慧榮科技 (SIMO) 2008 Q2 法說會逐字稿

Good day ladies and gentlemen and welcome to the second quarter 2008 Silicon Motion Technology Corporation earnings call.

My name is Clarissa and I will be your coordinator for today.

At this time all participants are in a listen only mode.

We will be facilitating a question and answer session towards the end of this conference.

(Operator Instructions).

This press release contains forward looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 as amended.

Such forward looking statements include, without limitation, statements regarding trends in the semiconductor industry and our future results of operations, financial conditions and business prospects.

Although such statements are based on our own information and information from other sources we believe to be reliable, you should not place undue reliance on them.

These statements involve risks and uncertainties.

And actual market trends and our results may differ materially from those expressed or implied in these forward looking statements for a variety of reasons.

Potential risks and uncertainties include, but are not limited to, continued competitive pressure in the semiconductor industry and the effect of such pressure on prices, unpredictable changes in technology and consumer demand for multimedia consumer electronics, the statement of any change in our relationship with our major customers and changes in political, economic, legal and social conditions in Taiwan.

For additional discussion of these risks and uncertainties and other factors, please see the documents we file from time to time with the Securities and Exchange Commission.

We assume no obligation to update any forward looking statements, which apply only as of the date of this press release.

I would now like to turn the presentation over to your host for today's call, Mr.

Riyadh Lai, Chief Financial Officer.

Please proceed.

Thank you Clarissa.

Good morning everyone.

Welcome to the Silicon Motion second quarter 2008 financial results conference call and webcast.

With me here is Wallace Kou, our President and CEO.

The agenda for today is as follows.

Wallace will start with a review of some of our recent business developments.

I will then discuss our second quarter financial results and provide our outlook.

We will then conclude with Q&A.

Please also note that we are using presentation slides for our webcast which offer highlights from the quarter.

So I would encourage anyone who has dialed into the conference call to click on the IR section of our website and view the slides there.

For more details on our financial results, please refer to our press release which was filed on Form 6-K after the close of market yesterday.

This webcast will be available for replay on our website, siliconmotion.com for a limited time.

To enhance investors' understanding of our ongoing financial performance, we will discuss non-GAAP information during this call.

We use non-GAAP reporting internally to evaluate and manage our operations.

We have therefore chosen to provide this information to enable you to perform comparisons of our operating results in a manner similar to how we analyze our own operating results.

A full reconciliation of the GAAP to non-GAAP financial data can be found in our earnings release issued yesterday.

We ask that you review it in conjunction with this call.

With that, I would now like to turn the call to Wallace.

Thanks Riyadh.

And thank you everyone for joining us today.

The second quarter turned out to be an extremely challenging period for us.

We certainly understand that a number of our shareholders are unhappy with us right now, but I do want to make sure that you all understand that our business and our long term prospects remain intact.

It is also because our business model key growth driver and long term prospects remain intact that we did not pre-announce.

We're trying to get away from making interim announcements and do focus on quarterly announcements unless there was an extraordinary issue.

This is also the first time since our IPO that we have missed guidance.

Riyadh will take us through the financials in more detail.

But before that I would like to take a moment to provide a very brief recap of our overall first half revenue performance.

In the first quarter we exceeded our revenue guidance by well over $6m.

In the second quarter we fell below our guidance by $3m to $5m.

In sum, our first half revenue performance came in line with our internal expectations though obviously there was some volatility with our strong first quarter being largely offset by our weak second quarter.

That said, our second quarter did not meet our expectations.

Our revenue fell to $48.6m which was below our guidance.

Net income was $8.8m, or $0.26 per diluted share.

Our gross margin was 47.3%.

While still strong, it was also below guidance.

Again, Riyadh will discuss numbers in more detail and provide guidance for the third quarter shortly.

Overall we faced a few different specific challenges, but I would also like to reiterate that our key growth drivers remain intact.

Let me begin with the key challenges to our business.

Our mobile storage products did not perform according to our plan in the second quarter and added to our overall revenue shortfall.

Sales were unfavorably affected by weak demand from many of our customers, both from our retail as well as bundled card controller segments.

Strength in our first quarter in our mobile storage revenue performance were partially offset by weakness in the second quarter.

Our retail card customers were negatively affected by both higher NAND flash prices during the early part of the second quarter, as well as softening of end consumer demand, primarily in Europe and the US starting in quarter.

Our sales into China met expectations, but were nevertheless negatively affected by the devastating earthquake in Sichuan.

In the second quarter NAND flash vendors started reducing their capacity and therefore also reduced their sale to OEM cards.

As a result, their procurement of controllers from us declined.

Our handset bundled business also underperformed, but mostly because of temporarily product transition issue.

Handset OEMs began taking advantage of improved affordability of the NAND flash latest quarter to transition from bundling lower density cards to bundling higher density cards.

Our storage products shipment was up 31% compared with the same quarter a year ago which happened to be a phenomenal quarter.

Sequentially, our storage shipments were down about 11%, but bear in mind our first quarter of this year was also a strong quarter.

Our second quarter storage shipments were also significantly higher than our fourth quarter of 2007, which was our biggest quarter last year.

Clearly our storage products are still growing and growing in line with the market.

Based on our latest estimation of the memory card market, we believe the market will grow about 40% this year in unit terms, from about 700m cards last year to about 970m this year.

We believe we should be able to maintain the same 35% market share that we had last year or higher.

We believe our business remains intact.

And our card controller growth will be driven by camera phones with higher pixel count cameras that require memory cards.

Our revenue for card controller business could grow approximately 5% a year for the next few years.

But it could grow faster if captive players will begin outsourcing, when next generation flash, such as 40 and 30 nanometer flash which have got more complicated controller, starts shipping in the fourth quarter.

And when preloaded and downloaded multimedia content such as games, movies, TV shows and music play an even more important role in mobile devices, we strongly believe flash controller will play an even more important role in the future.

And our addressable market is far from being saturated.

