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Integrated Silicon Solution, Inc. (NASDAQ:ISSI)

F2Q10 (Qtr End 03/31/10) Earnings Call Transcript

April 27, 2010 4:30 pm ET

Executives

Scott Howarth – President and CEO

John Cobb – VP, Finance & Administration and CFO

Analysts

Jie Liu – Auriga USA

Edwin Mok – Needham & Co.

Andy Ng – Morningstar

Shawn Boyd [ph] – Westcliff [ph] Capital Management

Operator

Good day everyone and welcome to the ISSI fiscal second quarter 2010 quarterly earnings conference call. As a reminder, today’s conference is being recorded. At this time, I would like to turn the proceedings over to Mr. Scott Howarth, Chief Executive Officer. Please go ahead, sir.

Scott Howarth

Good afternoon and welcome to ISSI’s conference call for the quarter ended March 31, 2010. I am Scott Howarth, President and Chief Executive Officer, and with me is John Cobb, our Chief Financial Officer. Before we proceed, I have asked John to comment on the nature of this call and any forward-looking comments that may be made.

John Cobb

Thanks, Scott, and good afternoon. During the course of this conference call we will provide financial guidance, make projections, comments and other forward-looking statements regarding future market development, the future financial performance of the company, new products or other matters. We wish to caution you that such statements are just predictions or opinions, and that actual events or results may differ materially due to fluctuations in the marketplace, delays in developing new products, changes in book demand or supply, our ability to secure manufacturing capacity or adverse developments in the global economy.

We refer you to the documents ISSI files from time to time with the SEC, specifically our most recent Form 10-K filed in December 2009 and our Form 10-Q filed in February. These documents contain and identify important factors that could cause our actual future results to differ materially from those contained in our financial guidance, projections, comments or forward-looking statements.

Scott Howarth

Thank you, John. Before I discuss our results for this past quarter, let me first discuss the DRAM and SRAM memory industry and some of the dynamics that we are seeing. From late 2007 to early 2009, the DRAM industry was saddled with excess capacity, low prices and severe losses, over $14 billion in losses according to Gartner.

In 2009, as recession was hitting all companies, DRAM companies had reduced costs, and as a result, 22% of all DRAM wafer supply was retired with approximately 8% of the reduction coming from the bankruptcy of Qimonda.

As the recession was coming to an end in late 2009, demand for DRAM, primarily DDR 3, surged with a growth of netbooks and PCs. That growth has continued into 2010. According to iSuppli, DRAM revenue in 2009 was $22 billion. For 2010, they are forecasting a DRAM market of $32 billion, a growth of 45%, while other market researchers have forecasted even higher numbers.

While ISSI doesn't participate directly in the PC market or DDR 3 at this time, the effects of shifting capacity away from low-density and legacy DRAM has benefited ISSI as our customers seek stable supply and the long-term support that we provide. We estimate our serviceable market for DRAM to be $5 billion which offers considerable opportunity for growth.

The SRAM market has been going through changes as well, as our competitors move away from SRAM, others are experiencing shortages and longer lead times. We estimate the total available market for synchronous and asynchronous SRAM to be $1 billion this year, which provides significant growth opportunity for us.

At ISSI, we provide complete SRAM and DRAM solutions plus long-term support which is what our customers want today and in the future.

I will now discuss the results of this recent quarter. We are very pleased with our results in the March quarter. The strong demand growth we saw in the prior three quarters continued into the March quarter resulting in 12.8% revenue growth quarter to quarter that far exceeded our initial expectations.

The demand growth occurred in all of our key markets and geographies. Overall end-market demand is approaching peak levels that we haven't seen prior to the world-wide recession and may soon surpass even those levels.

DRAM pricing continue to improve this quarter in our target markets as we saw increases for some products in various market segments. This pricing recovery shows a growing demand for DRAM that exceeded the markets supply this quarter. Our product mix also shifted to a higher margin products in market segments such as networking, telecom, and automotive which helped our gross margin this quarter. As a result of the improved demand conditions and our improved mix, we achieved one of the highest gross margins in our history. Looking forward, we believe this momentum will continue into the June quarter.

