輝達 (NVDA) 2006 Q1 法說會逐字稿

Welcome to the PortalPlayer, Inc. first-quarter fiscal 2006 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 7348100.

At this time, for opening remarks and introductions, I would like to turn the call over to Christine Moses, Investor Relations for PortalPlayer.

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 and 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. These forward-looking statements include but are not limited to statements as to our future plans and growth; our customers' inventories; development efforts; features, benefits and introductions of products and technology; sales of the PP5021; entrance into new markets; our plans to hire additional resources; our ability to execute our product roadmap; 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; market trends and demand for differentiated notebooks and anticipated growth of this market; availability of Microsoft Vista slideshow technology; market trends and demand for products with wireless connectivity and anticipated growth of this market; demand for our products and future financial results, GAAP and non-GAAP, including revenue, net income, expenses, gross margin, ASPs, stock-based compensation charges, tax rates, cash flow, weighted average shares outstanding and operating expenses, including but not 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, 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.

PortalPlayer reports earnings per share and net income in accordance with GAAP and additionally on a non-GAAP basis. PortalPlayer uses non-GAAP additional measures to exclude certain expenses it believes appropriate to enhance an overall understanding of its past financial performance and also its prospects for the future. PortalPlayer believes that providing these non-GAAP financial measurements is useful to both its management and investors, because they provide a consistent basis for comparison of the Company's financial conditions and results of operations between quarters, which comparison is not influenced by stock-based charges, the amortization of purchased intangible assets, the related tax effects of these items and the release of a portion of our tax valuation allowance. The full reconciliation of the GAAP to non-GAAP financial data can be found in our earnings release issued earlier today, and we ask that you review it in conjunction with this call.

Now, I would like to turn the call over to Gary for his introductory remarks. Gary?

Thank you and welcome, everyone. Q1 was a solid quarter for us, with strong financial performance and a resulting record cash position of 192 million. We are clearly disappointed with the product transition setback that we announced on April 19th. Later on, I will discuss the tactical initiatives we are implementing to address this change, along with an update on our key technology developments.

Let me now outline for you some of the highlights of this quarter. We have discussed in the past one of PortalPlayer's goals is to build intellectual property, either by creating it in-house or by acquiring or licensing key IP to ensure that we can continue to build great products and supply innovative technology to our customers. This quarter, we did indeed license and acquire some important IP for use in our target markets.

As for other aspects of the first quarter's business, there were two important trade shows where we were able to demonstrate our leading-edge technology. First, at the Consumer Electronics Show in early January, our Personal Media Player division demonstrated our video solution, working at 30 frames per second. By incorporating this high-quality video solution into our platform, we are enabling customers to choose a lower-cost, one-chip solution rather than paying extra for another video processor. Also at CES, our Personal Media Display division introduced and demonstrated our new Preface technology for secondary displays in notebook computers. Together with Microsoft, we showed the technology to many potential customers including on the show floor in a prominent position in Microsoft's booth.

The second show was the 3GSM show in Barcelona in early February. There, our Personal Wireless Entertainment division worked with a variety of leading-edge partners to demonstrate Wi-Fi and HSDPA technology to potential customers. In a few minutes, I will go into more detail about each of these initiatives and the steps we are taking in light of our recent announcement.

But first, I will turn the call over to Olav, who will take you through the details of our first-quarter financial results.

Thank you, Gary, and welcome, everyone. As Gary mentioned, today we're reporting strong first-quarter results. Revenue was $72.3 million, which is a 62% increase from the $44.5 million in the same period a year ago. As you would expect following an extremely active holiday quarter, we saw a significant seasonal quarter-over-quarter decline in shipping activity in the first calendar quarter of the year.

We started the first quarter with a record level of deferred revenue, representing the shipments we made in the last three weeks of Q4. This and the fact that we believe that our customers also restocked some of their channel inventory after leaving the year with lower-than-desired inventory position led to the strong revenue level in Q1. Revenue from our largest customer was, again, more than 95% of our total revenue. Our first-quarter gross margin of 42% is within our operating target model of 41 to 44%. The quarter-over-quarter decrease, as expected, was mainly due to lower ASPs. We expect gross margins for the rest of the year on a cumulative basis to be at or slightly below the low end of our long-term guidance, due to the fact that our largest customer does not intend to transition to our follow-on product to the 5021 device.

Net income for the first quarter was $6.5 million, compared with a net income of $7.8 million in the same period a year ago. Our GAAP tax rate for the first quarter was 51%, which is much higher than anticipated. A year ago, the Q1 GAAP tax rate was 25%. I will go into some more detail about this in a minute. The first-quarter 2006 net income resulted in an income of $0.26 per diluted share, based on 25.5 million weighted average shares outstanding, compared with a net income of $0.31 per diluted share, based on approximately 25 million weighted average shares outstanding in the same quarter a year ago.

Net income in the fourth quarter of '05 was $23.8 million or $0.92 per diluted share, based on 25.8 million weighted average shares. This included not only stock-based compensation charges, but also a one-time tax benefit of $8.6 million or $0.33 per diluted share related to the release of a portion of the valuation allowance against deferred tax assets.

Now, excluding stock-based compensation charges of $2.4 million for the first time in Q1, recorded in accordance with FAS 123(R), and also excluding the $115,000 of amortization for our recently acquired IP, as well as the significant tax effects associated with these charges, non-GAAP net income for the first quarter of '06 was $10.4 million or $0.40 per diluted share, based on 25.8 million weighted average shares outstanding. The non-GAAP effective tax rate was 35%, in line with our previous guidance. This compared with a non-GAAP net income in the first quarter of '05 of approximately $8.2 million or $0.33 per diluted share.

