Executives
Mike Burns – Chief Financial Officer, Vice President Finance, Treasurer & Secretary
Jeffrey Staszak – President, Chief Executive Officer & Director
Analysts
JoAnne Feeney – FTN Midwest
Rick Schafer – Oppenheimer & Co.
Nick Aberle – Canaccord Adams
Vernon Essi, Jr. – Needham & Company
Patrick Wang – Wedbush Morgan
Gus Richard – Piper Jaffray & Co.
Alex Gauna – JMP Securities
Arnab K. Chanda – Roth Capital Partners
Ramesh Misra – Brigantine Advisors, LLC
John Vinh – Collins Stewart
Tore Svanberg – Thomas Weisel Partners
Volterra Semiconductor Corporation (VLTR) Q2 2009 Earnings Call July 20, 2009 5:30 PM ET
Operator
Welcome to the Volterra Q2 earnings conference call. During today’s presentation all parties will be in a listen only mode. Following the presentation the conference will be opened for questions. (Operator Instructions) This conference is being recorded today, Monday July 20, 2009. At this time I would like to turn the conference over to Mike Burns, Chief Financial Officer.
Mike Burns
With me to review our second quarter 2009 results is Volterra President and CEO Jeff Staszak. As usual, we’ll begin today’s conference call with a few important reminders. First, our earnings release and our financial statements are available on the investors section of our website at www.Volterra.com. Second, we’re going to discuss certain non-GAAP financial measures and we’ve provided a GAAP to non-GAAP reconciliation in our press release. The non-GAAP measures exclude the effect of stock-based compensation expense and special items such as the effect of accounting changes net of tax.
Unless we specifically state otherwise, when we give guidance about a financial measure we mean the non-GAAP financial measure. Finally, today’s remarks will contain forward-looking statements that are based on the company’s current views and expectations. Our actual results or events may differ materially from these forward-looking statements due to a number of risks and uncertainties.
Please review today’s press release and our filings with the SEC including our Form 10Q filed May 4, 2009 for a detailed discussion of the risk factors that could cause the actual result to differ materially from the forward-looking statements. Also, please note that Volterra undertakes no obligation to update or revise these forward-looking statements. With that, I’ll turn the call over to Jeff to provide an overview of the business and our results.
Jeffrey Staszak
First, I’ll provide a short recap of the Q2 ’09 financials. I’ll then give a short update on our four focus markets and following this I’ll talk about Q3 ’09 and provide guidance for the quarter. Finally, I’ll hand it over to Mike to review the details of our financial performance for the quarter and then we’ll open it up for any additional questions you may have.
In Q2 ’09 revenue came in above the high end of guidance at $22.8 million versus $28.7 million in Q2 ’08 and $18.3 million in Q1 ’09. Non-GAAP EPS was $0.10 versus $0.25 in Q2 ’08 and $0.03 in Q1 ’09. Non-GAAP gross margins were significantly up from 56% last quarter to 59.1% in Q2. Of the 2.1% improvement, 1.8% was a benefit from the sales of products previously considered excess inventory with the balance due to product mix, yield improvement activities and cost reductions with all suppliers.
As I mentioned in our last call, we hit bottom in Q1 from a business and orders perspective and expected growth in Q2 and the second half ’09 as new product cycles and customer launches kicked in. We believe we are getting much better visibility from our customers as they adjust their forecast in order to reflect reality in the current economic environment. We continue to get improved visibility from our customers therefore, I am optimistic that we will see continued quarterly growth through the balance of this year and in to 2010 as new products in customer platforms continue to launch and the economy continues to recover.
Now, I’d like to talk about our four focused markets and our current and future business opportunities within those markets. The current macroeconomic situation has had an impact on our short term business however, our long term growth and profitability prospects remain very strong. We plan on sticking to our proven strategy of gaining market share, adding new customers and further penetrating our existing base of customers as new products and platforms are launched in these four target markets.
Server and storage; we indicated in our last call that revenue would be up in servers and storage in Q2. Revenue was up 39% from Q1 ’09 due to the Thurley server platform launch and an uptick in our storage orders. We expect to see continued growth and market share gains as our customers continue to launch new products based on this Thurley platform and other new server programs that launch over the next few quarters. Our fifth generation products for the Thurley platform have been very well received because our customers increased their total system efficiency demands and added more memory on these new servers to support the latest multi core processors.
This new generation of products enables us to provide the highest efficiency requirements in the industry while saving considerable board area. As evidenced by IBM earnings call last week they’re still seeing strong growth in our high end P-Series server business and X series improving. We believe the positive outlook for X-Series is a result of achieving the highest measured system efficiency per operation by the Standard Performance Evaluation Corporation or SPEC power benchmark on their new two year rack mounted server the x3650 M2 launched in the first quarter. Volterra’s latest products enabled IBM to achieve this best in class efficiency.
