Peraso Inc (PRSO) 2006 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen. We are now ready to begin the MoSys' second quarter 2006 financial results conference call. I will now turn the call over to Beverly Twing of Shelton Group Investor Relations.

Thank you, Pam. Good afternoon, everyone. By now, you should all have received the press release. However, if you haven't, it is available on the MoSys website at www.mosys.com.

Before we begin the discussion of the second quarter's results, I would like to remind you that this conference call will contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which include without limitation, statements about the market for the MoSys technologies, benefits and performance expected from use of the 1T-SRAM technologies and embedded memory designs, licensees of 1T-SRAM technologies and their strategy, the development and production of products that use MoSys' licensed technology, license fees and royalties attributed to 1T-SRAM technologies, and the Company's anticipated or perspective financial performance.

Forward-looking statements made during this call are subject to risks and uncertainties that could cause actual results to differ material from those projected. Additional information concerning factors that could cause actual results to differ materially from any forward-looking statements made during this call are contained in the Company's most recent annual report on Form 10-K filed with the Securities and Exchange Commission, in particular, in the section titled risk factors in the Form 10-K and in other reports that the Company files from time to time with the Securities and Exchange Commission. MoSys undertakes no obligation to publicly update any forward-looking statement for any reason except as required by law, even if new information becomes available or other events occur in the future.

Thank you for your attention. I will now turn the call over to Chet Silvestri, Chief Executive Officer of MoSys. Chet?

Thank you, Beverly, and good afternoon, everyone, and welcome to MoSys second quarter 2006 financial results conference call. Joining me today is Jim Pekarsky, our Chief Financial Officer. I'll begin today's call with an overview of our recent business highlights as well as provide updates regarding our products and markets. Following my remarks, Jim will provide a detailed overview of our financial performance, and afterward, we will open the call for a question-and-answer session.

So to begin, total revenue for the second quarter was $2.3 million, which was in line with our updated guidance announced on July 10th. Second quarter total revenue decreased sequentially from 3.5 million in the previous quarter. As discussed in our updated guidance release, the sequential decrease in total revenue was primarily due to a delay in finalizing a significant license agreement with a major integrated device manufacturer. As announced earlier today, this agreement was signed on July 24th and revenue from this license will be recognized in the third quarter.

From an overall business perspective, we continue to make solid progress on the strategic initiatives that we announced earlier this year. We signed multiple CLASSIC Macro licensing deals during the quarter, initiated programs with semiconductor manufacturers at the advanced 65 nanometer processed geometry, and further broadened our relationship with Nintendo and NEC.

So first, our CLASSIC Macro program has been very popular and continues to attract new customers as well as generating repeat business with existing customers. In Q2 we signed two Macro licensing deals with new customers and two with repeat customers. These preconfigured silicon-proven CLASSIC Macros enable our customers to move more rapidly from the development stage to the production stage, thereby shortening their time to market.

This advantage allows customers to reach volume production faster, which is critical in the highly competitive consumer electronics market. We launched this CLASSIC Macro program in the second half of last year, starting with a 0.13 micron geometry implementation. And its success is evidenced by the repeat customer business that we are already getting.

Starting in the second half of this year, we will begin shipping our 90 nanometer implementations and then continuing with our 65 nanometer products. In terms of basic technology initiatives, we're seeing a rapid market shift toward 90 nanometer and even 65 nanometer geometry for new SoC designs. We are well positioned to keep up with this market transition.

NEC is shipping our first 90 nanometer implementation for the Nintendo Wii game console. And our first 90 nanometer silicon proven CLASSIC Macros will be available in Q3. To address the shift to 65 nanometers, we've accelerated our development program, and during the quarter completed the research and development work, for porting the 1T-SRAM-Q technology to the 65 nanometer process node. We've also initiated Macro design work with pure-play foundries.

Also in July, we signed our first licensing and royalty agreement, as I mentioned, with a major IDM for the 65 nanometer 1T-Q. We believe the transition to 65 nanometers provides an even greater competitive advantage for MoSys, as the density and power advantages of our 1T-SRAM technology continue to improve as we scaled to smaller geometries, like 65 nanometers and beyond. Our 1T-SRAM technology approach is easily scalable to these advanced geometries, and we are able to capitalize on this shift to 65 nanometers with minimal engineering costs.