We entered the June quarter with a strongest backlog we have seen in several years and also strong backlog for the September quarter. So far, our bookings this quarter have also been very strong. Our employees work very hard to improve the company, grow our business and support our customers and these results show their hard work.

In addition, we’ve had one of the best quarters of design wins and continue to see a high level of customer design activity as our customers continue to face shortages and seek stable DRAM and SRAM supply and long-term support from ISSI.

Our top line growth this quarter was a clear highlight for us as we normally see fiscal Q2 as a seasonally flat-to-down quarter. Our revenue for the March quarter was $57 million. This compares to $50.6 million in the December quarter and $31.3 million in the March 2009 quarter.

Revenue growth this quarter was strong and surpassed our expectations and also showed a dramatic recovery from the depths of the recession a year ago.

Our gross margin was another highlight for the quarter as we achieved a gross margin of 37.2% in the March quarter. This margin includes a 1.1 percentage point net benefit from selling previously reserved inventory. This compares to the 39.8% gross margin in the December quarter, which included a 7.7 percentage point benefit from sales of previously reserved inventory.

Excluding the inventory reserve benefits, our gross margin increased again this quarter as we saw the benefits of improved mix and the cumulative effect of better pricing in certain target markets. Going forward, we expect these factors will continue to positively benefit our gross margins.

With our higher revenue and strong gross margins, we were able to achieve a net income of $7.2 million in the March quarter. We are very proud of the fact that we've been able to come out of recession so strong and demonstrate many of the positive changes that we made during the recession with profitable results for three consecutive quarters.

Looking ahead, demand is strong and visibility is improving. We believe that our strategy is sound, we have the right products for our key markets, a very strong customer base and remain focused on long-term revenue and profit growth.

When we entered the global downturn, we focused on strengthening the company. We now have delivered three consecutive quarters of strong profitability. In addition, we have added engineering teams, improved productivity and quality and strengthen our portion with key customers.

We are very optimistic about our long-term growth prospects and we will work hard to keep building a stronger company.

ISSI is a leader in high-quality memory products and our goal is to extend our products in the new applications and markets that require high quality and long-term support. In the past few years, we have transitioned our business to be a supplier of high-value specialty memory and in doing so has steadily improved our gross margin.

We continue to manage our business carefully, control the areas that we can, reduce our exposure to the risky commodity memory markets. We believe our financial results show clear evidence of the success of our strategic direction and hard work of our employees. We believe we have established an excellent foundation to continue to drive our strategy and penetration into our markets.

Now I will turn to our key markets and products. The DRAM markets continue to strengthen in the March quarter. Demand was the strongest that we have seen since 2008 and pricing was the best we have seen in several years. As a result, our DRAM revenue increased nearly 20% on a sequential basis.

DRAM represented 50% of our total revenue in the March quarter. Our focus DRAM business represented 52% of total revenue, while the commodity DRAM business represented only 5%. We began the June quarter with the strongest backlog in several years and April orders have also been strong.

Many of our customers are experiencing shortages from other suppliers in SDRAM and DDR and we have been actively supporting those customers and gaining many new design wins. We expect this trend to continue and to gain share in our DRAM market segment.

For the June quarter, we expect our overall DRAM revenue will increase 20% or more sequentially. During the March quarter, demand for our focus DRAM strengthened in all of our markets. We also had one of our best quarters in design win. For example, we had several large DRAM design wins for automobile infotainment systems, industrial equipment and telecom and networking applications.

We also achieved numerous key design wins in the automotive, telecommunications and consumer markets in both x16 and x32 configurations. In addition, we are experiencing strong design activity for our new DRAMs, our 256 megabit, 512 megabit and 1 gigabit DDR 2, our mobile SDRAM and our 64 megabit low-power SDRAM KGD product.

