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Spreadtrum Communications Inc. (NASDAQ:SPRD)

Q2 2009 Earnings Call

August 19, 2009 8:00 am ET

Executives

Dr. Leo Li - President and CEO

David S. Wu - CFO

Analysts

Charles John - Piper Jaffray

Timothy Lam - Citigroup

Quinn Bolton - Needham

Dan Heyler - Bank of America

Bill Lu - Morgan Stanley

Tse-Yong Yao - HSBC

Operator

Welcome to the Spreadtrum Communications Second Quarter Fiscal 2009 Financial Results Conference Call. At this time all participants are in a listen-only mode. Following management prepared remarks there will be a Q&A session. As a reminder this conference is being recorded.

Joining the conference today are Dr. Leo Li, President and CEO, Mr. David S. Wu, CFO, and Ms. Shannon Gao, Vice President and Finance of Corporate Controller. After the close of the US markets on Tuesday, Spreadtrum issued a press release announcing its second quarter fiscal 2009 financial results, which will also be available on the company’s IR webpage at www.spreadtrum.com. This is call is also being broadcast live over the internet and will be available on the company’s website.

Before management briefing, I would like to refer to the Safe Harbor Statement in connection with today’s conference call. This call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including certain plans meaning of the expectation and goals and projections, which are subject to enormous assumptions, risks and uncertainties. Such forward-looking statements include without limitation statements regarding the company’s ability to withstand the current adverse market condition. The Chinese government [conference] and the company are [enrolled] in China 3G and TD-SCDMA rollout. Our ability to continue developing new and innovation product and the company expect the financial performance in the third quarter of 2009.

Forward-looking statements involve known and unknown risks, uncertainties and contingencies many of which are beyond our control, which may cause actual results, level of activity, performance or achievements to differ materially from any future results. Levels of activity performance or achievements expressed or implied by such forward looking statements.

The company’s actual results can differ materially from those contained in the forward looking statements. Since with the number of factors includes and those described under the heading Risk Factors in the company’s final prospectus filed with the Securities and Exchange Commission. Its annual report on Form 20-F filed on June 30, 2009 and documents perpetually filed by the company from time to time with the Securities and Exchange Commission including on Form 6-K. Unless required by law, the company undertakes no obligation to update or revise any forward-looking statements, where as the result of new information, future events or otherwise.

I will now like to turn the call over to Mr. David S. Wu. Sir, please go ahead.

David S. Wu

Thank you for joining us today for review of our second quarter 2009 results. I will give you a very brief overview of the numbers and then turn the call over to Dr. Leo Li to talk about our operational performance and business outlook. After that we will be happy to take your questions.

The total revenue for Q2 was $16.2 million, up 97% sequentially and down 60% year-over-year. Baseband and RF revenue in 2Q ‘09 accounted for 99% of total revenue, a $16.1 million, up 101% from $8 million in first quarter ‘09 and down 58% from second quarter last year.

Our gross margin in 2Q ‘09 was 23.6%, which is a solid improvement compared to 19.4% in first quarter ‘09 and down from 45.2% in 2Q ‘08. Our GAAP net loss in 2009 was $13.1 million compared to a net loss of $8.3 million in first quarter of ‘09 and net income of $2.6 million in 2Q ‘08.

We incurred higher non-cash expenses in the second quarter, mostly driven by $5.6 million in share based compensation expenses. Excluding these charges the Company's non-GAAP net loss for second quarter '09 would have been $7.2 million, which is an improvement from the non-GAAP loss of $7.4 million in the first quarter.

The diluted loss per American Depositary Share in 2Q '09 was $0.29 compared to a diluted loss of $0.19 in the first quarter and diluted earnings per ADS of $0.06 in 2Q '08. The non-GAAP diluted loss for ADS, however was $0.15, compared to a diluted loss of $0.17 in first quarter '09 and an earnings for ADS of $0.11 in 2Q '08.

Let me now turn the call over to our President and CEO, Dr. Leo Li.

Dr. Leo Li

Thank you, David and thank you all again for joining us today. Looking at the our second quarter results, we have seen some clear signs of improvement in our performance and we are confident that our continual focus on the fundamentals, that is the products quality and customer support is paying off.

This is evidenced by the strong increase in the product shipments in second quarter this year. We have increased the baseband shipments by 86% sequentially, including our greater shipments of GSM, GPRS and TD-SCDMA baseband products. We also increased the shipments of RF transceivers by 93% sequentially as well.

