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Spreadtrum Communications (NASDAQ:SPRD)

Q1 2013 Earnings Call

May 08, 2013 9:00 pm ET

Executives

Leo Li - Chairman, Chief Executive Officer and President

Xiaoning Gao - Chief Financial Officer

Analysts

William Lu - Morgan Stanley, Research Division

Quinn Bolton - Needham & Company, LLC, Research Division

Daniel Heyler - BofA Merrill Lynch, Research Division

Randy Abrams - Crédit Suisse AG, Research Division

Jay Srivatsa - Chardan Capital Markets, LLC, Research Division

Jessica Chang - Deutsche Bank AG, Research Division

Qin Zhang - JP Morgan Chase & Co, Research Division

Ken Hui - Jefferies & Company, Inc., Research Division

Andrew Lu - Barclays Capital, Research Division

Roy Shen

Chao Kang Cheng - CLSA Asia-Pacific Markets, Research Division

Eric Chen - Daiwa Securities Capital Markets Co. Ltd., Research Division

Yolanda Wang - HSBC, Research Division

Operator

Welcome to Spreadtrum Communications First Quarter 2013 Results Call. [Operator Instructions] As a reminder, this conference is being recorded. Joining the conference today are Dr. Leo Li, Chairman and CEO; and Ms. Shannon Gao, CFO.

Shortly before the start of this conference call, Spreadtrum issued a press release announcing its first quarter 2013 results, which is also available along with a quarterly results presentation on the company's IR web page at irspreadtrum.com. This call is also being broadcast live over the Internet and will be available on the company's website.

Today's call will include forward-looking statements that involve risks and uncertainties that could cause Spreadtrum's actual results to differ materially from management's current expectations. Such forward-looking statements include, without limitation, statements regarding revenue, cost, profit, competition, customers, products, commercial availability, technologies, partners, business models, M&A, shipment, market share and market trends. Spreadtrum encourages you to review the Safe Harbor statements contained in today's earnings release, as well as the risk factors discussed in its annual report on Form 20-F filed on April 26, 2013, as well as other documents filed from time to time with the SEC. The company undertakes no obligation to revise or update publicly any forward-looking statements to reflect future events or circumstances.

Today's call will include a discussion of certain non-GAAP financial measures. These non-GAAP financial measures should be considered in addition to, and not as a substitute for, or in isolation from GAAP measures. A reconciliation of the non-GAAP and GAAP reporting for the periods discussed can be found in today's earnings release. All numbers discussed in today will be in US dollars, unless otherwise noted.

I'd now like to turn the call over to Dr. Leo Li. Please go ahead, sir.

Leo Li

Thank you. Welcome everyone, and thank you for joining us today. I am pleased to report that in the first quarter of 2013, we achieved USD 189 million in revenue, which is above the top end of our guidance. This strong performance was a result of very high demand for our smartphone chipsets, which contributed to approximately 60% of our first quarter revenue.

During the quarter, the shipments of the single-core smartphone chipsets grew sequentially and continue to remain strong because our customers have used them to establish a meaningful entry-level market segment.

In China, our customers that focus on the entry-level are now selling single-core TD-SCDMA smartphones with Android 2.3 and 3.5-inch screens for as low as RMB 300, which is around USD 50. This price level helping to make smartphones more affordable in the -- for the first-time buyers -- the smartphone buyers. And as a result, we are now seeing more rapid smartphone adoption in China Mobile's network.

This is a trend that we expect to continue for some time, as there is a very large and fundamental need for this type of low-end smartphones. This is because out of total 726 million subscribers on China Mobile's network, only 114 million are now 3G subscribers. So for the next few years, we expect that many of the subscribers who still have the 2.5G feature phones will move into entry-level smartphones as they replace their handsets. In addition, we're now beginning to see the same trend develop in overseas region for the EDGE smartphones.

In the first quarter, our EDGE smartphone segments were also extremely strong. Some of our customers are now shipping EDGE smartphones for FOB prices, around USD 30, which is improving smartphone affordability in those markets as well.

To add to our strong competitive position in entry-level smartphone chipsets, we're now also introducing chipsets for higher-tier phone segments that will increase our addressable market and further improve our product mix in the coming quarters. At the end of Q1 this year, we commercially launched our dual-core TD-SCDMA and EDGE smartphone chipsets, another significant milestone in our smartphone program. These 2 chipsets integrate a dual-core Cortex-A5 processor running up to 1.2 gigahertz, as well as dual-core Mali GPU with outstanding graphics performance.

We believe that these chipsets offer a superior feature set and highly competitive cost structure for dual-core TD-SCDMA and EDGE products. In addition to exceptional graphic performance, which allows the customer to integrate the large screen sizes, run more complicated graphics applications, our chipsets offer support for an 8-megapixel camera with imaging -- with an image signal processing for high-definition LCD display at a 1280 x 720 resolution and, of course, our best-in-class communication technology. We expect that these features and the chipset's competitive cost structure will result in a strong competitive position in the mid-range TD-SCDMA and EDGE segment as well. We have already achieved volume shipment for this platform.