Non-GAAP net income for the fourth quarter of '05, which in addition to excluding stock-based compensation also excludes the $8.6 million one-time tax benefit, was $15.9 million or $0.62 per diluted share. Two interesting details here. You will notice that under GAAP accounting rules, our diluted weighted average shares outstanding were 25.5 million, and under non-GAAP the total was 25.8 million, 300,000 higher. This difference is driven by the effect of FAS 123(R) on the rules for applying the treasury stock method to the weighted average shares outstanding calculation.

As we don't include option expenses in the calculation of our non-GAAP earnings per share, we also exclude the effect of FAS 123(R) in the calculation of our diluted shares outstanding. This yields a conservatively higher share count. The accounting principles behind this calculation are pretty complex, and are explained further in the earnings release we filed today.

I also want to take a minute to explain our tax provision. As I mentioned earlier, our tax rate for GAAP purposes was 51%. This is higher than we expected. And why is that? Because, based on our recent product transition setback, we have now revised our financial outlook for 2006 downwards. This revision compounds the effects that certain 123(R) expenses have on our tax rate, and it also has the effect of limiting our ability to establish certain deferred tax assets. While the effect of this is an overall increase of our tax rate for accounting purposes, it does not necessarily reflect our actual tax liability or benefit for the future. Excluding this accounting effect, as I said earlier, the tax rate for non-GAAP purposes is about 35%.

In our earnings release, we provided a detailed reconciliation between GAAP numbers and the non-GAAP numbers, which details the stock compensation charges and the charges resulting from the amortization of intangibles, together with their tax effect for each relevant quarter, as well as the one-time tax adjustment in the fourth quarter of '05.

Our operating expenses were about $16.5 million for R&D and SG&A in the first quarter, $2.3 million lower than our Q4 spending. We cautiously adjusted our spending to the seasonally lower activity level that we experienced in this quarter and also forecast for the second quarter of this year. We leveraged our operations in India, as well as our highly flexible spending model, to quickly respond to the seasonally lower first quarter. Through continued conservative spending, we expect operating expenses in Q2 to be about $13.5 million before non-cash charges. This is more than $5 million or about 30% below our OpEx level in the fourth quarter of last year. Looking beyond the second quarter, we will continue to be very cautious with our spending.

Our stock-based compensation charge of $2.4 million this quarter was for stock-based compensation in accordance with FAS 123(R), including expenses related to our restricted share grants that we began issuing in 2005, elements of amortization of deferred compensation and some variable charges. For Q2, we expect our total compensation charges under FAS 123(R) to be about $2.4 million before the effect of taxes.

Now, let's turn to the balance sheet. Our inventory balance at March 31st was $3 million, most of which is finished goods. We continue to successfully manage our inventory level, adjusting it to the seasonally lower level of activity we experienced in the first quarter. Our current inventory is primarily 5021 devices, which we continue to sell to our customers. Our deferred income position, which represents the gross margin for shipments in the last three weeks of the quarter, was $2.8 million, naturally a lower level than a quarter ago. Headcount at the end of the quarter was about 314.

And before I turn the call back over to Gary, let me summarize our guidance for the second quarter of '06. We expect revenue to come in between 30 million and $40 million. Total OpEx before stock charges is expected to be about $13.5 million. Stock-based compensation charges are expected to come in at $2.4 million before the effect of taxes. GAAP net income or loss per diluted share is expected to be between a loss of $0.03 and an income of $0.05, based on approximately 25.7 million weighted average shares outstanding. Excluding the stock compensation charges, $350,000 of amortization related to our purchased intangibles and related tax effect, non-GAAP net income per diluted share is expected to be between $0.03 and $0.14.

At this time, I would like to turn the call back over to Gary for his comments. Gary?

Although the first quarter was a good one, we recognize that we have significant challenges ahead of us, and we are taking action to address them. We have kicked off an active and thorough evaluation of our business strategies and how we can leverage our core competencies to respond to the product transition loss.

Supporting this is the fact that we have been working on our diversification efforts for quite a while now. For instance, we introduced our Preface technology to target the fast-growing notebook market and are actively working on our wireless initiatives. Once we go through our evaluation process, we will come back to you with our strategic plans moving forward.

In the meantime, the tactical initiatives that we will focus on from a high level are as follows. First, we certainly have not given up on winning back the business we have lost from our largest customer, and plan to aggressively pursue future product models with them. We will also continue to support them, and plan to ship the 5021 device to them for some iPod models. Second, we plan to leverage our existing products, including the follow-on product to our 5021 device and updated firmer development kit features, much more actively with other customers. Third, we will now take our super-integrated single-chip product roadmap, which will now include analog, advanced video and wireless capabilities, to a broader customer base. And finally, as Olav mentioned, we will continue to leverage our flexible spending model to ensure that we are investing prudently only in those critical areas that allow us to innovate in the portable multimedia market.

With that said, let's now turn to the first-quarter highlights. Let me discuss our intellectual property initiatives. We are very focused on developing innovative technologies. To support that, we are always working to create intellectual property in-house and licensing or acquiring additional IP from other sources.

