Quicklogic Corp (QUIK) 2004 Q3 法說會逐字稿

Good day, ladies and gentlemen and welcome to afternoon and welcome to the QuickLogic Q3 2004 earnings conference call. My name is Steven and I will be your coordinator for today. At this time all participants are in listen-only mode. We will be facilitating a question and answer session toward the end of this conference. If at any time during the call you require assistance, please press star followed by zero and a coordinator will be happy to assist you. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Mr. Tom Hart, Chairman, President and CEO of QuickLogic Corporation. Please proceed, Sir.

Okay. Good afternoon, ladies and gentlemen and welcome to our third quarter 2004 earnings conference call. Thanks for taking the time to join us today and hear about QuickLogic and our steady progress towards the development and our market leadership of this new category of semiconductor devices we call imbedded standard products. Before we get started here today I just want to call your attention to the fact that Q3 2004 marks our fifth year of being a public company, as we went public on October 15, 1999. SO this is earnings call number 20 for us and we're looking forward to many, many more.

Okay, Carl, our CFO, will take you through the Q3 financials and then I'll share my perspective On our business. Finally, Carl will detail our guidance for Q4 and then we'll take questions. Carl?

Thank you, Tom. Before I get stared, I would like to read short Safe Harbor statement. During this call we will make statements that are forward-looking. These forward-looking statements involve risks and uncertainties including but not limited to the stated expectations relating to revenue growth from our new product families and statements pertaining to our ability to convert new design opportunities into customer activity and QuickLogic's future results could differ materially from such forward-looking statements. We refer you to the risk factors listed in our annual report on Form 10K, quarterly reports on Form 10Q, and prior press releases for a description of these and other risks that could cause actual results to differ materially from our forward-looking statements. QuickLogic assumes no obligation to update any such forward-looking statements. For your information, this conference call is open to all and is being web cast live. It can be accessed from the Investor Relations area of the QuickLogic website located at www.quicklogic.com.

Our revenue was again the highest since the fourth quarter of 2000. Our revenue grew 6.4 sequentially and met our guidance that revenue would be up mid to upper single digits sequentially. We achieved this revenue growth during a quarter that was tough for many of our competitors and we achieved this growth with our existing products. We look forward to the future revenue contribution of our new Eclipse II and QuickMIPS advanced ESP products. Our gross margin of 49.3 percent of revenue was in line with our guidance of 49 to 54 percent. Our operating expenses were favorable compared to our guidance. Our net loss was $899,000 or 3 cents a share. Our revenue of $11.9 million and net loss per share were better than the analyst estimate of $11.7 million and a loss of 6 cents per share respectively. Other key points from our results include, as we expected during our last conference call, we released our Eclipse II and QuickMIPS families to production during the third quarter. Our Q3 revenue was $11.9 million. Solid bookings and 57 percent turns allowed us to increase revenue 6.4 percent sequentially.

ESP product revenue increased 2 percent. Advanced ESP products increased 3 percent and mature product revenue increased 9 percent compared to last quarter. Our pASIC 1 and pASIC 2 products contributed 43 percent of revenue in Q3. We increased cash by $900,000 during the quarter. We continue to experience strong design activity for our advanced ESP products which include our new QuickMIPS and Eclipse II product families, and we expect these products to provide significant long term revenue growth. Tom will discuss advanced ESP design activity later on this call. We want to re-emphasize that significant sales to a few customers can cause a dramatic fluctuation in our sequential comparisons. However, as we expected at the time of our last conference call, no single customer has accounted for more than 10 percent of Q3 revenue. So our revenue during the last few quarters has come from a broad range of customers and industries. Strength from military and aerospace customers and from graphics and imaging customers contributed to our sequential revenue growth. These two segments, compared to Q2, increased by 90 percent and 27 percent respectively due to increased demand from certain customers. We are also pleased to see strong sequential growth of 48 percent from Europe and 24 percent from Japan.

Compared to Q3 of last year, our revenue is up $800,000 or 6.9 percent. You may recall that one customer accounted for 11 percent of revenue in Q3 of last year. Our revenue from this customer has declined by approximately $700,000. Revenue from other customers increased 14 percent compared to Q3 of 2003 and is 26 percent higher on a year to date basis. We sell our products through distributors and directly to OEMs. Distributors accounted for approximately 75 percent of our revenue for the first nine months of the year.

Our third quarter gross margin was reduced by $865,000 as a result of one time charges including $255,000 of reserves for excess and obsolete material and $610,000 of charges for adverse purchase commitments. These charges are primarily being taken against wafers of one product that is not expected to yield usable die. We made risk starts for this device and believe we have adequate supply of this product in a released version. Excluding this charge, our gross margin would have been 7 percent in Q3 or approximately 56.5 percent of revenue. Moving beyond these charges, the products that we sold in Q3 had a higher standard margin than we expected and our yield and purchase price variances were favorable compared to our forecast. In addition, we benefited from the sale of reserved inventory. The sale of previously reserved inventory reduced our costs as a percentage of revenue by 2.2 percent.