So we are pleased with the progress we've made in our 65 nanometer initiative, both for our CLASSIC Macros and our technology licensing to IDM. We expect these initiatives to drive increased licensing revenue in the latter part of 2006 and to drive our royalty growth in 2007.

As previously mentioned, during the second quarter, we announced that our 1T-SRAM is being utilized in Nintendo's upcoming Wii videogame console. These solutions are fabricated using NEC Electronics Advanced 90 Nanometer Processor Technology and represent the second integration of 1T-SRAM into a Nintendo game console.

In 1999, a previous generation of our 1T-SRAM technology was incorporated into Nintendo's earlier game console, the GameCube, which achieved high volume shipments. For the second generation Nintendo game console, our 1T-SRAM will be used once again as the embedded memory of choice on the Wii graphics chip. We anticipate volume production with royalty revenue to ramp toward the end of 2006 and into 2007.

Now lastly, I'd like to give a brief update on our other major technology initiative, 1T-Flash. This program has been progressing very well and we now have working prototypes. We have begun engaging with early adopter licensees and expect to sign our first agreement for this Flash technology before the end of the year.

We are bringing our unique 1T-SRAM advantages of high density, high performance and low power consumption to the world of embedded Flash. We expect this program to be a contributor to revenue in 2007 if the market opportunity for embedded Flash is as large as the market for embedded RAM. So with our entry into the Flash space, we are greatly enlarging our target market.

So with that, I'll turn over to Jim Pekarsky, who'll now review our second quarter results, after which we'll open the call for questions.

Jim Pekarsky Thank you, Chet. I will begin my review of our financial results by starting with our statement of operations. During the course of my comments this afternoon, I will make several references to non-GAAP numbers. Unless otherwise indicated, each reference excludes stock-based compensation expense related to FAS 123(R). These non-GAAP financial measures and a reconciliation of the differences between them and comparable GAAP measures are presented in our press release and related current report on Form 8-K, which can be found at the Investor Relations section of our website.

To begin, total net revenue in the second quarter was $2.3 million, compared to $3.5 million in the first quarter of 2006, and $3.1 million in the second quarter of 2005. As Chet mentioned, second quarter total revenue was in line with our previous announced updated guidance and impacted by the delay in finalizing the IDM license agreement. This technology license and royalty agreement has now been signed, and we will recognize the associated revenue in the third quarter.

For the second quarter of 2006, our licensing revenue was 1.7 million, compared to $2.3 million in the previous quarter, and $1.9 million in the same quarter a year ago. Licensing revenue was recognized from 13 different chip development projects during this quarter compared to 12 chip development projects last quarter.

Royalty revenue in the second quarter was $639,000, compared to $1.3 million in the previous quarter and $1.1 million in the first quarter of 2005. Our royalty revenue from NEC will be lower in Q2 and Q3, as they shift production from the older GameCube product to the new Wii Game console. In the second quarter of 2006, royalty revenue was earned from 18 different licensees compared to 19 licensees in the prior quarter.

Under generally accepted accounting principles, the gross margin percentage was approximately 84% of net revenue in the second quarter of 2006, compared to 90% in the previous quarter, and 80% a year ago. The sequential decrease in gross margin for the quarter was due to the decrease in royalty revenue relative to license revenue.

On a non-GAAP basis, the gross margin was approximately 86% in the second quarter of 2006 and excluded stock based compensation charges of 52,000. On a GAAP basis, operating expenses were $4.9 million in the first quarter, compared to $4.6 million in the previous quarter, and $3.6 million in the second quarter of 2005.

Total operating expenses included approximately $570,000 attributable to expenses incurred from the UniRam litigation, up from 189,000 the previous quarter. We anticipate that this increased level of litigation cost will be maintained in the coming quarters as we seek to aggressively resolve this litigation.

