輝達 (NVDA) 2005 Q2 法說會逐字稿

Welcome to the PortalPlayer, Inc. second quarter 2005 earnings conference call. Today's call is being recorded and will be available for playback beginning one hour after the completion of the call. To access the replay, please dial 719-457-0820 with the passcode 6446864. At this time for opening remarks and introductions, I would like to turn the call over to Kristine Mozes, Investor Relations for PortalPlayer. Please go ahead.

Thank you, and thank you for joining us today. In addition to this call being available by phone replay, it is being broadcast live via the investor relations page of PortalPlayer's website at www.portalplayer.com. Earlier today, we issued our earnings press release and filed it with the SEC. The press release is also available on PortalPlayer's website. That press release contains certain non-GAAP financial measures which we will discuss during today's call together with the most directly comparable financial measures calculated in accordance with GAAP in reconciliations of the differences between these measures.

With me today is Gary Johnson, President and CEO of PortalPlayer, and Olav Carlsen, PortalPlayer's Chief Financial Officer.

I will begin this call by reading our safe harbor statement. The statements on today's call, which are not historical facts, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act. e forward-looking statements include, but are not limited to, statements as to our future plans and growth, development efforts, features, benefits and introductions of products and technology, our plans to hire additional resources, our plans with respect to our facility in Hyderabad, India, and our and our customers' market position, our revenue growth, including revenue from the flash market and timing thereof, market trends and demand for high-capacity players and anticipated growth of this market, demand for our products and future financial results, GAAP and non-GAAP including revenue, net income, expenses, gross margins, ASPs, stock based compensation charges, tax rates, cash flow, weighted average shares outstanding, and operating expenses, including, but now limited to, future R&D spending and selling, general and administrative expenses. These forward-looking statements are subject to a number of risks and uncertainties that could cause actual results to differ materially from those discussed in these forward-looking statements. Please refer to today's earnings release, our Form 10-K for the year ended December 31, 2004, and our Form 10-Q for the quarter ended March 31, 2005, as filed with the SEC and from time to time in our other SEC reports for information on risk factors that could cause actual results to differ materially from those discussed in these forward-looking statements. These forward-looking statements speak only as of the date hereof. PortalPlayer disclaims any intent or obligation to update these forward-looking statements. Additionally, this conference call is the property of PortalPlayer and may not be recorded or rebroadcast without specific written permission from the Company.

Now I'd like to turn the call over to Gary for his introductory remarks. Gary?

Thank you and welcome everyone. As you can see from our press release, Q2 was another great quarter for PortalPlayer. We successfully executed on our product roadmap and business plan and demand for personal media players that incorporate our technology was again stronger than seasonal trends this quarter. Second quarter revenue came in line with our guidance. It nearly quadrupled from the second quarter a year ago and was slightly higher than the strong revenue recorded in Q1. o in Q1 and Q2, quarters in which the consumer electronics industry typically sees sequential revenue dip, we did not experience these declines, but rather continued to see very strong demand. We again added more than $13 million to our cash position, which has increased now to more than $150 million. Our earnings per share came in at the highest point of our guidance range. We are very proud of what we achieved this past quarter. In summary, all our financial metrics were in line with or better than our guidance. Olav will give you more details in a minute.

So what were our major initiatives in Q2? We focused a lot of our attention on our operational execution. During the quarter, we successfully and quickly ran production of our new PP5022 device. In fact, as of today, we have already shipped more than 6 million units of this device. We have completed the design activity for our customer's exciting new models that are expected to launch in the second half of this year. In addition, we worked with our supply chain to prepare operations for significant demand in the second half of the year. And finally, we accelerated our investment in innovative wireless technologies that we believe will help fuel our growth in 2006 and beyond.

In a few minutes, I'll go into more detail about each of these initiatives but first I'd like to take a minute to thank Tom Spiegel for his dedication and support as a member of the board of directors as we have successfully transitioned from a startup to a public company. With this call, we are announcing that Tom has resigned from the board and on behalf of the board, I would like to thank Tom for his energy and involvement over the past three and a half years and wish him great success as he turns his attention to new endeavors. Thank you, Tom.

Now I will turn the call over to Olav who will take you through the details of our second quarter financials.

Thank you, Gary, and welcome everyone. The second quarter of 2005 was again a quarter of very significant year-over-year growth. We are very pleased to report that net revenue for this quarter was $44.6 million, which is about a 270% increase from the $12 million in the same period a year ago, and slightly higher than the revenue of $44.5 million we recorded in the first quarter of 2005. As Gary just mentioned, the second quarter of any given year is typically the weakest for the consumer electronics market so we're very pleased that the overall demand for products that utilize our technology continue to be so strong.

