our product portfolio to over 50 product families appear to be successful, enabling us to reach our primary management goals of revenue growth with higher margins, growing operating income and increasing cash flow generation measured against the investment in the company.
Revenue and Cost of Revenue
Our revenue for 2007 was $757.0 million, an increase of $16.4 million or 2% over 2006. This increase was made up of net growth in our end markets and our 2007 acquisition. Our various end markets performed as follows: Computing products had 12% in revenue growth, followed by high-end consumer products at an 8% increase. However, our Industrial products experienced a revenue decline of 4% and our Communication products declined 8%. In aggregate, higher unit demand increased revenues by approximately $102 million, which was partially offset by a decline in average selling prices (âASPsâ), which decreased revenues by approximately $86 million. Of this net revenue growth, approximately $43 million came from our sales to customers in the Asia/Pacific region, which was offset by revenue declines of $28 million in North America with Europe and other countries being approximately even. Higher sales of units resulted from our currently strong product offering in computing and consumer power management devices and consumer electronics. Declining sales prices has been a phenomenon of the semiconductor industry for much of its existence and is expected to continue into the foreseeable future.
Our revenue for 2006 was $740.6 million, an increase of $140.3 million or 23% over 2005. This increase was driven by growth in all of our four end markets. Communication products saw the highest growth at 27%, followed by computing products at 26%, high-end consumer products at 22% and industrial products at 19%. In aggregate, higher unit demand increased sales by approximately $161 million, which was partially offset by a decline in ASPs, which decreased sales by approximately $21 million. Of this sales growth, approximately $106 million came from our sales to customers in the Asia/Pacific region, $26 million from North America and approximately $9 million from Europe.
We anticipate that our revenue from Asia/Pacific region customers will continue to grow in percentage terms as that regionâs economy leads in the manufacture of the finished applications (consumer electronics, computers, communications equipment) that our products are used in. End market demand for those applications is global and hence dependent on aggregate global economic metrics and conditions such as personal incomes and business activity and not necessarily on Asian and Pacific Rim regional economic factors.
See âBusiness Outlookâ elsewhere in this Managementâs Discussion and Analysis of Financial Condition and Results of Operations relating to expected revenues in the near term.
Cost of Revenue
Cost of revenues consists primarily of purchased materials and services, labor (including stock-based compensation), overhead and depreciation associated with manufacturing pertaining to products sold.
Our gross margin declined by 40 basis points in 2007 over 2006 compared to an increase of 160 basis points in 2006 over 2005. The 40 basis point decline was largely a function of our sales mix. Generally, our computing products have lower gross margins than other products. In 2007 much of our revenue increase came from power management products in the computing end market. Additionally, in 2007 stock-based compensation costs
charged to cost of sales via direct overhead charges and through inventory relief increased by approximately 13 basis points over 2006. The 2006 increase in gross margin was partially due to our product mix in 2006, as revenues for our higher margin, general purpose products grew 28% over 2005 and sales for some of our lower margin products grew 20% over 2005. The 2006 increase in gross margins was also a function of lower wafer prices, improved yields and better pricing from our assembly and test partners in 2006.
Research and Development (âR&Dâ)
R&D expenses consist primarily of salaries and expenses (including stock-based compensation) of employees engaged in product/process research, design and development activities, as well as related subcontracting activities, prototype development, cost of design tools and technology license agreement expenses.
Our R&D expenses increased by 6% to $134.4 million in 2007 compared to $126.5 million for 2006 and $118.3 million for 2005. The 2007 increase of approximately $8 million is made up of some $10 million of increased cash compensation and fringe benefits due to higher headcount and pay levels, offset by a $1.1 million decline in non-cash, stock-based compensation charges and other net reductions in supplies and facility costs. Our R&D expenses increased by 7% in 2006 compared to 2005 due primarily to increased stock-based compensation costs due to our adoption of SFAS 123R in 2006.
Selling, General and Administrative (âSG&Aâ)
SG&A expenses consist primarily of salaries and expenses (including stock-based compensation) of employees engaged in selling and marketing our products as well as the salaries and expenses required to perform our Human Resources, Finance, Information Systems, Legal, Executive and other administrative functions.
Our SG&A expenses decreased by 4% to $131.9 million for 2007 compared to $137.1 million for 2006 and $106.5 million for 2005. The approximately $5 million decrease in 2007 compared to 2006 was substantially accounted for by a reduction in stock-based compensation expense of approximately $3.5 million. The remaining costs making up SG&A decreased by approximately $1.5 million, with advertising and outside services declining and personnel costs increasing within that net change. As with R&D stock-based compensation costs, the Company is managing SG&A stock-based compensation costs carefully. Our 2007 grants had more than a $20 million lower aggregate fair value to amortize over the multi-year vesting term than in 2006. The increase in 2006 compared to 2005 was made up of approximately $22 million of additional stock-based compensation costs due to our adoption of SFAS 123R in 2006 and increased selling and marketing expenses associated with higher sales.