On a non-GAAP basis, operating expenses for the second quarter were $4.4 million. This excludes stock based compensation charges of 235,000 associated with research and development and 337,000 associated with SG&A cost. Non-operating income, including interest income, totaled approximately $926,000 for the quarter as compared to $452,000 in the previous quarter. Last quarter, interest and other expense included a charge of 347,000 related to the reimbursement of Japanese withholding taxes. Otherwise, interest income grew by 107,000 from the first quarter due to higher interest rates.

On a GAAP basis, the net loss for the quarter was $2.1 million or a loss of $0.07 per share, and includes charges related to stock based compensation expense. This compares to the net loss of $974,000 or a loss of $0.03 per share in the previous quarter and a net loss of $579,000 or a loss of $0.02 per share in the second quarter of 2005. On a non-GAAP basis, which excludes total stock based compensation charges of 624,000, the net loss for the second quarter of 2006 was $1.4 million or a loss of $0.05 per share. First quarter loss per share was computed using 31,293,000 shares.

Moving to our balance sheet, as of June 30th, 2006, our cash, cash equivalents, including both long and short-term investments, totaled approximately $84.5 million, compared to approximately $85.4 million recorded as of March 31, 2006.

Lastly, I would like to provide revenue guidance for the remainder of calendar 2006. For the second half of the year, we expect total revenue to be in the range of approximately $9 to $11 million, which represents an approximate 75% greater than increase over the first half revenues. Revenue will be derived from a combination of 65 nanometer technology licenses from IDMs, 90 and 65 nanometer CLASSIC Macro licenses and per unit royalties. We expect some revenue from these 90 nanometer and 65 nanometer CLASSIC Macro licenses will be deferred into 2007, as there are new products without an established shipment history. This would be similar to the approach that we use when recognizing revenue for the initial shipments of our 0.13 nanometer CLASSIC Macros last year.

This concludes my prepared remarks. I will now hand back the call over to Chet for his closing comments.

Thank you, Jim. So in conclusion, we're very pleased with the significant progress we made during the quarter. We're seeing strong interest from IDMs in our 65 nanometer 1T-Q technology. We're ready to meet the market transition to 90 nanometer and 65 nanometer designs with our CLASSIC Macros, and 1T-Flash represents an exciting new market for us, for MoSys.

With that we'll open it up for Q&A. Operator?

[OPERATOR INSTRUCTIONS] Your first question comes from Nimal Vallipuram with Hapoalim Securities. Please proceed.

Hi Chet. Hi Jim.

Hi Nimal,

Hi Nimal.

Just thanks for taking my call. There are couple questions I want to answer that your second half guidance from 9 to 11, are you giving the guidance per six months or quarter because you're not sure about how some of your customer shipments are going to play out in the next three to six months. Can you give us some idea on that? And I have a follow up on that.

Nimal it's Chet. So what we're saying is we've got some major 65 nanometer technology licenses in negotiation. These will take awhile and they're lumpy, so we could see the experience that we saw in Q2, where a deal slips a few weeks and ends in Q3. So it could happen again in Q3 to slip in Q4. We want to be sensitive to that possibility.

As well as, the problem that we don't have enough VSOE on our 90 nanometer CLASSIC Macro, so we might be required to defer some of that revenue quarter-over-quarter or even from Q4 into Q1 next year. So the way that I would think about the guidance we're giving of 9 to 11, it's basically a range of 4.5 million to 5.5 million for each quarter, which in and of itself represents new milestones even at the lower end of 4.5 million would be greater than the revenue that we've seen in the company even as I look back two or three years.

Yes. I do understand. No, that's fine. I think what I'm trying to understand is that as a business model, how this is going to work going forward because this CLASSIC Macro also you're implying that might go from, some of them will go from 2006 to 7. And I'm trying to better understand the accounting. Now is there a critical mass of sales your auditors are expecting before they let you start recognizing those revenues on an ongoing basis? Or is that because of the characteristic of the business going to be part of going forward at any time, every sale you make, you have to wait for a certain time before you can recognize that sale? Can you explain that to us a bit more clearly on that?