To give you a little more color, we did see some seasonality with our business outside of our largest customer, as well as market share shifts in favor of our largest customer. As a result, revenue from our other customers declined slightly, 8% of our overall revenue, while revenue from our largest customer increased. And as a reminder, in the second quarter, all of our revenue came from shipments for hard drive based personal media players. We began shipping our new 5022 system- on-chip in volume during Q1 and demand for that product has proven to be very strong. Revenue from the 5022 in Q2 accounted now for a majority of our total revenue and as Gary mentioned earlier, as of today, we've shipped more than 6 million units of this device. So as you can see, this new product has really been a great success within the marketplace and we've executed flawlessly in ramping production.

Net income for the second quarter was $6.3 million compared with a net loss of $880,000 in the same period a year ago. This second quarter 2005 net income resulted in the income of $0.25 per diluted share based on 25.1 million weighted average shares outstanding compared to the loss of $0.64 per share based on approximately 1.4 million basic weighted average shares outstanding in the same quarter a year ago. And the significant difference in the share count between these two quarters is of course due to the fact that in the second quarter of 04, we were still a private company. Net income in the first quarter of '05 was $7.8 million, or $0.31 per diluted share based on 25 million weighted average shares.

I would note here that we have made some changes in our employee stock incentive program. In the second quarter, we decided to move to a mix of options end restricted shares to all employees, thereby reducing the overall number of instruments that are issued. So for the second quarter, for the first time we incurred charges for the expensing of these restricted shares that vest over a longer period, now five years. I'll give you more details in a minute.

And as a reminder on the tax side, for federal tax purposes, we're still carrying forward approximately $6 million of freely available net operating losses for this tax year. Based on our current strong financial performance and our business outlook for the remainder of '05, as well as the fact that we are quickly using up most of our NOLs,we began to provide for tax liabilities this year. As we said last quarter, using an effective tax rate of 25%, and this remains unchanged.

Now excluding noncash stock compensation charges of $470,000 non-GAAP net income for this second quarter of '05 was $6.8 million or $0.27 per diluted share, compared with a non-GAAP net income in the second quarter of 04 of approximately $780,000 or $0.5 per diluted share. Non-GAAP net income for the first quarter of 05 $8.2 million or $0.33 per diluted share. In our earnings release, we provided a detailed reconciliation between GAAP numbers and the non-GAAP numbers which details the stock compensation charges for each quarter.

Now let me discuss some information on this quarter's P&L and then I will move on to the balance sheet. The second quarter was again a great success on all accounts. Our gross margin for the second quarter was 43% and this is well within our long-term model of 41 to 44% and is about the same as in the first quarter of '05. As we've said in the past, we expect ASPs to decrease in the 20 to 25% range year-over-year on a single SKU basis and expect a blended portfolio ASP to decrease by only 10 to 15% year-over-year as we're able to achieve higher prices on our newer products. In Q2, our portfolio ASPs decreased by only 9% year-over-year due to the continued strength of our new products. Operating expenses were about $11.4 million for R&D and SG&A in the second quarter, a $2.1million increase from the previous quarter, exactly what we planned and guided to.

So let me break this down for you. The majority of the additional spending, about $1.5 million, was allocated to our R&D activities which came in at $7.9 million. As expected, our acceleration of some of our important R&D milestones result in additional NRE expenses in Q2, but more importantly, we were also able to fill some of our staff openings, especially in the strategic R&D area, here in the U.S. and in our subsidiary in India. Going forward, we expect to continue to manage our R&D spending to about 70% of our revenue as we make continuous investments in people and technology to support a very competitive roadmap. Accordingly, we expect R&D in the next quarter to be about $9.3 million.

SG&A expenses in the second quarter were $3.5 million, which is a $540,000 increase from the previous quarter. This increase is mostly driven by additional costs associated with our Sarbanes-Oxley compliance. For the third quarter of 2005, we expect SG&A to increase by about $400,000. Our noncash compensation charge included, as always, elements of amortization of deferred compensation and some variable charges, and for the first time, a charge for amortizing the expense of restricted share grants that I mentioned earlier. We booked $100,000 charge for this. Going forward, we expect our noncash stock compensation charges to be approximately $520,000 in the third quarter of fiscal '05. However, this stock compensation charge will again include a small variable element based on our ending stock price and therefore the exact amount is hard to predict.

So now let's turn to the balance sheet. Our accounts receivable were 25.2 million and our inventory balance as of June 30 was at $1.1 million, all of which is finished goods. Now this balance is quite low. It represents only about three to four days of inventory which is certainly below our targeted goal of thirty days. The explanation for this is in our deferred revenue for this quarter. Demand at the very end of the calendar quarter was stronger then we initially expected and so we responded to that. These shipments late in the calendar quarter are not included in our second quarter revenue in accordance with our revenue recognition policy with which I think you are very familiar by now. Rather, these shipments were deferred. Our deferred income position on the balance sheet representing the gross margin for those shipments increased from 4 to over $5 million at the end of Q2. So we ended the quarter with very positive momentum and we're now increasing our inventory back to a more normalized level as we prepare for a significant ramp in demand.