Amortization of Purchased Intangibles; Goodwill
Amortization of purchased intangibles for 2007 was $10.7 million; in 2006 and 2005 the amortization amounts were approximately equal at $9.6 million. The increase in 2007 compared to 2006 resulted from the additional amortization recorded from two acquisitions made in September 2007 for which amortization was included in the fourth quarter of 2007. Our purchased intangibles, which are definite lived assets, are amortized over their useful lives ranging from 3 to 11 years.
We review goodwill for impairment indicators quarterly and perform substantive impairment testing annually. During the fourth quarter of 2007, we determined that the value of our reporting units exceeded the goodwill value stated on our balance sheet and therefore, we did not record any impairment to goodwill. However, our goodwill value is dependent on many factors including future market demand for our products, our stock market valuation, valuation of our expected cash flow, relative values of our reporting units and many other factors. We could have goodwill impairment in the future which would negatively impact our earnings.
In-Process Research and Development (âIPR&Dâ)
In fiscal 2007, we recorded a charge to earnings for $2.7 million of purchased in-process research and development related to the acquisition of Planet ATE as described more fully in Note 6 to the accompanying consolidated financial statements. The amount of the purchase price allocated to IPR&D was the result of the purchase accounting appraisal, for which was management is primarily responsible. The IPR&D was determined using a cost-based approach to valuation due to limitations in the market value and income-based valuation approaches for this item. The cost-based approach related to approximately two years of historical Planet ATE research and development expenditures, net of associated tax effects, which relates to the lengthy and risky development life-cycle of the typical acquired âsystemâ IC product for the automated test equipment market. The Company expects to continue to invest in these and other development efforts for this new market and believes there is a reasonable chance of successfully completing the work undertaken at the point of the acquisition. However, there is risk associated with the completion of the projects, and there is no assurance that any will meet either technological or commercial success.
In March 2005, we announced a restructuring plan to further streamline operations and to reduce costs. We recorded $2.8 million in restructuring expense. Approximately 100 employees were notified that their employment would be terminated. The affected positions included manufacturing, research and development, and selling, general and administrative employees. At December 30, 2005, the affected positions had all been terminated.
Other Gains & Losses
During 2005 we recovered $2.0 million for insured business interruption losses resulting from the hurricanes in 2004. During 2004, our Florida facilities were damaged by hurricanes resulting in $2.7 million in reconstruction costs.
A key Company objective is to manage Operating Expenses carefully SUCH THAT in future periods they increase in both dollars and percent by amounts less than our revenue and thereby continue to utilize operating leverage to increase shareholder value.
Other Income and Expenses
Our interest income increased 4% to $30.9 million in 2007 compared to $29.7 million for 2006 and $19.0 million for 2005. Interest income increased in 2007 due primarily to higher balances and rates available in the first half of the year. In contrast, in the second half of the year, our interest earning balances declined as we conducted our stock repurchase program and funded the acquisition of Planet ATE. Further, rates began to decline in the second half of the year. In the fourth quarter of 2007, our interest income declined by 18% over the same quarter of 2006. Our 2006 interest income increased 57% to $29.7 million, due primarily to increased interest rates earned on our investments compared to 2005. With available interest rates currently falling and our interest earning balances expected to be further reduced in 2008 due to our increased dividend and continued stock repurchases, we expect that our interest income in 2008 will be reduced from our 2007 level.
Income Tax Expense
Our income tax expense from continuing operations was $41.0 million or 22% of pretax income for 2007 compared to tax expense of $28.8 million or 16% of pretax income for 2006. In 2006 we enjoyed the benefit of approximately $13 million in discrete tax events, notably the benefit from the loss on the sale of our interest in a
cost method investee, absent which the 2006 tax expense and tax rate would have been comparable to the amounts reported for 2007.
Our income tax expense from continuing operations was $28.8 million or 16% of pretax income for 2006 compared to tax expense of $32.3 million or 27% of pretax income for 2005. The effective tax rate declined in 2006 primarily because of a $150.0 million dividend repatriation in 2005 that did not occur in 2006 (see below). The benefit from the loss on the sale of our interest in a cost method investee was the other key driver in the 2006 tax rate decline.
Our income tax expense for 2005 included a provision of $6.6 million relating to our repatriation of $150 million of foreign earnings. See Note 16.5 in our consolidated financial statements for more information about our repatriation.
In the first quarter of 2008, the Company expects to reverse the non-current portion of our income taxes payable to income taxes in our consolidated statement of operations as a benefit due to the expiration of the statute of limitations for the tax years 2002 and 2003. That benefit to income taxes and earnings is expected to be approximately $40.7 million and will be apportioned between continuing and discontinued operations. Our expected effective tax rate in the first quarter, absent this event, is 24.6%.
In determining net income, we must make certain estimates and judgments in the calculation of tax expense and tax liabilities and in the recoverability of deferred tax assets that arise from temporary differences between the tax and financial statement recognition of revenues and expenses. In the ordinary course of business, there are many transactions and calculations where the ultimate tax outcome is uncertain. The calculation of tax liabilities involves dealing with uncertainties in the application of complex tax laws. We follow the recently promulgated Financial Accounting Standards Board Interpretation No. 48, âAccounting for Uncertainty in Income Taxesâ (FIN 48) model to establish reserves for potential future tax liabilities. Although we believe these estimates are reasonable, no assurance can be given that the final outcome of these matters will not be different than what is reflected in the historical income tax provisions and accruals. Such differences could have a material impact on the income tax provision and operating results in the period in which such determination is made.