Our business also had other important positive elements.

Increasingly affordable NAND flash continued to create new opportunities for us in SSDs, embedded flash and for non-consumer applications.

This quarter we won embedded flash controller business at Hynix and Numonyx for eMMC solutions designed for Tier one global handsets and GPS OEMs.

We also won embedded flash controller business at Micron for an eUSB solution targeting enterprise storage applications.

Importantly, we have already started shipping some of these embedded flash controllers.

Our embedded flash controller for handsets is on track to ship in the fourth quarter.

We believe the embedded flash controller addressable market is potentially at least as big as the memory card business.

Embedded flash could potentially be found in all mobile phones and other devices, both mobile and stationary.

Embedded flash is a compelling product to device makers because, increasingly, just about every device needs storage for data and code.

Data storage requirements continue to grow.

And embedded flash and embedded storage controllers play more important role managing the embedded flash and interacting with the data protocol of the whole devices.

SSD are the key growth drivers and are further along than embedded flash controllers to becoming relevant contributor to our revenue and profit.

This quarter, we shipped over 1m SSD controllers for ultra low cost PCs and other applications with a big part of our sales going to ASUS eeePC and HP Mini-Note.

We also shipped increasing numbers of SSD controllers for industrial and enterprise applications.

Separately, we are on track to release potential customers additionally engineering samples of our recently announced series of best in class MLC SSD controllers in the third quarter and expect to begin production in the fourth quarter.

Best in class MLC controllers will play an important role in more wider spread adoption of SSD by notebook PC manufacturers whether for mainstream products or low cost products.

We believe this year the size of the low cost notebook PC market will probably be smaller than expected, in the 6m to 8m unit range given limited availability of the Atom processor from Intel.

We believe the SSD market will be more meaningful in 2009.

Next year we expect to see more meaningful adoption of SSD controllers and applications.

Our mobile TV IC revenue increased over 31% in this quarter.

Our overall communications products now account for 21% of our total revenue.

We continue to have the leading position in Korea, our home market for this business, and have a developing presence in China with local handset OEM customers that include ZTE and Amoisonic.

We remain excited about our mobile TV business and believe we have one of the most comprehensive and competitive portfolios of mobile TV solutions, including for T-DMB, S-DMB in Korea, DVB-H in Europe and Asia, C-MMB, T-MMB in China and ISDB-T in Japan and Brazil in the global market.

We are investing and have original technology roadmap for mobile TV.

We're accelerating our tape-out for newer products which is resulting in R&D spending that is higher than we have had in the past.

I would like to point out that we think it's particularly important to take advantage of this point in the market to redouble our effort on R&D side.

We do not, and we will not, slash R&D spending and risk our long term growth to manage short term expectations in the market.

Within our R&D effort, we are accelerating our development and tape-out of more integrated solutions which combine tuner and demodulator in the SiP or SoC form.

Solution is a more advanced geometry node such as 90 nanometer and 65 nanometer.

It's multiple bands such as UHF, VHF and L-Band and a multiple node products that combine, for example DVB-H, T, T-DMB, DAB plus and FM.

We acquired a small demodulator company last year, in May last year.

And we are also developing our own demodulator technology.

And we have also license from Samsung Mobile and others.

And we continue to work aggressively with selected third party demodulator partners.

In the second quarter we tape-out our T-DMB SoC at the 90 nanometers.

This product is undergoing qualification test by OEM customers right now.

And it's targeted to enter mass production in the fourth quarter, and the first quarter next year.

Our DVB-H, ICBT and CMMB SoC will tape-out either second half '08 and in 2009.

We will like to caution that until our SoC products are shipping in volume, our mobile TV product margin will be continuing to be negatively affected.

Lower gross margins on our communications product line drag down our gross margins from now until early next year.

Our mobile communications and mobile storage products are all facing strong competitive pricing pressure.

Maintaining product margin and managing operating expense are all important factors in our business today.

For our mobile communications products, in order to add more value to customers, we are rolling out more integrated solutions and best in class internal reception sensitivity, power consumption, hi-fi and other factors.

In order to reduce the cost, we are rapidly shifting our geometry to finer nodes and to more competitive manufacturing processes.

For our mobile storage products, we are also facing strong competitive price pressure.

In order to reduce costs further in the second quarter, we began moving some production to [Setera].

We also actually redesigned the layout of our controller at the current technology node to make them smaller and thereby cut even more dies on a single wafer.

We have also been chosen to be more selective about our choice of customers which has enabled us to keep mobile storage margins stable.

We are actually reviewing our operation expense for the second half and put in place a global headcount freeze, although we will selectively upgrade as required.

To summarize, market conditions are increasingly challenging but we believe our growth drivers are intact, especially for mobile TV and for SSD controllers.

Our memory card controller are still growing rapidly, through more in terms of volume than revenue.

Our card controller growth could improve if certain factors materialize.

We are also still at the initial stage of embedded flash adoption.

I will also add that we are also increasing focus on protecting our margin while increasing our value add, reducing manufactured costs and selectively choosing business.

Finally, and I want to say again, we strongly believe that technology will not stay static.

So it is important for us to continue spending aggressively behind R&D to stay ahead of the curve and well position us when global economic conditions recover.

I will now turn the call to Riyadh.

Thank you Wallace.

First I will outline our financial results for the second quarter and then I will provide our guidance for the third quarter and the full year.

Our second quarter revenue of $48.6m increased 2% year over year and decreased 7% sequentially.

Mobile storage products accounted for 73% of sales, mobile communication 21% and multimedia SoC 10%.

Mobile storage revenue of $35.4m decreased 6% year over year and decreased 14% sequentially.

Primarily because of reduced memory card controller sales.

Storage controller shipments increased 31% year over year and decreased 11% sequentially.

Mobile communications products of $10m increased 126% year over year and increased 31% sequentially.

Primarily because of a significant increase in mobile TV sales.

Multimedia SoC revenue of $3.2m declined 43% year over year and increased 8% sequentially.