We generated a quarterly positive cash flow from operations in the second quarter, more than $30 million. This is taking into account a $4 million tax payment we made this quarter. So our cash and short-term investments increased another 10% to be more than $150 million at the end of the second quarter.

Headcount at the end of the quarter was about 228. We added 34 employees during the second quarter, more than 80% of them in R&D. At the end of the quarter, more than three-quarters of our overall headcount was focused on our current or strategic R&D activities and again, about half of our overall headcount was based in Hyderabad, India.

We recently moved into our new, more cost effective office in a much larger location in San Jose that offers us a more integrated space in which to expand. In addition, we recently purchased real estate in Hyderabad, India, close to the new planed international airport, where we expect to complete the construction of a new building in the second half of 2006 to support our planned growth in the coming years.

We're excited about the back-to-school and holiday seasons and believe we're very well positioned for significant growth in the second half of the year. We believe that our revenue for the third quarter will be in the range of $50 million to $60 million. And we recognize that this is a slightly broader range than what you're used to see from us and let me explain why. We expect September to be extraordinary strong month. Let me remind you of our conservative revenue recognition policy that has us cutting off GAAP revenue about three weeks before the end of the month, so relatively early in September. Accordingly, the exact timing of shipments within the month of September decides what we recognize as revenue for the third quarter and what will be deferred at the end of September.

Operating expenses are expected to be approximately $13.2 million and we expect our stock based compensation charges to be about $520,000 and GAAP net income per diluted share to be between $0.28 and $0.36, based on approximately 26 million weighted average shares outstanding. Non-GAAP net income per diluted share, excluding our compensation charges, is expected to be between $0.30 and $0.38. At this time, I would like to turn the call back over to Gary for his comments.

Thank you, Olav. As you see from a financial standpoint, the second quarter was a great success. It was also a tremendous success from an operational standpoint as well. Our entire PortalPlayer team has continued to execute impeccably on our business plan and product roadmap in supporting our world-class customers. This past quarter we focused on seamlessly and successfully ramping the production of our new 5022 device and transitioning from our 5022 device to this new one. As I said earlier, we reached a significant milestone of shipping more than 6 million 5022 devices to date. With the strength and support of our world-class partners, UMC and Edified Logic, ramping production on .13 microprocess was fast and seamless. In fact, it only took about three months for us to achieve full volume production. We believe this is a great testament to speed and flexibility of our operating model. The move to .13 microprocess was an additional factor that allowed us to reduce the chip power consumption, resulting in significantly improved battery life. With the 5022, we have also successfully developed a unified storage platform, or USP, that works seamlessly and interchangeably with both hard drive and flash storage media.

In doing so, we offer our customers more flexibility in designing and producing the new product models. With our 5022 device, customers have the option to choose the other system components they want to use in their designs or for those who want to go with a fully integrated approach, they can choose to use our 5024 device. In falling on that same trend, we expect our current and future platforms that support video capabilities will also offer our customers the flexibility to choose our natively supported video or choose a higher performance external video code process using, for example, our CSI interface.

In Q2, we also focused our operational efforts on planning for the second half of this year. We have been working closely with our supply chain partners to secure the additional capacity and testers needed to meet the significant increase in demand that is expected. We believe we enter the second half of the year well-positioned to handle the significant forecasted ramp in demand.

The last operational milestone I'd like to mention is that in Q2, we take the next generation of our technology in preparation for the 2006 product cycle. In the consumer electronics industry, which is very competitive and fast-paced, it is critical that we remain on the forefront of technology and innovation and that we achieve our billables on time. I am very proud of the entire PortalPlayer team for executing crisply on this front. We not only met all our production goals but in some cases, we even exceeded them. At the same time, we continue to build our power mode chip design team to broaden our product offering and accelerate our roadmap.

Now let's take a look at design wins. At this point in the year, the vast majority of design wins for personal media players that are planned to be introduced in 2005 are already locked in. I will not break out the number of design wins by customers' names but I will say that we are extremely satisfied with our wins. In particular, we're delighted with our success of flash based designs. Based on the design wins, we expect to see a significant portion of our revenue coming from the flash market beginning in the third quarter. On our last quarter's earnings calls, we told you that the high-capacity flash player market could exceed 20% of the total flash player volume run rate by the end of 2005. Well, due to non-flash price declines, we believe that market demand for high-capacity flash players has accelerated and could now exceed 20% of the total flash run rate sometime before the end of 2005.