In addition to the risks to the effective tax rate described above, the effective tax rate reflected in forward-looking statements is based on current enacted tax law. Significant changes in enacted tax law could materially affect these estimates. See Note 16.3 for our statutory to effective tax rate reconciliation for the three years ended December 28, 2007.
Discontinued Operations and Related Taxes on Discontinued Operations
In fiscal 2005 we settled a foreign tax liability relating to our 2003 Wireless Networking product group sale, which made up the majority of our loss of $1.1 million ($0.9 million net of tax) from discontinued operations. In fiscal 2006 we reached a settlement relating to remaining patent rights litigation connected with this sale. After the settlement payment, the remaining accrual of $0.9 million ($0.5 million net of tax) was released and is classified and presented as discontinued operations. In fiscal 2007, the Company was presented with an additional tax claim by a foreign jurisdiction. The Company incurred research and defense costs for the claim of $0.3 million and ultimately settled the claim for $5.5 million net of a $3.5 million tax reserve, resulting in a net tax charge from discontinued operations of $2.0 million. Therefore discontinued operations were a net loss of $2.3 million for 2007.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Results of Operations
Revenue and Gross Profit
Revenue for the quarter ended July 4, 2008 increased $37.9 million or 21.2% to $216.2 million from $178.3 million during the quarter ended June 29, 2007. The increase in net revenue was predominately from sales to the computing market, which increased $26.5 million or 59.6% over the quarter ended June 29, 2007. Sales to the high-end consumer, communications and industrial markets increased $2.2 million, $7.0 million, and $2.2 million, respectively. In aggregate, a 40% increase in unit shipments increased net revenue by $71.7 million, while average selling prices (ASPs) declined 14%, decreasing revenues by $33.8 million. The trend of declining unit prices, which must be made up by higher unit volumes for sales growth, is normal for the semiconductor industry and we expect it to continue. These trend characteristics are not currently believed to be a material change in the demand or financial return characteristics for our products and are expected to continue into the future.
Revenue for the two quarters ended July 4, 2008 increased $73.9 million or 21.3% to $419.9 million from $346.1 million during the two quarters ended June 29, 2007. The increase in net revenues was primarily from sales to the computing market, which increased $44.9 million or 54% over the two quarters ended June 29, 2007. Other sales increased as follows: high-end consumer, $8.9 million; communications, $14.0 million and industrial, $6.0 million. In aggregate, a 34% increase in unit demand increased net revenues by $117.2 million and a 9% decline in ASPs decreased net revenues by $43.3 million.
The long-term trend of revenue growth in the Asia/Pacific region continues to reflect in the geographic split. Revenues in the Asia/Pacific region increased 30% as compared with North America and Europe, which saw only modest increases in absolute dollars as compared with the two quarters ended June 29, 2007. As manufacturing of consumer electronic and computing/communication products continues to migrate to the Asia/Pacific region of the world, we believe our sales will continue to grow proportionately in that region.
We sell our products to customers in many countries including, in descending order by revenue dollars for our top ten countries, China (including Hong Kong), the United States, South Korea, Japan, Taiwan, Germany, Singapore, Italy, Malaysia and France. Sales to customers in China, including Hong Kong, comprised approximately 45% of revenue, followed by the United States (18%) and South Korea (11%) during the quarter ended July 4, 2008. Two distributors that support a wide range of customers around the world accounted for 12% and 10% of our revenues in the quarter ended July 4, 2008.
Cost of Revenue and Gross Profit
Cost of revenue consists primarily of purchased materials and services, labor and overhead associated with product manufacturing. During the quarter ended July 4, 2008, gross profit increased $20.6 million or 20.2% to $122.6 million from $102.0 million during the quarter ended June 29, 2007. As a percentage of sales, gross margin was 56.7% during the quarter ended July 4, 2008 compared to 57.2% during the quarter ended June 29, 2007. The gross margin was impacted by product sales mix changes at the product family level and by increases in the cost of gold.
Pure gold wire is used in many of our products and recent price increases have had a more visible impact to our production costs and our gross margins. We estimate that we incurred approximately $1.4 million in additional production costs during the quarter ended July 4, 2008 compared to the quarter ended June 29, 2007 as a result of increases in the cost of gold wire.
During the two quarters ended July 4, 2008, gross profit increased $34.0 million or 17.2%, to $232.2 million from $198.2 million during the two quarters ended June 29, 2007. As a percentage of sales, gross margin was 55.3% and 57.3% in the two quarters ended July 4, 2008 and June 29, 2007, respectively. Year to date, gross margins were impacted in part by expenses related to our reorganization, product sales mix changes at the product family level and increases in the price of gold. We estimate that gold related production costs increased approximately $2.4 million in the two quarters ended July 4, 2008 compared with the two quarters ended June 29, 2007.
We strive to improve gross margins from their present levels by emphasizing new high-margin products and cost saving opportunities in our manufacturing chain. We expect to realize savings from our restructuring initiatives late in 2009 and continue to make progress in our conversion from gold to copper wire in many of our high volume products.