In the second quarter, we also began the volume shipments of TD-SCDMA baseband chips through the fixed wireless market. The TD-SCDMA coverage will be present in more than 239 cities across China by the end of this year. Although we do not expect the TD-SCDMA to have a material impact on our financial performance this year, we should see the contribution of the product to the revenue and margins in the second half of 2010.

Once the TD products runs up, we will be able to also make a significant [progress] with the CMMB mobile TV product. We have been working very hard to improve the product quality and provide stronger customer support. As a result, we expect a significant rebound in the revenue of the third quarter this year. We expect the sales in the range of US $31 million to US $36 million in Q3, a substantial sequential increase. We also continue to streamline our operations and expect an improved margin sequentially as well.

Thank you again for your time today and we will now open up for questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Charles John with Piper Jaffray. Please proceed.

Charles John - Piper Jaffray

Hi, this is Charles from Piper Jaffray. Hello Dr. Li and David, thanks for taking my questions. So, maybe just start off with your revenue drivers for the next quarter and if you could just walk us through what’s driving the big sequential increase and also just some of your expectations for the TD market in 2010.

Dr. Leo Li

Yes. This is Leo. The driven part is mostly it’s in GSM products. Like I said in the beginning in the opening statement, TD products, to me the volume part, the significant volume will be in second half of next year. As everybody you can see that the last Q4 and this Q1 this year, our revenues are going downwards, and downwards that also included in our market share. So, we are gaining back the market share we’ve lost in the past, that’s why we could see some ramp up of the revenues in the third quarter.

Charles John - Piper Jaffray

This is being driven just by one single customer or are you scaling up with a lot of your previous customers also?

Dr. Leo Li

Yes, some other previous customers as well.

Charles John - Piper Jaffray

Did you have any 10% customers this quarter?

Dr. Leo Li

One more time?

Charles John - Piper Jaffray

Did you have any 10% of sales customers this quarter?

Dr. Leo Li

Four or five of them.

Charles John - Piper Jaffray

Four or five, okay and then in terms of just the sustainable run rate for the company going forward. Is that some kind of timing event, which is driving the Q3 guidance or should we assume something in the mid 30s as a sustainable longer term or could you maybe give us some color on what you’re expectations are for the second half of year and into 2010 for your revenue run rate?

Dr. Leo Li

On revenue run rate, like I said the Q3 that was the range, right and I hope our Q4 will be better than Q3. In terms of margins, I also hope to see the sequential improvement quarter-by-quarter as well.

Charles John - Piper Jaffray

Okay, and then so, could you help us with the gross margin, maybe, parse through some of the various elements for this sequential increase in the gross margin. Is it all volume-driven or are there some other elements here and is it reasonable for us to expect going forward into Q4, gross margin similar to 2008 levels. Is that realistic or still going to be some time before you get back to the first half of 2008 level gross margins?

Dr. Leo Li

That’s a good question. Yes, the gross margin actually determined by the few factors. The last Q4 and the Q1 this year including Q2 partially, you see there our gross margins pretty low, right? Maybe that was partially due to or mostly due to some of the inventory, some order kind of a generation of the products and while we’re reducing the inventory ordered ship. So, we have chance to see the higher gross margin, but your question is, when we can get back to the old days like the mid-40s margin. That remains to be seen. Our goal is to continue to improve the margin quarter-by-quarter. I’m having this Q3, Q4. We’re going to see continued improvement in terms of gross profit margins.

Charles John - Piper Jaffray

You just put some metrics around that, in your mind, when you talk about sequential increase in gross margins, is that an excess of 100 basis points or are you just talking about slight ramp in the gross margins over the next several quarters?

Dr. Leo Li

As far as exact numbers, I don't have the numbers at hand, but definitely a slight improvement over from one quarter to the other, that’s definitely is the thing I can see.

Charles John - Piper Jaffray

Okay and just one or two others from me. In terms of the R&D and the SG&A, given the big increase in the sales, are you expecting to add some significant headcount in the back half and also maybe for the R&D, if you could walk us through the main areas of focus, is it still TD or do you have some other areas where a lot of yours R&D staff is focusing on?

Dr. Leo Li

Yes, it’s a good question. In terms of R&D, our board is going to continue investing the R&D and I expect the pretty much same level or slightly higher level of the R&D. However, if you can read through the detailed parts of our financial reports, for the SG&A for the second quarter, compared with the same time last year second quarter of 2008, we have reduced SG&A part by 29%, excluding some the, basically that's for non-GAAP including some reoccurring, non- reoccurring costs and then some other one-time expenses.