Now let's look at some of the factors that are driving the use of content in high-capacity feature rich personal media players. First is subscription services. We believe that subscription services will fuel demand for high-capacity players since consumers can pay a monthly flat fee to have instant access to thousands of songs on a personal media player without buying each song individually. Yahoo has recently introduced a very low-cost distribution model that may prove attractive to consumers and Microsoft technology allows both a subscription model and a download model, which could help drive interest in the marketplace.

The second driver is podcasting. With Apple's launch of iTunes 4.9, which integrates podcasting into iTunes, this pushed what was previously a niche functionality into the mainstream. Within two days of the launch, customers subscribed to more than 1 million podcasts. With the content people store on their personal media players expanding beyond just music, they're going to need higher capacity products to store and manage that content.

The third key driver is streaming broadcast services, such as satellite radio. We believe that these new types of services, which can offer consumers time shifted radio content on their personal media players so they can play back whenever or wherever they want, will show good growth.

And the last driver is time shifted video. The best example of this today is the TiVo DVR. We are now seeing personal media players with 60 or even 80 gigabytes of storage, which is about the same as a personal DVR today. With this level of storage, consumers can use their personal media player to store movies, TV shows, music videos and more. Though this market is small today, we believe that continued innovation will continue in this space.

All of these trends point towards high-capacity players and the need for a powerful solution that can manage the content, catalog the data and provide a robust and snappy user experience. This is exactly where we excel.

In the second quarter, we also dedicated much of our time and effort in furthering our product development and innovation. We believe the devices in the near future will need to be constantly connected. And as such, we have accelerated our investment in a range of wireless technologies. The MP3 phenomenon has clearly entered the cell phone market. As happens with most technologies, it will take a couple of iterations to hit the market's sweet spot. The cell phones that are coming out this year are limited in battery life, cannot incorporate as many songs as a stand-alone player, and are inhibited by music distribution and content protection limitations. We think the next wave has to overcome these limitations and should be driven by and targeted to specific lifestyle type devices. We believe that these unified devices represent an exciting market opportunity down the road and we are making the appropriate investments in this area today.

In summary, we're having great success with our current customer base. Our 5022 and 5024 devices significantly raise the bar of technology offerings. We are excited about the momentum that is building for the second half of the year for both existing and new customers and we continue to invest in future technologies. We're happy to now open up the call to take your questions about our business but I do want to remind everyone that it is our policy not to comment on specific customers, products or roadmaps. Operator, we are ready for questions.

[ OPERATOR INSTRUCTIONS ] And we'll go first to Randy Abrams, Credit Suisse First Boston.

Good afternoon, guys. First question. Wanted to see if you could help us understand the guidance range a little more. How much do have factored in from the new products? How much from the flash market versus traditional hard drive products?

Hi, Randy. I don't think I can give you the data. So we don't break out how we arrive at our revenue guidance. We've given a 50 to $60 million range, a little broader than what you saw last quarter, because we see a very active shipping month in September. And our revenue recognition policy cuts revenue off pretty early in September. So between deferred revenue and recognized revenue, a change of a few days of actual ship dates could make a difference there between recognized and deferred, but breaking it out in terms of flash or hard drive is nothing that I want to go into right now.

Okay, maybe take it more on a market level. You were talking about more than 20% of the flash run rate by year end for high end flash. Could you talk about what type of run rate you see for the overall flash market and what kind of expectations are you expecting for the hard drive market?

Hi, Randy, it's Gary. Overall, we still see both segments being very robust. Reflecting back on some of the Gardner (?) forecasts for this year, as you're probably aware, they're forecasting 28 million units hard drive forecast this year, flash 46 million this year, with hard drive going over 50%. And they forecast flash growing only about 35%. We think the flash market in itself is continuing to accelerate so that is, we think, still going to experience robust growth there. I think, bottom line, is we're seeing the decreasing demand price is allowing this high-capacity segment to really become viable and we're excited to see growth from high-capacity hard drives, mid range hard drive and in the high end flash.

Okay, and then for average selling prices, want to see if you could maybe walk through an approximate way to look at the new flash product, how it fares relative to the hard drive product? And then also, how does it split out between yourselves & Ostro and Microsystems? Would you split that ASP?

So the ASP is for both segments are similar. And I can't break out the AMS between us and AMS. I can tell you that the AMS ship is building .35 micron process. It's a very mature process and it's certainly not an expensive process. So I hope that answers a little bit of your question.

Okay. Just to clarify, you'll get the same ASP for both flash and hard drive and then Oscar would be incremental above that for them?