Sure. It's a good question. So it seems to be very limited in time. Because when we started shipping our 0.13 micron, CLASSIC Macros in Q4, we expected a couple of two or three quarters of transition, where we would defer or partially recognize the revenue. So as we sit here today, we're basically at a point with our 0.13 micron macros, which we're still shipping and still seeing demand for. We are now recognizing virtually all of that revenue up front. So we've cleared that problem in a couple of quarters as we had expected.

But now, as we start shipping our 90 nanometer Macros, starting this quarter in Q3 and in Q4, we might have another two or three quarters of transition on that. So each time we launch a new technology node, we expect to see this problem. We don't see it any longer with 0.13 micron Macros.

I think that makes the issue much more clear. Just finally, you are the first or second time I would say, but I get a feeling that in this conference call, you seem to be a bit more bullish and open about this 1T-Flash business. Can you give us more color? Another thing I'd like to ask whether it is going to be your first ever second half in 2007, which you probably will not be able to answer it. But in essence of that, can you give us any more color on that, I would appreciate that.

Okay. So as you know, we have been working on the 1T-Flash technology for a while, first developing the bit cells and applying the basic techniques that we use to develop these high density embedded logic process memory macros.

I think the milestone we achieved in the second quarter was we got the first working Macro prototypes back in and they performed to our satisfaction. So although we haven't shipped these to anybody, what we see internally is our Silicon designs we like. So we will now engage with customers and begin to license these designs. In a cautious way, we don't want to have too many customers because we want to be able to work with each one of them carefully as we're getting this into volume production.

So we'll start slowly and we'll also start quietly. We don't anticipate making major public announcements, publishing data sheets, telling essentially all the competitors what we're able to accomplish. So, we're going to keep it under NDA and talk to companies that are interested, and there are a substantial number that are interested in embedded flash as you can imagine.

Thanks Chet, thanks Jim. If I have any questions I'll come back later, but for the time being, thanks a lot. Appreciate it.

Okay.

Your next question comes from the line of Chris Chaney with Stanford Group.

Thank you. Good afternoon gentlemen.

Hi Chris.

Couple of question here. First, on the license deal that finally got signed in July for 65 nanometer. When do you expect that this customer will actually go into production? Is this some sort of like a second half of '07 production timeframe or what's the expectation there and when should we begin to see that customer contributing to revenue -- to royalties?

I think the program is at a fairly advanced stage with the customer. And they have some -- they already have targeted customers. So there is a real sense of urgency. And we would expect to see this being in production in '07, certainly by the second half.

Okay. And is there any target of types of applications here? Is this sort of a consumer oriented -- ?

Yes, high-volume consumer.

High-volume consumer, okay. PC graphics or digital video for personal media players, what sort of -- any idea what - I guess, any more detail there?

We expect, probably in the next 30 to 60 days we'll be making a joint announcement with this customer. But before that, if I leak anything, I'm probably going to have an unhappy customer on my hand. And no reason to do that.

I see. So is that sort of hinting at potential initial production in 30 to 60 days because isn't the history been, typically that you can't announce the customer until they're actually in production?

Well, it's not we can't, they generally don't want us to. But this is I think we both view this as an exciting program. It's well - there is a conflict level on both sides that we're talking about announcing pretty quickly here.

Okay. And they have a significant customer that they're locking in. There is some sensitivity around that, but in 30 to 60 days, that sensitivity will have passed, and we will be able to put out an announcement jointly.

Okay. And do we expect or should we still continue to expect another four or so of these kinds of license deals to be signed by year-end?

Yes. Certainly, multiple license deals we expect to sign by year-end.

So, two to four still within the range of what you guys would expect?

Yes.

Okay. On the gross margin, I guess, was 86% non-GAAP. My calculations show that the licensed gross margin was down to about 80.7, down from 86.7 last quarter. It looked like there might have been a little bit of pressure on the license gross margin side. Is that due to the -– in the CLASSIC Macros, the four CLASSIC Macros? Was that part of the mix change or was there just some other work out there that cost you more getting the 65 nanometer licensee signed?