Over the past year, there have been two technology changes in our business that have influenced our IP investment decisions. First is the growth of NAND Flash memory-based products that use our technology platforms, and second is the increasing need for very memory-intensive capabilities such as video playback and encoding. Because of these trends, we have executed a three-pronged intellectual property strategy to, one, create innovative technology in-house; two, work with great technology partners to bring memory-related technology to in-house; and, three, purchase patents and exclusive licenses to IP in the area of memory technology and more general semiconductor applications.

On the patent side, this past quarter, we obtained a five-year license to the patent portfolio of MOSAID Technologies, consisting of more than 500 US and international patents. We also purchased 25 patents from them, and the combined transaction amount is approximately $8 million. According to the agreement, we have an exclusive license to grant sublicenses in certain markets. With these patents and our own internal developments, we believe we are building the right set of technologies needed to execute on a product roadmap for rich memory technology support and advanced video capabilities, as well as strengthening our overall intellectual property position.

Now, let's look at each of our divisions. First, let's talk about our Personal Media Player division. While we continue to support our largest customer in the market, we have also been very busy with additional customers to introduce their innovative products as well. For example, SanDisk introduced three feature-rich models that use our PP5024 device with up to 6 GB of Flash memory, the Sansa e200 series of MP3 players. These models utilize PortalPlayer's video capabilities and not a separate video chip, which allows them to offer a low-cost video solution to the consumer. Our strategy of offering high-quality 30 frames per second video capability on small form factor devices provided customers with important cost performance value points that other customers could find compelling and choose to implement. Our current technology implements 30 frames per second QSIF MPEG4 video, and we are continuing our technology and IP investments to ensure that we will have a roadmap of products to support the growing number of high-quality protected-content video services.

Now, let's talk about our Personal Media Display division. In January, we introduced our Preface technology platform for secondary displays in notebook computers. These always-on displays, in addition to eliminating the need to boot the computer to access notebook content, enable users to access up to 500 hours of music or other content on the notebook. Because this new feature is tightly integrated with the Microsoft Vista operating system, the introduction of Preface-enabled notebooks is highly dependent on the availability of Vista. A few weeks ago, Microsoft announced that it had delayed the retail launch of Vista from late 2006 into January of 2007. Due to this delay, we now expect our first production-level revenue from Preface to be in the fourth quarter of 2006, rather than the third quarter, as we previously expected.

In the meantime, notebook manufacturers continue to be excited about secondary displays and the ability it gives them to clearly differentiate their products, something they have not been able to do since notebooks were introduced in the early 1990s. We are seeing strong design activity for this technology, and are working with our partners and notebook manufacturers to be ready for timely launches. In planning for growth in this segment, we recently expanded our Taiwan presence to include a new design center. These additional resources will help in the development of our Preface technology platform and provide local engineering support for preface to our customers and partners in Taiwan and China.

We have also been active in supporting Microsoft in its worldwide third-party training, and have supplied more than 100 Preface development kits into this effort, with more on the way. We are excited about this market and the opportunity it gives us in leveraging our existing technology to an entirely new space, targeting a new customer base and significantly expanding our target market.

Our Personal Wireless Entertainment product division has also been hard at work. The group has been focused on the technology aspects of wireless applications, as well as engaging the ecosystem required to deliver a compelling user experience on the wirelessly connected devices. This past quarter, we announced partnerships with two market leaders in wireless technologies, CSR and Icera. We have partnered with CSR to bring wireless connectivity to personal media players. The companies expect to enable Wi-Fi technology that simplifies the synchronization of media players with a PC, as well as open up entirely new ways to download and stream content from the Internet. We can also enable wireless stereo headset connectivity through Bluetooth solutions. With Icera, we demonstrated technologies to enable a new class of portable multimedia devices that can support, in the future, an always-on connected service, allowing for on-the-air browsing and the fast download of music and video files through high-speed cellular broadband networks.

We demonstrated all of these technologies at the 3GSM show in Barcelona in early February, and the feedback from potential customers has been positive. They were excited about a class of wireless products that would incorporate the best-of-class multimedia technologies with the convenience of wireless technology.

Many existing products that combine wireless and multimedia compromise battery life and the overall user experience. That is why we are meeting with cellphone carriers, content providers and manufacturers to develop a no-compromise wirelessly-enabled platform that offers the features, functionality, battery life and user interface that consumers want and could have large mass-market appeal. Our plan is to have our wirelessly-enabled platform working for customer evaluation in the second half of this year.

In summary, we continue to focus on exciting high-growth markets. Our investments over the past 18 months have enabled us to put together strong product roadmaps. And we're excited about working with customers across a broader set of markets.

We now have challenging times ahead of his. Nevertheless, we believe the pace of innovation of our new technologies is accelerating. The market segments we have targeted are expecting to see significant long-term growth. And we have made substantial investments in developing technology to enable highly integrated, feature-rich products to pursue them. Over the past year, we have invested in developing a super-integrated single-chip product roadmap which now includes analog, advanced video and wireless capabilities, and are now seeing solid results from our internal testing on various silicon implementations.

We are now happy to open up to call to take your questions about our business, but I want to remind everyone that it is our policy not to comment on any specific customers' products or roadmaps. Operator, we're ready for questions.

(OPERATOR INSTRUCTIONS). Randy Abrams, Credit Suisse.

Implied in your guidance, are you factoring in a continuation of the hard disk drive business, or are you factoring in any slowdown or potential loss of part of that opportunity?

The guidance for Q2 definitely has the continued shipment of 5021 in there.

And maybe clarify on the 5021 -- you mentioned that you will still be shipping it to iPod for the 5021. Is that existing models, or does that also imply new models that have not been announced yet?