We expect these new devices to contribute to revenue growth in the coming quarters. Overall we continue to see in memory many opportunities for us to expand our market share and grow our revenue.

Our strategy is to focus on key applications and markets that can provide sustainable revenue and profit growth. Our strategy is designed to leverage our strengths and target those markets where we believe we can add value through engineering, quality, service and long-term support.

Our broad product portfolio, customer service, long-term support and high-quality products provide a competitive solution that we believe will help further our growth in our focused target markets.

The key markets we are focused on include automotive, networking, telecommunications, industrial and specific consumer and peripheral markets. Our goal is to use our strength to further penetrate these markets and to also expand our addressable markets with new products.

Let me give you an example of this in one of our key markets, the automotive market. Specialty automotive memories require a much broader temperature range to support the high temperature in vehicles to as high as 125 degrees Celsius and a highest quality memory with a goal of zero defects.

We have developed extensive product and process design expertise and knowledge to meet these stringent requirements. We have been focused on this important market for over 10 years and have leveraged our engineering expertise to develop specific products to serve this market opportunity.

Our automotive revenue continued to grow during the March quarter and we had a number of significant new design wins. Automotive revenue was 21% of our total revenue in the March quarter. Our telecom and networking customers also require high quality memory and long-term support, and important markets that we target for our SRAM and DRAM memories.

Additionally, our strong presence in Asia provides critical technical resources, closer access to our customers and exit leverage to our fabless business model. We intend to increase our market share through superior execution and high quality product support. Overall, we feel that our combination of focus on strategic markets, breadth of product offerings, long-term support and our low-cost model will drive continued success in our focus DRAM market.

For commodity DRAMs, demand and pricing remains strong in the March quarter for 64 megabit to 128 megabit SDRAMs. Demand for commodity DRAM exceeded our supply this quarter as we supported our focused customers instead.

While we continue to support some key customers in the commodity markets, we intend to gradually reduce our commodity DRAM revenue as a percentage of total revenue. As previously stated, the commodity DRAM revenue was approximately 5% of our total revenue in the March quarter compared to 7% in the December quarter and 12% of our revenue in the March 2009 quarter. We expect commodity DRAM shipments to continue to decline as a percentage of DRAM revenue as we place greater emphasis on our focus DRAM.

Let me now turn to our SRAM business. The SRAM ASPs were generally flat to slightly down this quarter due to competition. Demand in all end markets and geographies improved from the December quarter. Our SRAM revenue increased 11% from the December quarter, and was approximately 33% of our total revenue.

We saw strength in our async and also synchronous SRAMs. The March quarter was also one of our best quarters for SRAM design wins as our customers seek stable supply and long-term support. We won several major designs in our key markets for various densities of our products. For example, we had several large design wins for our 4 megabit, 8 megabit and 16 megabit asynchronous products, mainly in automotive, telecom and industrial applications. We also had other large design wins for networking equipment, industrial and automobile applications.

With our continued investment in SRAMs, competitive SRAM solutions and long-term support, we are confident that we will continue our long-term growth in the SRAM market. We expect SRAM revenue in the June quarter to grow by approximately 10% sequentially.

Our overall ASSP business declined 11% from December quarter and represented 10% of total revenue in the March quarter. The March quarter demand is usually seasonally weaker than the December quarter. ASPs for serial EEPROM and SmartCard declined slightly.

We secured several large EEPROM design wins for wireless networking and LCD panels, and had several large design wins for Smartcard in public transportation and security applications in China and India. We currently expect ASSP revenue in the June quarter to increase 10% to 15% from the March quarter.

As we announced in January, we have formed a new business unit called Giantec Semiconductor, focused on our ASSP business that includes EEPROM, SmartCard and analog power management products. We believe this new ventures strengthens our business opportunity in the all-important Chinese electronics market.