Operating Costs, Expenses and Other Income
Research and Development (R&D)
R&D expenses consist primarily of salaries and costs of employees engaged in product/process research, design and development activities, as well as related subcontracting activities, prototype development, cost of design tools and technology license agreement expenses. R&D expenses increased $4.6 million or 13% to $38.6 million during the quarter ended July 4, 2008 from $34.1 million during the quarter ended June 29, 2007. In the two quarters ended July 4, 2008 R&D expenses increased $8.9 million, or 14%, to $73.8 million from $64.8 million during the two quarters ended June 29, 2007. Stock-based compensation expense recorded to R&D declined in both comparative periods, which was offset by strong hiring of new design engineers and related materials and supplies costs. In order to increase the number of new products introduced, we increased our engineering related spending including labor and material costs. The quarter ended July 4, 2008 included an additional week, resulting in approximately 5% increase in expenses over the same quarter last year.
Selling, General and Administrative (SG&A)
SG&A costs include primarily salary and incentive expenses of employees engaged in marketing and selling, as well as salaries and expenses required to perform our human resource, finance, legal and executive functions. SG&A costs increased by $2.9 million or 9% to $36.3 million during the quarter ended July 4, 2008 from $33.3 million during the quarter ended June 29, 2007. In the two quarters ended July 4, 2008, SG&A costs increased $0.4 million or 1% to $63.8 million from $63.4 million during the two quarters ended June 29, 2007. The increase for the quarter ended July 4, 2008 related primarily to increased labor and sales commissions to support the increase in sales. The increase for the two quarters ended July 4, 2008 over the comparable period related primarily to the increased labor and sales commissions substantially offset by a reduction in stock-based compensation expense as a result of the departure of our former chief executive officer. The quarter ended July 4, 2008 included an additional week, resulting in approximately 5% increase in expenses over the same quarter last year.
Amortization of Purchased Intangible Assets
Amortization of purchased intangible assets increased $0.7 million from the quarter ended June 29, 2007 to $3.1 million in the quarter ended July 4, 2008. The increase from the two quarters ended June 29, 2007 was $1.3 million to $6.0 million for the two quarters ended July 4, 2008. The increases resulted from two acquisitions made in September 2007. We expect amortization of current definite-lived intangible asset balances to decrease to $2.8 million in the third quarter of 2008 and remain at that level until the third quarter of fiscal 2009 when certain balances become fully amortized.
Many factors, including future market demand for our products, could cause impairment of our goodwill and purchased intangible asset balances. We test our goodwill for impairment at least annually, or more frequently if impairment indicators arise. During the fourth quarter of 2007, we determined that the value of each of our reporting units exceeded its book value and recorded no impairments of goodwill at that time.
During the quarter ended March 28, 2008, we initiated a restructuring plan to reorganize certain operations, consolidate internal manufacturing facilities and reduce workforce. We expect to complete the reorganization and consolidation within the next five quarters, with most of the workforce reductions taking place upon completion of the plan. During the two quarters ended July 4, 2008, we recorded costs of $4.9 million for employee severance and other facility consolidation costs, included in operating costs and expenses. We expect to incur an additional $5.0 million over the next five quarters. Upon completion of the restructuring, we expect to realize annual cost benefits between $4.0 million and $6.0 million with no impact to revenue.
Loss on certain investments
During the quarter ended March 28, 2008, we recorded an impairment charge of $6.4 million, before taxes, on certain auction rate securities whose decline in fair value was determined to be other-than-temporary. We continue to monitor our auction rate securities and intend to hold all of these investments until the anticipated recovery in market value occurs.
We maintain a portfolio of approximately $11.8 million of mutual fund investments under two qualified deferred employee compensation plans. We have an offsetting liability recorded for the investments. Changes in the fair value of the asset are recorded as a gain (loss) on investments and changes in the fair value of the liability are recorded as a component of compensation expense. During the quarter ended July 4, 2008, we recorded a gain on investments of $0.8 million and compensation expense of $0.6 million. For the two quarters ended July 4, 2008, we recorded loss on investments of $0.1 million and a reduction of compensation expense of $0.3 million.
Interest Income, net
Net interest income decreased to $4.1 million and $8.9 million during the quarter and two quarters ended July 4, 2008, respectively, from $8.2 million and $16.1 million during the quarter and two quarters ended June 29, 2007. This decrease is attributable to approximately $203 million decrease in average cash and investment balances and declining interest rates when compared to the same period last year.
Income tax expense from continuing operations for the two quarters ended July 4, 2008 included a $20 million reversal of a previously established unrecognized tax benefit (UTB) due to the expiration of the statute of limitations on the tax years 2002 and 2003. Excluding this benefit, the effective tax rate on income from continuing operations for the quarter and two quarters ended July 4, 2008 was 21.4% and 22.1%, compared with 23.9% and 21.7% for the quarter and two quarters ended June 29, 2007. The difference was due to lower tax rates on our growing international business. Our tax rate is expected to be approximately 23% in future quarters.
