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Integrated Silicon Solution, Inc. (NASDAQ:ISSI)

F2Q2014 Earnings Conference Call

April 30, 2014 10:00 AM ET

Executives

Scott Howarth – President and CEO

John Cobb – VP-Finance and Administration and CFO

Analysts

Craig Ellis – B. Riley & Co.

Gary Mobley – Benchmark

Jeff Schreiner -Feltl and Company

Ian Ing – MKM Partners

Rajvindra Gill – Needham & Company

Richard Shannon – Craig-Hallum

Christopher Longlaru – Sidoti & Company

Operator

Good day everyone and welcome to the ISSI Fiscal Q2, 2014 Quarterly Earnings Call. As a reminder, today’s conference is being recorded. And 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 morning and welcome to ISSI’s conference call for the second fiscal quarter ended March 31, 2014. I’m Scott Howarth, President and Chief Executive Officer and with me is John Cobb, our Chief Financial Officer. Before we proceed, I’ve 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 morning. During the course of this conference call, we will provide financial guidance; make projections, comments, and other forward-looking statements regarding future market developments, market share gains, the future financial performance of the company, new products or other matters. We want 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 demand or supply, availability of foundry capacity, competition factors including pricing pressures 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 2013, and our most recent Form 10-Q filed in February 2014. 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 other forward-looking statements.

Scott Howarth

Thank you, John. Let me start by reviewing the highlights for the March quarter then move into more detailed look at our end markets. We set a quarterly revenue record of $80.9 million driven by record revenue for DRAM products as well as record sales in our IMM and automotive end markets. Consumer communication revenues were each approximately flat quarter-over-quarter. SRAM and DRAM revenue was 72.9 million, up 5.1% sequentially and 10.2% year-over-year. DRAM increased 10.7% over the prior year and SRAM was up 9.1% year-over-year. Flash revenue was $6.6 million and analog revenue was $1.4 million. Gross margin was 34.3% compared to 32.3% in the December quarter, and 33.3% in the March 2013 quarter. GAAP net income for the quarter was $8.8 million or $0.28 per share, non-GAAP net income was $7.2 million or $0.23 per share. We ended the quarter with cash and investments of $130.8 million, and we achieved multiple design wins for our DDR2, DDR3, SDRAM and automotive and industrial, as well as further RLDRAM2, Pseudo SRAM, DDR2 and DDR3 design wins with communication customers. Let me now turn to our end markets.

We’ll start with automotive which is our largest end market and accounted for almost half of our revenue. Revenue increased 1.6% sequentially and 10.6% from the prior year, setting a new quarterly record. This market continues to generate solid growth for ISSI due to our position as a premier supplier of automotive grade[ph] products and the ongoing application growth in vehicles requiring increased electronic and memory content. Our expanded product portfolio continues to gain momentum in multiple applications including displays, infotainment, bluetooth, safety cameras and telematic. During the quarter, we secured a number of new design wins including applications for 4-megabit ultra low power SRAM, 128-megabit SDRAM, 256-megabit DDR as well as our more advanced DDR2, DDR3 in mobile DRAM products. The rising popularity of vehicle camera systems continues to represent a growing opportunity for SDRAM and DDR2 solutions. In fact, the federal government recently issued a mandate that only vehicles will be equipped with backup cameras beginning at 2018. We are well positioned to capitalize on this opportunity as a key global supplier to the automotive market providing high quality products and long-term support.

Activity around our newer DDR3 solutions was also strong in the quarter including a large telematics win for 1-gigabit DDR3, as well as significant design wins for 2-gigabit and 4-gigabit DDR3 products for infotainment and cluster applications. These DDR3 designs are of significant dollar value for future years, so we are very pleased with progress we are making with our newer products. We expect these new-ins will be ramping in 2015 and last for several years. In addition to these design wins, we continue to actively sample our new 13 nanometer DDR3 products to customers. Additionally, we received strong customer interest for our recently introduced 1-gigabit low power DDR2 products, which we believe will be the cornerstone in next generation advanced driver system systems. Looking ahead, we now offer a more complete product portfolio for the automotive market and have a growing pipeline of design wins to drive our continued growth in this market. We see significant opportunity for both expanded content and share gains and that will position us to outgrow the automotive market over the coming years.

In our industrial, medical and military market, revenue increased 6.5% sequentially and 31.2% year-over-year. This follows 17% growth last quarter and set a new revenue record this quarter. Our continued success in this market reflects a broad-based recovery, among our European customers as well as our increasing role as a strategic supplier to large global OEMs. In addition, our expanded distribution network has allowed ISSI to secure larger share of these customers as we successfully leveraged our expanded product portfolio. During the quarter, design activity in IMM remains strong across a variety of products including our 512-megabit DDR products as well as our high-speed SRAM, 64-megabit Pseudo-SRAM 256 megabit DDR, 1-gig DDR2 and mobile DRAM. Additionally, design activity for our 512-megabit SDRAM products continues to be strong partly driven by the end of life notice from Micron that I mentioned last quarter. Many customers are in product allocation which has accelerated interest in ISSI as a reliable second source. In addition, a similar end of life notice has been issued from a competitor for 1-gigabit DDR3 memory with a second competitor expected to follow suit. As a result, we have increased sampling of 1 gigabit DDR3 products with many global customers. We anticipated this design win traction will drive further increases in volume throughout the coming year. Overall, IMM continues to be a strong growth market for ISSI, as a result of our strengthened market position and expanded sales channels to support future share gains.