In addition to IBM’s new servers we also expanded our position on HP servers with the launch of their new G6 server platforms where we are providing integrated power solutions. Examples that launched in the first quarter included HP’s DL-360, DL-380 and DL-460 servers. In the second quarter HP launched the [SL1 702], the [2X SL 1 702] and the [SL 1 602] using Volterra power management solutions. These high volume, high density server models at HP and IBM allowed us to expand our server market share at the two largest enterprise server companies delivering the best energy savings in the industry to their customers.
We will continue to benefit from the growing market trend for higher efficiency. Our server and storage business will grow in Q3 over Q2 with the continued ramp of Intel’s Thurley platform and we expect to see growth in the second half of this year with the refresh launch of [inaudible] products.
In the notebook market, our notebook revenue grew 103% in Q2 as our customers resolved their inventory issues and ordered Montevina platforms at a more normalized rate under the current economic conditions. In the second half ’08 we introduced our third generation of notebook products for the new Calpella platform expected to launch in Q1 of 2010 and have seen even stronger acceptance of these products from our customers as they use more silicon in more programs than the Montevina programs that are currently in production.
This new product family gave us another significant improvement in our cost performance metric and provided our customers increased battery life, component reduction and space savings through our integrated power solutions. In 2010 we are very excited about our notebook growth opportunities as our integrated solution gains momentum with the launch of the new Intel Calpella platform. Near term we expect to see notebook revenue flat to slightly up in Q3 from Q2 as we believe the inventory correct is essentially complete and as a more normalized demand has materialized in this macroeconomic environment.
In the communication market our communications revenue was up 7% in Q2. Currently we participate primarily in the high end metropolitan class of equipment at both CISCO and Juniper networks and have moved in to some higher volume enterprise class equipment the first half of this year. Our business has also been expanding slowly over the last few quarters with Alcatel-Lucent as they have adopted our integrated power solutions across more platforms. In Q3 we expect our revenue to be flattish with Q2.
In the graphics market, our graphics revenue was down 49% from Q1 since no new or fresh platforms were launched of any significance. Our Gen 5 products have also been well accepted in the graphics market as the power delivery requirements continue to become more demanding. We have competed for design wins with both customers on the next generation 40 nanometer cards expected to launch the second half of this year and early next year. For these new generation cards, we expect adoption on higher volume low end performance and mainstream programs in addition to the enthusiast programs. We expect graphics revenues in Q3 to be significantly up as the new 40 nanometer cards launch.
Guidance; finally, I would like to talk about the business outlook for Q3 ’09. As I mentioned earlier, visibility with our customers has significantly improved and we are optimistic that our business will grow through the balance of the year and in to 2010 as new product cycles continue to kick in with our customers and the economy continues it recovery. We are now anticipating Q2 revenue to be in the range of $25 million to $28 million with non-GAAP EPS from $0.11 to $0.16.
We expect our non-GAAP gross margins to be in the 57% to 58% range without any benefits or charges related to inventory reserves. At this point, I’ll turn the call over to our CFO Mike Burns for a closer review of the financials.
Mike Burns
I’ll start with revenue; second quarter revenue was up 25% sequentially to $22.8 million. We’ve diversified among our four market segments as follows: first, our server and storage business grew to 68% of revenue as our customers ramped their new Nehalem based server programs; second, our portable and consumer business primarily notebook recovered this quarter and was 13% of revenue, this is the first time our notebook business has ranked as our second largest segment; third, our networking and communications business is relatively stable this quarter at 12% of revenue; lastly, our desktop and work station segment which is primarily graphics was just 7% of revenue, the lowest percentage since 2007.
Looking next to gross margins, second quarter non-GAAP gross margin expanded to 59.1%. This includes the 1.8% positive impact from the sale of products previously considered excess inventory with no offsetting charge for new inventory reserves. Second quarter gross margin without the inventory benefit would have been approximately 57.3% up from the prior quarter due to product mix, yield improvements and cost reductions with all of our suppliers.
As a point of reference and for the sake of clarity, in the first quarter our non-GAAP gross margin of 56% had minimal net benefit related to inventory. Q1 did include a $670,000 benefit from the sale of products previously considered excess inventory but that was almost completely offset by $610,000 of offsetting inventory reserves booked in Q1.
Let’s move now to expenses; as expected non-GAAP operating expenses were up 13% sequentially and 11% year-on-year. The increase was primarily due to $1.25 million of litigation related expense. We did a significant amount of upfront work this quarter to prepare a motion seeking a preliminary injunction against Infineon Primarion to stop their manufacture and sale of products that infringe our patents. This quarter’s litigation spending peaked following litigation expense of approximately $650,000 in the first quarter of 2009, $350,000 in the fourth quarter of 2008 and zero prior to that.