Our research and development expenses were $3 million or flat sequentially. We had guided that Q3 R&D expenses would be as much as $300,000 higher compared to Q2 expenses. But lower masked charges and employee compensation expense than we originally forecast for the quarter. Our SG&A expenses declined by $470,000 sequentially compared to our guidance of an increase of up to $200,000 with lower compensation, legal and marketing expenses than we expected during Q3. To recap our sequential results, our revenue increased by $720,000, our gross profit declined by $870,000, a $470,000 reduction in operating expenses partially offset our declining gross margin.

Our net loss of $899,000 in Q3 was $370,000 higher than the second quarter loss due primarily to the $865,000 of charges to cost of sales mentioned previously. Our net loss in Q3 of $899,000 compared to a net loss of $709,000 in Q3 of 2003. This year's results were impacted by the charges against cost of sales and by our research and development expenses. Our R&D expenses were $330,000 higher compared to one year ago primarily due to higher expenses for Eclipse II and QuickMIPS masks, pre-production material, and related qualification expenses.

Our SG&A expenses in Q3 of 2004 are comparable to the level of expenses one year ago. We have $900,000 of positive cash flow in Q3. This was favorable compared to our guidance that we would use up to $1.5 million of cash in the quarter. Our accounts receivable balance was favorable compared to forecast accounting for much of this better than expected result. Let me take a minute to outline our Q3 actual cash flow. Our net loss, when you adjust for non-cash charges such as depreciation, the write off of long term assets and inventory reserves, was positive for the quarter. In total, these factors contributed $650,000 of cash. In addition, changes in working capital contributed $1.8 million of positive cash flow in Q3. We reduced our accounts receivable by $1.2 million during the quarter and our A/R is now at 22 days.

At September 30th, we had 112 days of inventory on hand and 10 days of inventory in the channel. As a result of these factors, we had a positive operating cash flow of $2.4 million in Q3. Capital expenditures consumed $400,000 of cash in Q3. During the quarter we used $1.1 million for financing activities. Of this amount, we used approximately $850,000 to repay debt and an additional $900,000 to repay our revolving line of credit. These uses of cash were partially offset by proceeds from borrowings at $650,000 during the quarter. Primarily as a result of these factors, our Q3 ending cash balance increased to $27 million from $26.1 million at the end of Q2. Our cash position less our interest bearing debt was $21.4 million at the end of Q3. This is a $2 million improvement over Q2.

The value of our Tower investment declined significantly during Q3. Tower ordinary shares had a market value of $3.35 per share at the end of our fiscal quarter compared to a value of $5.72 per share at the end of Q2. Our Tower stock was worth $4.5 million at September 30, or $3.2 million lower than at the end of Q2. $3 million of the value that we have in Tower shares is classified as a short term investment. We had 153 employees at the end of the third quarter compared with 154 at the end of Q2. Now let me turn the call back over to Tom.

Okay, thank you, Carl. Well Carl has already told you the good news for last quarter. I'll review a few facts and comment on where we are going, or where we are and then where we're going. We've just completed 6 of our last 7 quarters with positive operating cash flow which was a commitment we made to you when we told you we thought it was appropriate to continue to invest in our new products, investing in both R&D, sales and marketing. I'm sure you all know that you don't come out of these industry downturns with old products and expect to thrive. We now have two new families of world-class products released to production, Eclipse II and QuickMIPS. As I said to you in the last earnings call, in Q3 all devices and packages of both product families were released to production and we are cranking up the fab starts to meet coming customer requirements even as we speak.

Okay, well I think I know what's top of my priority for you, so let's talk about design activity and specifically design activity relating to Eclipse II and QuickMIPS. We have developed and implemented a design tracking methodology to track our key design opportunities in a very detailed fashion. While we won't be sharing the excruciating details with you, the business we see coming down the line gives us increasing confidence to project that Eclipse II and QuickMIPS will be very successful product lines for us with meaningful bookings in this, the fourth quarter, and significant revenue by the first half of next year. The design activity continues to grow, both in numbers of opportunities and the value of those opportunities. In Q3, the total value of those opportunities grew almost 40 percent over Q2. Opportunities from new markets and new customers which is very good news to us.

Eclipse II is aimed squarely at bridging applications where we're seeing significant customer interest in high volume, low power designs. For example, last week we announced our partnership with Renaissance which basically enables them to extend their served available market for their microprocessors to include applications requiring WiFi functionality. The solution consists of a Renaissance technology SH processor and a programmable companion bridge device from QuickLogic that enables connectivity to many PCI and card bus based WiFi modules or chip sets.