In our communications end market, revenue was effectively flat on a sequential basis and declined 15% year-over-year. This market continues to be affected by a lack of infrastructure spending, even though we are seeing some pick up in China as a result of the 4G LTE [inaudible] out in particular Synchronous SRAM products. Although this market remains constrained in terms of growth, we continue to make good products our design wins that we believe position ISSI for market recovery. These include wins for our 65 nanometer Sync SRAM and QUAD platforms in multiple densities as well as two solid design wins for RLDRAM2 products. We also won a number of additional designs for 512-megabit SDR, 1-gigabit DDR2 and 1-gigabit and 4-gigabit DDR3 products, which we anticipate to begin ramping in the next few quarters. As a result of our expanded product portfolio and long term support, we believe customers are looking to move more of their high speed memory business to ISSI. We are also seeing strong demand for high bandwidth and high density products including our DDR3 products, and are gaged in initial discussions on DDR4 and high-bandwidth memories with leading communications customers. This demonstrates our strategic positioning with major telecom and equipment customers as a key supplier in this market.

Finally, turning to our consumer market, revenue was essentially flat both sequentially and compared to the prior year. Flash revenue was $6.6 million, down from $7.9 million from the prior quarter. This decline in revenue was primarily due to the Chinese New Year slowdown, the continued weakness in the PC market, as well as significant pricing pressure for legacy flash products which affected new product revenue. We remain focused on securing additional flash design wins including several designs in Taiwan, Korea, China, U.S. and European Union for consumer, industrial and networking application. Early customer activity for 90 nanometer devices has been strong and we plan to have a full suite of lower density SPI Flash products by quarter end and continue to work on products at lower geometries to reduce cost. Sampling is going well for 65 nanometer 128-megabits Serial Flash products, and we expect to have 32 megabit and 64-megabit derivatives on this product sampling by the end of this quarter to meet customer requests. Our first 45 nanometer SPI Flash test chip taped out recently and we are making good progress to take out 512-megabit product later this year. Also want to briefly highlight our recent cross license agreement expansion. This agreement will further allow ISSI to expand arrange especially flash solutions for our customer through access IP portfolio. We’re excited to forward this partnership with one of our leaders and especially Flash to further our product development and create new opportunities for the future.

We are being committed to our long-term goals to grow our flash product line, and are pleased with our progress now with both 90 nanometer and 65 nanometer higher density devices which will improve our product cost structure and provide the flash memories we need to support our automotive and IMM customers. We believe we will begin ramping production devices toward the end of this year followed by 45 nanometer devices ramping in 2015. Analog revenue was $1.4 million and also down sequentially primarily due to the Chinese New Year impact as most of our analog customers are China based. However, we are seeing increased revenue from customers outside of China and secured audio design wins and Japanese accounts plus increased activity for variable design wins for FX LED products. Importantly, our new product development is advancing to expand our analog products into the automotive industrial market. In fact, during the quarter, we announced our entry into the automotive LED lighting market with new backlight driver products which is a new market for ISSI, and represents our ongoing efforts to expand our content penetration of the automotive industry.

In summary, we expect to further increase revenue in the June quarter, and we believe we are well positioned for long-term growth as we ramp design wins, gain share in new and existing customers and leverage our expanded product portfolio. We look forward to reporting our progress on these efforts in the coming quarters.

With that, I will now turn the call over to John to review the financial results in more detail.

John Cobb

Thank you, Scott. Total revenue in the March quarter was a record $80.9 million. SRAM and DRAM revenue was $72.9 million, Flash revenue was $6.6 million and analog revenue was $1.4 million. SRAM and DRAM revenue increased 5.1% from the December quarter and increased 10.2% from the year ago quarter. We had a book-to-bill ratio of 1.02 in the March quarter compared to 1.09 in the December quarter. Revenue in the March quarter by market was 47% automotive 23% industrial, medical and military 15% communications and 15% consumer. These percentages are similar to the previous quarter. Gross margin was 34.4% in the March quarter compared to 32.3% in the December quarter and 33.3% in the year ago quarter. As we discussed last quarter, we’ve been working to reduce our product cost and are now beginning to see the benefits of those efforts. In addition, since most of the backend assembly and test costs are in Taiwan we realized lower costs due to the weaker new Taiwan dollar during the quarter.

GAAP operating expenses were $22.3 million in the March quarter. This compares to $22 million in the December quarter and $21 million in the year ago quarter. GAAP operating income in the March quarter was $5.5 million compared to GAAP operating income of $3.5 million in the December quarter and $4 million in the year ago quarter. Non-GAAP operating income in the March quarter was $7.4 million compared to $5.4 million in the December quarter and $5.8 million in the year ago quarter. Our non-GAAP operating margin in the March quarter was 9.1% which is the highest it’s been since the fourth fiscal quarter of 2012, demonstrating the operating corporate leverage in our model as we execute our revenue growth plans. In the March quarter, we realized $3.9 million in gains on sales of Nanya shares compared to gains of $3.1 million in the December quarter. From our September 2012 purchase through March 31, 2014, we have sold tradable shares with a cost basis of $14.8 million and recognized aggregate gains of $19 million.