Charles John - Piper Jaffray

Okay, great, and just a last one. Maybe this is for you David. Could you maybe talk about the interest income, line item and the tax rate for the remainder of 2009?

David S. Wu

Interest income went up by $0.1 million, mostly because we have higher cash balance and we do not see a big change in the effective tax rate this year.

Charles John - Piper Jaffray

Okay, and that's it from me. Thanks guys for the color. Appreciate it and great job on the quarter.

Operator

Your next question comes from the line of Timothy Lam with Citigroup. Please proceed.

Timothy Lam - Citigroup

Hi thank you for taking my question. Dr. Li and David hope you are doing well. My first is related to the customer gains that you are seeing here. Just wondering you have a really good forecast or strong forecast into third quarter. Is it because you are gaining from the export market or is it mostly from huge customers or which other surprise so you think you are gaining market share from?

Dr. Leo Li

Like I said for the previous caller, yes, the gaining cards of the revenue of the Q3 or expected revenue of Q3 mostly coming from GSM products. As we are now one and half months into this quarter, so some of the numbers I thought are real numbers and then also the [POs] and other so its being that how we make the projection of the Q3 revenue number.

The revenue is mostly coming from the GSM customers and the I guess last Q4 and Q1 this year, we have lost on the market share to the other competitors and starting from Q2 and Q3 we are gaining back some of the market share we have lost before. So we have seen the incoming orders [FDOs] and then that probably, we would calculate the revenue range in Q3.

Timothy Lam - Citigroup

Right, so do you see this as more of a factor of having a better hardware and software for the market or is it more because of more favorable pricing that you can offer to your customers.

Dr. Leo Li

Pricing is just one of the factors. Mostly, also the quality of products we offer to our customers, and that improves the customer support and also the positioning our products, to meet the customer need, also pretty much many, many factor of training not just a price.

Timothy Lam - Citigroup

So, is there any like new features that you offering that you would able to in the past, and another question is that I want to ask about is on the pricing trend that you’re seeing in the last couple of quarters?

Dr. Leo Li

The pricing is a very tricky question, as everybody knows this GSM is almost like a killing sales to many. However, the pricing also determined by the products, so not necessary by the features alone, meaning for the fewer, fewer, simple GSM this pricing is kind of a very difficult to sustain right ASP. However, for the others like the TDs and CMBs and others, definitely you can see improve the part. Also owe that we provide the more features for the same price or slightly higher price, right? Not just compete with people on pricing.

Timothy Lam - Citigroup

So, would it be correct to say that pricing decline of kind of seasonal every quarter seeing 3% to 5% on the same product it’s a valid assumption?

Dr. Leo Li

Yes, again that’s a tricky question because we should say in our same product, same model of the product or same minor product. However, for given customer you can see every three to six months there is one model of the product will coming out or many, many products or models were coming out, right? So, always this is a very tricky question to answer. So, I don’t have general answer to this question.

Timothy Lam - Citigroup

My other question I have is on the TD platform, you comment earlier that you expecting the second half 2010 is when you see the ramp up. Now on the TD data cards part, do you see what your exposure is in that market and what is potential market share you can have by the end of this year? Thank you.

Dr. Leo Li

Yes, for TD, like the first half of this year, data cards were ramping up pretty rapidly. However, data cards is a data oriented products right and well, like I said, in the opening statement, TD, it just start ramping up or to have a provide coverage to the many TDs, right. The network is not necessarily optimized and not very even stable to that extent.

So, when the users use the data cards or concentrating this more area and then sometimes they do crash the TD networks. So, that’s why the second half of this year China Mobile kind of a less, significantly slowdown the data cards shipments or even the orders.

So, that’s why which we saw or we are seeing the volume growth of the product primarily in the fixed wireless types of the market, and in terms of a feature phones and others, the same reason because the network coverage is not quite there yet, at least that we can say, not before end of this year. So, we’re not going to see significant volume shipments for the feature handset as well.

Operator

Your next question comes from the line of Quinn Bolton from Needham. Please proceed.

Quinn Bolton - Needham

Hi Dr. Li. Hi, David, great job on the results. I want to ask about the gross margins and just kind of sense what the significant jump in revenue, I would guess that you’ve cleared out lot of the old inventory and obviously if you had fixed costs in the cost of good line, you are going to be able to absorb that higher revenue base. So, why not a bigger jump in gross margin in the second half of 2009?