A couple of other items to note on expenses, on R&D we increased our R&D investment sequentially and we remain focused on developing innovative and proprietary integrated voltage regulator technology. In total Volterra has now invested more than $150 million in R&D over the last 15 years in this area and now holds 53 patents on our technology with an additional 34 patents pending. One other update on spending, based on our improved business conditions and our outlook for continued growth and profitability, during the quarter we lifted the salary freeze, we hired for certain key positions and we resumed profit dependent accruals.
The bottom line in the quarter is that our non-GAAP net margin expanded to 11%, our earnings expanded to $2.4 million net income and $0.10 diluted earnings per share. Our GAAP net income which includes $1.37 million in stock-based compensation expense expanded to $1.1 million or $0.05 per share basic and $0.04 per share on a diluted basis.
Looking next at the balance sheet, we can see that we’ve got our working capital metrics back in line with historical norms and we generated significant cash. Through our continued focused on inventory management, we decreased inventory from 125 days last quarter to 94 days this quarter. When you look at it on a forward basis, based on the midpoint of next quarter’s outlook, second quarter inventory is approximately 78 forward days, cut in half from the 155 forward days we had just two quarters ago. Our other working capital metrics are in good shape as well. Accounts receivables day sales outstanding came down to 40 days. We generated a strong $8 million in cash and we ended the quarter with over $61 million in cash and structured investments and no debt.
A couple of cash flow related items to note for the quarter, our depreciation expense was $431,000, capital expenditures were $352,000 and there was no cash used for stock buyback. Looking forward at our outlook for the third quarter based on our strong order coverage and recent design wins in graphics we’re planning for sequential growth of 10% to 23% with third quarter revenue of $25 to $28 million. We current expect our ongoing cost reductions and our improved inventory management will enable us to achieve quarter non-GAAP gross margin in the approximately 57 to 58 points range. This assumes no net impact from inventory reserves.
We’re planning to increase spending in the third quarter for additional product development, for profit dependent accruals and for wages. We expect this to be partially offset by lower litigation expense. Also, we expect interest income to remain low and we expect our tax expense to remain low as well. If we achieve our goals on revenue, on margins and on spending, we’d expect to earn non-GAAP EPS of $0.11 to $0.16.
We plan to next update our financial results and guidance at our third quarter conference call which we have tentatively scheduled for Monday, October 19, 2009. We’ll put out a press release to formally announce and schedule the call when we get closer to that date. Also, each quarter we participate in a number of investor relations events. On Thursday, September 10th we’ll be hosting our analyst day in New York from 8AM to Noon. This is our biggest annual investor effort and we hope all of you will be able to join us in New York, or if not, via webcast on our website.
Our other activities this quarter include on September 2nd Wedbush will be hosting an investor dinner for us in San Francisco, on September 11th we’ll present at the Kaufman Conference in New York and on September 16th we’ll present at the ThinkEquity conference in San Francisco. In addition to these events we’ll continue our bi-monthly virtual visit programs. Virtual Visit 101 is designed specifically for investors new to Volterra and those who have not had contact with us in the past 12 to 18 months. The Virtual Visit 201 is for those investors more familiar with Volterra who may want to get caught up on more current topics and industry issues. Please contact Heidi Flannery, Investor Relations at 510-743-1718 if you’d like to participate in any of these events.
That’s it for our prepared remarks. Before we begin the Q&A, in the interest of time we’d ask that each analyst please limit themselves to two questions then, if time allows at the end, we’ll go back to any one that may have a follow up question. With that, we’d now like to turn the call over to questions.
Question-and-Answer Session
Operator
(Operator Instructions) Your first question comes from JoAnne Feeney – FTN Midwest.
JoAnne Feeney – FTN Midwest
I wanted to perhaps delve a little bit more in to the graphics side of things, I’m wondering if your exposure to the ATI and Nvidia product lines is still relatively balanced? You mentioned finding your way on to more mainstream cards, is that true for both of those product lines or just for one or the other?
Jeffrey Staszak
Well, we’re still pursuing opportunities with both in mainstream. We have won some design wins at one of these customers and expect those to launch the second half of this year, end of Q3 or early Q4.
JoAnne Feeney – FTN Midwest
Do you see that ramp continuing in to Q4 Jeff or is that something that’s going to have a strong surge right here now in advance of the launch and then sort of tails off pretty quickly?
Jeffrey Staszak
No, we would expect it in Q4 and then we would see kind of a tailing off in the Q1 time frame.