Further, the second quarter, we have already began shipping our quad-core Cortex-A7 platform, which introduces the integrated connectivity, including FM, Bluetooth, WiFi and GPS. We expect our quad-core chipset to contribute to revenue in the second half of this year. In tandem , as discussed in our last earnings call, we're also now sampling our TD -- our WCDMA/HSPA+ single-core smartphone chipset. We expect that this chipset, the SC7710, to ship commercially, either second or third quarter this year.

On the customer side, we have continued to expand our business with the first-tier handset makers. During the quarter, we announced that our single-core 2.5G baseband with integrated connectivity is now shipping in the handset distributed by one of the world's largest operators. We have also started shipping our EDGE smartphone chipsets to the world's largest handset maker. And these are now in the handsets launched globally. The adoption of EDGE smartphones products by top-tier handset makers for the global distribution demonstrates that the importance of this type of entry-level smartphones to the global market, as well as the quality and maturity of the -- our chipset.

Looking ahead, we are continuing to invest in forward-looking technologies and plan, as previously stated, to introduce our second-generation LTE products, supporting 5 modes, including TD-LTE, FDD-LTE, TD-SCDMA, WCDMA and EDGE, in the second half of 2013.

I will now ask Shannon, our CFO, to review our financial highlights for the first quarter.

Xiaoning Gao

Thank you, Leo. Total first quarter revenue was USD 189 million, down 6.9% sequentially and up 17.3% year-over-year, exceeding our guidance. We also form the first quarter seasonality that is typical in the China market due to the Chinese New Year holiday in the strength of smartphone demand.

Gross profit for the quarter was USD 70.5 million, down 6.4% sequentially and up 15% year-over-year. Gross margin was 37.3%, up from 37.1% in the fourth quarter and down from 38% in the first quarter of 2012.

Operating expenses for the quarter were USD 48 million, down 1.9% sequentially and up 35.5% year-over-year. The sequential decrease in operating expenses was due to a decrease in new product development, engineering expenses and employee compensation expenses, partially offset by a decrease in recognized R&D subsidies and an increase in legal fees. The year-over-year increase was primarily due to an increase in new product development, engineering expenses, amortization expenses, employee compensation and the legal expenses, resulting from our significant increase in investment in forward-looking technologies, such as multi-core smartphone platforms, WCDMA and LTE.

Operating income in the first quarter was USD 22.6 million, down 14.7% sequentially and down 13% year-over-year. Operating margin was 11.9%, down from 13% in the prior quarter and 16.1% in the first quarter of 2012. The sequential decrease in operating margin was primarily due to higher R&D expenses as a percentage of revenue.

GAAP net income in the fourth quarter was USD 20.3 million, down from USD 24.9 million in the prior quarter and USD 24.3 million in the year-ago quarter. Non-GAAP net income was USD 26.5 million, down 15% sequentially.

Net income per basic and diluted ADS in the first quarter was $0.42 and $0.38, respectively, down from $0.52 and $0.47 in the fourth quarter and down from $0.53 and $0.47 in the first quarter of 2012. Non-GAAP net income per diluted ADS for the quarter was $0.50, down from $0.59 in the fourth quarter and $0.57 in the first quarter of 2012.

Turning to our balance sheet. As of March 31, 2013, we had USD 168.4 million in cash, cash equivalents and short-term deposits, up from USD 165.2 million as of December 31, 2012.

In the first quarter, we generated $17.4 million in cash from operating activities and used $11.4 million on intangible assets and $2.1 million on equity investments.

Inventory, now including deferred costs, as of March 31, 2013, was USD 149.1 million, an increase from USD 128.8 million as of December 31, 2012. Inventory days increased from 90 days in the prior quarter to 107 days in the first quarter. We increased our inventory to prepare for the significant increase in demand that we are now seeing in the second quarter.

In the first quarter, we continue to return capital to shareholders. We declared our eighth quarterly cash dividend with distributed -- distribution of $0.10 per ADS occurring on April 25, 2013.

That completes our financial review. I would now hand the call back to Leo for his comments on our outlook for second quarter 2013.

Leo Li

Thank you, Shannon. I now like to provide the financial guidance for the second quarter 2013.

In the second quarter, we expect to achieve revenue in the range of USD 220 million to USD 228 million, which is a sequential increase of 16.4% to 20.6% over the first quarter, with a slight improvement in our gross margin. We're now seeing demand for smartphone chipset to continue to grow, especially in the low-end segments, where the entry-level prices are allowing the first-time buyers -- smartphone buyers in China and emerging market to switch from the feature phones. This is a fundamental trend that will drive the demand for single-core chipset for some time. As a result, we're now also updating our smartphone shipment forecast for the year. Previously, we have stated that we could ship between 80 million to 100 million smartphone chipsets in 2013. Given strong demand, we now expect to ship more than 120 million smartphone chipsets this year.

I thank you for your time today. Now Shannon and I will be happy to address any questions you may have. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Bill Lu from Morgan Stanley.