Well, as you know, we're always hyper-careful with our customers' product roadmaps. So no, we haven't disclosed the product roadmaps for both ourselves or our customers. As we said, the 5021 is shipping into existing iPod models, as we see, including, as you said, the hard drive-based iPods.

And to follow on to that, where did you see the biggest opportunity to reemerge with your customer for follow-on designs? Is that with that single-chip platform? And maybe within that context, can you talk about the type of wireless? Is that full kind of cellular wireless, or is that the more Bluetooth wireless and [that type] connectivity?

Well, as you point out, in the semiconductor business, there are design slots you compete for, and you have to win each of them on their merits at a particular time. As I alluded to in this call, we have embarked earlier on a very heavy integration path including, as you mentioned, wireless audio and advanced video. We are not going to be tipping our hand at this point in giving more details on the wireless applications, apart from to say that our home base is clearly the personal media player market. We think we understand the market and the requirements of that market pretty well, and so you should assume that the wireless technology we are referring to is directly relevant to the personal media player market.

And last question, just on the flexible spending model. Could you talk about in your pull-back in operating expenses what program you have had to tie it into at this stage, and what's kind of the next round [if you had to cut] deeper?

Mostly, we saved on SG&A. We also saved on some of the engineering expenses that we had actually already accelerated. So we didn't really have to pull any program. We continue to focus on what we consider critical for this company. How much further will we be able to cut? I think the 13.5 million that we guided for the second quarter, being 5 million lower than already in Q4, I mean 30% -- we're very comfortable with that at this time. It is important for us to continue to invest in critical areas, but we are going to be very cautious with spending. So we are going to give you an update on the second-quarter call. But I think we have moved, already, very swiftly.

Glen Yeung, Citigroup.

Olav, can you tell us how much of your business in Q1 was non-Apple?

Apple, as I said, was again more than 95% of our revenue, so the rest was non-Apple.

And if you look into the second quarter, what's the percentage you expect on Apple?

I don't break that out, but believe me, it's still a very important customer for us in the second quarter.

When you think about the business that was lost, is there a way to get a sense as to how quickly that was lost -- i.e., are we largely done with that business now? And as you move beyond the second quarter, it's basically no longer present?

I'm not quite sure how to answer that question; there's a fairly complex side to that. If we step back and look at it, essentially, as we have -- as you know, Glen, in the semiconductor business, there are design slots that you compete for, and there are clearly then follow-on design slots and new models that emerge typically in the consumer market probably twice a year. There's typically refreshes in those types of cycles. So you should rest assured that we are working to win back that business at our largest customer. And as was from the previous question, integration, low-power, performance and reducing the overall bill of material aspects [cost areas] where we will be focusing on.

The next question I have is own gross margin, because you can look at it in a number of ways, right? One is that revenues are lower and there may be costs that can't fall quite as fast. On the other hand, the business you lose is arguably very -- not low margin, but it was tough negotiations, obviously. Can you give us a sense as to where you expect margins to trend, maybe over a longer-term period, call it a year to two years?

I'm not going to comment on two years, but I think in the longer term, we do expect our margins to be within our 41 to 44% range. It's only in the shorter term that I see them at the lower end or slightly below the range. And as you can imagine, our customer's decision not to use the follow-on technology to the 5021 had a major impact on this. And we are not able to get the benefit from, at least for now, shipping a value-add technology, where we would be able to reset the price to a certain degree. And so, for the time being, that is the major impact on how I actually -- when I look at the margin over the next couple of quarters. As I said earlier, you're asking the longer term -- I think, with other business ramping specifically in 2007, I would expect the margin at this point in time to be back again in the 41 to 44%.

Is it typical that in a given device that you sell for a given opportunity in the market, whether that is with your biggest customer or another, that over time we would expect to see pretty typical price declines as time passes?

Oh, yes, absolutely. Over the lifetime of a product, if you take a year for a product, you probably would expect somewhere, a 25% decline year over year. If that product lives longer -- the 5021, for example, has been shipping now for five quarters -- you would expect a further decline. And as it matures, you certainly -- ASPs continue to decline. I think that answers your question, sorry.

And then, maybe a question for Gary. We've talked in the past about Preface and the opportunities that it presents for later this year and into next. Can you just give us any update on your thoughts with respect to Preface?

Yes. As I said, I think, certainly, the feedback we have been getting face-to-face with a wide range of the notebook OEMs and ODMs continues to be extremely strong. We're having very detailed conversations with them about both implementation and the ecosystem and how we support them in terms of a wide variety. So they are certainly engaging in our discussion discussing a wide range of plans, for example, even including marketing plans. So that, I think, is going extremely well.

We were proudly part of supporting Microsoft as they go out now and evangelize this technology to their developer network on an international basis. It's our development kit that is being used in many of those forums. And so we very much like that as a way of getting developers familiar with the 5024 platform, familiar with the Preface platform, familiar with the software platform we have. So we think that all bodes well for us as we look at the second half. Of course, we were a little disappointed that the Vista launch pushed out, but we still see a tremendous amount of interest from the major notebook manufacturers.

Just the last question here for Olav, which is just you're now looking at a $5 million reduction in operating expenses. Were there any major sort of features of that, things that drove that, i.e. were there headcount reductions or any other specific items that helped you get that number down?