JoAnne Feeney – FTN Midwest
Then, on the notebook side, you were clear about it being flat here for this quarter because you think the ramp is over, do you then see that the back to school build that sort of queues things up in May and June, that that is over and we’re not going to see another surge of builds for notebooks for holiday season, is that your take on things right now?
Jeffrey Staszak
Well, we do have some consumer I guess but that’s not the majority of the notebooks that we’re in, most of them are more business related.
JoAnne Feeney – FTN Midwest
So you feel like those builds have already taken place and that’s not going to get any further boost in the second half from consumer spending.
Jeffrey Staszak
No, like I said this quarter in Q3 we expect it flattish to slightly up and then we would expect assuming the Calpella launches mid Q1 of 2010, we would expect like historically we would start to get orders in the December time frame for the Calpella launch so we could see some small incremental uptick in Q4.
Operator
Your next question comes from Rick Schafer – Oppenheimer & Co.
Rick Schafer – Oppenheimer & Co.
I just had a couple of questions, just a follow up on the GPU, or sort of a follow up on the GP question, I was kind of surprised to see even with GPU becoming a bigger piece of the mix in the third quarter, it sounds like a materially bigger piece, that you’re going to be able to hold gross margins basically flat excluding those onetime benefits from Q2. Can you give us an idea of how you’re able to do that? Is that reflecting sort of the Gen 6 ramp in the back half?
Jeffrey Staszak
No.
Mike Burns
You have a good point there, graphics is going to spike and that’s one of our lower margin segments but we have a few things offsetting that. One thing is our production has been way down the past couple of quarters so we were expecting to get a little better absorption on the margins in Q3 and Q4. Then also, the server programs launch, that helps the mix as well here for the next few quarters so that we think those will offset each other so we’re pretty comfortable in that 57 or 58 point range right now.
Jeffrey Staszak
The reason I said no was because it’s not Gen 6, it’s Gen 5. It’s kind of a spin of the original Gen 5 that we had with the products that came out last year which is basically a slightly smaller dye, increased performance and as a result we’re able to, like Mike said, we can hold our margins. They are in the lower end of the range but we can still continue to hold our margins.
Rick Schafer – Oppenheimer & Co.
So Jeff to be clear, I thought you guys started sampling Gen 6 last quarter, didn’t you?
Jeffrey Staszak
Yes but it was not for graphics it is for the [VR-12] the next Romney platform that is just started from a design standpoint. So, we sent out sample and eval kits for that platform launch which doesn’t occur until 2011.
Rick Schafer – Oppenheimer & Co.
So we shouldn’t be thinking about Gen 6 impacting the model really until ’11, right?
Mike Burns
That’s correct. What you’re going to see Gen 5 will cross over to the bulk of our revenue in the second half of this year and that will continue through 2010 and then Gen 6, in terms of revenue, we expect to ramp in the 2011 time frame.
Rick Schafer – Oppenheimer & Co.
Then just one follow up real quick, given the strong upside in the quarter can you give us any commentary on sort of your shipping patterns through Q2 and maybe give an idea what the turns requirement will be to hit the midpoint of your guidance?
Mike Burns
Sure, Q2 in terms of shipping was extremely linear, I would characterize it as that and bookings were strong as well. They were stronger towards the back half, particularly in June, June bookings were quite strong. Based on those very strong June bookings, a pretty minimal turns requirement this quarter, probably in the roughly 10% range to reach the midpoint so we have very good backlog of orders heading in to the quarter particularly graphics.
Operator
Your next question comes from Nick Aberle – Canaccord Adams.
Nick Aberle – Canaccord Adams
Did you just say that you had good backlog for graphics? That’s a little unusual from over the years?
Mike Burns
Yes that’s right, graphics tends to be pretty turns based but this quarter I think we’ve got very good order coverage, it’s just a matter of when we’re going to ship it.
Nick Aberle – Canaccord Adams
And that’s dependent on the 40 nanometer ramps at the two suppliers.
Jeffrey Staszak
Well, that’s correct but we expect these programs to launch and products to launch so with the backlog that we have we’re pretty comfortable about shipping all of it and pretty comfortable that there’s going to be some reasonable volumes going out on 40 nanometer products starting in Q3.
Nick Aberle – Canaccord Adams
So even though you do have good backlog there, is GPU still the majority of that $3 million swing factor in the top line guidance?
Mike Burns
Are you saying what would swing us from the lower end of the range to the higher end of the range?
Nick Aberle – Canaccord Adams
Yes, it sounds like that’s the big –
Mike Burns
Our shipments would definitely be a main factor there, that’s right.