That's probably a way to look at it, yes. Randy, just to clarify. Remember that both of those products are incorporated in a system and package, so the resulting ASP for the system and package is the ASP comparisons we're referring to. I wouldn't want you to add on top of that the Austriamicrosystem cost. We as an ASP supplier to our customers integrate their dye and we're a one-stop shop to our customers and we give them one integrated ASP point.

Okay, and just a final question. Looks like gross margins held up around 43% toward the higher end. Is that something we should expect to continue in that range? And what are kind of the big swing factors you see over the next quarter or two on the gross margin side?

I think we're very comfortable with the model. I think it was nice to be at the high end of that 41 to 44% model that we referred to. The secret here, of course, is innovation. If you keep the innovation going and add new features, you can increase the selling price to your customers. So frankly, that's what we focus on is integration, generation and of course, keep our operations teams working. So we don't see a change, fundamental change, in that model at this point of 41 to 44%.

Okay, thanks a lot guys.

We'll go next to Glen Yeung, Smith Barney.

Hi, this is Jim for Glen. On the gross margin, a quick follow-up. Was there any benefit from previously written off inventory?

Yes, there's always of a little bit of that in every quarter, Jim. It was less than a percent again, like comparable to last quarter. These are mostly products that we're shipping to replace some of the earlier product with some of our customers.

Okay and then finally looking out into seasonality. You mentioned strength in September. Any outlook that we can expect going into Q4 for linearity for the quarter?

We don't give guidance that far out at this point. We're keeping our comments directly tied to Q3. We have clearly given color what we think the second half is clearly going to be a very strong half for us, but sorry, we have not broken out specific Q4 guidance at this point.

Okay, this quarter Q3 will be back end-loaded towards September, is that correct?

September is very active shipping month for us. Yes.

We will go next to Shawn Slayton, SG Cowen.

Good afternoon. Nice execution, nice guidance. Gary, can you help us understand what's happening in your estimation on the non iPod side of the business? Why is that, on a percentage basis, why is that business shrinking for you here, at least in the very near-term? Is it a function of the hardware, user interface, form factor or does it have something to do on the content side of things, the online content side of things?

Both.

Actually I think the major contributor is is neither of those. I think the major contributor, though those two are important, is frankly just the seasonality of the consumer cycle. Remember that Q2 is traditionally the weakest quarter for this segment and I think with the factors you just indicated, I think frankly it was a sluggish quarter.

Why would you have different seasonality when your largest customer and the customers that you have away from your largest customer?

Well, I think that is where it then kicks into the point you mentioned, the acceleration and ease of use of the very large customers we have of that product in the market is continuing to, as you said, get very strong response in the market. The ease of use, the integration into the services, as you mentioned, I think is very key. So I think we're seeing continued both response to the quality of the products that are out there in the market and also the great branding that goes with those leadership products.

Okay. On the R&D side, you're clearly adding headcount. Can you help us understand -- help us understand where you're adding heads and maybe on the SoC information side of things. Are you guys -- do you have any strategy in place to take in-house some of the services currently being offered to you by your factory partners? Your fab partners or third parties?

Let me address the R&D headcount in general. First of all, we continue to hire smart people across the board, so it's both in the Silicon engineering and architecture and software and in firmware and we're finding great folks both here in the U.S. and India. So I wouldn't specifically point out a particular area where we're adding heads, and aiming to now produce we have parallel development teams. We have so many ideas that we can execute. Some of your question from key customers are actually building out parallel development teams. Just over a year ago, we probably had one key engineering team running here. With respect to a transition of bringing more manufacturing capability in-house, as you know, we look at that on each chip generation to generation and we are slowly stepping up some of that expertise, but we have not particularly accelerated our efforts. We are looking at that on a case by case basis.

Okay, fair enough. My last question here and I'll yield the floor. So this quarter you guys are expecting direct revenue from 5024. This quarter, are flash player chips sales going to contribute to greater customer diversity? That's all I have.

Repeat the question on diversity.

This quarter, are your flash player IC sales going to contribute to greater customer diversity?

We not going to break out specifics of where our products go to. As you know, that's per our policy. As we look at the strength of our flash player solution, as we targeted that high-performance slot, what I will say is we have interest across the board, from both major customers that you would be used to and also customers that would not be our traditional customer base. So we plan on exploiting both of those.

So if I understand you correctly, you will recognize flash player IC revenue from what we call, meaningful flash player IC revenue, from more than one customer this quarter, Gary?

We haven't broken the number of customers just because we don't want to get into a constant reporting of --

Not a number. Just more than one.

Yes.

Okay, thanks guys.

We'll go next to Quinn Bolton, Needham and Company.

Just a clarification on that flash. I think you mentioned that you would see significant contribution from the 5024 in the third quarter. I'm just wondering is that, you guys typically define significant as, say, 10% of revenues. Is there any kind of number you can put behind that? And then I have a couple of follow ups. Thanks.