Let me share a quote with you from the press release. "Renaissance Technology chose to use QuickLogic's Quick PCI family of ESP devices because of low power consumption, high performance and ease of design features offered no where else" said Hasail Motakata [sp], department manager at Renaissance Solutions, a subsidiary of Renaissance Technology. "QuickLogic provided us with the lowest powered bridge from our SH processor to any mini PCI or card bus based WiFi module. This allowed us to leverage all our existing software development, meet time to market goals with stringent power consumption requirements and stay price competitive. Initial chip sets from the partnership will target wireless voiceover IP, also called voiceover wireless LAN and battery operated handheld applications that support the IEEE 80211 ABG specifications". I think this customer quote does a good job of succinctly capturing our overall ESP value proposition of low power coupled with a short time to market while being price competitive.

We are hearing similar messages from other companies like Renaissance, companies that are actively promoting our low power Eclipse II products as part of their solutions to their customers. One such company which is serving a fast growing market told our team there is no other FPGA supplier that can compete with our low power. A non-disclosure agreement keeps us from giving you their name. We are now actively engaged with many new to us companies to enable WiFi functionality for a wide range of their existing products. These products span several new markets and range from PDAs to medical applications to gateways and handsets. It seems that everyone these days want to have 80211 AGB connectivity and we have the unique low power solution. So I hope you can see that Eclipse II is bringing us into both new customers and new markets. Long live WiFi.

So how about the QuickMIPS family? Quite frankly, this has been a tougher challenge than we originally envisioned, but I think we're actively making good progress now. QuickMIPS is aimed at computing applications and this means we have a new set of competitors and some cases new customers. It also means we have a much different degree of difficulty in educating these new customers. You might then ask, how can we possibly go up against the giants in the embedded processor marketplace? Well clearly to do that directly would be very tough. Trust me, we're not attempting a frontal assault here. Our approach is unique. Based on the architecture of our ESP devices and our massive on chip interconnect offering the highest performance computing at the lowest power based on the applications that we've implemented to date.

This is accomplished by trading off which customer requirements are done in the imbedded processor being driven by software and which functions are implemented in the on chip programmable fabric. We call this using hardware to accelerate software. Perhaps a concrete example might prove useful here to enhance understanding. Virtually everyone's heard of mPEG 2, a widely used standard for encoding and compressing digital video. If you have a DVD, you've been using mPEG 2 whether you know it or not. Now decoding mPEG 2, while not trivial, is generally well understood and has been done in software driving microprocessors or in dedicated hardware and standard products in ASICs. Our systems folks felt we could use a well know standard, like mPEG 2 decoding, to showcase QuickMIPs unique capability. Since QuickMIPS has a powerful 32 bit MIPS 4KC pre-processor and programmable fabric on the same die.

They've written a white paper on the topic which is in final editing and will be available on our website in November. The first part of this paper does a very good job of summarizing the methods used to partition a system in order to accelerate performance by offloading software functions to hardware. The white paper then goes on to provide the detailed example of mPEG 2 acceleration. The bottom line - - we can accelerate mPEG 2 decoding using a QuckMIPS device by an order of magnitude. Yes, I did say a 10 times improvement in performance. Or, we can reduce the power used by the device by a whopping 75 percent compared to a software only implementation. These are pretty spectacular results from our perspective and from our customers' perspective.

Now don't get me wrong - - we're not going into the mPEG 2 decoding business. There are already enough guys beating each other's brains out in that business. What we are clearly demonstrating though is the irrefutable wisdom of using hardware to accelerate software. Need I say more? This is one way we believe we get the electronics industry off the megahertz treadmill. In the past, if a process didn't run fast enough for a customer, they bought a faster microprocessor. No problem you might say except it costs more, uses much more power and means you now need fans to cool the microprocessor. Stay tuned. I predict this capability to accelerate software with hardware in a standard product will, excuse me, let me start over. I predict this capability to accelerate software with hardware in a standard product will be a major advancement in the semiconductor business and is coming from a relatively small public company in Silicon Valley named QuickLogic. QuickMIPS design activity continues to build and we are now at a point where we expect several customers' designs to move into production over the next few quarters. And not a moment too soon, I might add.

The good news about QuickMIPS is that our customers can accelerate software with hardware using our device. We're pioneering here and to a certain extent, that makes revenue timing less predictable. Promoting a change in our customers' product architecture never comes easily, but when the benefits to them are this big, you know they will come. For change is inevitable especially when the economics are so compelling. You can feel free to quote me on that.

Okay, let me take a moment here today to review our product strategy which we believe can enable us to thrive, not just survive, in the face of the two primary, much larger direct competitors that we have. At a high level, our strategy is to bring this new product category we call imbedded standard products to market. ESPs for short. So how are these ESPs any different that what is being done by others in this space? Well, let's start with the most fundamental difference. ESPs are standard products which means the same product is sold to all customers and the customers then customize the functionality after they purchase the product. Contrast this to ASICs or the newest craze called the structured ASIC, which are both customized for the customer by the supplier in the supplier's factory. They're custom products. And what's the difference? First, you can't buy a custom product off the shelf which is another way of saying you can't buy one today and customize the functionality yourself which you can with an ESP.