Nick Aberle – Canaccord Adams
On Calpella, what can you say about timing there, about when we start to see that contribute to top line? And, is the design cycle finished there and is there anymore color you can give us on what type of market share you could potentially pick up sequentially from Montevina to Calpella?
Jeffrey Staszak
Well, I think what we said in the past is even in this environment we’re kind of going to be at the $3 to $3.5 million notebook revenue range for the next couple of quarters and then a slight uptick from incremental Calpella revenue in Q4 as that launch is in Q1 then you’ll see revenue growth in Q1, Q2 and Q3 from Calpella and we would expect to double our revenue in notebooks with the Calpella launch and that’s based on again, more platforms, more silicon on those platforms and the addition of another customer or two.
Nick Aberle – Canaccord Adams
Just one last quick question, did you guys see any supply constraints during the quarter and are there supply constraints going in to Q3?
Jeffrey Staszak
No, our suppliers have been very accommodating both at front end and fab as well as in the back end on moving materials through. Again, we’re in .35 so I shouldn’t say that there’s an abundance of capacity but our suppliers there have been accommodating in helping us move material through without any supply issues and in the back end in assembly and test our suppliers have done a very good job for us as well.
Operator
Your next question comes from Vernon Essi, Jr. – Needham & Company.
Vernon Essi, Jr. – Needham & Company
I was just wondering if you look at in to the third quarter from the trigger perspective, you’ve obviously got some great visibility here and some good backlog, is this a situation where you’re getting a rolling forecast on a 90 day basis or are you getting a look ahead further out in to those customers?
Mike Burns
We’re getting both. We’re getting the 90 days and a real decent look ahead in to early next year in terms of realistic forecast from our customers I’d say.
Vernon Essi, Jr. – Needham & Company
Then, this is a tough question, what do you expect that fourth quarter transition to look like? Do you think there’s sort of a channel situation where you’re going to fill that inventory for now or do you think there could consumption rising through the course of the year?
Mike Burns
In server?
Mike Burns
I think as of now our current expectations is we’ll see some continued probably more moderate growth from Q3 to Q4 in the server area.
Vernon Essi, Jr. – Needham & Company
Then if you could just revisit the figures, this is my final question, on the litigation I missed that in your prepared comments Mike, the fourth quarter through the current quarter.
Mike Burns
Fourth quarter of last year was $350,000, in the first quarter of this year it was $650,000 and this quarter it peaked at $1.25 million.
Vernon Essi, Jr. – Needham & Company
You expect that to be down to zero?
Mike Burns
Yes, we expect that to be down probably a little more in the $1 million, maybe a little under the $1 million range for the third quarter then we’ll see where we take it from there. We filed a preliminary injunction motion at the beginning of July against Infineon Primarion and there will be a hearing at the end of the quarter on that so we’ll kind of take it from there.
Operator
Your next question comes from Patrick Wang – Wedbush Morgan.
Patrick Wang – Wedbush Morgan
I guess first off just on server, we heard Intel talk about a nice surge in demand for Nehalem parts and certainly platform for them in the second quarter and which is kind of reflected here. I just wanted to see if we could talk about bigger picture, where you thought we were in terms of the recovery in server and I guess what ending you would kind of characterize this is in terms of recovery? If we just take a look at the numbers here, you guys are about $15.5 million in the second quarter and when you kind of compare it to the peak of last year’s $17.1, that was here in the third quarter any thoughts about that?
Mike Burns
Well, [inaudible] it’s early [inaudible], it just launched about three or four months ago so it’s still early days here. The switch over seems to be going as planned, the adoption rate is looking good, it’s definitely gotten good reception it the market so everything seems to be tracking well there. Jeff do you have anything to add there?
Jeffrey Staszak
Well, if you listened to IBM’s call last week their P-Series server business was still pretty good and their X-Series had come up from the previous quarter so they were doing a little bit better there but I think the overall demand situation is still balanced. For us it’s we’ve been able to gain market share at a couple of our customers here and as a result you’ve seen us come back to a reasonable revenue number for Q2 and you said that’s going to grow so we’ll be approaching what was it our Q3 of last year, of ’08 levels in server which was kind of in the $16.5 million to $17 million range, kind of in that area I would guess this quarter.
Patrick Wang – Wedbush Morgan
Then also, I wanted to see if you could talk about overall demand as we kind of get a sense of how supply catches up with demand, we’ve seen some of the benefits of inventory refill. Can you kind of just give a sense of across your four segments how you feel about how much more inventory refill there is, how much of the demand that you saw in the second quarter is actually true demand and kind of parse that out for us?