Actually, what it was, Chris, was we had some significant milestone shipments to a major IDM, okay. And this was NEC and you'll see it in the greater than 10% customer list. And that was on the old generation. So that's passed us now. And there were a number of new 0.13 nanometer deals. The gross margins on those are generally higher. But overall, for the quarter at 86% non-GAAP, you're right. It was impacted one, by the decrease in royalty revenues quarter-over-quarter and also this large IDM milestones on a percent completion basis.

You mean, NEC.

With NEC, correct.

I just -- remember NEC, we have final work to be done on the 90 nanometer implementation that they're shipping in Nintendo. That was a custom program -

Correct.

Not a CLASSIC Macro.

That's right.

Okay. Then along the same lines on the royalty revenues then that dropped from I guess 1.1 to about 0.9 million, I'm wondering -- was the only significant part that was missing there NEC or were there some other shifts going on? And I thought that NEC had stopped producing the GameCube, I guess the Hollywood chip for GameCube quarters ago and that there weren't really any significant royalties being generated there to begin with. What was the major change again?

Yes. The major change was the drop in NEC. The royalty in arrears hurts you on the front end and helps you on the back end. We've been collecting still significant royalties all the way through Q1. And that we are expecting now stops. So Q2 and Q3 have taken two quarters to make that transition stop and then pay us one quarter in arrears when they restart the new chip.

Okay. Then on the gross margin guidance then, going into Q3, should we then expect royalty to being to grow again and move that gross margin back to 90% or this sort of be -- is this sort of a flat gross margin outlook or how would you characterize that?

Actually, in Q3, you'll see a nice increase in gross margin percentage, but more highly attributable to this major IDM technology license that we just closed where the customer is -- will be doing all of the work themselves. Where you'll see a big ramp-up in the royalty revenues, which will impact gross margin is more in the Q4 time period. Because remember NEC will start shipping chips near the end of this quarter and we recognized royalty revenues one quarter in arrears. So for our Q4, royalty report will get probably a month, 1.5 months of shipments from the August, September time period. The bigger jump up will certainly be in the Q1 of '07 time period, which will reflect NEC shipments from October to December.

Okay.

Chris, it's Chet. Let me - let's just elaborate a minute because now there was another gross margin element to factor into our mix, right. Previously, we've had royalties at 100% gross margin. We have CLASSIC Macros that we estimate at roughly 90% gross margin. We have custom macros that are in the 75 to 80% gross margin. And now, when you look at these technology licenses, this is not where we're doing the design work. The customer is doing their own design work under license from us. They're back in the 90 to 95% gross margin.

Okay.

So you have to mix all of those together.

So one way to look at it Chris is getting back to the more normalized revenue guidance that we gave for Q3 and Q4. You can expect the gross margin percentage to get back to a more normalized, around 89, 90%.

Okay. That's helpful.

Yes.

And then finally on the revenues. We've gone through the year -- half the year now with about 6 million in revenues. And with the mid-point for the back half being around 10 million, that puts us around 16 million. My current estimate was before today about 20 to 21 million. So there is a $4 million difference here, which I'm wondering if this could be attributed to a pushout of one of those -- one or two of those large IDM Technology agreements, or if this should all be chalked up as simply revenue being deferred to 65 nanometer CLASSIC Macro licenses. It seems like a lot for that. So I'm just trying to get some help.

It's a mix of both, Chris. So there is some deferral on the CLASSIC Macros. But here again, remember we talked about the range in these technology licenses that we think we can actually get signed and recognized between now and the end of the year, it's two to four. That's a pretty big range --

Right.

Right. Because those are multimillion- dollar deals. So if it's two, it's a couple of million. If it's four, it's four or more million. I mean, so that's the difference.

Right. Okay. Well, that's helpful. Thanks gentlemen.

Okay. Thank you.

Your next question comes from the line of Dennis Wassung with Canaccord Adams. Please proceed.

Thanks, guys. A few quick questions here. I guess, first, on the major IDM license signed in late July, I guess, first off is that a new customer for MoSys?

Yes. I think we're going to ask everybody to wait one or two months until we really announce everything. Because if we -- to say the risk that people will start triangulating on who this is, is bad faith on our part and we'll end up with an unhappy customer for no good reason.