Second, the economics for the buyer are very different between ESPs and ASICs. For example, there are no recurring engineering fees for ESPs. And of course the fees can be huge for an ASIC. Third, the customer's time to get their product to market is also very different. Typically weeks using ESPs versus many months for ASICs. So how are ESPs different from FPGAs? Well there are many aspects to the difference, but let's focus on just one today. The economics for the buyer We can put 32 times more logic on an ESP die when compared to an S-RAM based FPGA die of the same size. Or said another way, if a million gigs of logic in an ESP requires a die size of X, the S-RAM based FPGA would have to be 32 X. Sounds incredible, doesn't it? The open secret here is that not all of the logic on an ESP is field programmable. Much of the logic functions required by our customers are implemented using standard cell technology or fixed logic. So the functionality that customer is unlikely to want to change, Ethernet PCI for example, are implemented in fixed logic which is much more efficient from a die area perspective.

In the semiconductor business, die size is the major contributor of device cost. A 32 times die size advantage is most significant. So why can't the big guys make their die as small as ours you might ask at this point. The challenge of building complex ESP products, again, which are a combination of fixed functions and programmable logic on the same die, means you need a massive amount of on chip interconnect. We're not using S-RAM based technology like the big guys. We invented and developed our own high performance interconnect technology which we've extensively patented. We have nearly 100 patents and more pending with over half of our patent portfolio directly related to ViaLink. ViaLink offers the massive on chip interconnect required to make complex ESPs. I hope you can see that what we're doing with ESPs is differentiated from what the FPGA and ASIC suppliers are doing. I think the confusion about ESPs results from the fact that there are overlaps in the application set which some people see as head to head competitive situation. When you look into the value for the customer, I think you can easily see why we believe that the customer gets the most logic functionality in the shortest time at the lowest power and cost from the use of ESPs. At this point, let's review our overall product strategy at a fairly high level.

We've divided up the application space based on how our products are used into three segments. Gluing, bridging and computing. Both application and product complexity increase as we move from gluing to bridging to computing as does the value to our customer. Now our mature FPGA product families pretty much cover the gluing applications. We've been shipping the oldest devices of these families since 1991 and their revenue has grown 29 this year over last. As you may know, we've given our customers an end of life notification on the pASIC 1 and 2 families which generally serves to stimulate sales We do expect to see good revenue from these product families through 2005 and we expect that the growth of Eclipse II and Quick MIPS revenue will occur in time to overcome the decline of our pASIC 1 and 2 business.

We plan to continue to offer the pASIC 3 family for many years to come. Several customers are redesigning their applications using pASIC 3 as a replacement for the pASIC 2 family, as it is pin for pin compatible. I know some of you are concerned that we have a classic product cycle going on here, one declining and another growing, and can this happen so as not to cause an overall dip in revenue? Or even better, can overall revenue grow in the face of this product cycle? Well, we're watching this very closely and we're encouraged by the design activity around our new product families. Carl, back to you for guidance for Q4 then I'll come back and wrap up.

Thank you, Tom. We expect Q4 bookings to be higher than in Q3. Again, we expect to see our first significant orders for Eclipse II products in Q4. Our turns, which are only 57 percent of revenue in Q3 have been lower than we would normally expect. Many of our customers are placing orders with longer lead times than we typically experience. In addition, we are starting the fourth quarter with lower starting back log than we had entering Q3. Given our back log profile entering the quarter, and the bookings consideration mentioned above, we are providing guidance that Q4 revenue will be down mid to high single digits sequentially.

Gross margin is planned to be between 47 percent and 51 percent of revenue in Q4. We expect to have margin pressures due to high initial production costs for our new .18 micron products, higher production variances than we experienced in Q3, and due to reduced benefit from the use of reserved inventory. We expect our research and development expenses to be sequentially lower in Q4 by up to $400,000 primarily due to the production release of or Eclipse II and QuickMIPS devices in Q3. The winding down of these projects is expected to reduce our expenses for masks, pre-production material and qualification activities in Q4. We expect that selling, general and administrative expenses could be higher by $300.000 to $600.000 sequentially due to higher Sarbanes-Oxley compliance costs and marketing costs associated with our new products.

Interest income and other net includes interest income on invested cash, foreign exchange gains and losses and interest expense on borrowings. During the third quarter, the net expense was $9,000. We expect that interest income and other net will be an expense of less than $50,000 in Q4. If the value of our Tower shares remains below $3.40 per share at the end of our fiscal year, we may incur a charge to our P&L for the write down of marketable securities during the fourth quarter. We may use up to $3.5 million of cash during the fourth quarter due to an increase in inventory of our Eclipse II and QuickMIPS devices, an increase in our days of accounts receivables, and capital expenditures of up to $600,000. In addition, we have $2 million outstanding under our revolving line of credit at the end of Q3 and we may decide to repay these funds in Q4.

