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Integrated Silicon Solutions, Inc. (NASDAQ:ISSI)

F3Q2012 Earnings Call

May 3, 2012 4:30 p.m. ET

Executives

Scott Howarth – President and C[Author ID1: at Wed Jul 25 18:54:00 2012

]hief Executive Officer[Author ID0: at Thu Nov 30 00:00:00 1899

]

John Cobb – Chief Financial Officer[Author ID1: at Wed Jul 25 18:54:00 2012

]

Analysts

Jeffrey Schreiner – Capstone Investments

Daniel Berenbaum – MKM Partners

Rajvindra Gill - Needham & Company

Richard Shannon - Craig-Hallum Capital

Chris Sigala - B. Riley & Company

Operator

Welcome to the ISSI Fiscal Quarter Three 2012 Quarterly Earnings Conference Call. As a reminder, today's conference is being recorded. At this time I would like to turn the conference 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 third fiscal quarter ended June 30, 2012. I am 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 statements 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 developments, market share gains, the future financial performance of the company, new products, our acquisition of Chingis 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, risk related to completing the Chingis acquisition 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 2011 and our Form 10-Q filed in March 2012.

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 providing a summary of the key highlights during the quarter. Our sequential growth in revenue is driven by record revenue achieved in the automotive market partially offset by continued weakness in the communications market. We had increased design win traction in our products in the automotive, communications, industrial, medical, military markets.

New product execution is on a track as we continue to introduce additional products, which we expect to drive future revenue growth. We're also seeing increased opportunities to gain share as some of the larger competitors reach end of life on certain DRAM and SRAM products.

Finally, last week we announced our tender offer for the shares of Chingis Technology Corporation, a Taiwanese company focused on NOR Flash. Now let me review the results for the June quarter and then I will discuss our acquisition of Chingis in more detail.

Revenue was $64.8 million, a growth of 3.6%, sequentially. GAAP net income was $3.1 million or $0.11 per share and non-GAAP net income was $6.5 million or $0.22 per share. Non-GAAP results excluded stock compensation, amortization of acquisition related intangibles and non-cash tax expenses. We also achieve $2.6 million in cash flow from operations.

Combine SRAM and DRAM revenue in the June quarter was $62.7 million, an increase of 4%, sequentially, and a decrease of 3% from the prior year quarter. DRAM revenue increased 7%, sequentially, as strength in the automotive market more than offset in-market weakness in the communications and consumer markets.

The weakness in the communications market also affected our SRAM products, contributing SRAM revenue decreasing 1%, sequentially. Analog in the June was $2.1 million, which was flat with the March quarter.

Automotive revenue grew 18% from the March quarter and 51% from the year ago quarter, as I mentioned earlier, reached a quarterly record. Automotive revenue was 44% of our total revenue in the June compared to 27% of our revenue in the same quarter a year ago.

Revenue from the industrial, medical and military market was flat, sequentially, and decreased 11% from the prior year quarter.

Revenue from the communications market decreased 7%, sequentially, and 25% on a year-over-year basis due to continue weakness and communication infrastructure spending.

Revenue from the consumer market decreased 10%, sequentially, and 50% from the year ago quarter due to overall weakness in the consumer electronics market and our continued transition away from lower margin business.

Now I will briefly review our key markets and products, including DRAM, SRAM and Analog. During the June quarter DRAM represented 66% of our total revenue. We had another strong quarter of design wins across all end markets including several high-volume SDRAM design wins for automotive applications and a large DDR2 design win in the communications application.

We also achieved a number of key design wins for both x16 and x32 configurations in automotive, communications and industrial. In addition, we had strong design activity for our new DRAM products, including our 256 megabit, 512 megabit, 1 gigabyte and 2 gigabyte DDR2, our mobile SDRAM and our 64 megabit and 128 megabit low power SDRAM KGD product.

We expect these new devices to contribute to revenue growth in the coming quarters and further expand our market share. We're also seeing increased market opportunities for SDRAM and DDR1 products as our larger competitors reach end of life on their equivalent products.