Since ISSI still owns more than 50% of Giantec, the financial statements of Giantec are consolidated into ISSI financials. However, we expect that additional outside investment after the June quarter will reduce our ownership percentage of Giantec to below 50%, which will result in ISSI no longer including the revenue expenses, operating results or balance sheet of Giantec in our consolidated financial statement.

Let me now turn to our manufacturing operations during the quarter. Wafer supply both DRAM and SRAM has become very tight in the last few months as foundry utilization has increased. We have experienced longer lead times in wafer foundry and assembly and test, and did have some small supply constrains in the March quarter.

We have strong relationships with the foundries. But with foundry capacity so tight, we have entered into a long-term supply guarantee with one of our key foundries, and also have placed long-term purchase orders with others to help ensure that we have the wafers to grow our business and support our customers.

This quarter, we increased our inventory levels to better support a growing business. We have experienced some constraints on assembly and test capacity and have made selective investments to help ensure we have the capacity to support our business in the future.

Looking forward to the June quarter, we do not expect wafer or backend capacity constraints to have a significant impact on our business. And we’ll continue to take actions to help ensure adequate supply of our products.

We continue to focus on product costs reduction programs and improving our operational efficiency and effectiveness. But we expect to see higher wafer costs in future quarters. We believe we can offset these cost increases with price increases in our target markets.

I’ll make some closing remarks in a moment but first let me ask John to discuss the numbers.

John Cobb

Thank you, Scott. As Scott mentioned, our revenue for the March quarter was $57 million which is a 12.8% increase from the $50.6 million in the December quarter and an 82.5% increase over the $31.3 million reported in the March 2009 quarter. Our March quarter revenue exceeded even the high end of our revised guidance as demand strengthened at the end of the quarter.

Gross margin was 37.2% in the March quarter which includes a 1.1 percentage point net benefit from sales of previously reserved inventory. This compares to 39.8% in the December quarter which included a 7.7% percentage point net benefit from sales of previously reserved inventory and 20.7% gross margin in the year-ago quarter.

Our gross margin in the March quarter reflects a significant improvement in end market conditions and our products mix shift to higher margin business. Our March quarter gross margin was within our revised guidance range.

Operating expenses were $14.4 million in the March quarter which was within our updated guidance range. This compares to $12.6 million in the December quarter and $10.6 million in the year-ago quarter. The company implemented an employee profit sharing program during the March quarter which was retroactive to the beginning of our fiscal year. As a result, our March quarter reflects the bonus expense for both the December and March quarters plus higher mass [ph] costs and sales commissions.

We achieved operating income of $6.8 million in the March quarter compared to operating income of $7.5 million in the December quarter and an operating loss of $4.1 million in the March quarter a year ago.

Interest and other income in the March quarter was $400,000, which included a $200,000 gain on sales of investment.

Net income for the quarter was $7.2 million or $0.27 per share. This compares to net income of $7.2 million or $0.28 per share in the December quarter and a net loss of $3.8 million or $0.15 per share in the March 2009 quarter. Our March quarter net income per share exceeded our revised guidance due to the higher revenue and the gain on investment.

Moving to the balance sheet, we ended the quarter with $83 million in cash and short-term investments, compared to $85.2 million at the end of December. During the March quarter, we advanced $10 million to one of our foundries as part of a long-term supply agreement. That amount is included in other assets on our balance sheet. We also provided a $5 million security interest in an investment to another foundry partner in order to assure adequate near-time supply. That amount is included in restricted cash on the balance sheet. We had $2.7 million in cash flow used in operations in the March quarter.

Our inventories increased by $8 million from December 31 and are still at very healthy levels. Our inventory turns were 4 turns in the March quarter compared to 4.4 turns in the December quarter as we intentionally increased our inventory levels to support our expected growth. Our accounts receivables increased during the quarter by $8.1 million to $37 million, and the days sales outstanding were 58 days compared to 53 days for December.

Overall, our balance sheet continues to remain very strong. At the end of March, we had $3.22 per share in cash and short-term investments and a book value per share of $5.82.