Let me take a moment to confirm our financial strategy. Our primary financial goal is to return to profitability by increasing revenue and gross margin dollars. We believe our new Eclipse II and QuickMIPS products will play a significant role in our revenue growth. The interest from customers to use these products in their new designs is the highest we have seen in the history of QuickLogic and we are continuing to add significant opportunities to our key design funnel. Our manufacturing strategy is to reduce the cost of producing our products so that we can pursue higher volume sales opportunities. We believe that fabricating products on smaller geometry technology at Tower will reduce our unit costs We are also actively reducing our other costs of sales by reducing the time and cost needed to test and program our products. As a result of our focus on profitability, we continue to carefully manage our expenses. We expect that our development project expenses will decline in the short term and we are carefully managing new hires. In general, we must believe new hires are essential to our new product or revenue objectives.

Our financial model based on our goal is $25 million of quarterly revenue as stated as a percent of revenue and to generate a gross margin of 60 to 62 percent of revenue, to have research and development expenses of 17 to 19 percent and to have SG&A expenses of 19 to 21 percent. This would result in income from operations of 20 to 26 percent of revenue. Our current expectation is to achieve breakeven operating profit at approximately $13 to $14 million pf quarterly revenue in n the first or second quarter of next year. We expect that our Eclipse II and QuickMIPS products will be a significant source of the revenue growth required to achieve profitability. Please remember, we have made forward-looking statements in our presentation and we will likely make others in the question and answer period following our prepared remarks. Our actual results could differ materially. Please review our SEC filings for specific information on the risks and uncertainties that we face. Let me turn the call back over to Tom.

Thank you, Carl. Before we wrap up our remarks here today, I specifically wanted to comment how pleased we are to welcome Arturo Krueger to our Board of Directors. Arturo is the past general manager of Motorola Semiconductor for Europe, Middle East and Asia and has been a guiding light in the acceleration of the adoption of semiconductors into automobiles. Arturo joins us at a crucial time in our exploration of the infotainment sector of automotive electronics and we look forward to his broad experience, clear thinking and astute strategic marketing talents. Welcome aboard, Arturo. In closing, Id like to extend my sincere thanks to Henry Montgomery, our recently departed product committee chairman. We have valued Henry's contributions to our understanding of this changing world of Sarbanes-Oxley and its implications for our business. Henry's contributions will continue to live and serve us well into our future. As we used to say in the Navy, fair winds and following seas to you, Henry. To fill the vacancy by Henry's departure, we have appointed Mike Callahan, Interim Chairman of the Audit Committee and Gary Tous has joined the committee. We're in the process of actively recruiting a replacement.

Now for your scheduling purposes, our 2004 earnings conference call is scheduled for Wednesday, February 2, 2005 at 2:30 pm Pacific Standard Time. IF you have the opportunity, we'll be presenting at the B. Riley conference on November 4th at the San Francisco Marriott and the Needham Conference in New York City between January 11 to 14 of 2005, which is of course before our next earnings call. Details of these can be found on our website at www.quicklogic.com. Okay, let's open up the call now for questions. Steven, please.

(Operator instructions). Our first question comes from Robert Kappes of Sunvest. Please go ahead.

Hi, Tom and Carl. Nice quarter. I have a question about I guess revenue guidance Q1 and Q2, you sort of suggested that there was going to be a pretty significant revenue ramp. And can you talk a little bit more about the type of products that your products will be going into?

Well, first of all, we're not forecasting revenues beyond Q4 so you don't really have guidance for that. We told you what we think will happen relative to profitability but we haven't given you specific guidance for Q1 and Q2. In terms of where we think that's going to come from, that additional revenue, we think it will come from Eclipse II and QuickMIPS and the applications are across a pretty broad set of requirements by customers. If you look at Eclipse II, as I just mentioned, we've got a lot of activity going on in bridging relative to WiFi. And I would suspect that some of the biggest opportunities, revenue opportunities we see for next year really will come out of that sector. People that build PDAs build them in millions of piece quantities and so while not forecasting that that's what we're going to do, that's the kind of opportunities that we're looking at which we've never been exposed to in the past. That's a direct result of the fact the Eclipse II offers this very, very low power bridging capability. The QuickMIPS area, we're looking at applications in digital signage. We've talked before about the KBM area, we think that will turn on by early next year. So those are the kinds of opportunities there.

This is - - programmable logic is used across a very broad range of product categories. I mean, we're seeing things that I never would have thought - - I guess if you think about it after the fact, you can see how it makes sense, but medical equipment, as an example, it wasn't obvious to me necessarily that you would want that to have 80211 WiFi capability and in fact, we're seeing opportunity for that. Remote printers There's just a very broad range of product categories, Robert

Where are you seeing the weakness in the out coming quarters? Is there a cross sell product category? I know test and instrumentation is a pretty large portion of your revenues and many of the semi cap guys are sort of suggesting that Q4 is weak. Can you give us a little more light of where the weakness is coming from in Q4?

Well, there is generally a softening in our sector and a lot of people guided down pre-announced for the quarter. So we're in some pieces of our business seeing a little bit of softness and that has been hitting us a little bit in instrument and test last quarter. On the other hand, our mature products are doing very well and are counterbalancing some of that softness.