In the second quarter we did not have any 10% customers.

Samsung was no longer a 10% customer.

Our overall sales to Samsung declined sequentially because Samsung significantly reduced its manufacturer OEM memory cards.

Overall TV sales to Samsung, however, increased significantly sequentially.

Gross margin was 47.3% and well below our 52%, 53% gross margin guidance.

The sharp decrease was due primarily to a rapid shift of communications products from higher margin tuners to lower margin SiPs which combines our tuner with procured modulators, as well as a $1m write-off of mainly obsolete MP3 SoCs, image processor SoCs, and card reader controllers.

Gross margin for our mobile storage and multimedia SoC products in the second quarter were unchanged from the first quarter.

Operating expenses were $14.5m in the second quarter which was higher than in the first quarter.

R&D expenditures were $8.9m, which was higher than in the first quarter mainly because of new project expenses.

Selling and marketing expenses were $2.3m in the second quarter, unchanged from the first quarter.

General and administrative expenses were $3.3m, unchanged from the first quarter.

Stock-based compensation was $2.2m in the second quarter, unchanged from the first quarter.

Acquisition related charges in the second quarter were $1.6m, unchanged from the first quarter.

Litigation expenses increased slightly from $0.6m in the first quarter to $0.7m in the second quarter.

Net total other income was $0.6m, unchanged from the first quarter.

Foreign exchange losses were reduced from $2.7m in the first quarter to $0.2m in the second quarter.

Net income of $8.8m decreased 44% year over year and 43% sequentially.

Diluted earnings per ADS of $0.26 decreased 44% year over year and 41% sequentially.

GAAP net income of $2m decreased 78% year over year and 76% sequentially.

Diluted GAAP earnings per ADS of $0.06 decreased 78% year over year and 76% sequentially.

GAAP net income was also negatively affected by a one-time $2.1m FIN48 tax charge which relates to uncertainties about income tax liabilities that have resulted from an arbitrary change in interpretation of tax codes by the Taiwan tax authorities following a routine review of our tax filings.

A full reconciliation of GAAP to non-GAAP financial measures can be found in our press release.

At the end of the second quarter cash, cash equivalent and short term investments were $95m, down from $112m at the end of the first quarter.

During the second quarter, the Company acquired $4m of office space in Shanghai to house our expanding R&D team and repurchased $25.2m of our American Depositary Receipts.

The Company had 78 days of average inventory in the second quarter, higher than our two month target but well below the 84 days of a year ago.

I will now move on to our guidance.

When we provided our 2008 full year guidance earlier this year, we had factored in the impact of the global economic slowdown.

However, we believe we may have underestimated the severity of weak global consumer confidence for the second half of 2008, especially as it relates to our mobile storage products.

We believe that since economic slowdown and related consumer confidence weakness is already leading to closures of older NAND flash fabs and push out of investment in new flash capacity, it is prudent that we take an even more conservative view regarding the second half of 2008.

That said, our sales of mobile TV solutions are tracking well.

And we expect sales of these products to scale further during the second half of 2008 and will become a larger part of our product mix by the end of the year.

We are on track in terms of our MLC SSD controller sampling and production timetable.

Sales of multimedia SoCs are expected to grow moderately in the second half of 2008.

Third quarter revenue is expected to be approximately $44m to $46m, which represents a 0% to 4% decrease year over year and a 5% to 9% decrease sequentially.

Third quarter gross margin is expected to be in the 48% to 50% range.

For the full year we expect revenue to be approximately $200m to $205m, which represents an 11% to 15% increase year over year.

Full year gross margin is expected to be within the 48% to 51% range.

We now anticipate our full year EPS to be approximately $1.30 to $1.40 based on fully diluted shares of 33m to 34m shares.

We will now open the call for your questions.

(Operator Instructions).

And your first question comes from the line of Quinn Bolton of Needham and Company.

Please proceed.

Hi guys.

I just wanted to try and get a sense from you what you think your longer term gross margin is.

I know you spent a lot of time in the prepared comments saying that you don't think your long term growth is affected by the short term weakness.

But it looks like you've taken a pretty big hit to gross margins, certainly on the mobile TV side.

But just trying to get a sense where you think long term margins -- should we be thinking something around the 50% level?

It looks like it's going to be tough to get back to 52% to 53% that you were at for most of the past two to three years.

And then I've got a couple of follow ups.

Quinn, for the longer term we're shooting to have our gross margin in the 50% plus range.

But in the shorter term, obviously second half year, it will be difficult.

And we will certainly provide a better guidance as we get closer to the end of the year.

But for the time being, what we are targeting is to get our gross margin up to the 50% plus range as our target for the foreseeable future.

And the mobile TV, the reason you think the margin has improved there early in the year is that at that point you'll have integrated SoCs that combine the demod and the tuner, so you won't have to purchase third party demods and package that in the system in a package solution?

That's correct.

Okay.

Second question, can you just talk about the -- I think Wallace you mentioned some die shrinks across multiple product families.

But I'm, I guess, particularly interested in the SSD -- sorry not the SSD -- the SD or MMC controller space.

Can you say where you are now and what the road map is and what kind of cost reductions you think you can achieve with those die shrink programs?

So our target in the next three months is on 10% cost reduction for SD and MMC controller product line.

We're moving certain lines from SMIC to [Setera].

So we believe we can achieve our target line around Q4 time frame.

Are these -- at this point are controllers die pad limited or is there -- or do you see that, yes, there is still fairly significant cost reductions that you can do if you migrate down from say 0.16 to 0.13 ultimately to 90 nanometer.

Are there limitations to scaling that you see in the core SD controller business?

I think SD controller you have products into the high end and low end for bundle.

High end we see in the future it become more complicated, because entering fourth quarter we're going to see 40 nanometers, 30 nanometers and potentially [0.3] come to the market.

So the controller requires much more advanced error correction engine, from 8 bit move to even up to 24 bit per 1 kilobyte correction capability.