No. And I already answered -- I think Randy asked the same question. No, we didn't do any restructuring or plan any headcount reduction. We had a lot of flexibility in our spending model, working with partners outside to develop technology for us. We accelerated a lot of that already in Q3/Q4, because we were preparing a little bit for some seasonality. It comes in very handy now that we are facing this particular situation. And we haven't really -- other than looking very carefully in some of the SG&A and some of the nice-to-haves, we're concentrating on the must-haves.

Jason Pflaum, Thomas Weisel Partners.

Now that you have had a couple of weeks to digest what has gone on here, do you have a better sense or can you talk about maybe some of the more specific reasons why there was the shift in your customer, whether that's more price-driven or were there feature set issues or another reason why they may have moved?

There have been no direct public sort of disclosure on those sort of items. We believe that our customer's decision was very complex in that decision, and that when we look at both technology and product features, we believe that it extends beyond that and covers a whole plethora of items beyond that point. We believe that the product follow-on for 5021 actually is a well-designed and an excitingly featured device, but we think customers sometimes have very complex decision-making processes. There could be numerous reasons why customers switch you out for a particular socket. Having said that, we certainly have not given up with that customer, and we will continue to engage and fight back for those types of future sockets.

So, as I said, no real news I can give you. We think it was a very complex argument that involved more than just sort of technology choices, but no more details on that at this point.

Maybe you can talk a little bit about the linearity of Q1. Looking at the balance sheet, it looks like the DSO is coming down pretty sharply there. It was, in fact, very front-end loaded. If you could talk about the momentum you're seeing into Q2? And then, I guess, just a follow-on with the question is how much legacy nano product may still be in the Q2 number?

Q1 was actually very front-end loaded. It was actually front-end loaded to the effect that we had a lot of revenue in the last three weeks of December, in accordance with our revenue recognition policy. So almost a third of that revenue was already in, happened in the last three weeks of December, as you know. Other than that, I think the quarter was relatively linear. And we don't see any change there in Q2. This is actually -- I mean, we said it earlier. This is actually kind of like the pattern that we see, especially with our largest customer. It is a lot of linearity. There is usually maybe some one-offs, in the past. But linearity is how they have actually operated with us.

And any sense for Q3 at this point? Can you give a general sense whether it's going to be up, down? Or maybe you can just touch on that?

No, I don't give guidance beyond one quarter. But having said that, we do certainly expect a significant impact on our financials. It's a little too early to say how much Q3 versus Q4 is impacted, and we had a planned transition in the second half. I can't tell you exactly for when. We certainly know that the margins are under pressure. I talked about this before. And we already talked about the spending reduction you have already seen already in our Q2 guidance.

The last question here is back on the Preface. Some of the feedback that we have been getting from customers is that the technology itself is pretty exciting and interesting, but it's still currently too expensive for mass-market adoption. Maybe you can talk just about where the bill of materials are today and where you see them, say, 6 to 12 months out from here.

So the bill of materials of Preface, I think, very much depends on customer implementations. When we were at CES, for example, we wanted to sort of show off some of the sort of high-end features. And when we displayed that, we used a fairly expensive color display, in the region of 18 to $20 on the prototype unit. We incorporated maybe a fair degree of NAND Flash memory. And then, there's our SoC, our [SOP], the 5024. So they really are the three key components. As we have now spent more time at customers -- and to your point, every penny becomes an item as they build their notebooks out -- we are seeing customers now look at a wider variety of displays in particular. And I think, as you start to look at just the general price trend for small form factor displays, we're seeing continued price declines as they gain volume in things like cellphones and such like. So we think maybe the initial starting point of $18 for the display on the notebook may have been a little high. But we are seeing customers attack that. And we do want, as you point out, to really drive both some price differentiation and offer our customers really choices of a different bill of materials. So we're working hard on reducing the bill of materials as well.

Daniel Ernst, Hudson Square Research.

Without trying to give specific guidance for the second half or tip your hand or your customer's hands about new products, obviously you lost a socket in one of their products, and it sounds like it's the follow-on to the nano and your failure for 2Q to continue to ship into other models, which is really their hard drive video product. I would think that the key question for you and for Apple is, are you shipping them in the second half? To whatever that product it is is irrelevant to us; it's sort of a binary situation, right? You either have them as a customer in the second half or you don't. Have you made that determination yet?

Well, when we talked about the product transition setback, we were pretty specific in terms of really trying to focus in -- again, without disclosing our customer's roadmap; we really don't want to be tipping our customer's hands. And we focused that in pretty tightly on the announcement about the follow-on from the feature Flash market. We didn't expand it beyond that. We kept it very focused. But again, don't take that into, necessarily, views of the customer's roadmap. So the follow-on transition for 5021, as we indicated, was not chosen for the feature Flash market. We are continuing to ship the 5021 into the video iPod, and beyond that, customer cycles will emerge as we go through that. But we are shipping today the 5021 into a variety of models, including the video iPod.

Understood, today. But I guess my question is -- again, without tipping Apple's hands -- whether they are launching a new hard drive model or not. But the natural question is, whatever product you, Apple, are shipping in the second half of the year, are we, PortalPlayer, part of that product or not?

I think I can't even answer it without tipping the hand, without doing it. I have no way of answering your question without actually talking about the customer's roadmap, which unfortunately -- and you know that -- we can't do.

Krishna Shankar, JMP Securities.

For the new product that you are prototype, showing with the full video capabilities, you said that it has the capabilities to do low-power, high-quality video on a single chip with MPEG2, MPEG4 capabilities. What about (technical difficulty) videos, H.264 and to do video quality equivalent to the current video iPod, which uses a separate video chip? Can you compare your feature chip with the current video iPod, which uses the separate chip?