At the end of March, the remaining tradable shares with a cost basis of $1.5 million at a market value of $3.1 million which is included in short-term investments March 31, since we intend to sell these tradable shares within one year. We have an additional 191 million restricted shares held at their original cost of $10.8 million in the non-current asset. Nanya shares are traded on the Taiwan stock exchange under the symbol 2408. In addition to our Nanya shares sales we also sold our remaining shares of SMIC for $3.2 million and we recorded a book gain of $2.1 million. We had previously recorded a charge in September 2012 to write these shares down to their fair market value at that time. With this sale, we were able to recover nearly all of the write-down amount. Interest and other income in the March quarter was $400,000 compared to $400,000 in the December quarter and $500,000 in the year ago quarter. In the March quarter, we had GAAP income tax expense of $2.9 million. This compares to GAAP income tax expense of $1.6 million in the December quarter and $3.2 million in the March quarter last year.

On a non-GAAP basis the company had $400,000 in income tax expense in the March quarter or an effective tax rate of approximately 5%. In the December quarter, the non-GAAP tax expense was 300,000 and in the year ago quarter. The non-GAAP tax expense was $200,000. GAAP net income for the March quarter was $8.8 million or $0.28 per share compared to GAAP net income of $5.4 million or $0.18 per share in the December quarter and $3.3 million or $0.11 per share in the year ago quarter. Non-GAAP net income was $7.2 million or $0.23 per share compared to non-GAAP net income of $5.4 million or $0.18 per share in the second quarter and non-GAAP net income of $6.1 million or $0.21 per share year ago quarter. Our non-GAAP results excludes stock based compensation amortization of the tangibles related to acquisition other acquisition related charges gains on sales of investments and non-cash tax expense. A reconciliation of GAAP results to non-GAAP results is provided in our press release.

Now to the balance sheet, on the balance sheet, we ended the quarter with $130.8 million in cash and short term investments, a decrease of $6 million from December. The decrease in cash was due to the purchase of certain technology licenses and temporary changes in working capital items. At March 31, inventory decreased $400,000 from December 31. Accounts receivable increased sequentially from $3.7 million. Days sales outstanding was 57 days in the March quarter, compared to 55 days in December. At the end of December we had $4.34 in cash and short term investments per share. Our total book value per share has increased 32% in the last three years from $7.43 in March 31 2011, to $9.89 at the end of March 2014. Now let me turn to guidance for the June quarter. We are continuing to see an uptick in demand as evidenced by the book to bill ratio and the beginning backlog in the June quarter. As such, we expect total revenue to increase to a range of $81 million and $86 million. This guidance reflects expectations of SRAM and DRAM revenue between $72.5 million and $76 million NOR Flash revenue between $6.5 million and $7.5 million and analog revenue between $2 million and $2.5 million.

Gross margin for the June quarter is expected to range between 33.5% and 34.5%. We expect pricing to be flat slightly down sequentially. GAAP operating expenses are expected to range between $22 million and $23 million. We also expect about $300,000 from interest and other income. We expect that our GAAP effective income tax rate will be approximately 25% excluding the non-cash deferred tax expenses and our other typical non-GAAP items our non-GAAP effective tax rate is expected to be 5%. We expect to realize additional gains in the Nanya shares in the June quarter however, it is difficult to predict the total gains in the quarter and as such these gains have been excluded in the GAAP and non-GAAP guidance. Taking these factors for the June quarter into account the company expect GAAP net income to be between $0.12 and $.16 per diluted share and non-GAAP net income to be between $0.22 and $0.26 per diluted share. Now back to Scott for final comment.

Scott Howarth

Thanks, John. We are excited to report another record setting quarter not only for total revenue, but also for automotive IMM and DRAM sales. These achievements reflect our improved market position as a strategic supplier of specialty memory through an expanding list of global customers in growing end markets. Our design win activity remains strong across our product portfolio with an increasing number of wins that will begin shipping later in fiscal 2014 and ended 2015 paving the way for further growth. We remain focused on expanding our product lines with new solutions at higher densities increasing our market penetration further reducing product cost and leveraging our position as a specialty memory provider for continued success.

With that, we will open the floor to questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions]. And we’ll hear first from Craig Ellis of B. Riley.

Craig Ellis – B. Riley & Co.

Thanks for taking the question and congratulations on the quarterly execution guys.

Scott Howarth

Thank you, Craig.

Craig Ellis – B. Riley & Co.

You’re welcome. The first question I had is regarding the outlook. It’s helpful to get the details by memory technology, but can you provide us with some color on some of the gives and takes by end market as you look at 2Q calendar 3Q fiscal? And then related to that what really will distinguish the high end from the low end of guidance? Is it something that is program specific, end market specific? What do you see differentiating high end versus the low end?