The statute of limitations for the 2002 and 2003 tax years each expired during the first quarter of our fiscal year 2008. Expiration for tax year 2002 was extended to December 31, 2007 by agreement with the Internal Revenue Service (IRS) and tax year 2003 was extended to December 31, 2007 by the IRS for relief from multiple hurricanes that affected our Florida operations in 2004.
In determining net income, we estimate and exercise judgment in the calculation of tax expense and tax liabilities and in assessing the recoverability of deferred tax assets that arise from temporary differences between the tax and financial statement recognition of assets and liabilities.
In the ordinary course of business, the ultimate tax outcome of many transactions and calculations is uncertain, as the calculation of tax liabilities involves the application of complex tax laws in the United States and other jurisdictions. We recognize liabilities for additional taxes that may be due on tax audit issues based on an estimate of the ultimate resolution of those issues. Although we believe the estimates are reasonable, the final outcome may be different than amounts we estimate. Such determinations could have a material impact on the income tax provision, effective tax rate and operating results in the period they occur. In addition, the effective tax rate reflected in our forward-looking statements is based on current enacted tax law. Significant changes in enacted tax law could materially affect our estimates.
Income from discontinued operations in the two quarters ended July 4, 2008 included a tax benefit of $19.4 million reversal of a previously established UTB due to the expiration of the statute of limitations on the tax years 2002 and 2003.
As of July 4, 2008, our 1999 Equity Compensation Plan (1999 Plan) includes several available forms of stock compensation. Only stock options and both deferred and restricted stock units have been granted to date. Additionally, we have issued options in exchange for outstanding stock options of acquired companies. The 2000 Employee Stock Purchase Plan (ESPP) allows eligible employees to purchase shares of our common stock. Shares issued upon exercise, release or sale under these arrangements are made from newly-issued stock.
Unrecognized Compensation Cost - The aggregate future charge for compensation costs relating to share-based compensation is approximately $69.5 million, pre-tax, as of July 4, 2008. That amount will be recorded as expense over the remaining vesting period of outstanding stock options and restricted stock as of July 4, 2008. The aggregate unrecognized compensation cost for share-based compensation was $77.7 million, pre-tax, as of June 29, 2007
Beginning in fiscal 2006, we awarded performance-based grants of share-based compensation. The grants consist of performance-based deferred stock units (PDSUs) that contain the usual service conditions but also have performance conditions relating generally to revenue and operating income measured against internal goals or peer groups.
We evaluate performance-based grants periodically to assess the likelihood of meeting the performance measures and estimate the number of shares likely to be issued when fully vested, including a factor for forfeitures. We adjust compensation and/or income tax expense accordingly in the period the assessment changes. These changes could be material to results of operations in any such period.
Accounting for Stock-Based Compensation - We use a lattice model to estimate the fair value of stock options, which is amortized as compensation cost over the life of the stock option. The lattice model uses historical exercise patterns to predict the life of stock options and estimates the future volatility of the underlying stock price, considering historical and implied volatility in its calculations.
Factors affecting future financial statement effect of share-based payment awards - Our use of share-based payment awards affects our current and future financial statements, including but not limited to:
increased or decreased grants of share-based payment awards will add to or reduce the unrecognized compensation cost to be recognized in future periods
re-assessments of the input variables to the fair value calculation may cause either a higher or lower total fair value to be recognized for future grants, and
re-assessment of the likelihood of achieving performance conditions might cause fluctuations in the recognition of compensation cost, which might be materially higher or lower than the original anticipated recognition schedule
Our sales are made pursuant to purchase orders that are generally booked up to six months in advance of delivery. Our standard terms and conditions of sale provide that these orders become non-cancelable and non-reschedulable thirty days prior to the most current customer request date (CRD) for standard products and ninety days prior to CRD for semi-custom and custom products. Backlog is influenced by several factors, including market demand, pricing and customer order patterns in reaction to product lead times. We had a six-month backlog as of July 4, 2008 of $190.7 million compared to December 28, 2007 of $176.4 million and $157.4 million as of June 29, 2007. Although not always the case, backlog can be a leading indicator of performance for approximately the next two quarters.
On July 23, 2008, we announced our outlook for the third quarter of 2008. Although our overall business remains strong, we remain cautious given the economic uncertainties of the global markets. At that time, we expected revenue growth of approximately 1% to 3% from the second quarter, given the strength of orders in the second quarter and our backlog entering the third quarter. Excluding the extra week in the second quarter, which accounted for approximately 5% sequential growth, we expected the business to be up 6% to 8% sequentially, which is in line with normal seasonality. We expected GAAP earnings per diluted share of approximately $0.31 to $0.33. The full announcement can be referenced in the press release that is an exhibit to a Current Report on Form 8-K filed by the Company on July 23, 2008.
Contractual Obligations and Off-Balance Sheet Arrangements
Our contractual obligations and off-balance sheet arrangements have not changed significantly from December 28, 2007. As of July 4, 2008, we had committed to purchase $23.6 million of inventory from suppliers.
The Planet ATE agreement contains a provision for payment of additional consideration to the former stockholders of that business. This additional consideration is a multiple of the net revenues of or attributed to Planet ATE during the period from October 1, 2007 to December 31, 2008 with a maximum additional payment of $12 million. We have not accrued any amount for additional consideration as of July 4, 2008.