Let me turn to our guidance for the June quarter. All of our comments in this conference call regarding future numbers are forward-looking comments and subject to a number of risks and uncertainties. As previously stated, we saw strength in our key end markets in the March quarter. In addition, our beginning backlog in our orders-to-date this quarter had been very strong. As a result, we expect revenue for the June quarter to be in a range from $64 million to $70 million.

We expect DRAM pricing to be flat to slightly up, and SRAM and ASSP pricing to be flat to slightly down. Gross margins will likely be in the 34% to 37% range. Operating expenses should decline sequentially into the $12.9 million to $13.4 million range. We expect to realize gains from sales of investments in the range of $2.5 million to $3 million and about $300,000 from interest and other income.

So taking all of this into account, we expect to achieve net income in the range from $12 million to $13.5 million for the June quarter or net income of $0.44 to $0.50 per diluted share.

Now back to Scott for final comments.

Scott Howarth

Thanks, John. Worldwide memory demand has now strongly recovered from the downturn, and currently DRAM demand and even some SRAM demand is exceeding supply for many devices and markets.

As our customers seek stable supply and long-term support, we've been working hard to support many new design wins which is helping our growth. In addition, we have taken many actions to strengthen our company.

Our revenue has nearly returned to peak 2008 levels, and we are achieving some of the highest levels of revenue and operating profits in our history. We are working hard to develop products for the future, support our customers and generate profit from operations.

From our results, we clearly see success for the long-term strategy as a specialty memory provider. In the months ahead, we will continue to focus on our five key objectives, which are; number one, grow our customer base and number of design wins; number two, increase our product portfolio while maintaining long-term support in our target markets; number three, identify and extend our reach into underserved and growing markets; number four, serve our customers as strategic partners; and number five, remain focused on profitable growth and the effective use of our resources.

In the past few years, the memory markets have been difficult yet ISSI continuously improved its gross margin and generated cash. Now with an improving economy and healthier memory market we believe we have an opportunity to improve on those results. We also believe that if we continue to successfully execute on our objectives we will also continue to build a stronger business. We remain committed to achieving that goal.

We will now take your questions.

Question-and-Answer Session

Operator

(Operator instructions) And our first question comes from Jie Liu with Auriga USA.

Jie Liu – Auriga USA

Hi, good afternoon. Congratulations on the good results and the guidance. Could you give us an update on the competitive landscape in the SRAM market?

Scott Howarth

I’ll try to answer that as best as I can, Jie.

Jie Liu – Auriga USA

Sure.

Scott Howarth

In the SRAM market, we continue to see some of the bigger competitors in the industry, particularly Samsung is focusing less and less in some of the market segments that we see. I think that's caused opportunity for growth particularly in the higher end sync markets. At the same time, we have seen lead times wise [ph] competitors have pushed out which is telling me that there is obviously some capacity tightness in the market as well.

But overall, what we've seen in the past and we have mentioned before is there is just decreasing competition in this market segment as many of the competitors just continue to defocus on SRAM.

Jie Liu – Auriga USA

Okay. But I thought you said earlier on the call that your SRAM revenue will increase – I'm sorry, go ahead.

Scott Howarth

I think you're referring – we did mention that we saw prices decline slightly from competition.

Jie Liu – Auriga USA

Correct. Yes.

Scott Howarth

In some of the market segments that we are in, we have seen competition within those segments.

Jie Liu – Auriga USA

Okay. All right.

Scott Howarth

That’s what we were referring to.

Jie Liu – Auriga USA

Okay. I see. Could you also talk about your market share gain at DRAM market? You said you're going to gain some market share in the fiscal third quarter.

Scott Howarth

We just said that we were going to grow our DRAM revenue in the third fiscal quarter.

Jie Liu – Auriga USA

Okay. I see. Okay, I have a couple of housekeeping questions. How should I think about your tax rate going forward?