John Cobb

So on the specifics by the end market we’ve seen very nice growth industrial markets so we are expecting to see continued growth there as well as ongoing growth in automotive. The common market is still difficult to identify specific growth. So we’re expecting kind of flattish very consistent with this current quarter in terms of overall end market. Now on the range, it’s really a reflection of ongoing activity for booking throughout the quarter. We enter the quarter typically about 50% booked. So it’s really based on the ongoing strength of specific customer specific end markets, it’s easy for a particular customer if they have any change in their shipments to push a $1 million or $2 million in the next quarter or to delay shipments. So that’s typically where we’ll put a range, so that we can predict some of that variability.

Scott Howarth

Okay. And also Craig just to add based on the guidance we’re also seeing somewhat of a rebound to the flash and analog business from what’s typically a seasonally down March quarter, and that revenue is exclusively the consumer market. So we would expect the consumer market to grow sequentially into the June quarter.

Craig Ellis – B. Riley & Co.

And that’s just a working dynamic in Asia John?

John Cobb

Yes.

Craig Ellis – B. Riley & Co.

Okay. The follow up question is on gross margins. You mentioned on the prepared comments that you’re starting to see some of the early signs of the product cost benefit that you had teed up and you’ve talked about on prior quarter calls. So where are we in terms of realizing that and over what time period would we expect to get the balance of the benefit that the company is looking forward for? Is that something mostly in 2Q and therefore in the guidance that we see or is that something that’s going to extend into the back half of the year?

Scott Howarth

Good question. So the immediate change is really where some of the newer products now that are shipping, we’re able to reduce the product costs. So we saw some immediate effect this quarter, but in terms of just ongoing cost reduction that’s part of our quarterly strategy, so that we can continue to offer lower pricing to customers as well. And in some of our end markets, we have guaranteed pricing and certain price reductions each quarter or each year. So it’s baked into our guidance, and then as we look out, it’s really matter of cost reduction versus price reduction, and the goal is to at least keep the culmination flat and ideally start to grow our gross margin.

Craig Ellis – B. Riley & Co.

And then the follow up question is related to that, as we think about the business’s gross margin potential I think the company’s talked about 34% to 35% range and you’re certainly well into that range. Are you feeling like we’re at a sustainable level or were some of the things like the currency help in the reported quarter something that you would look at as more temporal?

Scott Howarth

We feel that we’re in the range that we should be at this point. Certainly the currency benefit helped a little bit it can have some swing on us. But when we look at our overall product mix and market mix, we do think we’re in a sustainable range on the gross margin. And like I said I mean we’re going to keep working as hard as we can to try to keep raising it. And I think if we look at last quarter as we talked that was a bit of a temporary dip in our gross margin. Our goal is to try to keep it as close as we can to 35% and grow from there. So I think we’ll be able to sustain this range.

Craig Ellis – B. Riley & Co.

Thanks, guys. I’ll hop back in the queue.

Scott Howarth

Great. Thanks, Craig.

Operator

And our next question comes from Gary Mobley of Benchmark.

Gary Mobley – Benchmark

Good morning, guys. Thanks for taking my question.

Scott Howarth

Good morning, Gary.

Gary Mobley – Benchmark

Apologize for my voice. I had a question about your flash revenue. You’re guiding for what mid to high single digits sequential growth for the June quarter and but that’s still well off the previous high which I believe on a quarterly basis was around 9 million. I’m curious to know as you progress to the year and as you ramp your production in sale of 90 nanometer product and eventually 65 and 45 nanometer. When might we see the NOR Flash revenue approach the previous high or should we not even expect that in the intermediate term?

Scott Howarth

In the short term, we are working to move our designs into industrial automotive. So I’ve discussed in the past we’ve been in principally in lower density in the consumer market which pricing for NOR Flash has been very, very aggressive. Competitors there are really being competitive in pricing down to cost and below in some cases. It’s been difficult for us to even gain shares to even hold some of the existing shares. So our whole plan as we’ve shown with the memory of the DRAM side is to migrate into a more industrial automotive which values higher quality long term support. And now with the 90 nanometer devices it gives us some higher density gives us stability to start migrating to those other designs that will still take at least a couple of quarters before we start seeing material revenue to that. So I think we’re looking at, at least two to maybe even three more quarters of what I would consider the lower revenue range on flash and starting to grow towards the end of this year into the industrial and some of the automotive segments. We do believe we’ll get back above that level and when we look at the opportunity still in the market we clearly see the opportunity for us to expand our role in more specialty in the flash segment and also getting into 65 nanometer now that starts giving us a lot more competitive cost structure to be able to compete even in some of the consumer electronics areas. But principally, it’s the higher density that we need that’s why we have 90 nanometer 64-meg 32-meg devices which are crucial in end market and also the 128-meg that we have coming on to 65 nanometer.

Gary Mobley – Benchmark

Great. That’s very helpful. And Nanya’s recently announced restructuring and I think it was primarily capital restructuring we announced the sale of a Fab if I’m not mistaken that Fab is where some of your product is produced. Could you talk about how this may impact your supply chain if at all? That’s it for me.