Mm
It’s hard to say, we have good visibility at our stocking reps and their inventories is basically exactly the same as where it was last quarter in terms of days going forward, about four weeks for them. So, there doesn’t seem to be any major resale going on there but we do get a surge of orders at the end of June so there may have been something going on there, we just don’t know for our other customers so limited visibility on that. We’re keeping an eye out for that sort of thing, we’re being fairly cautious and we’re not depending on a lot of turns orders this quarter so we’ll kind of take it as it goes.
Patrick Wang – Wedbush Morgan
Then if I can squeeze in one last one, as we think about gross margins going forward, a great job on gross margins in the second quarter and also third quarter guidance but as we think about a little further out here, it’s 57, 58 kind of base line to think about and then having product mix kind of nudge it up and down?
Mike Burns
That’s right that’s a good way to think about it. Our target market as you know is 55 to 60, we’ve been more towards the lower end of that range last year and early this year, now we’re moving up in the 57, 58 point range so kind of the middle of that range and we’re planning to stay there for the next few quarters and next year we’re planning to stay and model there as well. Each quarter of course things can move around as the segments go up and down and that sort of thing, that can move it around a point or two either way quite easily but, our margins are looking quite good at the moment.
Operator
Your next question comes from Gus Richard – Piper Jaffray & Co.
Gus Richard – Piper Jaffray & Co.
Just quickly, in looking at relative strength in Q3 between servers and graphics, it seems like you’re going to go back to your current levels in server and that would imply your graphics business is going to a pretty significant jump but not back to the peaks that you achieved last year. Is that a reasonable way of thinking about it?
Mike Burns
Yes.
Gus Richard – Piper Jaffray & Co.
So the $4.5 to $5 million range for graphics is a good guess?
Mike Burns
Probably somewhere in that ballpark, yes.
Gus Richard – Piper Jaffray & Co.
And again, somebody earlier asked about the gross margin impact of that, it’s not so much lower that it’s really going to impact your gross margin in the quarter?
Mike Burns
That’s right. It tempers it a little bit Gus, but the other segment’s margins are looking pretty good so we don’t think it’s going to have a huge negative impact for us this quarter.
Gus Richard – Piper Jaffray & Co.
Just on the model on R&D, given where you set your EPS range, you’ve got a lot of litigation coming out of the model so I would expect SG&A to be down sequentially, is that the right way of thinking about?
Mike Burns
That’s right. SG&A will likely be down sequentially, that’s where that litigation expense resides. We’re expecting our R&D expense to be up and that will offset that. Overall, we’re expecting spending to be up again from q2 to Q3 and that’s just a mix of a number of things, some of its product development and R&D, some of it is wages and accruals and that sort of thing. Then, we think the litigation expense, we’re expecting that’s going to come down to the $1 million, maybe a little bit under the $1 million range.
Gus Richard – Piper Jaffray & Co.
On the R&D expense, is that more lumpy stuff like mass tape outs or is this more of a sustainable pick up?
Mike Burns
Yes, that’s more the lumpy thing because as you know, that line item can move around quite a bit quarter-on-quarter so we’ve got some more protyping and product developing going on, on the plan for Q3 than we did in Q2. That’s what’s driving that.
Operator
Your next question comes from Alex Gauna – JMP Securities.
Alex Gauna – JMP Securities
Jeff, did I understand you to say that you expected growth throughout 2009 and then in to 2010. Does that imply that you have some visibility on an up sequential quarter in Q1 right now or is that just an expectation based on seasonality and mix?
Jeffrey Staszak
Well, it’s based on the forecast that we’re getting from our customers, the forecast and the orders that we have got and like for this quarter against forecasts and we’re starting to get a reasonable amount of backlog already in to Q4 so our expectation is that we’re going to see some growth in Q4 as well.
Mike Burns
Alex, in terms of the Q1 there are a couple of things going on there, one is we’re expecting an increase in our notebook revenues starting in Q1 of next year as the integrated graphics version of the Calpella launches, so we’ve got that going for us. But, as Jeff mentioned we’re expecting that a surge in graphics here in Q3 that will likely go in to Q4 and then that will typically tail off in to the Q1 so that could offset it there as well. So, too early to try and call precisely Q1 versus Q4.
Jeffrey Staszak
And in the Q1 time frame Intel is coming out with the new processor, the EX processor and the Westmere refresh and we will be getting some additional market share there. We’ve gained some sockets on some programs that we weren’t on before so we expect to see some revenue uptick there as well.
Alex Gauna – JMP Securities
If I could, on the graphics you mentioned that you’ve got pretty good coverage this quarter, what would you expect for normal seasonality in Q4 with graphics? Is there pretty good turns business that carries you through the quarter or do you think it will temper because of the surge that you’re seeing with Q3?
Mike Burns
Typically graphics Q3 would be the strongest quarter for graphics but really what swings it more than anything for us is the product launches.