John Cobb

Our tax rate, since we have loss carryforwards, we have to pay ultimate minimum tax both in the US and in Taiwan. But our tax rate would typically be very low single digits.

Jie Liu – Auriga USA

For the remainder of the fiscal year?

John Cobb

Yes, definitely.

Jie Liu – Auriga USA

Okay. All right.

John Cobb

And into next year also.

Jie Liu – Auriga USA

Okay. I see. So are you going to have any inventory reserve deferral for the third quarter?

John Cobb

Our reserve benefit?

Jie Liu – Auriga USA

Yes, reserved benefit from previously written down inventories.

John Cobb

I would expect it would be equal to or less than what we experienced in the March quarter.

Jie Liu – Auriga USA

But it won’t be zero? Is that right?

John Cobb

It wouldn't be zero but it should be between zero and 1.1.

Jie Liu – Auriga USA

Okay, understood. I understand that you would help your inventory in the quarter in anticipation of strong demand. So how should we think about your inventory level for the remainder of the year?

Scott Howarth

The goals I've had for inventory have been higher turns than where we are today. As you saw last year, we reduced inventory to where we were achieving over six turns. The difficulty we are having right now is really seeing growth to the rest of the year. But what we want to make certain with tight wafer capacity right now is that we do have inventory to be able to support our customers. As you know, one of the key value add that we bring to our customers is long-term support. So we are making certain that we have inventory we can support them throughout the rest of this year and even into next year.

Jie Liu – Auriga USA

Right, understood. Maybe just – go ahead.

Scott Howarth

Quantitatively coming back, we will probably see some additional increases in the next quarter, then I would expect those to probably stabilize and start to decline.

Jie Liu – Auriga USA

Okay, I see. Just one more; what was your operating cash flow in the quarter?

John Cobb

We used $2.7 million in cash in operations.

Jie Liu – Auriga USA

Okay, understood. Thank you very much guys.

Scott Howarth

Sure. Thanks, Jie.

Operator

And we will go next to Edwin Mok with Needham & Co.

Edwin Mok – Needham & Co.

Hi. Thanks for taking my question. First, I have a logistic question, so you mentioned that you will own less than 50% of Giantec in the coming quarter. Is that why you're guiding for the OpEx to come down and should we stop following you're ASSP revenue for the coming quarter?

John Cobb

No. Actually we expect that for this quarter, the June quarter, we will continue to consolidate Giantec. However, we expect later, perhaps in the September quarter that because of additional investment, outside investment into Giantec that we would no longer consolidate Giantec. So for the June quarter, there is really no impact but beginning the September quarter and beyond, as I mentioned, then you could see Giantec not be included in our consolidated financial statement.

The decline in operating expenses is really a lower bonus. As I mentioned in the March quarter we booked employee profit sharing retroactively, so it included bonus for both the March and the December quarter. So basically two quarters, plus we had higher mass costs and sales commissions. So in the June quarter, we only have one quarter’s worth of bonus and we are expecting a decline in our mass costs.

Edwin Mok – Needham & Co.

Okay. That's very helpful. And just to be very clear then, if assuming that you will own less than 50% of Giantec in September quarter, would that imply that we should take all the ASSP part of your revenue in that quarter and beyond?

John Cobb

If we owned less than 50%, then yes. That revenue would not be included in our consolidated revenue.

Edwin Mok – Needham & Co.

Can you help us out in terms of your operating margin of the Giantec subsidiary. How should we think about that?

John Cobb

In terms of the income statement, this last quarter we did about $5 million in revenue from the ASSP business or from the Giantec business. The gross margin of that business is below our corporate average and on the bottom line that business is currently about breakeven.

Edwin Mok – Needham & Co.

Great. That’s very, very helpful. And then can I ask you guys in terms of your DRAM business, is the commodity DRAM price has been increasing? And I am sure that is also benefitting you guys on your focused DRAM side of the business. Have you guys thought about if you take that price increase out of the equation, what kind of margin benefit that you would have gotten just from the fact that you guys are focused on specialty versus the price.