Dr. Leo Li

Yes. There is a lot of factors. Our burning off inventory it doesn't happen overnight. So, and the lot of other improvement is not happening overnight and I hope maybe that the revenue can grow very quickly just because we, even we sell the existing or all the inventory we should see the revenue grows, right?

So I, extremely in cases there are kind of case we definitely can see the gross margin all remain the same. So, yes, improving like a few percent of the margin or 10%, that's a pretty significant achievement by itself. Also, like I said, in GSM this is a very much low cost type of a very competitive market. So that's gaining or have a very, very high growth or improvement, overnight it's pretty hard.

Quinn Bolton - Needham

It sounds like then its only just the continued sale of some of the older inventory on the books at lower margins, is really why the margin isn't increasing faster, is that sort of what's happening?

Dr. Leo Li

Pretty much, like I said, that's one of the factors. Yes

Quinn Bolton - Needham

Yes, okay. Obviously, with the big revenue increase, you'll be shipping significantly greater volumes in the second half of 2009. If you had fresher inventories or any sense of how much higher the gross margins could be. I mean, is margin on sort of new inventory at the product level, say greater than 30% from the new GSM basebands?

Dr. Leo Li

Yes. With a fresh, a fresh product that shipped out without the old inventory definitely I could see a significant improvement in terms of margins. As far as the number is definitely above 30% I can give you that exactly numbers I don’t have at hand at moment.

Quinn Bolton - Needham

Okay that’s directionally that’s very helpful. Thank you. Question for Dr. Li, can you just you had mentioned a couple of times the fixed wireless application for TD starting to ship in volume. Could you give a little bit more color on that application?

Dr. Leo Li

Yes, I am not [pressuring] this is only unique in the China market or not because I was told even US has, we have this fixed wireless type of products. It is to replace the telephones at your home. However, there is no telephone line attached to it pretty much you are using the TD-SCDMA as a wireless platform and then you can place the call and then just almost a user as a regular phone.

However, there was a reason it is gaining the popularity among people is China government support to this TD-SCDMA standards right? So there is a subsidized money going into that so the China Mobile uses ready to compete in this fixed wireless market with China Telecom, who is the maybe one of the largest competitor for China Mobile. So, as pretty much the market segment is for people used the phone at home I don’t know if that’s enough color for you. I don't know

Quinn Bolton - Needham

No that’s great and next question I was just you guys have obviously done a great job increasing the transceivers along with the baseband. So, I was wondering if you could comment on what you think your attach rate is now between your GSM baseband and your transceivers?

Dr. Leo Li

Yes, that’s an excellent question. Now we’ve achieved a 100% attachment rate for our baseband. So, any baseband we ship now to customers excluding the very old ones right, because I mentioned there is some old inventory to clear out. We achieved a 100% attachment rate and also obviously shipping to same (inaudible) those are the FR transceivers. So, that’s why we saw the 93% increase for FR transceiver this quarter.

Quinn Bolton - Needham

I’m sorry I just got a sense of I might have missed it, but did you give a percent of your transceivers shipments that went same side I believe you gave that figure last quarter?

Dr. Leo Li

I don’t have a numbers with me. So, yes sorry I don’t have exact numbers.

Quinn Bolton - Needham

Okay. Directionally it was with the shipment to same side in the higher than last quarter?

Dr. Leo Li

This quarter definite to same side is higher than last quarter. Yes, that part is true.

Quinn Bolton - Needham

Then just lastly for David, you had mentioned the stock composition expense went up in the second quarter. Can you help us sort of how should we be thinking about stock compensation in the second half of 2009 also just overall levels of R&D and SG&A &A any guidance you can provide on the expenses?

David S. Wu

There are two different price of SBC that is reflected in the second quarter. The first one is the, non-recurring one-time expense that relates to the separation of management executive that happen in the second quarter.

The second element is under the leadership of Dr. Li, they have broaden the base of our workforce that is incentivise with the stock option options to help us focus the company better. So, if you exclude the one-time expense, we would anticipate that the SG&A would come down going forward and we have already given you the one-time expense estimate in the second quarter at a little bit over $4 million. So, there should be a decrease if you exclude the one-time expense in second quarter going forward. Is a responsive to your question?

Quinn Bolton - Needham

Okay. I believe you mentioned $5.6 million stock comp expense, that’s the total stock comp and then just over $4 million was one-time.

David S. Wu

Correct.

Operator

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

Dan Heyler - Bank of America

Yes, hi, this is Dan Heyler from BoA. I had a couple questions. A few questions, thanks for you time. I wanted to know if you could give us your unit shipments forecast for the third quarter?