Scott Howarth

Yeah good question, Gary. So on the supply side right now, we really didn’t comment specifically in the script, but we are starting to see tighter wafer supply across some of our foundries. And as you’ve mentioned Nanya sold off one of its Fabs called Sumpro and that went to Vanguard. Now we do have relationships with Vanguard, we’ve been discussing with them their long-term goals with this particular Fab and we’ve been working to make certain that we can secure supply with them in the short term. While it’s for – we’re still uncertain exactly what their long term strategy is for this Fab, but we do see it will have anywhere from one to two years worth of wafer supply from them. And we are working to make certain that we have alternative wafer supply for specific products that are being manufactured at Sumpro. The other piece to it is that Sumpro designs or products there are 0.11 micron and 99 nanometer so they are older technology. And we want to – we’ve been wanting to move customers down to some of our 72, 63 and 38 designs so that we can give them lower product cost. Now having said that, we also have automotive customers that are still buying a lot of these products that don’t want to change. So we are working with customers to really balance that out. So that long term we can support them either on the older device as well as the newer device but we do think at least in the short term we have a good strategy to be able to support.

Gary Mobley – Benchmark

All right. Thanks, guys.

Scott Howarth

Yes. Thanks, Gary.

Operator

And we’ll go on to our next question from Jeff Schreiner of Feltl and Company.

Jeff Schreiner –Feltl and Company

Yes good morning gentlemen. Thanks for taking my questions.

Scott Howarth

Good morning , Jeff.

John Cobb

Good morning, Jeff.

Jeff Schreiner –Feltl and Company

Just to follow up on Mr. Mobley’s question there. Given that you think that you still may be able to get one to two years supply we’ve seen this before when you had a Fab kind of move away from you. In the past, you had new kind of significant one time wafer buys to secure these wafers and make sure they’re in place. Are we going to have to see a one-time wafer buy in relation to the Fab that’s been moved to Vanguard?

Scott Howarth

Yes we don’t see that in the immediate term like I said, right now Vanguard is discussing maintaining supply for one to two years. So what I would expect is probably in 2015 we’ll have to look at the last time buy. Now having said that, we are working with customers right now to make certain we can offer them alternative devices and we even started before this. We knew we wanted to move away from the older 8-inch technology, and we will continue to offer customers alternative solutions and try to transition. Those customers that don’t want to transition, we do have some automotive customers that want to maintain these legacy designs then we will look at doing a last time buy in most likely in 2015. And we’ll have to do a wafer purchase in order to support the lifecycle they have in some of their designs.

Jeff Schreiner –Feltl and Company

And just to be clear Scott, are you looking to replace this Fab or is this something that after the two years or so goes away if legacy and you don’t need to support those products anymore?

Scott Howarth

It’s a combination Jeff. So the goal we have – again this is 99 nanometer as well as 110 nanometer devices. So we have alternative designs at 72 nanometer and below at another foundry, for all products except I think we have one device that we still have to complete the design to transition. So our goal is always to transition customers. This accelerates for us the transition timeline and what we’ll do is for customers that who don’t want to transition or want to maintain these specific devices on a legacy basis then we’ll do a last time buy. Somewhere we expect in 2015 to support it. Having said that, we think some customers will transition so that we will ramp down the volume gradually, but eventually we know we will lose supply of the wafers for 110 nanometer and 99 nanometer and we expect that to be toward the end of 2015.

Jeff Schreiner –Feltl and Company

Okay. And then John, just wanted to know you talked about being typically 50% booked heading into the quarter. Where are you right now in terms of what percentage of the June quarter do you have booked?

John Cobb

So, we won’t talk about the specifics of it, but we are ahead of where we were in the March quarter. And as Scott said, not only did we start with a strong backlog, but the orders that we’ve had to date have also been very strong ahead of where we were last quarter.

Jeff Schreiner –Feltl and Company

Okay. And could you just break out the DRAM and SRAM revenue individually in the quarter, John?

John Cobb

So SRAM was 21.6 million which I’ll just comment was the highest our SRAM revenue has been and at least 10 years. We used to be a totally SRAM company back in the 90s, but this is the highest it’s been in a long time. And then DRAM, we had record DRAM revenue in the quarter of 51.2 million.

Jeff Schreiner –Feltl and Company

Okay. And final question for me is, Scott help us here, in terms of may be understanding why the communication segment is continuing to lag as we constantly see you putting press releases out about design wins, talking about design wins in your earnings releases for several quarters now. And I have to say that the end market during the last few quarters have been pretty strong, there’s been a rather CapEx cycle going on capital equipment expenditures by service providers such as AT&T, Verizon continue to be maintained if not slightly increased. What is holding back communication revenues in your opinion? And when are we going to see some acceleration in this end market segment?

Scott Howarth

Good question. So there is couple of thesis if we break down the end market first. We still are not seeing any significant pick up in end market demand outside of China, and recently at one of our larger European customers visited just a couple of weeks ago is echoing the exact same thing. Our strength in this market has been more in base station build out. So that’s the particular aspect of the end market has been strong and then we’ve also been in a number of legacy designs some edge routers and other solutions. So what’ve seen is some of the legacy revenue has been declining as customers migrating over to higher end designs and from the high end than as we reported we’ve been focused on bringing out our TDRSRAM as well as ramping RLDRAM. And as reported we did have some package level issues with our RLDRAM, we’ve corrected those and we’re now back to sampling the devices and going through the calls again for these devices and we’re seeing nice progress.