I understand. I'm just trying to see if that's a brand new revenue stream across the board for the company, that's all. I guess, second question, when you look at the revenue in Q2 and kind of the decline quarter-over-quarter on the license side, had you signed that license within the June 30 timeframe, would that have got you back up to sequential parity or back to your guidance level for the quarter?

I think, what we said at the time -- if we had signed the license in the quarter, we would have been at the high end of our range.

Okay. So you're expecting a pretty sizable piece of license revenue in Q3 from this deal immediately, it's not a milestone base?

Correct. Our range was 3.5 to 4.5. And had we signed this during the quarter, we would have been able to recognize enough revenue we would have exceeded the high end of the range. And in terms of is it a new revenue stream, certainly, what we can tell you is that from a royalty point of view, we expect this to be a brand new revenue stream.

Okay. That's helpful.

Yes.

Second question when you look at the guidance for the second half of the year - I know Chris just went through a lot of this stuff - the number of contracts and all, I'm just curious what kind of backlog coverage you have, if you look at these deals. Is the guidance essentially predicated on deals you have in negotiations plus current revenue streams, or do you have some things in backlog that are ready to roll into that revenue? I'm just trying to get a comfort level or a coverage ratio or something along those lines if you can provide something.

We carry backlog in various ways, although we don't report it publicly, because it's not a true indication of our business on a going-forward basis. But obviously, we factor in what we generally forecast our royalties are going to be for the second half of the year, since they are recorded one quarter in arrears.

And we do have an anomaly where we have the Wii game console that's going to be ramping. So we're getting some indications from NEC what those royalties may be. We also, of course, carry some backlog on custom projects that we carry in engineering that we're still in the progress of making milestone deliverables.

We have a number of these CLASSIC Macro deals at 90 and 65 that are -- sat in a sales funnel that we need to close. And so it is a combination of some business that's already locked in and a fair amount of business that we have significant confidence in.

The other thing, as you said, we're in the negotiation process on a number of these large technology licenses and -- that we're expecting to close between now and the end of the year, we'd say between two and four. And so they still have to be done. They have to be completed and signed. But there's a range.

Okay. That's helpful. And I guess just sort of following on on the Nintendo Wii question. Is there anything you could say about the sort of dollar content you guys will receive in this generation versus last generation? If you assume that it's larger or at least I'd assume it's larger, anything you can say around that topic?

Yes. I'm not sure, because, I wasn't here when we announced the original GameCube in -- what we said about what we're collecting in royalties. The royalties per unit are significant. They're -- obviously, because this has been a -- it's a volume-based royalty structure, they're now down to a lower royalty level than they were when the original GameCube started shipping. All right? So they'll pick up at that royalty level with the new Wii. But it's not -- I mean it's not more than a factor of two different, it's just still significant.

Okay. Great. And last question for me. When you just look at I guess a broader environment question, how would you gauge your customers' activity levels, design activity. I know you talked about 90 and 65 as kind of ramping in terms of activity. Any just broad customer environment questions from design activity?

Sure, it's Chet. So, I guess the answer is we're seeing a lot of design, a lot of these SOC designs even for the low-end consumer products are now getting to the point where they need enough onboard memory that it's coming in to the sweet spot of our 1T technology.

So we're seeing still very good demand even for the 0.13 micron macro in the consumer products, particularly in Asia. Right? And then for the new sort of the leading edge, particularly cellular handsets, they're all ramping 90 and doing 65 nanometer designs now. So they stay more at the leading edge. So we're seeing good advantage, strong interest across the whole spectrum of geometry.

Thank you.

Okay.

Thanks, Dennis.

Your next question comes from the line of Dan Scovel with Tokeneke Research. Please proceed.

Yes. Thank you. A couple of questions. You mentioned NEC is over 10%, anybody else over 10%?

They were the most significant customer during the quarter.

Okay. Also, you had mentioned something about the license revenue, I guess milestone payments to NEC. I guess what is the situation there. You were sort of implying that that was a lower gross margin licensing business.

What I was implying is that for NEC, we could -- technology licenses can take the form of different ways. In terms of NEC, our internal engineering group did a lot of custom work for NEC in terms of helping them with the 90-nanometer development, of which case turns into a very high-volume royalty product.