Dr. Leo Li

I don’t have the numbers, but the number of units that will be higher than second quarter. I’m pretty sure.

Dan Heyler - Bank of America

Okay. Could you tell us second quarter number, baseband shipments?

Dr. Leo Li

Again, I don’t have that number either. No, I don’t have it.

Dan Heyler - Bank of America

You don’t have the actual unit shipments.

Dr. Leo Li

No, I do, but some other. I don’t have right now here. That’s my point.

Dan Heyler - Bank of America

Okay. Then I’ll get that from you tomorrow, I guess from David that would be quite helpful. Is that’s possible?

David S. Wu

Yes, absolutely it is possible.

Dan Heyler - Bank of America

Okay, great and then, from the standpoint of inventory, what’s your inventory target for the third quarter?

Dr. Leo Li

Inventory target, I can see the from inventory levels there have been a decrease a quarter-by-quarter. In terms of the inventory targets, the net numbers, inventory net numbers going downwards, definitely much lower than the inventory, net inventory levels this quarter. Because I am looking at just right now the, from the end of the last year first quarter and second quarter, it's been steadily, consistently decreasing.

Dan Heyler - Bank of America

Okay. So, when I guess, maybe I could ask another one on this, when do you think you may see that at a more normal run rate that you feel comfortable with, would we wait until the first quarter you think, that you'll be probably back to normal, comfortable or for the fourth quarter?

Dr. Leo Li

Yes, I will soon be able to see the back to normal maybe Q1 next year, I hope.

Dan Heyler - Bank of America

Then from a market standpoint, what do you think in terms of underlying demand and should we anticipate a seasonal pattern going, the typical seasonal pattern right now, is there something else going on in China that would make it stronger or weaker than seasonal?

Dr. Leo Li

Yes. On product (Inaudible) yes. We haven't been able not quite impacted by the seasonality of the market yet because we are talking about the coming back or turning things around story right now. So, we are, because our starting points are fairly low from the Q4 last year and Q1 this year, but seasonality for handset, almost a worldwide similar as that to China, Q3 usually is a height of season and Q2 and Q4 are second highest and Q1 year-to-date is the lowest quarter of the year, and I answered your question?

Dan Heyler - Bank of America

Sure and so to counter the seasonality, you would need to see maybe some new customers in the fourth quarter and first quarter?

Dr. Leo Li

Right. That’s one of the ways or yes the new customers or new products opened up new markets right? However, you have a certain percentage of the market sometimes very hard to avoid the seasonality.

Dan Heyler - Bank of America

Then because you have talked about the second half of the 2010 being where you expect significant increase in TD. I am wondering if you could give us a little more detail on your road map for products between now and then. So we basically have three to four quarters between now and TD. So, what GSM products and applications could we expect to roll out over the next couple of quarters?

Dr. Leo Li

Basically I was talking about the second half of next year for the TD-SCDMA type of products.

Dan Heyler - Bank of America

Right.

Dr. Leo Li

We have three different kinds of products that we are working on right now, one already I earlier stated we have some volume shipments through the fixed wireless and the second is kind of a low end feature phones that we designed for China Mobile. The third one is kind of a like a smart type smart phone alike meaning, we call it OMS phones for China Mobile. Its open mobile platform, I believe that is right pronunciation for the OMS for China Mobile that is for smart phones. So, we have a three platform going forward for this year and next year.

Dan Heyler - Bank of America

Those three products are shipping now, Am I correct?

Dr. Leo Li

No, it’s, like I mentioned only the fixed wireless type of things being shipped out right now. We’re working on the feature phones and we’re working on the smartphones.

Dan Heyler - Bank of America

I see.

Dr. Leo Li

That will be coming on next second half of next year.

Dan Heyler - Bank of America

Okay. So those will be second half next year as well. My question was more relating to between now over the next few quarters, so the revenue driver, which you were saying will be more your existing product mix. Is that fair to say?

Dr. Leo Li

We’ve had quite a few customers before. So, we’re gaining them one at a time. So, yes, it gets the Spreadtrum in the past that we have worked with many, many customers. Many of our customers had worked with us obviously at one point in time and other. So, they switched to the competitive solution. So, we’re started to gaining them back by offering the better quality, competitive price products.

Dan Heyler - Bank of America

Okay. So, still the mainstream 2, 2.5G mix is the main driver now?

Dr. Leo Li

Right, which is the biggest market a wireless market in China at the moment.