William Lu - Morgan Stanley, Research Division

You just raised your smartphone shipment guidance. We've all seen the [indiscernible] of China Mobile. I'm hoping maybe, as the first question, if you could just update us on how big you think the TD chipset market is this year, how that's going to break out maybe in the first half versus the second half. And then also in the second half of the year, Apex [ph] said that they think it's 70% quad core, 30% single core versus -- you're saying the single core is going to be relevant for a little much longer. Is that size of the market that's looking different? Can you just talk a little bit more about the difference there?

Leo Li

Sure. I'll answer the first question first. The China Mobile company stated that this year -- last year is around 60 million newly added subscribers, actual shipments more than 80 million to 90 million, right? And then this year, their publicly saying that the 120 million newly added subscribers. Actual shipment, we think there'll be 140 million to 150 million new shipments. And having said that, we saw -- like I said in my previous statements that very strong demand for the low-end TD-SCDMA smartphones, we have this very question discussed with the executives of China Mobile handset division and other executives in the marketing and sales divisions. They're all saying that, yes, the first half is strong and also the second half is equally strong. Reason being, very interesting, that the -- in particular, our single-core 8810 enabled the China Mobile to sell their products, I think at this moment, the lowest selling price of the smartphone to the market, in particular 3.5-inch screens and 4.5 -- 4.0 screens, so RMB 300 and RMB 400, which is extremely affordable for those who still own a feature phone, wanting to switch to a smartphone. Now to switch to a -- to answer the second question, yes, dual-core and quad-core platform chipsets are coming to China Mobile, to everywhere else. However, those dual core and quad core, particularly used for larger screen, larger than 3.5, the breaking point of the screen size is a 4.0- or 4.3-inch that kind of thing. In other words, 3.5 definitely, which is the largest volume by the way, is the single core used adequate -- or 3.5 by the way, also I want to add one more thing, it's iPhone 4 screen, it's not that bad, okay, for the usage. And then 4.0 or 4.5 above dual-core, 5.0 and above quad-core, so the screen sizes determine to the extent that what -- how many cores or the CPU power used. If it is smaller screens, you kind of wasted your CPU and GPU power. So my understanding, and as China Mobile has concurred the same thing that, for the entry level, low-end single core is adequate. And then for the higher, larger screen, more complicated, the processing and gaming and everything, dual core and quad core are needed. So the dual core, single core and quad core, these 3 things address different segments on the handset. However, I just want to say that the largest segment is still low end, always true.

William Lu - Morgan Stanley, Research Division

So that makes sense to me. If I look at your shipment this year, it's probably 120 million. What do you think is going to be EDGE versus TD single core versus TD dual core, quad core?

Leo Li

Good question. I think that TD is still more than 50% of the total volume of 120 million. However, I think that they are picking up the speed of growth rate in emerging market of the smart -- EDGE smartphones. Very interestingly, even -- like I say, even if we can start the same subject, like I say 8 months ago or 9 months ago, people won't believe what I said that EDGE phones will be very important, not to the China market, by the way, to the -- in the emerging market, where I said the FOB around USD 30 for the 3.5-inch smartphone. This is very unheard of. The price is very close to the feature phones, right? So those -- when the price dropped this low, it really enables the so-called feature phone buyers to buy, to afford the so-called smartphones. So second half -- the further down the road, more and more I see the up-ticking speed for so-called, the EDGE smartphones. The TDs -- I think it spreads -- [indiscernible] of China Mobile spread pretty evenly over the quarters -- 4 quarters of the year.

Operator

Your next question comes from the line of Quinn Bolton from Needham & Co.

Quinn Bolton - Needham & Company, LLC, Research Division

Leo, just wanted to follow up on that Bill's last question about the split between EDGE and TD. It sounds like China Mobile still -- you still expect somewhere between 140 million to 150 million TD units to ship in 2013. So I guess I'm trying to figure out, when you raise your smartphone guidance from 80 million to 100 million to 120-plus million, is most of that incremental growth coming from the EDGE platform, especially now that you have a Tier-1 customer for the EDGE smartphone platform?

Leo Li

It's a good question. Partially, yes, our increased -- like shipment target of smartphones are coming from the EDGE up-ticking speed of adoption of the EDGE smartphone in the emerging market. Also, we saw a stronger than we expected low-end smartphones. In other words, single core, that type of demand in China market. And very interestingly -- I'm not quite sure I said that in my earlier statement. TD-SCDMA -- or China Mobile is a TD smartphone. Actually, it is the lowest cost among all. In other words, the China Unicom, China Telecom, none of which are able to sell their smartphones under RMB 400, not even RMB 300. In other words, the strong demand actually is entry level. However, not -- other 2 operators not be able to offer. So the only operator offered the entry-level smartphone is the China Mobile, and this is the TD-SCDMA. So that surprised us for the volume.

Quinn Bolton - Needham & Company, LLC, Research Division

And a follow-up on that, it sounds like the strength in the TD segment is coming from the low-end smartphones. Without asking you to quote a specific market share number, do you think that, that has allowed you to gain share in the overall TD segment here in the first half of 2013?