In the next generation with NEC, then we'll have discussions about will their internal group do more of the work and just exactly how much our people need to do. With other IDMs however, particularly some of the IDMs that we've worked with in the past, we may be in a position to push a lot of the work into their internal design teams.

Right now, if you look at -- where our engineers are spending the bulk of their efforts currently on an ongoing basis is really all of the CLASSIC Macros that we're going to be building out with pure-play foundries that we could build ones and sell many times, off-the-shelf products. That's where the bulk of our engineering resources are actually being spent right now.

Okay. So the NEC happens to be -- I guess a fair amount of overhead required internally to support that particular piece of business.

Correct, which has now been concluded.

Yes, there's a custom development program partner for Nintendo with very high performance, special memories.

Correct.

Also, Chet, you had –- when you were just talking about the royalty issues with the Nintendo Wii, you had said that they're volume based and I guess they're going to tick up relative to what they had been, but not that much. I guess could you clarify that a little bit?

No. What I was saying is that the percentage of royalty that they pay us, the percentage of the ASP, right, of the chips they're shipping they pay us goes down over cumulative volume. So they got through the -- the highest royalty percentages with the original GameCube. And now, we're down to the base royalty percentage that we collect from them, which they will be able to use for the Wii and everything they do going forward on the new Nintendo.

So they've gone down the learning curve and the price curve on royalties. And so if it was 100% -- what I said is was 100% of the royalty we got in the initial shipments of the GameCube, we're down to something between 50 and 70% on the future volume.

Okay. So you're still collecting cumulative volume on the Nintendo game platforms, even though the platforms have migrated to the next generation?

Chet Silvestri. Yes. They get to apply the previous volume to the new machine.

Okay. So the accumulation is over the long-term.

Chet Silvestri. Yes.

Okay. I understand. Thank you.

Chet Silvestri. Same customer, so they can aggregate their volumes. Yes.

What a deal. Sign me up? Finally, another question. Obviously there has been revenue recognition issue associated with transferring your technology over into the macro or the CLASSIC Macro product offering, but you also have now a whole new technology node at 65 nanometers. I guess could you clarify the different milestones from an accounting treatment perspective that allow you to recognize revenue on, say, an existing technology node with a new product offering on a CLASSIC Macro versus a new technology node? I would think it would be a lot longer.

Well -- so what I said is we've gone through this exercise. We launched the CLASSIC Macro program in 2005, mid 2005. We shipped our first 0.13 micron CLASSIC Macro. So we launched the CLASSIC Macro program, starting at 0.13 micron, everything in the past was custom. So with 0.13, we started shipping those macros in Q4. But because it was the first time, you don't have returns, you don't have payment history, you don't have any [BSOE], right.

So we had to defer a bunch of that into 2006. Now as we sit here today if we book an order for a 0.13 micron classic macro, we ship it, we recognize it all, we're through that whole exercise, if you will. But we're expecting the auditors will take the same position when it's 90 or 65, it's new. You don't know what your reliability returns payment is going to be on these, until you establish some shipping history over a couple of quarters. So we expect just to repeat that process at each node. We're being conservative, but we got surprised once. We don't want surprises.

I guess what you're saying is, you're not expecting more than a couple of quarters even though we're migrating now to a smaller, the 65 nanometer, and -- regardless of the macro offering or whatever?

Our technology scales very well. The stuff is working, we qualify it, we don't really expect any technical problem. This is just a question of business and accounting issues.

Most of the classic macro deals that we're forecasting through the rest of the year are at 90 nanometer. Those early adopters at 65 as we're building out the 65, that's more of a full custom type of approach. But 65 nanometer macros won't be completed and available on the shelf until '07.

Okay, great. Thank you. Good luck.

Okay. Thank you.

[OPERATOR INSTRUCTIONS] And your next question is a follow-up from Chris Chaney with Stanford Group.