The software implementation, which is how we have put this together on our existing platform, the 5021 that we demonstrated at CES, is really targeted to the smaller screen implementation. So that would not scale to a larger screen implementation. The video-for-free strategy, as we call it, essentially providing that 30 frames per second capability on the 5021 on video, is targeted at the smaller handheld devices.

In terms of other codec standards, our customers, for example, can help. They have applications which transcode the video applications to run on that type of platform. So that is what we call our video-for-free strategy. As we said, we have also been working extremely hard internally and are not making product announcements at this point, but we do have a very aggressive roadmap that does start to really span the full high-end view of video playback. But that's a product yet to be announced.

And also, can you give us some sense for the Preface technology, how exclusively are you with Microsoft in terms of the Vista implementation? And what level of competitive dynamics do you see for that Preface type platform going forward?

Well, without disclosing specific agreement aspects, what I will say is that I think we certainly have the first-mover advantage. We have worked very closely with Microsoft during 2005. Together, we learned a great deal as we put together the platform in understanding how to develop the APIs and the technology. So we think we do have a significant both implementation and optimization advantage with our platform going to market.

Also, what is very important for this segment is that we're having so many more new ideas brought to us from customers and from input to Microsoft that we're already starting to think about the second and third generations already. And so part of this is not standing still, making sure that we have the great features needed for generations two and three, and we have already started to focus on them. So part of it is familiarity with the platform, optimization with the platform and then, frankly, competitively it's be ready with our next platform iteration of features when competition does arrive.

And I just wanted clarification -- did you say in your prepared comments that the video and wireless-enabled single-chip solution will be targeted at a broader range of customers than just your single largest customers? Is that what you were saying?

Yes.

So the wireless digital media player chips that you're working on are really targeted at a broad range of customers, and not necessarily your largest customer?

That's correct. As you know, I think our vision of a single-chip implementation with audio, video and wireless single chip, we think, is applicable to many market segments. So yes, we are taking now that broadly to quite an exciting customer set.

Adam Benjamin, Jefferies & Co.

Just to go back to the OpEx, what is the bare minimum OpEx number you can get to, Olav, that does not include an NRE? And, maybe to ask it a different way, with respect to your guidance for Q2, what's the amount of the NRE in Q2?

We don't disclose the NRE in it. But there is NRE in there, if you're asking. So every quarter, there is NRE; it depends on your product roadmap and where you stand. There is one-time events that happen one quarter or the other. So Q2 has NRE, as did Q1 or other quarters. What is the minimum we can drive it down to? I think, as I kind of signaled, the 13.5 million that we guided to for the second quarter is a very comfortable level. We said that ensures that we can actually continue to focus on the critical areas. We want to continue to innovate. As Gary said in his prepared remarks, we have a tactical plan that focuses on working to win back the business at our largest customer, to leverage our current and future technology to a broader base of customers.

There's a lot of innovation we need to do. There is Preface, there is wireless. So we have a business to take care of, and we do this with a minimum of operating expenses. We really leverage what we have in the flexible spending model. Can it be another million? Sure, but this is for us to evaluate now. We did what we could do in these ten days of response to the situation. There's probably more we can do when we look at it further down, but now we have to really go and evaluate the situation further, and then we come up with a plan.

So is it fair to say, Olav, that roughly the amount you have guided to Q2 is roughly where you can get to in terms of a bottom, maybe give or take 1 million?

For the time being, yes. But again, as I said, we can evaluate this. But this is a number that we already feel very comfortable with. This has all the resources that we currently have. This has all the headcount we currently have. We're going to be very cautiously evaluate what we want to spend further, whether we want to grow in certain areas in terms of headcount. So it is a level that, for now, we feel comfortable with. There's still flexibility in the model. I don't want to say that. As we said, 1 million or 2. But for now, 5 million lower than Q4 is quite an achievement, already.

Previously you have given the ASP declines on a year-over-year basis. Can you give the ASP decline for Q1?

Yes, I can give you that. The ASP declined was, year over year, about 30% year over year for Q1 over Q2, which is a little higher than the 20 to 25% that we would expect. But it certainly has a little bit to do with the maturity, the continued maturity of the 5021 product, which is now in its fifth quarter of shipping.

With respect your guidance, I'm just trying to get a handle on the 30 to 40 million. Can you try and qualify for us with respect to is it a burning-down of channel inventory versus the design loss at Apple? And can you give us some kind of percentages as to how that guidance shapes up, the 30 to 40, based on that?

Yes. It's hard to give you the percentages, but let me talk about the guidance, maybe, and let me explain that a little bit. So first you need to analyze the Q1 revenue before you can actually evaluate the second-quarter revenue guidance. So we started, as you know, Q1 with a record deferred revenue position. We believe that a significant portion of that relates to actual customer product sell-through in the fourth quarter, as you know. So you're familiar with that. You also believe that our customers -- I think is our belief that our customers left 2005 with lower-than-desired inventory balances. And they ordered some of our products during the first quarter in order to restock their channel inventory to a more desirable level.

So, after eliminating these two effects from our Q1 revenue, you can compare Q1 now with Q2, and we see two factors that affect our Q2 guidance. One is we expect, certainly, to see some additional decline of ASPs, as our 5021 product continues to mature. And also, we expect to see a bit of an overall seasonal slower demand for our products in Q2 compared to Q1. So what we don't believe is that the product transition setback that we announced has materially affected our Q2 guidance yet.