Leo Li

We are the one, almost the only one, the single core very -- have a outstanding performance and then competitive cost structure on the chipset. Yes, our products are not only very affordable and they're such solid performance, really actually enjoyed by large consumer segments. And then the -- like I said, from feature phone to smartphones are the major trends. Usually, actually they're buying the low-cost smartphones. And then the 3.5-inch is just adequate for those feature phone users. Actually, it's pretty good. So yes, affordability, competitive -- the cost structure and then outstanding performance enabled us to, yes, to have that segment.

Operator

Your next question comes from the line of Dan Heyler from Bank of America.

Daniel Heyler - BofA Merrill Lynch, Research Division

Leo, I wanted to ask you on your roadmap. You've got a pretty positive outlook on the upcoming dual core and you're pushing into the quad-core TD smartphone. I wanted to know what kind of price points you think those phones will come in at in the second half? And maybe elaborate on some of the dynamics, whether this would be mostly through the China Mobile programs or whether it would be more through the open channels.

Leo Li

Yes. I think it's -- the -- we are actually shipping a small volume now the dual-core platforms, we call 8825. And yes, like I said in my prepared opening statement, dual core and quad core for larger screen size of the smartphones which would sell higher price. I think to answer your question, I think it will be RMB 400, RMB 500 and above, all the way to, say, RMB 700 to RMB 1,000. It depends on the -- a lot of the other features associated with the phones. So to address that, yes, our -- the dual core with the outstanding graphics performance and then, like I said, very competitive cost structure, our -- the dual-core platforms actually are competing very well in that segment. As for so-called open market, I think China Mobile usually have this subsidies, the money, right, associated with the TD handset they are selling. I think the majority is still through the normal China Mobile's open channels -- or China Mobile's stores and everything. And then as for the open market, the volume generated is not as great as the China Mobile's. However, I think for open market, from what I can see, I think the demands are usually for single-core cheaper ones, not necessarily dual-core, even quad-core expensive ones.

Daniel Heyler - BofA Merrill Lynch, Research Division

That makes sense. If I can ask one follow-up then. So China Mobile, to some extent, has been very successful at this program. I find they'll somewhat fret about the cost potentially of the subsidy program and aren't really giving clear visibility if it will go on. So what is your view? Do they need to continue this program for a couple of quarters? Or do you foresee this being a longer program for them to promote TD smartphones?

Leo Li

Yes. At least, I have discussed this very issue with the executives in China Mobile. I was told that the subsidies, the money, are evenly spread over the quarters. In other words, like a -- because I was a little bit concerned they'll spend most of the money first half, right? And second half, they're running out of their money. I was told that it is not true. So the money will be spent evenly over the quarters, and then interestingly enough for the low-end smartphones, to put a little bit like a RMB 20 there is like -- actually, they hit the target pretty forcefully, right? If you're talking about RMB 1,000 or RMB 20 there, it doesn't really do much. So actually, for the local China Mobile, they prefer the money to the low-end smartphones so that they can sell more units to finish their KPI, that type of thing.

Operator

Your next question comes from the line of Randy Abrams from Crédit Suisse.

Randy Abrams - Crédit Suisse AG, Research Division

One is on the discussion on single core and dual core, interesting good momentum in single core. There are some concerns from investors about slowdown in momentum once we get to a low cost dual core and if the entry-tier were to move up into dual core. If you could talk us -- if you do have a faster migration to dual core, maybe talk about your expectation or design traction or percent of mix or share in dual core you could achieve?

Leo Li

Sure. I think some analysts or some people told me that dual core will kill the single core. I don't think that people really go to the market to really see what's going on there. Like I said in my opening statement, 3.5-inch, right? You kind of a wasteful -- it is wasteful to use dual core there. Single core, at least my chipset operates a 3.5, just right, perfect. In other words, the screen -- the LCD sizes are really, really expensive. 3.5 versus 4.5, that really determines the selling price of the handset, right? So I still believe, and it is true that from a market point of view, that the single core addresses the lowest end of the smartphone, dual core addresses the higher segment and quad core, the higher, even higher segment. So they are different type of things. I don't understand why people mix up the subject. And then to say, "Oh, people come up with dual core, will kill my single core." The market is -- actually, this is not true. So I can tell you this, like I say -- I can say it will be priced $30 for 3.5-inch. And then with the dual core, you can't achieve that, right? And then the lowest cost of smartphone in the emerging market actually is really most welcome one, the products at the moment. I do not -- really do not -- not because I'm on dual core, too, by the way. I have a very competitive cost structure, outstanding performance, everything. But I'm not saying that I have a dual core, I'm going to reduce the single core. There is different segment in the market, different type of consumers and different size of screens of smartphones. So to address the different needs of the things, right? So I don't simply mix them up. I think it's very easy for them to make not very wise decision.

Randy Abrams - Crédit Suisse AG, Research Division

Okay. I wanted to ask a question on WCDMA. You announced recently the termination on the CTO. If you could just talk about some of the factors involved there or maybe what it indicates about the WCDMA development, which is sampling. So if you could tell us your expectations now on WCDMA. And also, if there's -- potentially, are you trying to create the same entry-level single core class to get this low-end smartphone into WCDMA? But if you could signal on the CTO, if there was anything involved with that.