Hi, guys. I have two additional questions. One is sort of a follow-on from what Dan was discussing a moment ago, and that's the revenue recognition issue. And I'm wondering on the 1T Flash design – 1T Flash win that you might sign up by year end, even though that -- the devices may go in production in the second half of '07, will there be associated deferrals? I know this isn't really I don't think it's a classic macro design, it sounds more like a technology license or a more involved custom design to me. But will there be any deferral issues that really - that might mean that revenue won't be recognized until 2008?

No, no. I mean our history has been and we're expecting to apply the same process with flash is we start first by engaging with early adopter customers on custom macro development programs. And for custom macro development programs, like with NEC and others, we recognize on a percent of completion basis.

Okay.

So we'll start recognizing revenue even in '06.

Okay. So really it's only the CLASSIC shipments that might be deferred at new nodes?

That's right, that's right, because, we're trying to - that we tried to change to an off the shelf finished product.

Right, that makes sense to me.

And the case where the customers -- the company has had no history of taking any revenue upfront, because the classic macro program did not exist prior to 2003 -- or 2005, that's right. And so it's - you're really starting from ground zero establishing a history of delivering off the shelf products of which we did this year for 0.13. And we'll start now building creditability behind the 90 nanometer program. By the time we get to 65 nanometer you'll have three generations of technology then with off the shelf products, but -

But I think at this point, for Flash, I think it's best to think of that as a custom program for the foreseeable future.

Correct. Okay. Well then are most of your -- how would you characterize your engagements right now with CLASSIC macro customers? Are they mostly in 130 nanometer or 65 nanometer or 90 I guess? What's the sort of mix there?

Across the board, we've got engagements on all of those nodes. I think you can imagine the 0.13 CLASSIC interest is primarily in Asia for what you'd consider lower end consumer product devices. And then, streaming through with 90 nanometers in the midrange and cellular handsets, and communication products and then, 65 is really starting up now for high-end, like network processing or cellular handsets.

Okay. That's helpful. And the last question then is I know that the new technology license you signed was with an IDM, but how do you think about technology licensees or licenses with the foundries, such as TSMC, UMC, Charter, SMC and the others? How will that be developing and will the approach be the same in trying to engage them with technology license, or will you try to generate demand through the fabless companies?

Yes. That's a good question. So, in general, when we went to the CLASSIC Macro program, we made a change in our foundry strategy, if you will, and relationship in the sense that we're doing the macro development on our nickel. We do our own macro development.

We expect -- we don't expect the foundry to pay us any money to do that, but we expect them to support us with Silicon qualification and shuttles and so forth, so that they're ready to take -- to accept those designs. So they do their part, we do our part, then we go directly to the fabless chip companies to license our CLASSIC macros. That was a fundamental change.

Okay. Do you feel that the TSMC, UMC, Charters et cetera are doing their part to be ready with producing silicon when the customers want it?

We do. We feel like we have very good cooperation from these guys even working with us on the advanced nodes.

And when do you think you'll sign the first 60 or when do you think you'll be producing 65 nanometer at the foundries?

Maybe this year.

Great. Okay. Thanks a lot.

Okay.

Thanks Chris.

Your next question comes from the line of Timothy Chen with Tricadia Capital. Please proceed.

Hi. Gentlemen, how are you?

Hi, Tim. Fine.

Just following up with Chris' question, can you give us a sense on the business potential for this CLASSIC Macro design that you're doing with the Foundries?

Which one are you referring to?

Well, in other words, on your CLASSIC Macro design, what you were just talking to Chris about. So what sort of potential does that business actually have?

Well, this is the ongoing process of developing these CLASSIC Macros and selling them. And we've been doing this for now - it's coming to the one-year anniversary of launching this program. And, as we said, we closed four of those deals in Q2. So you can expect similar kinds of business momentum going forward.

The mix between 0.13 and 90 and 65 may change over time, depending on where the new design starts are. But we'll have a good array of CLASSIC Macros in all the geometries. So we'll support what the customers want.

And what type of customers are asking for the classic macro product as opposed to, say, an IDM?

These are fabless chip companies that are going to foundries for their direct products. So you can just -- you can imagine the names of the big -- even big fabless chip companies out there doing consumer communication products.

Okay. Thank you.

There are no further questions at this time. I would now like to turn the call back over to Mr. Silvestri for closing remarks.

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