So controller becomes much more complicated.

In order to keep the cost competitive, we have to move into potentially from 0.16 microns to even 0.13 microns.

But at the moment, because of die bounding limitations, because the die bound only from two sides instead of four sides, so there is a -- it's a simple limitation.

Currently majority of product lines will all move to 0.16 microns.

For specific product lines, when the day comes to move to a certain range, we will move to 0.13 micron.

Okay.

Great.

And then just lastly can you talk about you made some prepared comments about the embedded application with the design wins with Micron, Numonyx and Hynix.

But can you give a sense of what kind of ramp do you think you'll see, especially in the mobile phone business for those solutions?

And what kind of cannibalization do you think you see on the memory card or the bundled card businesses when embedded solutions take off?

We start to see from late Q3 and Q4 some Tier One mobile handset maker will move to mass production.

And we believe, when such solutions become more mature, we'll see more adoption from mobile handset maker.

But China, I think it probably will be -- it won't move to embedded solutions.

But we believe our top five makers -- handset makers, will have embedded solutions next year.

But do you think this is at the very high end of the market and the external memory cards, or card slots continue to penetrate a greater percentage of the mobile phones, so that right now, at least the first couple of years, the embedded solutions aren't necessarily cannibalizing the opportunity for bundled flash cards in the mobile phone business?

I believe mobile handset with three type of business.

One is for removal only, or embedded only, or combination.

So embedded solution is a vehicle to allow the lower density mobile handset move to adopt higher density NAND flash with a cheaper cost.

So embedded solution will allow handset manufacturer, without changing software or hardware, to immediately utilize 40 nanometer, or 40 nanometer process in NAND flash.

So there's a bridging solution.

And we believe eventually embedded could be more than 70%, 80% of the mobile handset adopted solution.

Okay.

Thank you.

Your next question comes from the line of Dan Morris of Oppenheimer.

Please proceed.

Hi guys.

I just wanted to touch on the topics that you had in your prepared remarks, mainly about the pricing pressure.

Could you talk about how much you're seeing this past quarter, and if we need to update our expectations for what kind of full year ASP declines we should be seeing?

This is Riyadh.

For this quarter, the second quarter, our ASPs for our storage products, on average, declined around 3.5% or so.

For the full year we're now expecting a decline of 30% or below for the full year.

So that 30% for the full year, up from 20%.

Yes.

But the 3.5% doesn't sound terribly onerous I guess.

Was there some pricing pressure in other segments as well that you were talking about?

We're more cautiously to select the customer.

So some business we turn down because the margin is very low.

Okay.

Also we -- prices have declined fairly sharply in the first quarter.

And, as Wallace just mentioned, we have been more selective in our choice of business.

So that's helping stabilize our rate of ASP decline.

Okay.

So -- the selective, you've been a little bit more selective with your customers.

That obviously implies a little bit of giving up some market share.

Do you have any estimate where you think your market share was during the quarter?

We believe, for second quarter, we still maintain at least about 35% market share.

Okay.

One of the indicators that we heard from our customers, a lot of our customers have this view that the card business as a whole declined around 20% to 30% in volume terms, sequentially.

Our volume, in fact, has declined by much below -- by a small amount.

And so we believe we outperformed the market in general despite our focus on profitability in the second quarter.

Okay.

And turning to inventories, your inventories picked up a little bit.

Could you also comment on where you think inventories are in the channel and at retail?

I think the -- for our customers for retail play, their feedback inventory in retail is still pretty high.

So that's why we're going to continue to see price decline in the coming third quarter.

But they're adapting.

It seems all the major players are going to reduce their price.

So I think probably the movement could continue and enter in the fourth quarter.

The major issue we see is that the market demand is still soft.

Let me also add, in this business there are two types of inventory.

You have legacy inventory and operating inventory.

Most of the excess inventory in the market relates to legacy inventory.

For us, our inventory is more on operating inventory.

We have very little legacy inventory right now.

Okay.

And so does that mean that there is not -- the chance for inventory write off on the storage products is not very high?

That's correct.

We are actively managing that and we are being quite disciplined on it, but markets do change quite rapidly.

Okay.

All right.

Thank you very much.

Your next question comes from the line of Daniel Amir of Lazard.

Please proceed.

Thanks a lot.

Thank you for taking my questions.

A couple of things here.

First of all, as we look at kind of the mobile TV opportunity, can you highlight kind of the key milestones that we should be looking here for the next six months as an opportunity for next year?

And what type of growth rates should we be looking at '09 in terms of the mobile TV segment?

I think for this year, our growing momentum, one is in Korea for S-DMB and also in second half in China for both T-MMB and C-MMB.

Entering 2009, we are going to ramp DVD-H as well as IPPT for Japan market.

I think we believe we will double our shipment -- we can double our shipment from '09 compared to '08 in mobile TV solutions.

Okay, and then if we look at Q3 here and now you are a month into the quarter, kind of what's your visibility like?

Obviously this is this more of a back end loaded quarter.

What do you expect in terms of how the shipments go kind of throughout the three months here in the quarter?

For mobile communication product line we have a much better visibility because we have probably around 70% backlog in hand.

For mobile storage product line, for the OEM business, we also have a very good visibility.

The other 50%, mobile storage, we don't have a good visibility.

Okay.

And then if you look in kind of Q4 by your guidance, obviously you are expecting Q4 to be up compared to Q3.

What's your visibility into Q4?

What gives you the confidence that Q4 could look potentially better than expected?

What are the key metrics that we should be looking at here as potentially your business rebounds here off of the current environment?

It seems that we have several major OEM design in pipelines.

So we have the confidence that will give us potential growth momentum entering Q4.

But we cannot release the specific design and major customers.

We believe when we enter in late Q3 and move in Q4, that will add the momentum for us to increase our confidence regarding our revenue forecast in Q4.

And this is largely in the embedded space?

That is in the embedded space, the solid state, SSD, as well as our mobile communication product line.