So the two aspects still we’re waiting to see a pick up really from an end market standpoint and we were not seeing that yet. And then secondly, positioning ourselves stronger from a product standpoint, and we’re pleased with the product positioning now. We have all of our product level issues fixed which has been corrected now for over a quarter and the culmination there we believe will start we’ll expect in this end market. And we do have customers looking for expanded supply base but as I say that, the telecom guys are pretty slow as they look at bringing in new designs so we continue to work with them as we’re able to work with those. The other piece that we’re excited with longer term we’ve mentioned in the past we’re working with Cisco on a very unique specific customer device which will start contributing 2015. And we’re looking at other high bandwidth memory solutions to be able to deliver to also generate future revenue.

Jeff Schreiner –Feltl and Company

All right. Thank you for your time gentlemen.

Scott Howarth

Great. Thanks, Jeff.

Operator

And going on to our next question we’ll hear from Ian Ing from MKM Partners.

Ian Ing – MKM Partners

Good morning. Thanks for taking my questions. First question is on communication just pick up in China. Is there the content is it going up or is it flat in terms of these base station versus [inaudible] generation other equipment? Thanks.

Scott Howarth

I’m sorry Ian, you said – can you repeat the question?

Ian Ing – MKM Partners

Sure. So China obviously it’s 4G based stations and some related edge equipment being deployed right now. So is your SRAM content is – what’s the trend in this generation of deployment versus prior is it flat is it higher or is it lower?

Scott Howarth

So the memory content is basically what you’re asking right or our content? So from the [inaudible] I mean they are configurable so for that particular customer that we’re selling to, I don’t know exact configuration of what they’re selling, but we are seeing increased content. For us, it’s principally in SRAM solution.

Ian Ing – MKM Partners

Okay. Okay, great. And may be if you can clarify your efforts to reduce your product cost largely process migration and yields of your foundry partners. Is there anything happening on the backend like testing packaging efficiency and just want to clarify DRAM does that still have cost structure at the moment?

Scott Howarth

So the simple answer to your question would be yes. So we’re constantly working on both aspects both front end as well as back end. So cost reductions everything from try to negotiate with wafer cost reducing CP cost test time on the front end as well as back end test time assembly cost reduction any yield improvement we can get. So we are looking buying our own tester where we can increase our overall utilization get lower costs from that perspective looking at suppliers either Taiwan or China that can provide lower cost as well. So we really – it’s a constant effort to identify the lower cost that we can get across our product portfolio and that continues really across our entire product line, new products as well as even legacy where we can keep try and reduce cost.

Ian Ing – MKM Partners

Okay. And lastly, just on the balance sheet just a housekeeping question looks like you have 1 million in restricted cash now and is there can you give some color on that something? Thanks.

John Cobb

The restricted cash is merely a guarantee that we give to one of our suppliers.

Operator

Mr. Ing, did you have anything further sir?

Ian Ing – MKM Partners

No, that’s it for now.

Scott Howarth

Great. Thanks, Ian.

Operator

And we’ll go next to Rajvindra Gill of Needham & Company.

Rajvindra Gill – Needham & Company

Yes thanks for taking my questions. Congrats on good execution. Just one housekeeping guys, could you just break up the employee stock option expense again by COGS, R&D and SG&A?

John Cobb

Actually there’s two components to our stock option expense. So the non-cash stock option expense is about 1.5 million and that’s disclosed in the GAAP to non-GAAP reconciliation. We also had about 400,000 of expense related to stock appreciation rights as we mentioned couple of quarters ago we started grant stock appreciation write and the expense related to those was about 400,000 in the quarter that is a cash item so it’s included in our expense. So the total stock related expense was closer to $2 million but the non-cash piece is $1.5 million. Almost all of it is in operating expenses probably 100,000 is in cost of sales.

Rajvindra Gill – Needham & Company

Okay, that’s helpful. Thanks. And Scott, could you talk little about the competitive dynamic that you’re seeing in SRAM and DRAM specifically in the automotive market. If you could elaborate a little bit further what you’re seeing last six months or so and what do you anticipate in the future?

Scott Howarth

So specific to automotive?

Rajvindra Gill – Needham & Company

Yes.

Scott Howarth

Okay. So from SRAM standpoint automotive there’s really two competitors that are focused there. We remain the stronger and have larger share in automotive SRAM but automotive SRAM it’s a declining market so there’s not a significant amount of growth there. On the DRAM side we continue to see competition from micron in this area they are clearly the leader in this market and we’ve seen other entrance now coming out of Taiwan trying to also target the automotive market. We still are looking at some of their focus on it more as a way of trying to pick up share quickly and easily with lower pricing versus really providing the long term support and quality like we do. So our focus with this is we have to remain competitive, but we’re not going to walk away from long-term support and high quality that we’re providing. So there we’re still quite pleased with results that we’re seeing particularly on some of our design wins across the product portfolio, but we are seeing as that market grows more competitive entrance coming out of Taiwan.