I am just trying to get a sense of how much of it is price of your higher or your strong margins come from pricing versus your focus on specialty which obviously has better pricing in the first place.

Scott Howarth

That’s a good question Edwin. It is difficult for us to analyze when we haven’t broken out specifically in that factor. What we are seeing though is higher product mix from two different areas. One, we are seeing a mix and a shift towards higher end, higher density memories, which typically carry a higher margin. We are also seeing increasing shift to automotive and telecommunications which, again, are higher margin businesses for us.

And then we are seeing the effect of price moves that we have made in prior quarters. As you know, we typically give contractual prices anywhere three months to six months for our key customers. So as we increase prices, then there is a delayed effect that's occurring within that.

And in the commodity segment, you know now commodity business is down to 5% of our business. So it’s quite small and any pricing impact there really doesn’t have a significant impact on the bottom line.

Edwin Mok – Needham & Co.

I see. And then I guess one question on the balance sheet. It looks like your business has grown quite a lot and your very strong guidance, cash came down a little bit because of expand working capital, but it sounds like that will stabilize in the coming quarter and beyond. So, your company flowing off so much cash besides cash buyback, any other thoughts in terms of what you are going to do with your cash?

Scott Howarth

As I said in the past, we continue to look for strategic growth opportunities. And we still are looking for opportunities and ways for us to grow our business beyond just organic growth. In the short term, we are needing to spend a little bit more in terms of some CapEx in the back end, but that’s not a significant amount to take much of the cash that we have available. So it’s really something we see. We want to figure out ways we can grow the business strategically.

Edwin Mok – Needham & Co.

Okay. One last question and I will jump off the queue. In terms of your inventory, previously reserved inventory, can you quantify for us how much revenue potential you can generate from the inventory that you have previously written down?

Scott Howarth

How much revenue?

Edwin Mok – Needham & Co.

Yes.

Scott Howarth

It’s probably less in terms of what’s been previously reserved that we would expect to sell. It’s not much more than $1 million.

Edwin Mok – Needham & Co.

I see, but on the last quarter you generated one, additional 1.1% in the gross margin rate. So in coming quarter you expect somewhere around that range, you should almost fully exhaust that inventory by the September quarter, is that a fair way to think about that?

John Cobb

It would be fair. The chances are we could add to it but if we did exhaust all that would be correct.

Edwin Mok – Needham & Co.

Great.

Scott Howarth

Edwin, if you recall, in each quarter we do take some incremental reserves. We have what we call ODC, old date code policy, so we reserve any inventories beyond 12 months. And then we also use some of those inventories as we are able to sell it in some of the markets that we support.

Edwin Mok – Needham & Co.

Right, that’s correct. But the 1.1% you mentioned was a net benefit, right? Is that a fair way to –

Scott Howarth

Correct.

Edwin Mok – Needham & Co.

Okay, great. Just want to clarify that. Thanks, that’s all I have. Thank you.

Scott Howarth

Thanks, Edwin.

Operator

(Operator instructions) And we will go next to Andy Ng with Morningstar.

Andy Ng – Morningstar

Hi guys, how is it going?

Scott Howarth

Hi, Andy.

Andy Ng – Morningstar

I was wondering if you can talk about the factors that are going into your gross margin guidance for next quarter. I was just wondering why gross margin will be flat to down when revenue will be up.

John Cobb

Well, so first of all we are fabless, so our costs are almost exclusively variable costs. So as our revenue goes up or goes down, it doesn’t directly impact our gross margin. As Scott said, we do expect the DRAM margins to be flat to slightly up; however, we do expect SRAM margins and ASSP margins to be flat to slightly down. And if you take out the 1.1% benefit, then that would put you about in the mid range of the guidance that we gave.

Andy Ng – Morningstar

Okay. And just another quick question; for your outlook next quarter, which end markets do you expect to be the strongest?