I hope that -- if you put all these together, between how Q1 was certainly higher than the actual shipping activity level in Q1, you followed our customers' announcement in terms of how -- and about the sell-through for their products was in Q1 versus Q4, if you also consider that they left 2005 was a pretty low inventory level -- all of them, I guess -- and ordered some restocking, and then look at Q2, a little bit of seasonality, and ASP dropped, you can actually reconcile the 72 million to your guidance of 30 to 40.

It just appears from the ASPs that your units were up sequentially from Q4 to Q1. Is that right?

The unit shipments? Well, it's a discussion here -- do you want GAAP data, calendar data? On a calendar basis, the units were down. On a GAAP basis, I think the units were almost similar.

Quinn Bolton, Needham & Co.

I just wanted to come back to, Gary, your comment on the follow-on to the 5021 was not designed into your customer's or your biggest customer's future products. I just want to clarify; you're saying sort of what you said two weeks ago, that that's the Flash-based future products but no comments on hard drive at this point?

That's correct.

And then you mentioned sort of the -- I think to follow-on to the 5021 was taped out last summer. On this call, you have talked about the super SoC, that integrates more analog, more wireless. Is that a sort of next-generation chip, or is this one and the same?

No, that one is quite a leap in terms of the degree of integration. And as we have pointed out, in terms of silicon implementation, we're actually already in-house, having various aspects of that type integration tested out. So you should regard the sort of follow-on for 5021 by the term follow-on, as a more traditional type of architectural increase, the super-integrated chip. We have got a very positive response back from in terms of the leap in the level of integration we have taken with that next generation.

If one of your big customers has sort of designed your software out with, say, a 5021 generation, what's the likelihood that you can get sort of future generations back and designed back in? How much does the software change? How important is software to, say, new features such as wireless? Is that an opportunity to get the software back in, or is it sort of once the core firmware is out, does it tend to stay out?

No, I think you hit the nail on the head, in that in offering new features and capabilities of new platforms, as is common in the chip market, you have to bring a complete solution to it, which inevitably today involves firmware, in particular, with the new features. So no, I think the capability that we have in-house of developing the firmware in parallel with the new chip features, I think, serves us particularly well -- to your very point. As you look at things like wireless and, in the future, other types of advanced video technologies taken to a customer and a chipset with new features, plus the firmware ready and plus they know how to work with you on the firmware, I think, is clearly an advantage.

And then lastly, Olav, I think you had said a couple weeks ago that you might be able to give us an update on sort of what percent of your business was Flash-related, and I was just wondering if you could follow up on that?

I don't know that I actually said that I could break out Flash versus hard drive. And so I'm not prepared to do this today.

Chris Caso, Friedman Billings Ramsey.

I just wonder if you could clarify something you said earlier, just relative to the Q2 revenue run rate didn't yet take into account the design loss yet. Just clarify my understanding on that.

And then, if you can help us out with sort of the magnitude between the excess inventory, in terms of in comparison to the magnitude of the design loss. I guess what we are trying to get to is sort of order of magnitude, what we should expect going into Q3. But I understand your difficulty in answering the question.

So you mentioned inventory, so let me comment on that. We don't currently have any inventory on hand for that follow-on technology. It's mainly the 5021 that we have on hand. So I don't expect any unfavorable impact from our largest customer's decision on our balance sheet or on inventory or gross margins or anything. So I'm not sure whether I got your question there correctly.

Gary Johnson And then on the first point, just to reiterate, so we're perfectly clear, as Olav said, we don't believe that the product transition setback has materially affected the Q2 guidance. So just to make that crystal clear, as we don't believe it has materially affected Q2, as we see it today.

I guess, then, just order of magnitude as you go into the third quarter, you get some positive seasonal effects. Should we expect revenue to be up or down in Q3?

Unfortunately, I am not going to be able to tell you that today. Number one, it's too early; number two, it's our policy not to go above and beyond one quarter of guidance. So I'm going to have to -- we will have to wait and we'll give you that guidance in our second-quarter call. I told you a little bit about -- against, certainly, our impulse, we have given a little more insight into the second half. We talked about the margins, we talked about the spending that you could expect from us. We have also given you some tax rate information for the rest of the year. And how we are impacted on revenue, I wouldn't tell you at this point in time; it's a little too early.

But could you share maybe some of the factors that you're looking at going into the second half? I guess, as you're looking at the second half, is it safe to say it is sort of more design win-dependent at this point in the calendar on what actually revenue turns out to be in the second half?

There's certainly an element of design wins in there. We have, certainly, exciting design win activity with customers outside of our largest customer. There is, in the second half, a little bit of an element of what our first revenue from the Preface technology in the fourth quarter could be. And then there is the element of the announcement we made. It is really too early to say how we're going to be impacted by it in the second half. It is a transition that was planned for sometime in the second half. The timing of this is -- to some degree, has been announced. And we are not totally clear what the timing is. And I can't make any comment on this, because any announcement I would make here could be taken as a comment, an indication of my customer's roadmap. So it's really too early to make those statements. It is clear that our finances are going to be impacted, and it is clear, we said, as we revised our internal forecast for 2006 downwards. I think that's as much as I can tell you about the second half at this time.

Craig Berger, Wedbush Morgan Securities.

You have talked about doing 30 frames per second of QSIF MPEG4 video. Can you tell us what bit rate that's at?