Rajvindra Gill – Needham & Company

And John, can you talk a little bit about the seasonality that you’re seeing are you expecting to see September quarter or December quarter. Is it kind of varying from historical seasonality because of some of the new ramps of should we expect similar type of seasonality?

John Cobb

So normal seasonality is sequential growth in the June growth followed by sequential growth in September and then December may be flattish. However, the last few years, seasonality has been difficult to predict because of cyclicality factors. If you go back last year I think this December sequentially was well flat but the prior couple of years there was some downturns and some adjustments in the market. So seasonality is more difficult to predict than what it had been previously but as I said I think we would expect sequential growth June September and December is a long way out but flattish to may be slight growth in the December quarter.

Rajvindra Gill – Needham & Company

Thank you.

Scott Howarth

Thanks, Raju.

Operator

And we’ll go to our next question from Richard Shannon of Craig Hallum.

Richard Shannon – Craig-Hallum

Hi Scott John how you guys doing?

Scott Howarth

Good Richard. How are you?

Richard Shannon – Craig-Hallum

Doing just fine. Thanks. I’ll add my congratulations on nice numbers and guidance. A couple of questions for me and I think I’ll follow up on the latest question on the automotive side here you talked about some increasing number of entrance in the DRAM part of the automotive market. Are there applications that more aggressive pricing that typically resonates with or geographical or specific automakers that respond to more to that than others?

Scott Howarth

Yes, certainly. I wouldn’t articulate on applications but we do see geographic designs and location being more aggressive in terms of trying to use lower price lower cost solutions. And in Asia, I would say principally we see customers will be a bit more aggressive trying to use lower cost designs so that’s an area where it’s more competitive, whereas we look at U.S. and Europe and with the customers we have there typically quality long-term supply is primary and then cost comes in second, although we still have to remain competitive obviously with the leaders in this market. So our goal is to continue support our customers in all of the end markets and in several situations where we’ll see lower quality competitors come in and get a design our focus is always to make certain that we also get designed in and then when customers run into quality failures support failures or other issues then we can jump in and supply that customer. That’s the strategy we always have and many times we see that exact scenario playing out.

Richard Shannon – Craig-Hallum

Okay. And to follow up on those questions topics in general how can you may be if you can describe puts and takes thinking about medium term kind of growth rate in the automotive space. I know I think I have asked this on last couple of calls but love to get your latest updates taking those competitive dynamics in mind, but also adding new thoughts on increased content and your higher what looks like higher SP products coming down the pipeline. If those last few quarters you and your growth rate in automotive is roughly 10% is that kind of growth rate you’re comfortable with or do you think it can do better than that? And if so, when do you – when you might see that accelerate?

Scott Howarth

Yeah so on the automotive side, we’re clearly seeing increase in content, increase in volume into that end market. As I’ve discussed in the past though we are seeing price erosion from the standpoint of going from SDRAM to DDR and now into DDR3 and with DDR3 today we are designing at 30 nanometer price per unit basis pricing has declined. So we’re seeing unit growth that certainly higher but we’re seeing when you bring in the overall price decline moving into lower geometries that’s where we’ve seen revenue has slow down. Having said that, we do think we will continue to see revenue growth I think in the short term it’s difficult for us to maintain some of our historical growth rate. So I’d probably put it into the 10-ish plus range at this point with the expectation that we’d be able to start growing even faster as we look going forward. And as I said, it’s really about getting a design win and supporting the key applications and the one we mentioned which I continue to be excited about is with our low power DDR2 there are very few competitors right now offering this particular device we’re seeing a lot of interest in automotive particularly in the camera systems and solutions. So we think we’ll see solid design wins and some growth coming from that in the future.

Richard Shannon – Craig-Hallum

Okay, perfect. One last question from me, you mentioned some end of life with some products with your competitors and you talked about starting some qualification[ph] there. Can you give us some sense of breadth of your calls that you have initiated when those might get finished and start to see orders? And what kind of do you think we’re addressing with the size of markets your competitors are leading?

Scott Howarth

Good question. So the first one is 512-meg and we’ve actually been sampling that now for a couple of quarters. I’d say increasing sampling. So we saw our sampling rate more than doubled on those particular devices. And we’re already starting to ship increased volume of 512-meg, and we continue to see design activity across the board. On the other one, I mentioned 1-gig DDR3, we’ve certainly seen a pickup in design wins as well sampling activities increasing and we expect that, that will probably start shipping increased volume in one to two quarters and we might even see some short-term upside with that. And we expect that we’ll probably see additional end of life notices also in this period where we’ve had number of customers starting to report to us that they are seeing allocation from some of their suppliers. So that’s created additional opportunity for us to make certain we can provide product across the portfolio of customers that we have so that we can supply any of the upside needs that they have as well.

Richard Shannon – Craig-Hallum

Okay. Perfect. I think that’s all for me guys. Thank you very much.

Scott Howarth

Great. Thanks, Richard.

Operator

And moving on, we’ll go to our next question from Christopher Longlaru of Sidoti & Company.