Scott Howarth

The largest end markets that we have been supporting have been quite strong has been the telecommunications and networking market. We’ve also see automotive has really come back substantially strong and we are hitting the highest levels in automotive revenues that we have hit in our history.

And in some of the industrials we are now starting to see are growing again. They are probably the last to recover. And then in the few of the consumer electronics area that we do participate, we have seen strength there as well.

Andy Ng – Morningstar

Okay. Thanks, guys.

Scott Howarth

Thank you.

Operator

And we will go next to Shawn Boyd [ph] with Westcliff [ph] Capital Management.

Shawn Boyd – Westcliff Capital Management

Good afternoon. Congrats on good quarter.

Scott Howarth

Thank you.

John Cobb

Thank you.

Shawn Boyd – Westcliff Capital Management

I just want to hit a couple of points. Overall, we talked about – you started the call with talking about the overcapacity in DRAM in 2007, 2009, and since then having quite a bit of supply coming offline, and of course ISSI being able to offer significant amount of customer support and that allowing us to have several consecutive stronger quarters here. Is anything changing on that competitive front where we are seeing some of that capacity that got pulled off, but you are seeing signs of that potentially coming back in here.

Scott Howarth

So the only data that I can go, just a couple of analysts’ reports – I think Gartner I have read a little bit. Citibank recently came out with talking about future capacity edition. So in the main stream area there have not been large-scale investments yet, meaning no new fabs have come into play. And with the amount of capacity that did go offline, half of that was 12 inch fab, half of that was 8 inch fab, and those are permanently retired.

Now what we have seen though is some of the bigger players in the DRAM market have moved down to 50-nanometer and 40-nanometer that requires the higher cost emergent tools to get down to that level and that has increased capacity incrementally for them. So at this point, we don't expect at least all the data I've said, nobody expects to see that capacity or a surge of capacity come into place yet. In fact, Gartner has quoted they don’t expect to see really much of a capacity increase until 2012.

Shawn Boyd – Westcliff Capital Management

Okay, got it. That’s very helpful. And my other question, Scott, was related to sort of where we are now versus target model. So, at one point we were hoping to get to a point where we might see $70 million a quarter in revenues and 35% gross margin or beyond that. In terms of the gross margin, we are about there, I guess, I should say, and at the midpoint of the guidance on slightly lower revenues. So what I am asking is, is there any update on a target model on the gross margins and operating margins. And maybe we can – I am sorry, let me say one of the other things, maybe we can talk about that in the context of the mixed shift toward the focused markets also.

Scott Howarth

Well, a couple of things that we were expecting to occur that would help us and one of them is as I mentioned is spinning off ASSP business. We felt that would have a long-term benefit and support for us as well. So it’s difficult for us to – at this point to evaluate say what’s the right long-term model given the dramatic changes in the environment that we have.

In the past, I’ve said my goal was to get to $70 million and I had said 30% margins so we could generate 10% operating profit, and the only exception to that was if we saw a much stronger memory environment that we could actually see that being (inaudible). So what I think we are seeing now the numbers that we are giving going forward is a set of that occurring in 2011, we are really seeing it pulling in based on just some of the DRAM market dynamics and SRAM market dynamics. And to be quite honest with you, it is something that I am studying and John and I keep looking at trying to figure out what’s now the right long-term model for us as we look at 2010 and 2011.

Shawn Boyd – Westcliff Capital Management

Very good. Well thanks for the additional color and good luck.

Scott Howarth

Sure, thank you, Shawn.

Operator

Mr. Howarth, there are no further questions at this time. I will turn the call back over to you, sir.

Scott Howarth

Okay. Thank you for participating in this call. We will be presenting at the B. Riley & Co. Investor Conference at Santa Monica, California on May 25 and at the ThinkEquity Semiconductor Conference in New York on June 3rd. We hope to see you at these events. Have a good evening.

Operator

Ladies and gentlemen, that does conclude today's conference. We thank you for your participation.

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