Leo Li

Yes. I won't comment specific reasons, letting go. However, I can say this, that the meantime, [indiscernible] departure impact to the WCDMA programs are pretty minimum. And then I view the same statement that the 7710 and 7701 and 7702, the 3 different kind of products, will be launched to the market either in Q2 and Q3 this year. So the -- we're putting more effective resources, and the contrary is true to the program. So actually our people are working much harder now and then to deliver the WCDMA program, and both for the single core 7710 smartphones and 7701, which is a feature phone, to the marketplace either the second quarter or third quarter this year.

Operator

Your next question comes from the line of Jay Srivatsa from Chardan Capital Markets.

Jay Srivatsa - Chardan Capital Markets, LLC, Research Division

Leo, with these prices of smartphones dropping so rapidly, are you concerned about your ability to command the pricing that you have had before? And what's your judgment in terms of where -- what it does to your margin profile going forward?

Leo Li

I think it's -- I see pretty stable as it compare with feature phone. I guess, that's what you're saying that the GM, gross margin, I think it's much more stable for the smartphones compared with the feature phones. And also, I think for the smartphones, a lot of other things that matter, in other words, the memory chips, the PAs, and then the LCDs and software in particular, there are a lot of -- other things matters for the handset makers. So the chipset actually, it's a smaller percentage overall of the handset compared with feature phones, things like that. And then I think I'm happier with the so-called ASP trends of smartphone than with the feature phones. So also, the smartphones, above our corporate ASP guidance, right? And the feature phone, absolutely below the guidance. So I think the smartphone is a much better, better thing for us than feature phones.

Jay Srivatsa - Chardan Capital Markets, LLC, Research Division

All right. As you introduce your dual-core and quad-core products, I'm sure you've realized that MediaTek has been getting a lot of the design wins already with a lot of the white box guys. What kind of -- I guess, what kind of barrier do you face to get into the white box guys as you introduce your own solutions?

Leo Li

By the way, my single-core and dual-core are getting to the -- exactly the same customers, the -- whatever you mentioned, that they all get the my dual-core platform as well. For the -- like I said, the single-core and dual-core address different segments of the market, and then our dual-core product actually have outstanding CPU performance and a very competitive cost structure. So we are confident that our dual-core chipset will compete favorably in the marketplace.

Operator

Your next question comes from the line of Jessica Chang from Deutsche Bank.

Jessica Chang - Deutsche Bank AG, Research Division

My first question is regarding your ASP trend. Given smartphone continue increasing the contribution in revenue, do we expect your blended ASP going up and what's the implication for your gross margin continuously? Because your guidance for second quarter gross margin is stable, but will this be a little bit conservative?

Leo Li

The -- I think as far as ASP is concerned, with a better mix of the products down the road, we definitely can see the much improved ASP, average ASP. And then I can -- definitely can say that with the dual-core and quad-core and other products mix that we offer to the marketplace, we definitely see the further improved gross profit margin as well. So I am confident that the -- when we introduce more and more products, not just the single-core, and then we definitely see a much better or higher ASP and also improve the gross profit margin.

Jessica Chang - Deutsche Bank AG, Research Division

Okay. And then my follow-up question is for Shannon. Shannon, can you tell us what the -- your estimates for operating expenses in Q2?

Xiaoning Gao

Sure. We will continue to invest in R&D. So the dollar amount for the total R&D spending will increase for sure in Q2 compared to Q1. However, as we guided a higher top line, so the R&D expense as a percentage of revenue will definitely decrease. For SG&A, I think we -- in Q2, I think we will keep the same amount -- dollar amount and the percentage of revenue will also decrease a little bit. So the operating margin will slightly improve in Q2 compared to Q1.

Operator

Your next question comes from the line of Qin Zhang from JPMorgan.

Qin Zhang - JP Morgan Chase & Co, Research Division

I'm wondering like for the tablet market, what's our ASP strategy as taking advantage of the potential, particularly with the launch of the quad-core products? And also, what are the main potential customers of our quad-core products in tablet market?

Leo Li

Sure. The tablet market is one of the important markets to expect from. Like I said, we are addressing the smartphones as we speak. I think we are introducing the quad-core products now. And then with that type of products, we're able to address the pad market as well. So we have a separate team to work on it. My belief will be maybe Q4, the type of [indiscernible] which should able to send for that to the customers, the pad. Our pads actually is one of the growing segments for Spreadtrum. I think there's -- like I said at the -- in my investor presentation, we have a lot of the drivers for growth of the Spreadtrum business, and pad is one of them. And then our quad-core, we integrated connectivity and other products. We've also integrated communications, so we're definitely are able to address that, the pad segment effectively.

Qin Zhang - JP Morgan Chase & Co, Research Division

Yes. And my second question is regarding the ultra low-end smartphone market. Currently, we actually have the dominant market share in TD and also have a major market share in the EDGE '12. But one competitive RDA is [indiscernible] it's own address smartphone chipset. And so using that, you say, can successfully penetrate to this market, will we see increasing pricing pressure?