Okay, and then my final question is it seems like the issues with your guidance is largely macro related, which is impacting many companies today in the market, and you cannot really hide from it.

Has anything changed on the competitive front?

It seems like this is more macro, but can you comment on any changes on that front specifically related to mobile storage?

We really did not see any new competitors.

We did not lose a single customer and we did not see we lose market share either.

I think the whole Q2 is really -- is very, very challenging.

In the beginning of Q2, we saw it is really is just like normal.

But entering middle of Q2, the demand was very soft.

The movement in the channel was very, very slow.

It is disappointed and we did not anticipate such a slow movement in the second quarter.

Okay.

Alright.

Let me also add, as I previously mentioned, our card customers were expecting -- had expected the market to decline about 20 -- the market declining about 20% to 30% sequentially in the second quarter.

And our volume in fact, had declined by a much smaller amount.

And so we believe we have actually done pretty good out of the challenging environment.

Okay, great.

Thanks a lot, guys.

Your next question comes from the line of Bob Gujavarty of Deutsche Bank.

Please proceed.

Hi, great.

Thanks, guys.

Could you just give us -- talk about a little bit about how you saw the quarter?

You alluded to it a little bit that the quarter started out pretty normal and then deteriorated.

I mean entering the quarter you probably thought there was a little inventory build because Q1 was so strong.

Can you just think about the transition between what happened in Q1 and Q2 and then how the linearity of the quarter went?

We cannot comment on a specific customer we have.

But it could be some customer they just they both manufactured excess flash memory card in the end of the first quarter.

But the market condition, it changed.

I think from the middle of the second quarter it becomes soft and slow.

And we did a very broader customer check from US, Taiwan, Korea, Japan and China and Europe.

And particularly in US, it is really slowing down quite a lot.

I see.

Can you estimate your US exposure?

It is pretty low, right?

Our US exposure is pretty low.

But the resell, some customer also manufacture in China, they sell to -- OEM to the retail market in the US.

I see, so your indirect exposure might be substantially higher.

Then do back booking.

Okay.

And then I guess the second question is you commented that kind of earlier you saw some movement of low density cards, and now, it seems with the price declines, you're are moving -- the OEMs are moving upward to higher density cards.

Can you quantify that a little bit in terms of whether you are seeing in kind of average capacities them moving?

Are they moving from like 256 to 512 or 512 to 1 gig?

What are you seeing there?

We see in the past, the majority of the bundled business for MicroSD card are in the 128 megabyte and 256 megabyte.

Now, I see the transition move to 1 gigabyte and 2 gigabyte as a bundled business for top tier OEM customers.

In China, it remain lower density.

But I think in the past, because we are unit play, we have focused on the evolving areas.

That is why we focused on lower density product line.

Now, we are in the transition -- in transition to be requalified with higher density with the top tier OEM customer.

I see, and since you are a unit play, is there any opportunity that the higher density card helps here, or is it pretty neutral to your business since you are a unit play?

I think the total unit is going to grow.

But just in the transition, we lost some of the lower density bundled card business.

Now, we have transitioned into the higher density card.

Okay, great.

Thank you.

Your next question comes from the line of Daniel Berenbaum of Collin and Company.

Please proceed.

Hi, thanks for taking my call.

If I could just ask on the mobile communications product and help me clarify a little bit.

I understand that gross margins were bad, but if I'm doing my math right, it looks like both unit and ASP actually went up in that segment.

So is that the right way to think about it and was it just a margin problem or did ASPs actually go down?

That's correct Dan.

Both ASP and volume went up significantly in the second quarter.

And then if you could clarify on the mobile storage ASPs, again if I'm doing my math right, it looks like the ASPs in the quarter were down about 22% year over year.

And you are now saying that we should expect the full year to be down 30% year over year.

Am I understanding that correctly?

Up to 30%, yes.

Up to 30%.

But they were down 22% year over year?

Yes.

Okay, and so then more broadly, I mean looking at your guidance, it would seem to imply that units are going to be down pretty sharply in Q3.

You are talking about unit demand slowing from your customers.

What does that say about the industry and the perceived elasticity of demand for NAND products?

Based on your guidance with -- even though we heard from very large players in the space that they're slashing pricing and expect to push more units through the channel, your guidance would lead us to believe that fewer units are going to go through the channel, and in fact, overall NAND demand might not be as elastic as we thought.

Is there something specific to you where there was inventory built up at one of your customers?

How should I think about that?

Dan, our business model is different than the system integrator.

The system integrator, because they have liability for the flash, they also have inventory in the channel.

So they have to reduce the price in order to move the inventory.

But most of our customers, if they don't secure NAND flash, they don't play the PO2 controller maker.

So if there is a lot of inventory in the channel that will slow down to build a new flash memory card.

So does that mean that the inventory is building up in die bank and wafer bank, and I should ultimately expect all of that to sell through?

I mean is it that more -- whereas now, we are starting to burn off inventory in finished goods and ultimately there will be a slug of NAND that comes through from wafer bank and die bank?

You see, for the card business, for the flash memory card business, they were purchasing the wafer from NAND manufacturer, [TSoft] because they have a bigger size card and purchased die from flash controller makers.

However, the business model is they need to -- after they purchase, they will ship out within five days to the channel of their OEM customer.

The current issue in the market, we believe there is varies in the level of inventory in the channel, finished good products in the channel.

So the new build momentum for flash and memory card will be slowed down.

Okay, could I then extrapolate that since that new build momentum is slow, is inventory now building up on the other side of the dam?

You know is inventory building up stream in die form or wafer form?

No, the card.

We are talking about the card.

The finished good card.

Okay.

Inventory is building at the card level which needs to clear before it starts rebuilding.

Right.

So then the inventory is building at the card level which means that even though pricing has been cut, the industry is not seeing the demand elasticity on those cards that we expected.

That's correct.

Okay, thank you.

Your next question comes from the line of David Duley of Merriman.

Please proceed.