Alex Gauna – JMP Securities
Lastly, with Calpella, you mentioned Gen 5 still has a lot of legs to it, you’re on the third generation of your notebook refresh, how much further can you squeeze Gen 5 or what can you do to help yourself on the cost competitive profile for notebooks moving in to next year?
Mike Burns
On gen 5 we’re really still relatively early days on Gen 5 in terms of our revenue on that and there’s a lot of things, particularly on the design end that they’ve done in the notebook product area that bring our cost down and all of our suppliers have been cooperating as well because they see it like we do as this Is a very large opportunity for us if we can get our cost down.
Alex Gauna – JMP Securities
Does that cost down, are we talking like a 4th Gen, 5th Gen kind of notebook [inaudible] to kind of move forward, is it that kind of design cycle?
Jeffrey Staszak
You mean for Calpella?
Alex Gauna – JMP Securities
Yes, for Calpella.
Jeffrey Staszak
Those products have been out for a year and a half already, about a year and a half since Calpella got pushed out. I mean, right now we’re already in the process, we have next generation products for the following on platforms so the notebook products we crank out, they are usually 12 to 15 months.
Operator
Your next question comes from Arnab K. Chanda – Roth Capital Partners.
Arnab K. Chanda – Roth Capital Partners
One question about your notebook business and your outlook, do you think it’s because you don’t participate in netbooks that you’re seeing that phenomena or is there a market share issue because it seems like the market itself on the unit side does seem to be helping so I’m just curious at your opinion of that.
Mike Burns
No, there’s no market share issue, it’s just we’re on all the platforms that we’re on and I think we’ll see some sequential growth but as Jeff referred to, the platform and the programs that we’re on in notebook are primarily for businesses and we think that will grow somewhat in Q3 but it’s not so dependent on the back to school.
Arnab K. Chanda – Roth Capital Partners
I have a follow up, you said your business was very strong and ended up strongly in June, is that a phenomena of sort of the graphics business itself or maybe their launch got a little bit pushed out or did you see that across the board?
Jeffrey Staszak
I would say that we got reasonably good orders in server storage, our notebook orders definitely picked up, communications came in okay and graphics was up more than we expected.
Arnab K. Chanda – Roth Capital Partners
Just one last question on graphics, it seems like the [inaudible] ahead in 40 instead of behind, that’s kind of flipped around a little bit but the first 40 millimeter nanometer is starting to ship from one of the suppliers. Are [inaudible] represented, I think you said that but then there was another discussion of why maybe you were in one and not the other or something like that. Could you clarify if this is an opinion on the entire market or is there one that is shipping ahead of the other?
Jeffrey Staszak
Yes, there is one. I mean, we’ve gotten more orders from one of our customers than the other, that’s correct.
Arnab K. Chanda – Roth Capital Partners
Is it the same person that was ahead maybe a couple of months ago because it seems like things have changed a little bit?
Jeffrey Staszak
A couple of months ago we weren’t getting orders from either one of them.
Operator
Your next question comes from Ramesh Misra – Brigantine Advisors, LLC.
Ramesh Misra – Brigantine Advisors, LLC
The first question was how much of the previously observed inventories do you still have?
Mike Burns
I don’t know the total balance, we are always kind of reserving things as we go along. The previously reserved, why we break that out separately is because it was reserved last year so anytime you kind of go past the calendar year you can’t release that reserve until you actually sell it and then at that point you disclose it. That’s why we’re just kind of breaking it gross this quarters versus what we’ve done because typically you’ve always got stuff kind of coming in and out of reserves.
In terms of our outlook for Q3, we think that we’ll probably sell some more of that stuff that is on reserve, probably a little less than we did this quarter. But typically each quarter we’ll have some offsetting inventory reserves there that offset it.
Ramesh Misra – Brigantine Advisors, LLC
The items in gross margin for the 57 to 58 that incorporates the portion that you expect?
Mike Burns
Yes, it in corporate a little bit of sales previously reserved and a little bit of additional reserves.
Ramesh Misra – Brigantine Advisors, LLC
On the notebook side obviously, it was a phenomenal quarter, can you kind of quantify how much of the sequential growth was due to new wins and how much is from the continuing business from older products or maybe have customers refilled their own inventory?
Mike Burns
It’s primarily just recovery of the business that we’ve had for a number of quarters was really suppressed particularly in Q1 of this year. The notebook customers got a little bit ahead of themselves before the economy turned south and so now the orders are coming back to a more normalized run rate, that’s predominately what’s going on.
Ramesh Misra – Brigantine Advisors, LLC
Then just one final brief follow up, maybe this might be for Jeff, Jeff what are the key differences between your Gen 6 and your Gen 5 product?