Liquidity and Capital Resources
Our capital requirements depend on a variety of factors, including but not limited to, the rate of increase or decrease in our existing business base; the success, timing and amount of investment required to bring new products to market; revenue growth or decline; and potential acquisitions. We believe that we have the financial resources necessary to meet business requirements for the next 12 months, including capital expenditures for the expansion or upgrading of worldwide manufacturing capacity, working capital requirements, our dividend program, our stock repurchase program and potential future acquisitions or strategic investments. As of July 4, 2008, our total shareholdersâ equity was $2.2 billion. At that date, we had $340 million in cash and short-term investments, as well as $120 million in long-term investments. We have no debt outstanding.
Thanks Shamiqua. Good afternoon and thank you for joining us today for Intersilâs third quarter 2008 earnings conference call. Today with me is Dave Bell, Intersilâs President and Chief Executive Officer; and Dave Zinsner, Intersilâs Senior Vice President and Chief Financial Officer. In a few moments, they will deliver remarks on the third quarter of 2008 and provide a summary of our business outlook. After our prepared comments, we will open the line for questions.
We completed our third quarter on October 3, 2008. A press release was issued today at approximately 1.15 Pacific Time. A copy of the press release is available on the Investor Relations section of our Web site at www.intersil.com. In addition, this call is being webcast live over the Internet and may also be accessed via the Investor Relations section of our Web site. A replay of the conference call and webcast will be available for two weeks through November 5.
Please note that some comments made during this conference call may contain forward-looking statements. I would like to remind you that while these statements reflect our best current judgment, they are subject to risk and uncertainties that could cause our actual results to vary. These risk factors are discussed in detail in our filings with the Securities and Exchange Commission. In addition, during this call, we may refer to financial measures that are not prepared according to Generally Accepted Accounting Principles.
We use these non-GAAP measures because we believe they provide useful information about the performance of our business and should be considered by investors in conjunction with GAAP measures that we also provide. You can find a reconciliation of non-GAAP to comparable GAAP measures on the Investor Relations section of our Web site.
For those of you interested in learning more about Intersil at an upcoming investor event, we will be participating in the Credit Suisse Technology Conference on December 4 in Scottsdale, Arizona and Barclays Capital Technology Conference on December 11 in San Francisco, California.
I'll now turn the call over to Dave Bell.
Thanks Jonathan. Good afternoon and thank you for joining us today for Intersil's third quarter 2008 earnings conference call. Before we discuss the results for the third quarter, I'd like to make a few comments on our fourth quarter guidance.
For the fourth quarter, we are expecting revenue to be down 20% to 25% and our non-GAAP earnings per share of approximately $0.22 to $0.26. The current credit crisis along with the economic slowdown has caused many of our customers to become more cautious, diminishing our visibility, and making forecasting more difficult. We also remain very cautious given the economic uncertainties ahead. Our guidance is based on a detailed bottoms-up analysis with inputs from the sales force, management's judgment, and consideration of macroeconomic conditions.
As mentioned before, the global economic environment has severely diminished our visibility making it very challenging for us to forecast the near term. However, we continue to see the benefits of our business model. Intersil's balanced product portfolio, satellite strategy, and variable cost structure enable us to maintain profitability and positive cash flow during periods of economic slowdown. Despite their lower order rates, customers continue to show a strong interest in our products as evidenced by our growing design wins. Again, we believe the slowdown in orders reflects our customers' prudent caution going into an uncertain environment.
Now, letâs turn to the third quarter results. The third quarter was a record revenue quarter for Intersil. We achieved net revenues of $218.7 million, an increase of 10% over the same quarter last year, and grew our non-GAAP earnings by 22% over the same quarter last year. Intersil remains committed to returning cash to our shareholders. During the quarter, the company repurchased approximately $30 million or 1.3 million shares of our stock and also paid approximately $15 million in dividends.
As a result of our strong continued positive cash flow, the companyâs Board of Directors authorized and declared a quarterly dividend of $0.12 per share of common stock. At our current stock price, this is a dividend yield of over 4%. In addition to our financial achievements, we successfully completed two acquisitions, D2Audio in Austin, Texas and Kenet in Boston, Massachusetts. These two acquisitions broadened our product portfolio and leveraged new and innovative technologies to further penetrate both existing and unserved markets.
At this time, I'd like to turn the call over to Dave Zinsner who will provide a financial summary. I will then discuss results from each of our end markets and provide additional comments on our fourth quarter 2008 outlook. Dave?
Thanks. Let me begin with the income statement. As Dave stated, we reported $218.7 million in net revenue for the third quarter of 2008, a 10% increase from the same quarter last year, and an increase of 1% sequentially.
Our second quarter had 14 weeks instead of the normal 13. Normalized for the 13 weeks, revenue for the third quarter grew roughly 6% sequentially. As Dave mentioned, we are entering a period of uncertainty and many of our customers are being cautious with orders. As a result, we enter the fourth quarter with a lower backlog than last quarter.