You know, you asked the same question a quarter ago and I think I said significant means between 10 and 90. So I don't want to be repetitive. I think significant is a good number and it's certainly more than 10. Let me be a little more specific this quarter. Sorry I can't be more specific.

More than 10 is fine. And then one for Gary. You talked about your next generation device that just came out. I know you guys haven't formally introduced the platform, but you've talked in the past about being able to support video coprocessors through your existing solutions. I'm kind of wondering, does this next generation chip sort of remove the need for a video coprocessor? Can you talk about whether you can support MPEG4, H.T64 video codex with the platform that you plan to release for 2006.

After the fact, the base platform versus tipping off the competition to tomorrow's platform. So on today's platform, we natively support video on the 5022. So we should not necessarily assume that we have to always use a video coprocessor. From time to time, our customers, from time to market, we'll partner our chip out to different networking solutions, different video solutions, and so we have many support for video today and the 5022 generation. On the next generation, for competitive reasons I don't particularly want to tip our hat there, but I think it's fair to say, I think you know we push the envelope on introducing new features that we believe will bring innovation to the market and that will certainly continue along those same trends.

It sounded like you have come up with the scheme for the 5024, where you add the analog support chip in a system and package devices. Can you talk about whether, it looks like you're planning to do the same thing with next year's platform, to offer that flexibility to the customer base?

Again, I don't want to pre-announce our products. In general, the two axis, of course, you work on is actually cost and integration and power and performance. And so I think the combination of those four elements that we're constantly working on, so we intend to move quickly. I think but the tapeout this time of year points very well to us getting the timing and sequence right for the 2006 product introduction cycle. In this space, you really do have to get a line correctly to really hit very cleanly the very large customers' product production cycle so that's why that tapeout in Q2 is very critical to us.

Okay, and then just lastly, it looks like the 5022 is now the majority of the hard drive revenues. Can you say when you expect the 5020 to phase out of the revenue stream?

I thank it will phase out of the revenue stream by the end of this year.

Okay, thank you.

We go next to Jason Pflaum with Thomas Weisel Partners.

Yes, good afternoon. To start out, looking again at your guidance and your commentary on the flash market, or the flash segment being a significant portion of your revenue. Is if it isn't greater than 10% or so, it would seem to imply that your hard drive business would only be up modestly. Is this more out of conservatism or are we seeing other dynamics at play?

You know, the guidance, Jason, 50 to 60 is certainly a wide range. I don't thank you can read any kind of conservativism into this right now. We're looking at [inaudible] right now. It's still beyond September at this time. It's hard to actually answer that question without going into detail of what we see in the breakout flash versus hard drive so I can't really comment any further than that.

Okay and maybe just thinking about the end of the quarter. It seems to be somewhat back end loaded yet exiting the June quarter, you saw some good strength. Has that strenth continued into July?

It was a very busy couple of days at the end of the quarter. July is not the busiest of all months. So I can say that. July was as expected, I guess. August is going to be stronger than July and then September is really ramping up in terms of shipments.

Okay, and then I know you kept making comments regarding your inventory levels, they're running a little bit below normalized levels. Are you comfortable with your ability or flexibility to hit any upside demand that may come your way throughout the quarter? In other words, if you could help us understand, are some of your logistics' partners sitting on a lot of finished goods right now?

Yes, how flexible can we respond to upside. What we did in the end of the quarter is actually proof of how flexible we are. We saw some upside and we responded to it in a very flexible way. We're building inventory levels back up to a normal level, a more normalized level, finding that all the target models, 30 days. It's relatively, certainly not an overbid. I agree with that. So in summary, it's a snapshot in time. We respond to some upside with flexibility and I'm very positive that we can continue to respond to some additional upside if it came in the future with the same flexibility.

Jason, one thing that is beneficial of us with the [inaudible] we had in the 5022. We had already hitting the volumes we're hitting -- place at a longer cycle but necessary orders to our supply partners. Once you have a proven part that's shipped as many units as the 5022, you can actually then start working with your supply chain in a much more predictable manner. So when I look at the second half, I think we've planned very well to make sure that we have the necessary flexibility to be able to execute on a very strong plans for the second half.

Okay, that's helpful. Last question, just on the handset opportunity. When do you expect the earliest chance to start recognizing some revenue there?

Again, we haven't pinpointed that down at this point for externally. The pointers we would point toward would be 2006.

Okay, fair enough. Thanks guys.

We'll go next to Daniel Ernst, Hudson Square Research.

Yes, good afternoon, Gary, Olav. Thanks for taking the question. Actually three, if I might. One, can you comment on how your revenues, recognized revenues, track with the sales group of end market products? And then secondly, on the the 6 million 5022s that you shipped, can you say what percentage of that was actually recognized in Q2? And then, last, can you comment on a blended ASP in the March quarter was down 8% year-and-year, less than initially expected. Could you talk about that trend in the second quarter? Thanks.