Leo Li

Yes. Like I said -- when I answer other analyst's question, the -- for smartphones, the hardware costs or chipset costs, the percentage of the entire cost of the handset is much, much smaller compared with the feature phones. So that the -- if we talk about it, just like a $0.20 but in delta, it's not much impact -- as much impact as with the feature phones. And yes, the software -- the stability of the software. There was the drivers and cameras and there were a lot of things that really matter in the smartphones. And then those things are -- takes time to develop. So I think you saw everybody -- whoever developed the smartphone needs to address that carefully. So the hardware, it's not just competing on the pure price. There is software features, there is -- even LCD performance, camera performance, a lot of things that really, really matters. So actually, you need to put a lot of effort to that. So my thinking is that the price competition, things like that, we will not be as strong or as terrible as the one for the feature phones.

Operator

Your next question comes from the line of Ken Hui from Jefferies.

Ken Hui - Jefferies & Company, Inc., Research Division

My first question is regarding the feature phone. Can you give us some color regarding your outlook for this year regarding the ASP and revenue compared to last year?

Leo Li

I think there's a -- the general trend for semiconductor business, ASP always go lower, right? So I believe this year for the same products, it will be lower -- slightly lower than last year. However, I think of the feature phones, all of us really to cut to the bone, so to speak, it's pretty low already. I think that once you hit a certain price, nobody wants to go any further. So I don't think that the price drop to say will be as significant as last year's.

Ken Hui - Jefferies & Company, Inc., Research Division

And your outlook for the volume and revenue compared to last year?

Leo Li

I think the volumes will be slightly smaller, smaller total volume -- you asked the total volume for feature phones, right?

Ken Hui - Jefferies & Company, Inc., Research Division

Yes, yes.

Leo Li

Yes, it will be smaller than -- this year than last year because overall market also is declining. And then, obviously, total -- the reduced volume will be offset by increase of volume of the smartphones. So we -- I'm not quite sure whether our fourth quarter or first quarter next year, we're going to see this smartphone volume will be higher than feature phones for Spreadtrum. So yes, the volume will be -- gradually, you'll see a higher and higher smartphone segment, and then gradually smaller and smaller for the feature phones.

Operator

Your next question comes from the line of Andrew Lu from Barclays Research.

Andrew Lu - Barclays Capital, Research Division

I have a couple of question. Could you give us some color on this 120 million units first half and second half breakdown?

Leo Li

We don't provide exactly the first and second half of breakdown. I think they're pretty evenly distributed, first and second half, not exactly numbers. And yes, we do not give a breakdown.

Andrew Lu - Barclays Capital, Research Division

Yes, do you have any color for second quarter over first quarter? For example, you provide a first quarter revenue for smartphone will be 60%, that's about 6 percentage point up from Q4. Are we going to see a very similar trend in second quarter like it goes to 66%, not a 6 percentage point increase?

Leo Li

I think, yes, the 40% to 50% in the first quarter, right? And then we -- each quarter, we increased the percentage of smartphones, each quarter like Q1, Q2, Q3 and Q4. And then the further down the road, the more -- the percentage of the smartphones to the total shipments contribution.

Operator

Your next question comes from the line of Roy Shen from SWS Research.

Roy Shen

Your second quarter guidance suggests there's 16% to 20% quarter-on-quarter increase, but your operating expense increased significantly in the first quarter. My question is do you expect a significant operating leverage to kick in, in the second half of the year?

Leo Li

Yes.

Xiaoning Gao

I'll answer this. Yes. Our -- actually, our first quarter total operating spending in dollar amounts decreased because of seasonality for the first quarter as the top line decreased from last Q4. So the operating expense as a percentage of revenue increased. As for the future quarters, starting from Q2, we will -- we expect our top line will continue to increase so -- even though we increased our operating expense, but the expense as a percentage of revenue will decrease quarter-by-quarter.

Operator

Your next question comes from the line of Dan Heyler from Bank of America.

Daniel Heyler - BofA Merrill Lynch, Research Division

I have a quick follow-ups. Leo, since you're introducing a number of products and your ramp is pretty steep, you've raised your smartphone guidance. I'm wondering how you think about your foundry outsourcing strategies. In the past, you've been pretty concentrated, you have talked about the benefits of moving some of that production to China. But then when you look at capacity available in China, that's fairly limited. So I'm wondering to what extent would you entertain perhaps a third foundry in your ecosystem given the strong unit prospects?

Leo Li

Sure, that's a good question. I think it's -- starting last year, we prepare -- saw a potential growth -- volume growth for this year. So for 40-nanometers of foundries, we have a 1, 2 and 3 foundries. And also for the packaging and testing, we have -- not just in overseas and also we have a Mainland Chinese. And adding the China ones, not necessarily to reduce the cost, rather to improve the capacity. Yes, we use quite a bit of the companies and factories for packaging and testing where some of them, which you're aware, are our #1 customers there. And we're sending our engineers to help them to improve the quality process, and then they reduced the cost, overall system cost. So that by doing that, we are sure to have -- not only have a very stable capacity to provide the chipset, also the -- to ensure the quality of the thing. So we have a very -- as you said, a very steep ramp-up of smartphone demand. And, yes, our volumes are very large. However, the quality of the products we deliver to the customers are very good. So for that, I'm pretty happy.