Dan Heyler - Bank of America

Right for sure and then finally on the operating expense side, could you give us your forecast for the third quarter for total operating expense?

David S. Wu

It will be less than the second quarter because of the non-recurring expenses.

Dan Heyler - Bank of America

Okay. I was just wondered, if you had a number you can give us a range.

David S. Wu

It will be difficult for us to provide any specific estimate on the SG&A right now because we’re still walking through the third quarter in identifying different elements of the SG&A going forward.

Dan Heyler - Bank of America

Okay and finally I guess what I wanted to seek; if you give me more color on would be the pricing environment someone asked earlier. I know you said it’s very, very hard, but perhaps without talking about your own pricing, what would you think the pricing environment will be in 2G over the next couple of quarters, just for the overall market.

Dr. Leo Li

Yes, overall market, I said the market condition remains pretty challenging and then for GSM, it’s very challenging, although market size is very big. However, also very competitive and then kind of a like relatively matured market. So, the pricing competition there is pretty tough. However for the TD, the SCDMA product and associated with DMB mobile TV types of product, we hope we will be the first mover to gain the market share and also hopefully by doing that we can increase our vis-à-vis average ASP for our products.

Dan Heyler - Bank of America

Well, I guess, we are also looking for a rough number because if you are looking at a 10% to 15% ASP decline. I’m just wondering if you can offset that with your suppliers if you can get that degree of discounts from your incoming. Your incoming foundry and back end if that’s possible or not, if you think the market pressure will be greater than that?

Dr. Leo Li

Well, this is very tricky question. Definitely, one thing I just said, once the volume increased, right, we have a fairly larger volume. Obviously we can talk to the foundry people basically, at least kind of get a volume, more volume discount. However for others, definitely, there are many, many factors to play out, which one is a greater it’s a little tricky for me to answer right now.

Dan Heyler - Bank of America

It’s a last one. If you what were to diversify, I know are you're looking diversifying your foundry base at all to get better pricing?

Dr. Leo Li

That part also, not just focused on single foundry. Yes we, like I said, the volume goes up we definitely would like to diversify over a few foundries also to get a better pricing to.

Dan Heyler - Bank of America

I see. Okay, right now it's still one.

Dr. Leo Li

We use more than one, but starting to use the second and third, yes.

Dan Heyler - Bank of America

Okay, just starting, okay. Great, thank you.

Operator

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

Bill Lu - Morgan Stanley

Yes, hi, good evening. Couple of questions, first of all going back to your inventories, you exited the quarter with about $9.5 million. So, of that amount can you just talk about what percentage or how many million is in the order, lower margin products?

Dr. Leo Li

Yes, I don't have the exact numbers with me for existing ones and for the fresh products. The only thing I can say is again, I am just looking at numbers, its 9.5, net inventories for this quarter, last quarter Q1 is the $12 million and then by the end of 2008, is $13.8 million. So, we have seen the decrease of the inventory, net inventory levels, yes.

Bill Lu - Morgan Stanley

Yes, I guess, I’m just wondering how much longer was the see the impact of all the inventory on your gross margin? Do you think that you've burnt through most of that or all of it in the third quarter?

Dr. Leo Li

We were burning through obviously. It's that the level of the old inventories, the level of that is getting less and less quarter-by-quarter and that's for sure, starting from last quarter.

Bill Lu - Morgan Stanley

Okay. So if we ignore the old inventory and looking at all the newer products. Is there a big difference in margins between the baseband RF and the TD fixed wireless application or chip?

Dr. Leo Li

Yes, the TD fixed wireless is the TD product. Again we are the first movers in that market obviously we enjoyed some of the current premium right. For GSM for old inventory GSM or even fresh out GSM and their relatively lower ASPs and relatively at lower margin as well.

Bill Lu - Morgan Stanley

So if I was to rate your newer product is it RF lowest margin, baseband in the middle and then TD at the very top?

Dr. Leo Li

You could be right there.

Bill Lu - Morgan Stanley

Okay. How big is the gap between your lower margin products and the higher margin products?

Dr. Leo Li

Again I don’t have exact numbers. The gap sometimes, this is a pretty tricky case, supplement to customers market-to-market our prices are different. Could be, relatively significant.

Bill Lu - Morgan Stanley

Got it. Okay so if I take all of these comments on margin, it seems to me like you don’t quite get the breakeven for third quarter, but looks like you may get the breakeven for fourth quarter is that fair to assume?

Dr. Leo Li

Yes, the assumption is, I hope its right yes.