Could you -- I just wanted to quickly review on the core controller business the two things that you seem to have highlighted as to why numbers weren't achieved there were you see a soft retail demand environment with one segment of your customer which is -- and that is mainly driven by US and European business slowing down.

And the other piece of the puzzle is your bundled business with your big handset OEMs like Samsung has slowed as well.

Are those the two -- is that the right summary way to talk about the controller miss?

I think In China, also we suffered the Sichuan earthquake in May.

So China business also in May slowed down quite a lot here.

Okay.

And could you explain -- I think I understand the demand in US and Europe being slow.

And I guess the one question I would have for you is, with that in mind, I guess I would expect to see lots of electronics companies missing their numbers given demand in US and Europe is slow.

And not component people like yourself, but people that sell components to the retail people.

So a lot of retail device makers are going to be missing their numbers.

Would that be the way to look at what you are seeing in the marketplace?

I don't think it would be appropriate for us to comment on other companies.

We really don't know enough of how they operate their business.

What we do see is the issues that we have on hand at our Company.

Okay.

And then the second piece of that was that your handset guys are slowing their bundled new business.

What is going on there?

Why did the handset business not perform to what you expected?

It is the transition issue that Wallace had talked about, the transition of bundling lower density products to bundling of higher density products.

We used to sell primarily lower density and now we are transitioning to supply higher density.

In the meantime, we are going through a requalification process.

So, but Samsung is still buying lower density cards from somebody else or are you transitioning?

I don't understand what that means.

Samsung is still buying controller cards with more lower density.

However, the volume decreased.

So in order to increase the volume, we will need qualifying to the handset maker with higher density products.

Also, all fab makers, they are in the transition to move to 40 nanometer and 34 nanometer.

So in the transition, the qualification part of it will take time.

Overall, they are just buying less.

Okay.

That particular customer, because this has been a point of contention for a long time, with that particular customer we are not going to read in the Digi Times that someone else has taken the low density business?

I don't think anybody will take over our low density business.

Okay.

The global low density card business is just going down.

Okay, I just wanted to clarify that.

Now, just a couple of questions -- a final question from me is you took an inventory write-off of I think $1m in the quarter as I recollect the number, and that impacted gross margin I think by about 200 basis points.

Why was the inventory write-off now?

Why was it taken now?

As you know, starting late last year, we started ramping down some of our worse performing businesses like our MP3.

Some of our MP3 products, despite not selling well, were still selling but in limited numbers.

And now we went into the second quarter, a lot of these MP3 SoCs, image processor SoCs, card reader controllers, they just stopped selling and so we are required to write them off.

Okay.

And the final thing for me is I noticed the R&D budget cranked up quite a bit in the current quarter.

I think that was surprising versus where I was thinking the R&D number should be.

What was the exact reason for that?

So during the second quarter, we had -- we would tape-out 1.5 --- [joined] a project for 90 nanometer RF-CMOS process, the 90 nanometer RF-CMOS process, just in that itself is about $900,000.

So the majority increase of R&D really isn't seen in that cost and R&D has new development for SoC product line in mobile communication areas.

And so you know eventually, you are going to have to spend this money on [masks].

So did you accelerate this development because of the current market environment or -- because I don't think anyone was expecting $10m in R&D expenses in the quarter since you spend $7.5m last quarter.

That's correct.

We do have -- we have accelerated our spend.

Okay.

The final thing for me is what was the rationale for not pre-releasing this quarter?

As Wallace had said at the start of our call, we are trying to get away from making interim announcements and focus on quarterly announcements.

We kind of run our business on a long term basis, focusing on long term objectives.

And so from our perspective, it is all about focusing on what is important.

If there indeed was a very significant extraordinary change, we will certainly pre-announce.

But from our perspective, our growth drivers, our business model, our long term growth opportunities they are all pretty much intact.

There is a lot of turbulence, granted.

There is a lot of turbulence -- significant turbulence, but we didn't believe that it warranted us to start making pre-announcements.

We compete in a very dynamic market.

We don't want to go down that route where every time there are bumps in the road we are constantly making pre-announcements.

Okay, thank you.

Thank you, gentlemen.

And your next question will come from the line of Dunham Winoto from Avian.

You may proceed.

Thanks guys for taking my phone call.

A couple of questions, first of all, maybe this one is for Wallace.

I know that you said in your press release that you guys are sampling your SSD controllers in the third quarter with mass production to start in the fourth quarter.

Can you just clarify if that is the SSD controller that is for the mainstream notebook?

And I've got a couple of follow ups on that.

I cannot comment whether it is mainstream notebook or low cost notebook.

But there is the MLC-based SSD controller.

Okay.

Can you give us an idea -- there has been a news -- or report out there that the adoption --- the mass adoption of SSD might be pushed back a little bit more?

Can you give us your input on that?

Do you think that the mass adoption is still on track for say early '09 or has it been pushed back a little bit in your mind?

I think as I said, the low cost PC, the low cost notebook, UMPC, the predictions looks like it could be lower than expected.

We believe this year it is about 6m to 8m units range.

We also see because Intel still has a severe shortage in delivering the Atom chipsets.

So certain programs have been pushed out from Q3 to Q4 and some OEMs even cancelled the program.

So that is one of the major factors slowing down so we have no expectation and forecast.

What is happening there is through the economic situation, some low cost notebook, they are also in combination with micro hard drive in the solid state drive that also -- I think there is also the factor to impact the current solid state drive forecast in '08.

However, with the NAND flash continued going down and moving to 40 nanometer and 34 nanometer in '09, we believe that is going to create a new momentum for low cost notebook as well as the mainstream.

Because we believe that there will be marketable solutions ready before the end of '08 to support MLC-based solid state drive application.

How about on the mainstream cycle?

I mean has there been a change in terms of the timeline for volume shipments?

I cannot comment specific OEM customer demand or their need.

Everybody has their own strategy and sometimes they, based on specific time, they have a very good deal and qualify certain solutions they will move on.