Daniel Heyler - BofA Merrill Lynch, Research Division

But are you anticipating a cost benefit for that as well?

Leo Li

No. I'm really -- I think it's -- down the road, the second half of the year, I think we should have a better operations because we have more foundries and then the factories are up and running for us. In that regard, I think that things would get even better.

Operator

Your next question comes from the line of Bill Lu from Morgan Stanley.

William Lu - Morgan Stanley, Research Division

Two follow-ups for, I think, Shannon. One is, can you give us some guidance for gross margin in the second half of the year? You've talked about fixed shipping to smartphones. We're going to start shipping the dual-core and quad-cores in the second half of the year, moving to maybe lower cost foundry. Is there a reason -- is this a scenario where the [indiscernible] money gets back to 40%?

Xiaoning Gao

Yes, sure. As Leo have stated, we launched more high-end products in the second half and especially when these products start to ramp up, we will see higher ASP and more improved margin. So we expect our gross margin will continue to improve in the second half.

William Lu - Morgan Stanley, Research Division

Would a 40% number be reasonable?

Xiaoning Gao

We don't give exact guidance. Yes, we will go towards that direction.

Operator

Your next question comes from the line of Randy Abrams from Crédit Suisse.

Randy Abrams - Crédit Suisse AG, Research Division

Wanted to ask a follow-up on the Tier 1 business. Where you have a global Tier 1, you started on feature phones last year. If you could talk about continued potential for more feature phone volume to ramp, and then also if you could talk how much you're extending the relationship in the smartphones with that customer?

Leo Li

Sure, yes. For the feature phones, we have higher and higher volume shipments per month or per quarter with the first tier customers. Actually, it's helping stabilize the total volume on the feature phones. And then also, like I said, both of our TD-SCDMA and for EDGE smartphones, in particular EDGE smartphones, the first tier customers launched that product globally, which is a very important product for Spreadtrum. And then the -- because launched product globally and these are different operators globally, and then these -- the different network requirements that add value, this shows the quality and maturity of our products.

Randy Abrams - Crédit Suisse AG, Research Division

Okay, great. And the inventory, just a question for Shannon, you noted some of the inventories to support second quarter increase. Just want to, I guess, confirm on the inventory mix if just -- how much of that are the new products and then even how much your starting inventory on some of the dual-core products?

Xiaoning Gao

Yes. We built up some inventory to prepare for the half season and the continuing increase in the demand of our smartphone. The new increase in the inventory in Q1 from Q4 are mainly our new products, including dual-core smartphone products and the single-core products and some new feature phones.

Operator

Your next question comes from the line of CK Cheng from CLSA.

Chao Kang Cheng - CLSA Asia-Pacific Markets, Research Division

My first question is that you mentioned this year, you're shipping more than 120 million smartphone. Can you tell us a little bit about what's the split between the single-core and versus -- dual-core versus quad-core?

Leo Li

Yes. Since we introduced the dual-core and quad-core much later of the year, obviously, the single-core will be majority of that 120 million. So I think, further down the road, the percentage or revenue contribution from dual-core and quad-core will be more and more significant.

Chao Kang Cheng - CLSA Asia-Pacific Markets, Research Division

Okay. And the second question is that when you launch the dual-core TD versus the single core TD, should we expect the gross margin for dual-core is higher than the single core?

Leo Li

I think generally, it's true, yes.

Operator

Your next question comes from the line of Eric Chen from Daiwa.

Eric Chen - Daiwa Securities Capital Markets Co. Ltd., Research Division

The first on the feature phone IC. And Leo, could you give us the idea that your market share right now and also you have the new integration, the 65 and the 31 (sic) Y the feature IC, they're coming. So what kind of the market share you expect in the second half of this year?

Leo Li

Like I said, overall, our feature phone volumes have declined somewhat this year compared with last year. I think the overall market declined as well. And then as far as the market share is concerned, we still have a 20% to 25% of the feature phone market. And then we have introduced in Q1 and Q2, 6531 with an integrated Bluetooth and FM. I think the -- it takes some time to transition, right? We're still selling some old ones and then still selling new ones. I think that by second and third quarter, we should complete that transition. In other words, we'll be selling more and more the new ones to the customers. And also, with the first tier customers, we have increased our feature phone shipments, month-by-month so that augmented our overall feature phone volumes, too.

Eric Chen - Daiwa Securities Capital Markets Co. Ltd., Research Division

Okay. And how big is the market size you think for this year, the feature phone IC, roughly?

Leo Li

No. This is -- you asked -- this is very dangerous to speak of the numbers because if you ask different persons, they give you different numbers. So it's sometimes even meaningless to give a number. But our guess is it's about 600 million to 700 million overall instead of -- in the billion range.

Operator

Your next question comes from the line of Qin Zhang from Westfield [ph].

Qin Zhang - JP Morgan Chase & Co, Research Division

Just one more question. When do you plan to switch your platform from 40-nanometer to 28? I think you planned it like in the second half, but I just want to get some updates.