Jeffrey Staszak
There’s some obviously circuit changes, there’s some dye size differences, performance differences, there’s new specs to hit the new Romney platform specifications, increased performance from an efficiency standpoint so it’s a lot of changes.
Ramesh Misra – Brigantine Advisors, LLC
So you’re not just shifting to a different geometry or anything?
Jeffrey Staszak
No, that will happen with Gen 7.
Ramesh Misra – Brigantine Advisors, LLC
In the past you had some issues related to packaging so I wanted to get a sense, is the package going to be any different on Gen 6 versus Gen 5?
Jeffrey Staszak
No, it’s basically the same package that we just received from our largest customer their number one quality rating for last year and one of the top OEMs in Taiwan, we were number one quality semi quality supplier for last year for 12 months in a row now. So, it’s the same package, it’s doing very well for us.
Ramesh Misra – Brigantine Advisors, LLC
So the likelihood of having that same problem that you had about a year and a half ago, two years ago is probably pretty low?
Jeffrey Staszak
That was a completely different package. That was two generations ago packaging.
Operator
Your next question comes from John Vinh – Collins Stewart.
John Vinh – Collins Stewart
The first question I had was on the Nehalem, if I look at your server revenues in Q3 it peaked at $17 million in Q3 of ’08, one obviously Intel has talked about the crossover point next quarter in the August time frame, when do we reach kind of the peak revenue run rate on your Nehalem platform and where do we think we could get to some sort of peak revenue run rate? Do you think you can get to kind of a $20 or $25 million run rate or is that out of the question at this point?
Jeffrey Staszak
Yes, I think $20 to $25 million is more like the Romney platform in 2011. We would think that in a normalized environment $20 million a quarter in server and storage with the Thurley platform and the new AMD stuff coming out is not out of line.
John Vinh – Collins Stewart
What’s your sense of the timing of when we hit that run rate?
Jeffrey Staszak
You tell me when the economy gets back to a more normal environment. We’ve gone from I think $12 or $12.5 million in Q1 up to $15 something this quarter and we said we’d probably be in the $16.5 to $17 million range next quarter and we expected to see growth in the fourth quarter. But, to get to that more $20 million I think we need a more normalized economy so I would guess it would probably be in the first quarter or second quarter of next year.
John Vinh – Collins Stewart
Intel commented that they see the cross over point happening in August, based on your [inaudible].
Mike Burns
That’s consistent with what we’re seeing John. I mean, in terms of our revenue, we ship in to Intel based server programs and AMD based server programs and other Intel based, we’re expecting that to cross over next quarter as well.
John Vinh – Collins Stewart
Then last question for me is on your notebook side, have any of your shipments in Q2 CLV based, maybe you can give us an update in terms of where you’re positioned on CLV at this point?
Jeffrey Staszak
We do have some designs that we’re working on in Taiwan for CLV but what we talked about is it would probably be the end of the second half of the year. We’re still in design progress right now, I should say design end opportunities but that would be a small portion of our business anyways. Again, most of our growth next year, I mean there will be some opportunities there for us that we expect to win but the majority of our business is going to be in this $1.2 billion market opportunity for us which is kind of in the 12 to 16 inch screens and in the kind of $600 to $1,600 range of notebooks.
Operator
Your next question comes from Tore Svanberg – Thomas Weisel Partners.
Tore Svanberg – Thomas Weisel Partners
I realize your visibility is starting to improve and certainly the bookings are there but could you just comment a little bit on just qualitatively what your customers are telling you? Is it not just about new progress but just about their demand in general? I’m just trying to get a gage of where end demand is heading here in the second half.
Jeffrey Staszak
The visibility has been getting better every quarter since Q1 and their telling us that the demand, as recently as last week with IBM that their revenues were down I think 12%. I think the overall demand is still down, it’s slowing coming back but when it’s going to come back to where it was back in Q2 and Q3 of last year, that’s anyone’s guess. All of our customers are feeling much more positive in general than they were just three or four months ago.
Tore Svanberg – Thomas Weisel Partners
Just coming back to the notebook market and Calpella and maybe even the ultra thin market, are you hearing anything from your notebook customers about potential inflection point where that business really starts to fire on all cylinders for you?
Jeffrey Staszak
Yes, in Q1. We’re getting put for Q1.
Operator
At this time there are no additional questions. I’d like to turn it back to management for any closing remarks.
Mike Burns
Thanks all of you for your questions and interest in Volterra. A webcast of today’s call will be available on the company’s website until Monday, August 17, 2009. Thanks for joining us today.
Operator
Ladies and gentlemen this does conclude the Volterra Q2 earnings conference call. Thank you very much for your participation and for using ACT. You may now disconnect.
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