Bill Lu - Morgan Stanley

Okay got it. Question for David, when you do get the breakeven, what should we use with the headcount? I assume that’s going to go of a little bit right?

David S. Wu

It would not go up significantly. Right now we are in the process of monitoring our headcount very carefully and we do not anticipate any significant increase in headcount. Our revenues ramps up.

Bill Lu - Morgan Stanley

Yes, its not headcount, share count.

David S. Wu

Share account

Bill Lu - Morgan Stanley

Yes.

David S. Wu

Shares right, the number of shares you mean?

Bill Lu - Morgan Stanley

Number of shares we used to calculate the EPS, yes?

Dr. Leo Li

Shares, noted to be increase either.

David S. Wu

There would not be any significant increase in the share count.

Bill Lu - Morgan Stanley

Okay, that’s fine. Yes, couple of other question. Leo, you said you made big improvement in customer service technology the products. If you compare, where you stand today versus the industry leader, if you think that you have caught up all the way, how far away are you from the leaders in the account?

Dr. Leo Li

We are continued to improve the quality of products and customer support. I definitely see the result of it and also appreciation coming from the customers. As far as the comparison especially on compared to leader I always think there is a room for us to improve. Yes, but certain areas technically and customer support, yes we’re (Inaudible) very bad I mean.

Bill Lu - Morgan Stanley

Okay. The other question is on, you just talked about OMS, I notice that Dell had announced a OMS phone a couple of days ago, and some of the other companies, should be coming out with these phones pretty soon as well, the 2G version. Are you in any of these 2G smartphones?

Dr. Leo Li

We’re working on 2G smartphones. I am not quite sure it’s OMS. Yes, the one I mentioned is in the TD area.

Bill Lu - Morgan Stanley

Right, okay. One last question, I’m sorry if I missed it, I don’t think you gave the breakout between baseband and RF. Could you give us a color on that?

Dr. Leo Li

On the breakout, I mentioned a 100% attachment rate, right? Yes, I don’t want to break it up rather on to a 100% attached. I don’t have a numbers. Having asked of previous callers, exactly percentage RF, the shipping percent some versus RF shipping to, I don’t have the numbers with me here yet.

Bill Lu - Morgan Stanley

Okay. If I could maybe ask a slightly different way, if you look at your RF shipment, is the majority for your own baseband or is the majority for other people’s baseband?

Dr. Leo Li

Yes, for month to month different. Again it’s hard for me to give you numbers of which one. Maybe our baseband numbers are higher as the (inaudible) just started shipments end of Q1 in this year.

Operator

Your next question comes from the line of Tse-Yong Yao with HSBC. Please proceed.

Tse-Yong Yao - HSBC

The results from guidance, I guess, keep hammering on the [GM] question, I guess firstly, could you give us some color as to the relative gross margins between the different products between say, TD and RF only and maybe I guess it’s difficult to break out the baseband and RF separately because its bundled, but maybe between the bundle baseband RF versus RF only?

Dr. Leo Li

The Bill Lu of Morgan Stanley reported, I just called [Kim] in terms of gross margins, he gave me the renting sequence. So, he said always one was the RF and the second one is GSM. The third one is TD. I just call it Bill.

Tse-Yong Yao - HSBC

Is it possible to give us, I mean is it maybe like 500 basis points difference, 1000 basis points difference just kind of, roughly what, how much difference between the different product groupings?

David S. Wu

I don’t have a numbers here. I need to do maybe more calculation, is this, again this is a, even for GSM right? Customers to customers and market-to-market some different features, that itself it varies quite a bit. For TD like I said, we could enjoy the some premium for now just because the whole market just started the volumes are fairly small, right? For RF, traditionally, the margin is apparently low.

Tse-Yong Yao - HSBC

All right, thanks. Then I guess, you mentioned the gross margin on newer products definitely over 30%. Then if I look at where you are inventory levels are today $9.6 million and I guess roughly translates to maybe $12 million to $15 million for the revenue, that's maybe a third of what you are doing in Q3, what you guided for Q3, so then does this mean that Q3 revenues is probably closer to the 30% range, Q3 gross margin?

Dr. Leo Li

The gross margin, what we said was it 20 something, right?

David S. Wu

24%.

Dr. Leo Li

24% in Q2 excluding the inventory and others the, the range could be about 30. It could be at that.

Tse-Yong Yao - HSBC

Okay and then I guess maybe for, trying to do some rough calculations to make our own estimates, could you give us an idea of the mix in 2Q between say the older inventory that you are trying to flush out and the new inventory was it on the order of 9010 or may be closer to 6040?