All right, Dan, I'll definitely take the first one. The tracking of our revenue with the self group. I don't think I have sufficient visibility to really know exactly what the self group (?) is. There's numbers coming from our largest customers. There's MPD data that is actually here for the domestic market but there is a lot of seltzer ? in the non-US market. So, you know, we have a deferral policy in place. On top of that there is the supply chain into our customers has intermediaries in between the ODMs. So there's a lot of buffers in between that makes the tracking a little more difficult. Having said all that, we certainly do track it and from what we see right now, based on the limited information that I just described to you, I think we're tracking very well with those numbers.

Great.

And then, I'm sorry, could you repeat your -- what was the second question?

The second question was on the recognizing shipments of the 5022. You said you shipped 6 million through now. What percentage of that was recognized in the second quarter? And the last question was ASP trends.

So we actually specifically said,as of today, so that we didn't have to break it out into quarters. So that's the information that we wanted to tell you because we're very proud of the number but we didn't want to break it out by quarter. So now I'm sorry -- are moving from one question to another. I'm sorry, repeat the third one again.

The trends for ASPs in the quarter. Thanks a lot.

Sorry about that. So the trends for the ASPs, and of course, again, it was 9% down from a portfolio basis year-over-year. So comparing it to the second quarter of last year, our portfolio ASP dropped only 9%. Kind of like a 9 with the 10 to 15% that we guiding a little bit low. Our cost declined about 11% so if you compare margins year-over-year, we improved slightly. I think that's as much as I can break it down for you.

Great, that helps a lot. Thank you.

Thank you.

We'll go next to Jason Paraschac, Kaufman Brothers.

Hi, good afternoon gentlemen. Couple of quick questions here. First on the manufacturing side. There's been increasing talk about factory utilizations kind of peaking out and then there was an article this morning about UMC hitting some thresholds on their utilization, starting to cut back some of the smaller customers. First, have you seen any indication that there is going to be a potential shortage? Is that plain to your planning at all and the second part of that, have you seen that affect pricing from your partners? And the second part of that is do your customers worry about your manufacturing capabilities, given the utilization rates?

The short answer is no and no. The beauty of having -- working with world-class customers is they give you great visibility and we translate that into long ordering cycles. So we feel very confident that we put those second-half plans already in place and our key suppliers know what they need to supply for us and our key customers. So that's the beauty of having the high visibility and also frankly, having the caliber of customers we do, we clearly get a great deal of attention from our large fab partners. So no, we believe we've already taken care of any potential supply chain issues from both the supply point of view and we haven't seen the pricing elements that you refer to.

Okay. As a follow-up to that, how far in advance do you have visibility on your pricing with your customers? Is that set in any kind of timeframe like a three or six month pricing timeframe?

n general, our customers work on a per quarter basis and there is no fixed period for pricing negotiations. It tends to happen that a number of times per year. So it would be misleading to say that we have particular visibility in that. We sit down and negotiate with our customers on an as-needed basis a number of times per year. So that's the best color I can give you.

Okay. And then one final question on the gross margin. You talk about the 5022 now representing a majority of revenue and units, I assume. Given that move from .18 to .13 micron, I would have assumed more of a positive impact on your cost basis. Am I just wrong in that assumption or is there some cost-benefit that's yet to flow through?

.13 is still not as cost-effective as some of the more mature processors, like a .18 or .35. But I think in us going early to .13, as we look in the second half of this year and into next year, there is a dip in the current where these new advanced processors really get into volume and really hit the cost efficiency. So .13, we don't think is yet the very most cost efficient process but the way the physics and financials work means that it is clearly moving that direction. So we think we've chosen the process early and it points to good cost economics for us moving forward, frankly.

Okay. Great, thank you.

We'll go next to Craig Berger with Bush Morgan.

Thank you. Just kind of follow on the last question. You talked about the process being cost effective or not. Can you tell us where you were and the yield ramp and maybe how much goodness we can expect going forward from improved yields?

Unit information, per se, we don't break out. What I will say is one of the real benefits of working with our intermediaries in this productionless environment with LSI and the UMC is we have two world-class partners, all in the same boat with us, working on things like yield and cost improvement and quality. And so I think we are very happy with the present yields we are achieving and we're very happy to be working with companies like LSI who pay a great deal of focus on that and together, we make sure we really come out with a cost efficient products. But the yields are not a significant factor in a delta in our financial model. We've got great partners that are helping us deliver the volume and quality we need.

Got it. Can you -- I know you referenced the ASPs declined 9% year-over-year. Are you able to give us the sequential?

No, Craig, I can't give you the sequential. I don't break that out.