You know, I think there's just a lot of nervousness in general about the market, Robert. If you look at everybody, you know, all the PLD guys have guided down sequentially. And well I guess that's not true. Zylinx and Altera have guided down sequentially. The big guys guided down. And we don't see anything specifically that gives us this caution, but you know, you don't get any points out of being bullish and missing it. So we'd rather be pessimistic and exceed it than be optimistic and underachieve it.

Do you manufacture only at Tower or do you manufacture at TSMC at well?

We manufacture our mature products, actually pASIC 1 and pASIC 2 are still manufactured for us by Cypress in Round Rock, Texas and the reason we are doing an end of life there is because our contract with them is coming to an end at the end of 2005. We manufacture pASIC 3 and the ESP products at actually at TSMC and the advanced ESP, the first member of the advanced ESP family, the Eclipse family is also built there. And then the Eclipse II and QuickMIPS are built for us at Tower.

And is that a..18 or .13?

.18.

And when will that migrate to .13? Or is that not on the roadmap?

We haven't stated that publicly yet.

Okay, I'll cede the floor now, Tom.

And as a reminder, if you do wish to ask a questions, please press star one on your touchtone telephone, And we have a question from Gary Mobley of B. Riley & Company.

Can you give us a little color on the increase in the military and aerospace business during the quarter as well as for the graphic, too?

In terms of military and aero, you know we have a very good customer base there and we really benefited from some customer military buying cycles in Europe. And that really took our numbers up for the quarter. That was the main driver for the increase. In terms of the graphics and imaging, we have a handful of customers that all contributed to our growth.

I'm not sure you're willing to do this, but what's your best estimate as to what semiconductor capital customers represented in the quarter, Paradigm, LTX and [inaudible].

I haven't run those numbers yet, but I could, I guess I would say probably between 10 and 15.

Yeah. I would say that would be a safe number.

Okay and to the previous question, and I don't want to beat the topic to death, but is that the primary reason for your cautious stance on the fourth quarter? How much visibility do you have there in terms of your customers business declines and what their demand may be for the fourth quarter?

We think our bookings are going to be very strong in the fourth quarter. The thing we've got that's kind of balancing that a little bit is we expect several of these orders, which are significant, to be requested for delivery in Q1 and Q2. And that's what's really given us our conservative stance for the fourth quarter.

You guys have a high turns business model and I would assume you're not really suffering so much from an inventory crunch but just really more in demand. Is that a fair statement?

Well, that's for us, but that may or may not be necessarily true for our customers. If they've got a big lot of inventory from other people that they need to build their systems and they're not building systems as fast, they won't order from us. So while they don't have a lot of inventory to burn off from us, the effect is still the same. They wait to order it until they need it.

All right. Thanks, guys.

Thank you, Gary. The good news by the way there is we don't have the inventory liability. You don't have people trying to return it to you. And your distributors aren't trying to return it to you because there isn't anything on the shelf. S that's a very strong plus for us. But our part doesn't build the complete product for our customer and if he's got more than enough than he needs for his run rate, he isn't going to be ordering ours either.

We have a follow up questions from Robert Kappes. Please go ahead.

Hi. I have a question about the fluctuations in gross margin. I know there's some variances and write downs of inventory and start up costs with, I guess, new wafers. But in general you're an established company. What should sort of a steady stay gross margin be? And how much variance is also due to volume?

We feel that we can drive our gross margins to 60 percent which we had in Q2 over time. We feel very good about our gross margin and last quarter's margin it would have been 56.5 percent except for the write downs. But we feel like we're in a pretty solid margin position. What we've got going on though is that we're at a new facility with Tower on a new technology, .18, and we expect to have higher production variances primarily due to that activity in the fourth quarter. In addition, we're building some material for our pASIC 1 and pASIC 2 products and so our activity out of the fab in Q4 is probably a little bit higher than our demand and that's causing our variances to be a little bit abnormally high in Q4 as well.

Okay, so that's because the Cypress fab is really into light stuff, lower gross margin?

I think the products there have very high gross margins but if we're producing 2 or 3 quarters worth of die in one quarter, we're going to get 2 or 3 quarters worth of variances. So our costs are in line and our revenue and gross margin in that business is very good. It's just the timing of when we're building the inventory that's going to drive our variances higher in Q4 both at Tower and at Cypress.

So you're estimating that by Q1, all things being equal, your gross margin should go back to where they would have been this quarter?

Right. I would - - don't quote me on that, but that concept is right.

Okay, thanks.

We have a question from Mike Barry. Please go ahead.

Hi guys, nice quarter. You're starting to remind me of that little engine that could. On behalf of the shareholders I'd like to welcome Arturo Krueger to the board and I hope that his recruitment is a signal that you're making some traction in the automotive segment. Last January you announced that you have an alliance with Oasis utilizing their most networking technology for automobiles. I'd like to try and get a little bit of understanding of that. Is it correct that every device that would hook up to that most network would have to have a QuickMIPS PLD?