Leo Li

Yes, yes. Second half, usually everybody says second half means fourth quarter, right? So I think this is the fourth quarter.

Operator

Your next question comes from the line of Yolanda Wang from HSBC.

Yolanda Wang - HSBC, Research Division

Just a very quick question on LTE. Could you update us on the progress of the LTE -- your LTE solution, and which category is your LTE solution?

Leo Li

Sure. I think last year, we launched the first LTE, TDD-LTE. We called it 9610, right? And then, like I said, our second half, late third quarter or fourth quarter, we're going to have a second -- a CAT 4, [indiscernible], TDD-LTE, SCD-LTE, WCDMA, TD-SCDMA and EDGE, the modem chips the -- by second half.

Operator

Your next question comes from the line of Quinn Bolton from Needham & Co.

Quinn Bolton - Needham & Company, LLC, Research Division

Shannon, just wanted to ask on a year-over-year basis, do you think you'll see operating margins expand in 2013 from where they were in 2012?

Xiaoning Gao

Yes, I think operating -- like I said, operating margin will start to improve in the following quarters and we will see a slightly improvement quarter-over-quarter. And so year-over-year, I think the operating margin we -- especially in the second half, as I said, the -- when the more new products ramp up and the gross margin starts to improve, and then we will see the operating margin improvement. So I think we hope this year, operating margin will improve year-over-year from last year.

Operator

Your next question comes from the line of Jessica Chang from Deutsche Bank.

Jessica Chang - Deutsche Bank AG, Research Division

I have 2 questions. First is regarding your annual target, 120 million smartphone shipments. What's your estimate in terms of breakdown in China in the emerging market, roughly?

Leo Li

We do not obviously provide a breakdown. Someone asked a breakdown, and I refused to answer. So I think it's -- there's a lot of TDs, and then I think that also second half or further down the road, we saw -- or we're going to see higher growth rate of the EDGE type of smartphones. So I don't have a specific breakdown numbers to give you. However, I think this -- the first half of TDs, obviously it's a -- have a much higher percentage.

Jessica Chang - Deutsche Bank AG, Research Division

Right. But if we just talk about like overall emerging market versus China, not really by air interface?

Leo Li

I know, I know. I don't have many business lines, so I don't want to give too many details, breakdowns. I know you guys want to have the exact numbers, right? To model the business. Anyway, I gave you a general trend. I think this -- the first half of TD growth rate is very significant. My thinking is that second half emerging market, smart -- low-end smartphone growth will be very significant. Further down the road and then growth rate of emerging market will be more significant.

Operator

Your next question comes from the line of Dan Heyler from Bank of America.

Daniel Heyler - BofA Merrill Lynch, Research Division

Can I ask 2 really quick ones? I guess, first to Leo. Could you elaborate on the dynamics of this emerging market trend? Because I mean, smartphone has been out there for quite some time in emerging markets. And I'm wondering why, why now are you seeing this big uptick in the very low end smartphone market?

Leo Li

Sure. I think it's -- I just need to talk to the emerging market customers. I think a couple of things. Okay, yes, smartphones being around for like quite some time. However, $30 smartphones have just been introduced, right? So you need like very good solid performance of the smartphone yet at affordable price. I think only now with our chipset, that's why I think the single core that really important for the emerging market. So as long as the -- you provide the smartphones, not only have a good performance yet a very affordable price to the consumers, to the emerging market, you're going to see uptick of this huge demand for smartphones. That is the truth in China, already proven that, and that will be very true in the emerging market as well. That's a very solid and fundamental demand for the low-end, ultra low smartphones. We saw it in India, and then actually, that growth rate surprised me. That's why I kept saying this, as soon -- once you have good products, you definitely can enable the segment. There is a fundamental need for this type of product in the emerging market.

Daniel Heyler - BofA Merrill Lynch, Research Division

Yes, makes sense. And then a quick one for Shannon, just simply a housekeeping one. Shannon, you mentioned on the first quarter in your press release, there were some legal charges there. Maybe explaining what those were on the OpEx, and then the employee compensation in the first quarter, how should we be modeling that going forward?

Xiaoning Gao

Okay. Legal charges, the regular legal fees, as we have a couple of litigations going on, but we -- the impact to the financials we already disclosed in the 20-F is not that material. As we continue to grow the company, we hire more people, that's why the employee compensation keep going on each quarter -- going up each quarter. So I think we will continue to hire more people in this year, we expect to increase more than 200 head count. So in the following quarters, the employee compensation will continue to go up. However, this already being considered into the total operating expense, and we still believe the top line growth will definitely overgrow the spending. So we still believe our -- we will continue to improve our operating margin and show more leverage in the following quarters.

Operator

Unfortunately, we have ran out of time. There will be no further questions. I'd now like to hand the call over to management for closing remark.

Leo Li

Thank you. We are very pleased with our outlook for 2013 and the strong demand for our smartphone chipsets and the expansion of first-tier business. We look forward to building on this demand with coming commercial introduction of our WCDMA, quad-core smartphones, multimode LTE and connectivity products. We thank you for continuing interest and support for Spreadtrum.

Operator

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

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