Okay. And then, finally, if we go back in time, you guys used to say that the model was the first half of the year heavy on R&D as you tape out products and what not. Now we're looking for a pretty sizable increase in R&D into the third quarter. How do we think about, sort of, bucketizing the R&D between first half and second half as we go forward -- is the first half heavy a done deal or can you just help us out there?

I would put a slightly different sort of tone on that. I would categorize that more as a management team focus than maybe R&D spending. Maybe when we were a little smaller that was how it worked out, but fundamentally you're right. You have to have the design wins locked and loaded here for the second half. So you tended to have a lot of management attention on R&D and product development in the first half and then execution and operations in the second. Now, as we've successfully transitioned to a public company and can afford to fund these parallel developments, we keep the gas on multiple developments and don't think there will be as much tied to quarterly seasonal basis as we will to our ability to fund and grow these new programs. Does that make sense?

Yes, so I think what you're telling me is we should expect tapeouts during any or every quarter of the year, kind of on a go forward basis?

That's correct.

Okay.

What's important is to be early enough for the next critical cycle so that's the issue. Yes, you'll see a variety of tapeouts but as we taped out in this last quarter, again, pointing to 2006, you have to get that runway really fine correctly. Otherwise you can be in serious trouble.

Got it. Question, and I know this has kind of been asked, but on the flash sales in Q3 or beyond, are you able to offer us any metrics, i.e., number of customers, number of design wins, anything at all quantifiable?

It's ahead of its kind. We will be very happy as our customers announce their products, to follow their announcements on our quarterly calls and give a little bit more color around that, but we're not going to pre-announce our customers and such like. So we're going to stay somewhat mum until our customers launch some great products in the second half.

Can you just comment on maybe what your customers are telling you from a high-level what they're seeing in the flash market? Is that inventory getting worked through and is that pushing back maybe the ramp of some new products targeted to age or what are you guys seeing and what are your customers telling you on the flash market?

I can't really add much color on the inventory side. I think your comment that they would delay introduction is not what my experience tells me. The actual product introduction cycles and innovation in this market goes ahead irrespective of where people sit on inventory. They have to get new models refreshed for Christmas. The have to start shipping to the major brands around the world. So just because maybe some customers or other suppliers in the channel may have inventory, they can't afford to slow down the innovation cycle.

Got it. Then just a last question from me. I heard Samsung has come out with a somewhat compelling media processor, dubbed the blues processor. Have you guys seen any impact from that? Do you expect Samsung to continue to be a big HDD customer going forward?

Samsung Semiconductor is a very able semiconductor company itself. The firm has strength, the systems strength has typically not being their strong point. Whether a customer uses their vertical integrated again, really depends on whether there's enough differentiation in that the performance so frankly it's a case by case basis. Just because there's internal versus external silicon, we have to work with our customers, provide the best solutions, and we can very successfully compete against vertical integrated customers if we have the right solutions and the right price point.

So no specifics as to whether Samsung will be a HDD customer in '06?

As we indicated earlier, we are not giving guidance into Q4. Frankly, 06 is even further out for us. So wait and see.

We'll take our final question, Shaw Wu, American Technology Research.

Thanks, just a couple of clarifications. You talk about how the next quarter you will see a more sizeable contribution from flash. Just wanted to clarify if that was the 5022 or the 5024. That's the first question. And the second question is, should we think of the 5024 as the successor to the 5022? Thanks.

I'm going to answer the second question first. Now the 5024 is really a more integrated version of the 5022. It's no secret that the actual host CPU in the 5022 and the 5024 is actually the same die. With respect to design wins moving into the second half of this year, it's mixed between the two, between the 5022 and the 5024.

What's the difference, in terms -- if there is a mix, should we think of one as more high-end and one more low-end? I mean, how should we think of that?

It frankly depends on the customer's choice. Some customers, if they're really driving for maximum integration, very much like the 5024, more highly integrated device. Other customers have their own particular demands and differentiation and they like to use other system components around our host CPU. And so it really is the choice of our customers' design team. So we provide both and they can choose either, depending on how they like to architect their new models.

Okay. Sorry. So to clarify, for Q3, you expect to see a contribution from both the 5022 and the 5024 in the flash market?

Actually go back to the second half. I didn't give the Q3 granularity but for the second half you'll see a mix of, we believe there'll be a mix of both those design wins for those two products.

Okay, thank you.

Thanks a lot. Thank you, everyone. And thank you for joining us today and we plan to meet with the investors on August 22, in San Francisco at the media conference and plan to present at the Smith Barney Citigroup conference on September 6. We look forward to seeing many of you there and with that, we'd like to conclude this conference call. Thank you.

This does conclude today's conference. Thank you for your participation. You may now disconnect.