No, that's not correct. The device that connects directly to the network is a device from Oasis, so you can think of that if you will as an intelligent Fi. If you're familiar with the Ethernet model, where you have a physical layer and you have a mac layer, we're more we're more equivalent to the mac layer, if you will. So we don't hook directly to a network. We hook to a device that hooks to the network. And there are other people that could do that as well. That interface is called MLB and that's the one that we're dealing with.

If I remember right, that's Media Link Plus?

Yes.

Can you give some idea of what kind of revenue you'd get on that then for automobile?

We haven't made public those forecasts yet. It's really, really too preliminary for us to really make that public.

Could you comment on how preliminary it is? Are you making progress in penetrating the market?

Well penetration - - if you're familiar with the automotive market, penetration is a very long, drawn out situation with the car manufacturers themselves. And of course their major suppliers, first of all, this stuff would not be sold directly to car manufacturers. This would be sold typically to the tier one suppliers, the Visteons, the Boshes, the Siemens VDO, the Parmen Becker, or what are typically called the tier one suppliers for the infotainment sector of automobiles. But we're looking to get earlier revenue than we would have gotten out of just the automotive channel is from both consumer and from the after market sales, so the after market guys move a lot faster than the tier one guys do. So that's at 100,000 foot telling you what it is we're doing there. We're not really ready to talk about revenues yet at all.

I appreciate that. On one other topic, it sounds like you're looking for some significant traction in 2005 in the wireless and WiFi area. Could you comment on the wireless USB standards and do you see that becoming the standard for the home entertainment area?

Well, we've certainly got folks looking at USB on the go and USB wireless and it appears that there's clearly going to be a place for that. But I can tell you in the short term, our energy is really focused on WiFi 802.11 AB&G and providing connectivity to that. So that's our focus for probably the next several quarters. And yes, we are betting on that big time for significant revenue in 2005.

Last question. On your recently announced partnership with Renaissance, can you give us a little more color on that? In terms of when we might see a revenue stream?

Well again, it's 2005, we believe. I think there'll be a relatively small amount of revenue in Q4, but 2005 is what we're betting on.

Thank you very much.

And we have a follow up from Gary Mobley. Please go ahead.

I just wanted to follow up on the topic of pASIC 1 and 2 and the end of life. Though your mature products is about 60 percent of your overall revenue and that includes pASIC 1, 2 and 3. I would assume p1 and 2 are the majority of that mix and you expect by the end of '05 that to go away as you conclude your relationship with Cypress?

Gary, they were 43 percent of our revenue last quarter, those two devices. They were 38 percent in Q2. So you can see, as Tom mentioned, we're getting a good up tick from end of life activity on those parts and we think we're going to have customers take a lot of this product all through next year. But we do think it will trail off after that. And really two things are going to happen. One is, customers will buy - - or 3 things. Customers will buy sufficient quantities to meet their requirements past 2005. We're seeing a lot of that activity. The second thing is that a customer that used pASIC 2 may decide to redesign their application to use our pASIC 3. We're starting to see that as well. Then finally, they could redesign to a competing product. That business looks to be very strong for us through next year but we do expect it to tail off after that.

We did want to extend the horizon that we could provide those products and we believe we'll be able to get parts from Cypress after the end of our contract. But we don't have a commitment on what volume we can expect on a monthly basis. And because we don't have a commitment, we couldn't make a commitment to our customers, We thought the best thing to do to our customers was to let them know in advance, give them plenty of notice to place their lifetime buys so they could be sure to continue to ship their products as they planned.

Sure. Would you anticipate carrying a hefty amount of inventory at the end of '05 as old customers transition?

I don't think it's going to be healthy by any stretch. We're expecting to get most of the orders from our customers by the end of Q1. We can build those parts at Cypress all through next year, so we're planning to build most of the inventory for back log. We may speculate on it a little bit, but we don't have any definite plans at this point.

Why are you not continuing your contractual relationship with Cypress?

Well, it was a great deal for us. Cypress honored the contract through the entire term. They've been a good partner. But they did not want to extend the agreement so we didn't have a choice.

When we looked at this a year ago, Gary, they were seriously considering shutting down that fab. They've now changed their mind about that, but we can't - - they don't want to be constrained to what they do with that fab based on their contractual commitments to us.

Okay, so as long as they continue to operate it, you feel you can get parts from them but they don't want to be under a contractual relationship?

Got it.

All right, thanks guys.

So with any luck, we'll still be selling this stuff in 2007.

And our next questions comes from Luke Williams of Micro Capital.

Luke Williams. Good afternoon gentlemen. I wonder if you could tell us whether you've experienced any specific reactions by Zylinx or Altera to what you are doing and to what extent do you face direct competition for Eclipse II and MIPS II. And then go into some detail about the role of your [inaudible] portfolio.

Well, in terms of direct competition, we seem to have an echo here, somehow. Steven, can you fix that?