That means certain companies, they will be more aggressive to move to solid state drive solutions.

I think 2009, we are going to see -- it is going to happen.

And you don't need to wait for 2010, but 2009, you are going to see solid state drive move to mainstream PC.

Okay.

Just one last question on SSD.

In terms of developing MLC based solutions on the controller side, has there been a change in terms of the challenges that has been talked about up to now that prevents wider adoption or wider volume shipments?

I think that all top tier PC makers, they look for no compromise SSD solution to replace hard drive.

So they are challenging around several areas.

So reliability, endurance, performance, power cycling and security, many things.

So I think the controller makers have to overcome the fundamental issue from MLC NAND flash in order to provide no compromise solution.

So it is very challenging.

The qualification, this all takes time.

Okay, the next question is I know that Samsung is no longer a top customer and as Riyadh said, that there is no 10% customer during the quarter.

But can you provide us with additional color as to who might be your top customer during the quarter?

Our core customers, it is pretty much the same group of customers that we have had quarter after quarter.

There has always been changes from one quarter to the next.

But generally, it is the same group of customers.

So for the second quarter, in fact, it has remained the same.

On the topic of Samsung, they obviously have ramped down significantly their own manufacture of OEM cards and hence, ramped down procurement controllers from us.

But nevertheless, our sales to Samsung for our other products for primarily mobile TV related products have increased significantly.

So they still remain a very important customer of ours and we still maintain a very good relation with Samsung.

Okay.

Thanks.

My last question has to do with share buyback.

I know that you purchased about $25m worth of shares during the second quarter.

What is your plan going forward?

Are you going to keep buying shares back or are you going to wait until things change?

It is our strategy and it is our intention to complete the buyback that our board has authorized us.

Okay.

So you have about what $10m worth of buyback left?

That is correct.

Okay.

That's all I have.

Thanks.

Thank you, gentlemen.

And your next question will come from the line of Kevin Vassily from Pacific Crest Securities.

Kevin, you may proceed.

Yes.

Thank you for taking my call.

So just some clarification on kind of Q3 mix, or second half of the year mix.

You commented that you expected the mobile TV business to ramp fairly nicely through the second half of the year.

And I think by implication, it would grow faster than the rate of the mobile storage, yet you guiding for Q3 to a gross margin that is roughly 200 basis points up above where you were in Q2.

So help me with how that works.

If mobile TV is going to be a bigger part of the business and you had some margin challenges there, how are you able to get gross margins up in Q3 versus having them come down?

Kevin, this is Riyadh.

The big issue that we had -- one of the issues that we had in the second quarter was we had a $1m write off of obsolete inventory.

So that hits our gross margin.

$1m is about approximately 2 percentage points,

Okay.

So that 47% did not include or did include the inventory write down?

If we were to exclude that $1m write off, our gross margin would be around 49%.

Okay.

So again, go back to the next question, if that part of the business is growing faster than mobile storage you would still expect to be a kind of negative gross margin impact on a blended basis versus -- even flat, so again, help me.

Am I not thinking about the way the businesses are growing, or are you seeing a margin improvement in the mobile storage side of the business?

There is some improvement.

They're actively working to reduce cost.

To -- through the second half of the year, it is our plan to raise gross margins from our communications product line and so there will be some improvement as the year progresses.

Sorry to kind of keep harping on it, if I heard correctly, kind of the gross margin improvement was going to come from some of the more highly integrated products which didn't sound like it was going to have a real impact until fairly late in the year, if not, early next year.

Are there things in place besides that to kind of improve the margin profile there?

We are also working to improve our yields and also to improve our costs from reduced testing time and so forth.

Okay, okay.

I think, Kevin, the -- the issue regarding mobile communication margin was lower because we have a portion of product SDMB with SIP.

That demodulator comes from our partner.

It will not come from us.

So that specific product line has a much lower gross margin than the overall other product line.

Right.

So as they are moving, the reason we have to this IP is because Samsung only qualified us as the supplier.

Through the end of Q3, the issue would be resolved so we can sell only the tuner to other module maker to build SIP.

So that will also help us to improve the overall gross margins for mobile television bottom line.

Okay.

That is helpful.

Thank you.

Thank you, gentlemen.

And your next question will come from the line of Ray Rund from Shaker Investments.

You may proceed.

Thank you.

I was wondering can you give us some sense of how your R&D is going to play out over the rest of the year?

You kind of have this major increase, does it continue at that level, does it come back down to $7.5m or $8m?

Can you kind of help us understand that better?

For the second half of the year, we are going to keep our total OpEx fairly similar to what have in the second quarter.

Our second quarter total OpEx was around $14.5m.

So we will probably trend that for the second half of the year.

But obviously, we have a hiring freeze in place, a global hiring freeze.

We don't expect to hire other than to very selectively upgrade.

We are also actively looking at our cost structure to see if we can better use what we have and take cost out of our system.

So as much as -- we do have fixed cost overhead.

It is what it is.

We have a lot of R&D programs that need to ramp in order to support all our growth drivers but we are also actively looking to see if we can take cost out of our system.

Okay.

Can you also comment on what sort of tax rate we should be using for the rest of the year?

We are internally, using 10%.

Okay.

And I know you mentioned that the higher tax rate in Q2 is a one time thing.

Can you discuss that a lit bit?

Yes, we -- a big part of our business is in Taiwan.

We do a lot of R&D work in Taiwan at our Taiwan legal entity.

We enjoy a lot of tax credits from doing R&D work.

As part of the re-examination of our filings, a new -- even though the tax legislation has not changed, it was seen that we -- our tax filings needed to be re-evaluated.

And so that resulted in a FIN48 liability -- a potential liability.

We are challenging that.

We don't believe that the tax reexamination is a fair one and so we are challenging it.

We have a fairly conservative and prudent tax filing.

This is in fact, part of our regular application for tax credits for doing R&D.

We believe it is an arbitrary decision based on no change in tax legislation.

Okay.

Thank you.