David S. Wu

Again I wish I could answer your question, I don’t have the numbers with me so I just can’t answer it. I don’t have the numbers.

Tse-Yong Yao - HSBC

All right thanks. So I mean I guess it seems like all of the old inventory should both definitely be cleared out by the end of this quarter right?

David S. Wu

The older inventory will clear out maybe June 4; because of they are older so selling them is not as easy sometimes. So it’s definitely like I said from the year, end of last year Q1 this year Q2 this year. We definitely achieved the inventory levels are coming downwards right? We have seen the reduction of the net inventory levels. So hopefully the old inventory, the old chips definitely we are going to have a clear amount of quarter-by-quarter.

Tse-Yong Yao - HSBC

I guess maybe another way to ask is of the old inventory that you have remaining just could we get a rough idea of how much is left in terms of $10 million worth or $5 million worth?

Dr. Leo Li

That’s a very good question. I don’t have exactly the numbers in terms of the how many million dollars of the old revenue; definitely I can promise you that we are going to bring them quarter-by-quarter. They are going to be less and less moving forward.

Operator

Your next question comes from the line of Charles John with Piper Jaffray. Please proceed.

Charles John - Piper Jaffray

Dave just a quick follow-up, I’ll give the gross margin question a final try. In terms of the RF and the baseband, could maybe just help. In the past you have given some color on the sets of gross margins for the divisions. Going forward, is it something you would disclose and can you help us with this quarter what the difference has been from historical levels for the RF and the baseband margins?

David S. Wu

Let me refer that to Dr. Leo Li.

Charles John - Piper Jaffray

Okay.

Dr. Leo Li

Exactly the gross margin for the RF and for the baseband for that matter, I’ve said, also I quoted to Bill Lu that RF gross margin in general is lower than the baseband margin. So, the baseband there is a lot of software protocol has been R&D have associated, RF also, but however in terms of the R&D work, definitely a lot of more R&D work are put into the baseband then put into the RF.

Charles John - Piper Jaffray

Okay and then in terms of your pipeline, as you talk to your customers, you have given some pretty strong guidance for Q3 based on what you have in your pipeline. Given how seasonality is, can we expect just a slight downtick in Q4 or does your pipeline give you increased confidence that you could actually buck the seasonality trends for Q4?

Dr. Leo Li

That’s a very good question. I hope Q4 for Spreadtrum, will be better than Q3. The whole one I’m having now. Obviously the predicting the market is the pretty dangerous thing, right. Anything I said could be proving wrong. So, better not. Because I can say the Q3 just because it was one and half month gone by see some real numbers. So, real orders.

For Q4, even for given customers quite a few variables are impacting them. Also like I said, seasonality relatively lower quarter, but my hope is that Q4 will be better than Q3 for Spreadtrum.

Charles John - Piper Jaffray

Then just a quick clarification so for stock-based comp and the intangible amortization, we just going forward the quickest way to think about it is just to exclude the one-time 4.9 million, one-time charge related to the management separation and we just model that going forward?

Dr. Leo Li

In principle that should be correct, again this is Leo.

Charles John - Piper Jaffray

Okay.

Dr. Leo Li

We gave a stock option that to intensify as the incentive to employees.

Charles John - Piper Jaffray

Then with your big increase in sales for Q3, do you have those commissions tied to any sales target so if they are able to achieve the Q3 numbers for the sales. Can we expect a sequential uptick in the commission of the stock-based comp for Q3 because the previous command I’m not sure I got that correctly was there was going to be a downtick in OpEx in Q3, but if your timely incentives of the sales force to the top line. I’m just curious, why the OpEx is actually downticking sequentially?

David S. Wu

The reason is because there are substantial amount of non-recurring expenses in second quarter 2009. As the sales revenue increases in the third quarter, there will be some increases in sales-related activities and expenses including your commission, but keep in mind, we also motivating our workforce through stock-based compensation, so as related to company performance and not just higher sales revenue and therefore overall if you exclude the one-time expenses in the same quarter we anticipate a lower total amount of SG&A.

Operator

At this time there are no further questions. I will like to turn the call back over to management for closing remarks.

Dr. Leo Li

Yes. Ladies and gentlemen, let me close by thank you for your interest and support today and if you have any additional questions, please feel free to contact us directly. Thank you.

Operator

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

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Source: Spreadtrum Communications Inc. Q2 2009 Earnings Call Transcript
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