Christopher Longlaru – Sidoti & Company

Hey guys. I’ll add my congratulations nice quarter.

Scott Howarth

Thanks, Chris.

John Cobb

Thank you.

Christopher Longlaru – Sidoti & Company

I’m going to just put you back on a question just in terms of the supply constraints over the next couple of years and you also mentioned that your orders have been picking up. Is there anywhere for you to be confident or what gives you confidence in this isn’t your customers preparing for a little bit of a shortage versus demand driven is there anything that you see that gives you that confidence?

Scott Howarth

Well generally our customers know that we maintain inventory and we don’t see a sudden ramp up in terms of bringing on supply. So we stay pretty close to it, we talk to customers and I think we have a good enough relationship so that we know what their needs are. So we don’t see this as just kind of a short-term immediate supply base or pick up just based on the shortages out there and again it hasn’t been a sudden swing it’s been more of a gradual and again talking to different customers right now we see just some tightness in supply. We think that will gradually continue just the end markets keep getting up and our goal is to keep supplying a great and greater percentage.

Christopher Longlaru – Sidoti & Company

And just in terms of you mentioned your strength DRAM and SRAM, is there one that’s stronger than the other in terms of the incoming orders of late?

Scott Howarth

Nothing specific between the two, but DRAM is a bigger percentage of our overall business. So we always see stronger orders on the DRAM side. We’ve been pleased with the industrial growth also for SRAM and I think we’ve been able to continue to grow and gain share and add end markets. So SRAM is not a growth market so for us to continue to show growth we’re very pleased with our success there.

Christopher Longlaru – Sidoti & Company

Great. I’ll jump out. Thanks guys. Congrats again.

Scott Howarth

Great. Thanks, Chris.

Operator

And our next question is a follow up from Craig Ellis of B. Riley.

Craig Ellis – B. Riley & Co.

Thanks for taking the follow up. In the prepared remarks there was a commentary around the IMM end market area and the progress the company’s made on improved strategic relationships with key customers. I was hoping you could provide some color on where those customers are whether it’s industrial, military, medical or may be touching a couple of those and where are we in terms of getting those established versus driving material revenues off of those relationships?

Scott Howarth

Good question. So some of the questions we’re referring to there are European based as well as U.S. based mostly in industrial application and solutions, particularly with Europe we mentioned in the comments. Europe economy improving we’ve seen a nice rebound and pick up there in industrial applications. So that’s broad-based from a key customer standpoint, we’ve seen really solid growth across key customers who’ve recognized the benefit of our long-term support strategic relationships instead of trying to always guess or second guess supply in the market and going for lowest cost, they are really just looking for good stable supply, competitive pricing, long term support. And our goal is to keep working with these major customers and gaining a greater and greater share. But challenge for us in industrial is always the breadth of this market is more of a challenge, but we continue to see success as we keep working to penetrate individual large customers.

Craig Ellis – B. Riley & Co.

So to be clear Scott, you’re talking about somebody that’s incremental to the substantial relationship you’ve had with a German domicile industrial company?

Scott Howarth

Correct.

Craig Ellis – B. Riley & Co.

Okay. Switching gears on to the gross margin side. In part of my earlier question, you talked about the potential for 35% gross margins longer time. Do you feel like you got a line of sight to that Scott? And if so, can you provide any color at all in terms of how do you think the business ramps there? Do you think it could be a somewhat linear ramp or are there going to be gives and takes along the way? And if so, what are some of the factors that are going to move things around a little bit to try to get to that target level?

Scott Howarth

Well there’s always some give and take as we mentioned in the past, currency fluctuation can have some impact on us, tightness of supply can have some impact if we see wafer price or backend cost etcetera we have to manage our way through. But at the same time, if we can migrate our way or density on flash I think we can gain or improve margins on flash business our goal we want to increase analog although it’s going to be a lot slower margin business in ideally start seeing a pick up again on automotive will help overall margins. Having said that, there is a lot of play between each of the different segments and different end margins associated with it, but our goal is we think we can gradually keep growing our margins with the goal of at least getting 35%. And it’s going to take us some time to get there still, but that’s what we’re going to keep working toward.

Craig Ellis – B. Riley & Co.

Thank you. And then the last one’s for John, John cash balance declined quarter-on-quarter it looked like largely due to capital issues. What should we expect in the fiscal third quarter?

John Cobb

Our cash should rebound in the third and fourth quarter. You’re correct, we did spend some money on some technology licenses, but actually the bigger driver is just the working capital items which are just temporary. So I’m expecting that we’ll have strong cash flow in the second half of the year.

Craig Ellis – B. Riley & Co.

Great. Thanks, guys.

Scott Howarth

Thanks, Craig.

Operator

[Operator Instructions]. And it appears there are no further questions at this time.

Scott Howarth

Okay. Thank you for participating in this call. We will be presenting at the B. Riley Conference in Santa Monica on May 30 as well as participating and travel through a number of markets in May and June including Minneapolis, Chicago Boston and New York. We hope to see you at one of the events. Have a good day.

Operator

And again that does conclude the call. We’d like to thank everyone for their participation today.

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