Thank you, gentlemen.

And your next question will come from the line of [Timothy Lam] from Citigroup.

You may proceed Timothy.

Thank you very much for taking my questions.

Hi Wallace and Riyadh.

Just two questions from me here.

I think some analyst already mentioning that Samsung is no longer a 10% customer.

I think you have also answered the competitive landscape.

Just to be clear, are you seeing any impact by the in sourcing by the memory makers?

And how would the Company try to gain market shares going forward?

Will it be mostly through adding more technology on your controllers or more through pricing?

I think that our technology and our development are very unique and differentiate compared with our competitors.

We believe when the flash memory moving to 40, 30 nanometers, especially by 3 next year, they really require much more complicated controller.

Not only have global real leveling technology, but also more of the advanced error correction engine.

Beyond BCH, maybe LDPC, more than even 40 bit error correction per 1 kilobyte.

We also start to see outsourcing opportunities on [captive] company.

We cannot make announcements right now as we believe in late Q4 we enter the production stage with some of the very respected customer.

So I think we are in development, developing with more future product lines with all NAND flash makers except Toshiba at the moment.

So we do see our leading potential and also from the development process, we should be able to continue to grow the market as we provide the value to our OEM customer.

I see.

And just one more question, just a follow up.

I think Wallace, you also mentioned that your customers are moving to a higher density such as 1 to 2 gigabytes for your Tier One OEM customers.

What would you see as a percentage of sales for your bundled card customers for these OEMs will be 1 gig higher by the year end?

Thank you very much.

I think that in our flash memory card business, from time to time, it is about 30% bundled business, 30% about retail.

Within the bundled business, China is -- the majority still maintain lower density.

Therefore, other Tier One customer in mobile handset, they are shifting in the second quarter from lower density to the higher density.

So we are in the process qualification.

We believe the volume would be back to the ramp up around late Q3 or early Q4 timeframe.

So I think we should remain the same volume or even higher potential than lower density controller business in the past.

So would you say for your bundled business that your Tier One customers are going to be mostly in 1 to 2 gig by year end?

Yes.

Thank you.

Thank you, gentlemen.

And your last question will come from the line of Daniel Berenbaum from Collins and Company.

Daniel, you may proceed.

Yes hi.

Just a quick follow up to some of the tax rate questions and just in general, between pro forma and GAAP.

What are you excluding in the full year GAAP guidance?

Is there more taxes, more of these arbitrary tax charges that are excluded from pro forma that you are including in GAAP and what else is there in the pro forma that is excluded?

The tax, that is only a one time item.

We did not plan for this tax review.

It came all of a sudden and it's the only tax item in -- that differs between our GAAP and non-GAAP.

The other items that are different between our GAAP and non-GAAP of course, are staff based compensation, acquisition related charges from SCI as well as on [Limmer], our Sentronics acquisition.

We also have litigation expenses related to the Sandisk litigation.

So it is both gains and expenses related to litigation.

We also have foreign exchange gains or losses from the other income line as the final piece.

Foreign exchange, obviously we cannot predict, and it does affect our financials.

And so for the purposes of managing our numbers, we exclude that.

We do not actively hedge to manage our numbers.

Okay.

And then just one last question on the market and your place in it.

So what percentage of NAND controllers are for cards versus embedded or solid state drive and what -- how should I think about your mix versus that market mix?

I think for our total mobile storage product line, our card controller is around about 80%.

About 78% to 80%.

So remaining will be USB flat drive controller and the solid state drive controller.

Okay.

And then is that -- so card, when you say card, that is external card and --

Card means it is like an SD or MMC compact flash.

Okay.

So, and we talked about embedded potentially growing faster than card, and I think you highlighted that card would grow about 5% annually, at least 5% annually over the next couple of --

Revenue.

Revenue.

If I heard that correctly, okay.

So then the question is how much is your embedded business and it seems like your embedded business is a very low percentage, and then how fast do you expect that embedded business to grow?

So I think embedded currently is still very low.

Next year, we haven't seen any forecast regarding embedded solutions.

We are looking for even iPod, iPhone, you can view as a wonderful embedded solution today for mobile handset.

But we believe all major makers, including Nokia, Samsung, LG, Sony Ericsson, Motorola, they are going to be having embedded solution by either later this year or moving to 2009.

Okay.

And then just how does your mix compare to the industry mix?

If you are 80% card, how does that compare to the overall industry mix?

The embedded solution which all belong to flash maker, Samsung has their own solution.

Toshiba have their own solution.

Sandisk also have their own total solution.

Fortunately, we also work closely with Numonyx, with Hynix, and other and especially on micron.

So we potentially can take a part of a share for embedded solution into market.

Beside the handset market, embedded could be in consumer electronic devices such that we do have a major design in certain GPS manufacturers in Taiwan as well as in the US.

We have a major design in portable DVD.

We have a major design in Samsung Electronic video camera camcorder.

So the embedded solution could be used widely in all given type of consumer devices to.

So you can see that business grow very rapidly for you?

We start some shipment right now.

We see the adoption for embedded solution can grow very, very fast.

They allow consumer selling integrator to use a current solution to reach to the advanced new NAND flash components.

Okay, great.

Thank you.

Thank you, gentlemen.

And at this time, sir, due to time restraints, there are no more questions in the queue so I'd like to turn it over to the main speaker for closing remarks.

So as we discussed on the past one hour, we are disappointed about our second quarter result.

This was a first time that we missed our guidance.

I really apologize to let our shareholder down.

However, we do have high confidence in the NAND industry and our position as the leading controller maker.

We know exactly what we need to do to manage through the near term challenges.

We are very focused on mobile storage product line, embedded flash, solid state drive and mobile TV product line.

We are in the right direction and we are a solid Company.

We have confidence to get back to our growing track within six months.

So thank you for listening and we will see you next quarter.

Bye-bye.

Thank you, ladies and gentlemen, for your participation in today's presentation.

You may now disconnect and have a wonderful day.