Our guidance, which assumes a softer market, requires approximately 40% turns. As expected, gross margins were 56.3%, down 40 basis points from 56.7% in the second quarter due to product mix as computing grew to 36% of revenue. We anticipate gross margins will improve in the fourth quarter due to mix partially offset by some under-absorption.
In the third quarter, R&D expenses were $35.1 million or 16.1% of revenue, down $3.5 million from the prior quarter. This decrease was expected and is primarily due to one less week in the third quarter and lower incentive expenses.
Fourth quarter R&D spending should be approximately $2 million higher due to the acquisitions of Kenet and D2Audio. SG&A expenses were $31.8 million or 14.5% of sales, down $4.5 million from the second quarter, driven by one less week and lower incentive and deferred compensation expenses. Deferred compensation increases and decreases from this program are neutral to the P&L as they are offset by gains and losses on deferred compensation investments. We expect fourth quarter SG&A expenses to be approximately flat with the third quarter.
In-process R&D expenses was $100,000 during the quarter. This represents only the D2Audio transaction. In process R&D for the Kenet transaction, which we estimate will be approximately $5 million, will be recorded during the fourth quarter.
As previously discussed, we continue to execute on our major cost reduction and restructuring initiatives. We incurred $600,000 during the quarter as a result of these activities and expect approximately $1 million in the fourth quarter. We expect to realize approximately $6 million in annualized savings from these projects as they phase in during 2009.
We made improvements on our operating profits. Operating profits were $52.5 million or 24% of sales compared to 20.1% last quarter and 19.5 % in the same quarter last year.
Interest income was $3.1 million, down $1 million from the prior quarter as interest rates were lower this quarter. We expect interest income to be slightly lower in the fourth quarter. Our cash is invested primarily in high quality investments to maintain principal, which currently have a relatively low yield. Our tax rate for the third quarter was approximately 7% due to the R&D tax credit benefit that was reenacted by Congress on the last day of our quarter and a one-time tax reserve release recognizing the closure of a previous audit year.
For the fourth quarter, we expect our tax rate to be approximately 25% which includes the ongoing benefit of the R&D tax credit and the impact of Kenetâs non-deductible in-process R&D expenses. During the quarter, we continue to grow our earnings faster than revenues. Diluted earnings per share was $0.41 up 52% from the same quarter last year and non-GAAP diluted earnings per share of $0.44 grew 22% from the same quarter last year.
Now moving to the balance sheet. On an absolute dollar basis, net inventory increased by $11.7 million from the second quarter and our days of inventory increased to 106 days. Inventory at distribution was up moderately from the second quarter as we replenished historically weak inventory in the computing business. Looking ahead, we are taking steps to decrease inventory both on our books and at distribution and bring turns in line with the historical levels.
Days sales outstanding was 52 days, essentially flat with the prior quarter. Depreciation was $5.6 million and capital spending was $8.7 million. We expect CapEx to be approximately $4 million to $5 million in Q4 as we scale to revenue in return to a more normal spending for our fab like model. The increase of goodwill of $25.6 million was driven by our acquisitions.
For the third quarter, we generated $30.3 million in free cash flow and exited the quarter with approximately $408 million in cash and long-term investments and no debt. As Dave stated, we repurchased approximately $30 million or 1.3 million shares of our stock and paid out approximately $15 million in dividends in the third quarter. Our weighted average share count was relatively flat to the second quarter. For the upcoming quarter, we expect weighted average shares to be approximately flat with this quarter.
Last week, the company closed a $75 million revolving credit agreement with Bank of America acting as the agent. Securing the revolving credit enhances Intersil's ability to continue to strategically invest in our business, and given the current environment of the credit market, highlights how banks view the solid cash flow of our business model.
Now, I'll turn the call to Dave Bell who will provide highlights into each of our foreign markets.
Thanks, Dave. As Dave mentioned, Iâll now address our business in each of our foreign market categories beginning with high-end consumer. Revenue in the high-end consumer market represented approximately 25% of third quarter revenue. On an absolute dollar basis, revenues in the high-end consumer market decreased 1% year-over-year and increased 7% sequentially. The sequential growth is due to seasonal strength in handhelds and growth in gaming and Ambient light sensor products.
The third quarter was a highlight for the area of gaming. We saw impressive sequential growth in shipments of our DC-to-DC controller used in game consoles. We're optimistic that we will be able to expand our footprint in this segment over time.
During the third quarter, we continued to see exceptional growth with our Ambient light sensor product family. Revenue ramped quickly as we continued building design win momentum with multiple Tier 1 customers. As anticipated, our optical storage business continued to decline with the slow adoption of Blu-Ray. However, we expect the business to begin its recovery in 2009 based on new Blu-Ray opportunities. In summary, with the uncertainty in consumer spending, we expect the consumer-end market will be down significantly in the fourth quarter.
Now letâs look at our computing business. Revenue in the computing market represented approximately 36% of third quarter revenue. On an absolute dollar basis, revenues into the computing market increased an impressive 39% year-over-year and increased 11% sequentially. We achieved record shipments in revenue in the third quarter and enjoyed solid demand for our full portfolio computing power management solutions. We saw particular strength from our VCORE and battery charging solutions for both Intel and AMD notebooks. We continue to win with our VCORE power solutions for the Montevina notebook platform. During the quarter, we maintained our position as market share leader in both Intel and AMD-based notebook platforms and we recorded numerous design wins for the Montevina refreshed platforms.