Just one moment, Sir. Okay, go ahead, sir.

Okay, Luke, are you still there?

Yes, I am.

In terms of direct competition from Zylinx, Altera - - let's go back a little bit here. When we first introduced ESPs, actually they very quickly brought out products or relatively quickly brought out products, announced products and then brought out products, that had similar functionality. We started with memory and then we added imbedded computational units which they also did as well. And then we brought out QuickMIPS. Actually we brought out before that a PCI controller, 56 megahertz 64 bit PCI controller, which they did not bring out a counter to. But when we got to the QuickMIPS level of ESPs, they brought out devices - - actually they announced that they were going to do the whole wire front of devices. And eventually they brought out - - Zylinx brought out devices with power PC and Altera brought out devices with R9. They have not extended those devices significantly beyond that like QuickMIPS.

One of the major differences in QuickMIPS is that if you look at it, you'll see that it really is an out of the box micro computer. In other words, it will run, it will boot and run Linux of VX Works, or any of these other operating systems like Windows CE or QNX, or Integrity from Greenhills. It will run all those straight out of the box and none of those can run directly on the Zylinx or Altera part straightaway. You've got to add a lot more functionality around those devices. So you might say well why wouldn't they do that? Why wouldn't they just add that functionality and make it be a more complete solution? And the answer there, of course, gets back to this whole issue of on chip interconnect. The more hard wire logic they add, the more interconnect they have to have and the S-RAM technology, one of the things that it's not good at is on chip interconnect. And of course ViaLink excels at that. So that's one of the reasons you haven't seen them bring out more complete solutions.

When you say we have competition from them, we always have competition from those two guys. They're the 800 pound gorillas. Are they targeting on us specifically relative to QuickMIPS? I don't believe so. I think our solutions are different that theirs. We allow this tradeoff, this easy tradeoff, between hardware and software, or accelerating software by the use of hardware, which they don't offer. And again, that's an architectural issue. So from a QuickMIPS perspective, we don't see them head to head there at all/ In terms of Eclipse II, the very, very low power capabilities of Eclipse II -- none of their S-RAM devices come close to that. Let's talk about their newest one, from either one of them. You're talking about hundreds of mils of current versus micro amps. So you're talking about several orders of magnitude different in current between the two solutions, And therefore there's no comparison. Now the only exception to that might be the CPLDs. CPLDs that they offer have very low current. But they don't have any memory. So you have to - - by the time you go add memory to that and in most of these bridging applications require memory. Then you're back up to much higher currents. So as I read to you today, and as we've had customers tell us, we're the only guys that can offer these very low power bridging applications.

And finally, the last area that we really are head and shoulders above them is the whole area of intellectual property security. There is virtually no IP security associated with an S-RAM based FPGA in that the code, you have to reprogram the device every time you turn the power off. So when you go to use it again, because the memory is volatile, you've got to reprogram the device and that means that active reprogramming is susceptible to being intercepted and copied or cloned. And therefore the intellectual properties in an S-RAM based devise is not secure. Ours is bullet proof as we describe it, owing again, to the inherent characteristics of ViaLink. So that's kind of a maybe 25,000 foot overview. Probably more than you wanted to know, but I hope that answers your question.

Yes, it does. Thank you very much.

Our next question comes from Robert Kappes.

It sounds like you're trying to go after some higher volume markets.

You broke the cod, Robert.

What does that - - what are the implications on your ESPs? Has there been a trend towards lowers ESPs as you sort of dip your toes in these higher volume markets?

[technical difficulty] over the last several quarters we shipped into China. We shipped over a million units to one customer. And we came out of that with a strong belief that we have very good back end costs and we felt that with our .18 micron technology, that we could achieve the die costs that we need to compete in those kind of volume applications. So our Eclipse II parts are really designed to go after, one of the families in particular is designed to go after sub $5 business. And we feel very good about that. No other parts go for as high as $30- or $40 in that family. But we feel very well positioned for volume opportunities with our Eclipse II devices.

And the margins on these sub $5 parts are at your target as well?

It's on a case by case basis. We are not turning down business if it's less than 60 points of margin if it's significant.

That's good to know.

We're not driven by gross margin percentage, we're driven by gross margin dollars, so we're well in tune to that reality.

And you sort of just touched on it, but on the IP security for the networking area - - and I know a few quarters back you talked about this as showing meaningful interest in your products. I think that was sort of around when Cisco was having problems with Wally in China. With IP protection. Has any headway been made there? Not necessarily Cisco, but in that area?

Yes, there has, but the people that we've made it with don't want to talk about it. In fact, it's interesting. We program about 75 percent of the devices that we ship, we program. Those guys are so nervous about their IP that we don't program their parts for them. They program them themselves.

Great. Thank you very much, guys.

Okay, Robert. Our pleasure. Okay, well thank you very kindly for your interest in QuickLogic. We're going for it folks and Eclipse II and QuickMIPS are the answers. We still believe that and we look forward to seeing you after the first of the year. Take care.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day.