Frankly, not off the top of my head. But we'll look it up and find a way to get that information to you.

That would be great, thank you. With respect to the follow-on product to the 5021, you have talked about this super-integrated chip. Did you note what features are on that, and also whether this you said wireless radios are going to be integrated on chip? I think that might be a departure from some of your previous comments.

Yes. Just for clarity, so the follow-on chip to 5021 is sort of a member of its own family, and you should view that as one path. What we have started to talk about today -- you are right -- is this more aggressively highly-integrated solution we have underway. Again, it does include for the first time integrated audio, integrated wireless and integrated advance video. But frankly, for competitive reasons, we are not going to tip our hat beyond that, apart from saying that we have made good progress on that and that we think, from customer response we have had, that we're certainly on the right track with that type of aggressive performance increase in that solution.

And with respect to the follow-on to the 5021, I guess the question is, where is it?

Where is it? Well, we have it here. We obviously have it here in-house. It is a product that is available. We now, frankly, are looking at how to use that more aggressively with our other customers in the second half. It's a product that we now think is very stable, and we look forward to discussing that now with other customers in the market.

With respect to the Sansa e200, is that business ramping and captured in the second-quarter guidance, or does that ramp more in the back half of the year?

All of our customers' backlog is captured in the guidance. So as always, we have given you the guidance as we see it. So we continue with our process that we had in the past couple of quarters; we don't judge or be overly conservative or anything. We just really look at the customer backlog and tell you as is. And SanDisk is a part of that.

Tayyib Shah, Longbow Research.

I guess you're not able to provide a lot of clarity on whether you expect to retain the video iPod business through this year. Can you give us an idea of where the competition is coming from for that product and what, if any, actions you guys have taken to fend off that competition?

Well, in the high-end video market, if you look across a broader swath of competitors, there are a number of areas that the competitors are offering solutions. Companies like Texas Instruments at the high end has good video capability. Broadcom clearly is -- through acquisitions, has started to bolster its video capability. They would be two, in particular, that I think that we have done a lot of work on in analyzing their roadmaps, look for their weaknesses and strengths. So I would point those two out, in particular, as very worthy competitors. As I said, our job now is to make sure that we fight and win every socket on the merits of our solution, focused primarily on integration and performance and, obviously, cost has to be a part of that. We do our market intelligence well. We have a fast-moving team, and we're going to compete very vigorously for each and every one of those slots that's available for us at our biggest and big customers.

And then, after having some time to digest the Apple news, what do you have to change, in terms of product design, to possibly maybe get back Apple's business next year? Is it something in terms of power consumption, or is it software? I know you have talked about integration, but is there anything other than integration involved (indiscernible)?

Well, I wouldn't necessarily make the assumption that integration is necessarily a winning scenario or a current scenario in the decision-making process of customers. At different times, they look at different elements in terms of cost, for example, and such like. So there are various reasons why design slots get won and lost. When we move forward, as we do, we have to address all the key elements at a time. We think that the development of a highly-integrated SoC is critical. We think the knowledge of which market that is going to apply to and take the learnings from the last five years to really drive down, as you said, power consumption, are critical elements.

But also, all in all, we know we have to satisfy sometimes very, very aggressive price points that are offered by the competition. Some of them appear very difficult to reach, but you have to go at them with a better technical solution. And when you do at that time, other elements of cost and such like can be overwon. So we have not lost the customer. We are working to win back business at our largest customer, and we're going to be very aggressive at going at that, with great integrated power optimized solutions and be a very vigorous competitor for each of those design slots.

And the next-organization platform with (indiscernible) and [with you] integrated, is that going to come out in time for any design wins this year?

As you can imagine, particularly at the moment with a very competitive environment, we're clearly are not taking our hats in terms of the timing aspect there. We are moving very expeditiously, have a great deal of focus on that. But no, we are not announcing timing at this point in time.

Maybe you can give us any idea of the follow-on to the 5021? How many design wins or how much revenue can we realistically expect this year?

Well, as we sort of indicated on that follow-on, we're essentially -- it is essentially available today. We are able now to make that available and discuss that with a variety, a larger variety of customers. In terms of its prognosis for the second half and its timing, it's really too early to tell at this point. We are still literally just moved into May. There are customers, particularly in Asia, that are in the ODM market that can move quickly. But I wouldn't want to pre-forecast particular additional revenue from that follow-on product as we sit here today. But trust us, our sales teams are going to be very actively engaged with that product and pursue the opportunities we have out there. We will use this new part very aggressively in Asia.

Again, finally, for Preface, I think we have talked about 6, 7 million units in the first year, but that was before the Vista delay was announced. Now that you're talking with the notebook manufacturers, do you think 6 or 7 million units within the first half-year after launch -- is that realistic?

6 or 7 million, you're asking, in the first half of the year. So I will be cautious with this at this time, because we still need to continue to discuss with all of our ODM partners there, in terms of how they are actually going to see the market with the pushout of Vista now. But everybody is pointing to a January release at this point of time, so when we stick with that, I think there's going to be probably an even faster ramp than before, because now some other guys have more time to integrate it into their roadmap. It's a little too early to give you a first-half number. I don't want to do that at this time, but from the feedback that we are getting from the discussion we're having, we are very encouraged.

That does conclude the Q&A session. I'll turn it back over to Gary Johnson for any additional or closing remarks.

Well, thank you to everyone for joining us today. With that, we will conclude this conference call.

This does conclude today's conference call. You may disconnect at this time. Thank you for participating.