The rampant sales of Atom-based notebooks and laptops drove increased demand for low-power variants of our highly efficient notebook and desktop VCORE power solutions. These variants are optimized for NetX platforms which will help drive sales of chargers and additional power content.
As anticipated, we have seen our share in the desktop segment begin to recede. However, given the fierce competitive environment, weâve been pleased with the level of design wins and design inactivities for our Intel VR 11.1 and AMD AM2+ VCORE solutions. Of particular note is strong interest in our designs that deliver industry-leading power efficiency. We continue to develop innovative solutions for desktops and servers and believe that our technical leadership in notebooks uniquely positions Intersil to participate in the greening of the PC.
Looking ahead to Q4, we expect our revenue in the computing market to be down strongly due to the current macroeconomic conditions and our actions to maintain inventory at healthy levels.
Moving now to the industrial market, revenue in the industrial market represented approximately 19% of second quarter revenue. On absolute dollar basis, revenue into the industrial market decreased 12% year-over-year and decreased 12% sequentially. This year-over-year and sequential decline is mainly driven by uneven timing for military programs.
In the third quarter, we designed in two new video drivers in our projectors. These video drivers enable significant reduction of board space and total component cost and are ideal for systems such as projectors and video conferencing equipment. We anticipate revenue to grow nicely for these two products through the remainder of 2008 and into 2009.
During the quarter, we delivered samples of our first micro-powered chopper stabilized amplifier. This amplifier offers best in class performance with superior speed, noise, and power consumption relative to our competition and is used in a wide range of industrial applications, factory automation, and medical markets.
Looking ahead to Q4, we expect the industrial market segment to be up slightly. We expect the industrial segment would grow steadily in 2009 as many design wins continue their momentum and recent design wins are slated to go into production.
And finally, moving to the communications market, revenue in the communications market represented approximately 20% of second quarter revenue. On an absolute dollar basis, revenues into the communications market increased 10% year-over-year and decreased 8% sequentially. The sequential decline was driven by lower spending for DSL in Asia and Europe.
During the quarter, we started shipment of our first generation LNB power controller for satellite TV receivers. This highly efficient, integrated controller is compliant with green energy standards and offers significant cost advantages over the currently available discrete solutions. We continue to expand our family of highly integrated, efficient, single-phase controllers with the release of a single-phase, non-synchronous buck controller. The controller features an ultrawide operating input voltage range providing maximum efficiency and flexibility for a variety of telecom and industrial applications.
We continued experiencing strong sales and high reliability space as numerous communication satellite programs in both Europe and Asia grew. Looking ahead to the fourth quarter, we expect the communications market to be down moderately from the third quarter.
Before we open it up for questions, I would like to summarize with these key points. The global economic downturn is discouraging to all of us and has created a great deal of uncertainty in the markets we serve. However, one thing has not changed. We remain absolutely confident about Intersil's strategy and we will remain focused on executing that strategy this quarter and in the quarters to come.
We continue to invest in highly differentiated new products and design win momentum is building because of these investments. We also continue to focus on driving cost reduction programs that will contribute to steady improvements in gross margins and operating profits.
Even though the economic conditions are discouraging, they actually create an opportunity for Intersil. As Warren Buffet recently said, bad news is an investor's best friend. It lets you buy a slice of America's future at a marked down price. We have clearly taken advantage of this fact during the last quarter with two various strategic acquisitions; D2Audio and Kenet.
D2Audio is recognized as the leader in intelligent Class D audio amplifiers. These amplifiers accept digital audio inputs, provide audio enhancement with a built-in DSP, and eliminate the sound quality tradeoffs usually associated with Class D amplifiers. Our entire sales organization is excited about these new design win opportunities this powerful technology is already bringing to Intersil.
Kenet is the world leader in very low power, high speed analog-to-digital converters. These ADCs consume three to five times less power than competing products and open a host of new applications in the industrial and communications markets.
As with D2Audio, Intersil's sales organization is already finding many new opportunities to sell this new product family. And as an ancillary benefit, these acquisitions have also given Intersil new designing centers and two analog rich communities; Austin, Texas and Boston, Massachusetts.
We will continue to grow Intersil both organically and through strategic acquisitions like D2Audio and Kenet. We continue to evaluate many acquisition candidates and plan to exploit the unusual opportunities created by our strong balance sheet and the present economic conditions.
During the last quarter, we also announced a top level reorganization in which two product groups were created; a power management products group and an analog mixed signal products group. We believe that this new organization will make us even more agile and will support Intersil's growth well beyond $1 billion in sales.
Despite the present downturn, Intersil's executive leadership is absolutely convinced that our recent re-organization, our cost control programs, our highly differentiated new products, and our strategic acquisitions position Intersil to continue outgrowing our competition in the years to come. The patient investor will be rewarded when Intersil emerges from the present downturn, a much stronger and more profitable company.
With that, I would now like to open the call to questions for either Dave Zinsner or myself.