As we mentioned before, both Samsung and Hynix informed their customers that they will be exiting SDRAM and DDR1 markets by the end of 2012. We have made multiple crosses to replace both and recently had DDR design wins with Japanese automotive companies to provide long-term support once they start shipping. This shift provides an opportunity for ISSI to gain share and support customers as they seek stable supply to meet continuing demand for their products.

Additionally, we have made significant progress with our growing number of customers for our growing number of customers for our new RLDRAM memory products. We have sampled our RLDRAM2 memory to over 20 customers who are currently evaluating and designing in our part. We expect to begin our first revenue shipments in the September quarter and then ramp revenue into 2013.

We are also sampling our RLDRAM3 memories and to day more than ten customers have expressed designing interest. Initial production shipments of RLDRAM3 are anticipated in the fourth quarter of calendar 2012 and expect it to ramp slowly throughout 2013 or '14.

Overall, the addition of RLDRAM to our memory portfolio positions, ISSI to become a source of newer technologies and designs and we continue to see increased opportunities to expand our market share and grow RLDRAM revenue.

Turning to our SRAM revenue. SRAM represented 31% of our total revenue in the June quarter. Design win activity was again strong in our key markets for various densities of our products. This includes several large design wins for the automotive, industrial and communications markets for our 4 megabit, 8 megabit and 16 megabit and synchronous products and a communication applications with our synchronous products.

We also have several large design wins for our QUAD SRAMs and for our high performance 36 megabit and 72 megabit QUAD PSRAMs with leading communications companies.

Similar to the situation with DRAM, Samsung also plans to exit the synchronous SRAM market by the end of 2012, which has also created significant share gain opportunities for ISSI. This is very timely as we have been sampling our new higher performance 65 nanometer, 36 megabit and 72 megabit QUADP synchronous SRAMs to target our customers' new designs and replace designs being vacated by Samsung.

As a result of Samsung's exit plans, we currently have design activity at more than 50 customers. Some of these customers are new for ISSI, which will increase our count base and market share.

We expect these design opportunities to result in additional revenue in two to three quarters from now. Also, we will be expanding our SRAM product line later this year with additional 65 nanometer devices and an even higher performance 28 nanometer synchronous SRAM in the future that will provide us with leading edge SRAM memory products.

With our continued investment in providing competitive SRAM solutions and long life cycle support, we are confident that we will continue our long-term revenue growth in the SRAM market.

And, finally, our analog revenue was $2.1 million in the June quarter. Since the majority of our analog revenue is related to products in Chinese feature phones, the shift towards smart phones, that market has continued to make for a weekend market. We are working with our customers to cure both audio amplifier and LED driver designs in the new smart phones and are introducing several new products.

In addition, we are working to expand our opportunities in other markets in China such as consumer appliance and industrial applications and have secured several design wins. We are also targeting cell phone and other consumer industrial applications in other Asian countries such as India, Korea and Taiwan and have also had design wins in those markets.

As a result of these efforts, we believe our analog revenue will rebound to the earlier levels within a few quarters. We remain optimistic about our opportunities for long-term growth in the analog market.

Looking at our guidance for the September quarter, we expect total revenue to be in the range of $65 million to $71 million, which would be flat to up 10%, sequentially. We started this quarter with a significantly higher backlog compared to the June quarter, a higher book-to-bill ratio of 1.16 and have seen a good order flow so far.

Operational, we did see some wafer shortages tight vacuum capacity which made it challenging for us to meet customer demand. While we've been able to procure adequate wafer capacity to meet our future demand, we've also been informed that one of our foundries will no longer be supporting DRAM in the future. We are moving products to another foundry and have also made a last time buy of wafers to cover customer demand for one to two years.

Before turning over to John, I would like to discuss the details regarding our tender offer for Chingis Technology. Founded in 1995, Chingis provides a variety of NOR Flash memory technologies used in standalone and embedded applications with more than 80 worldwide patents and patents pending. The company has 75 employees in Taiwan, Korea, China and the United States.

For the year ended December 31, 2011, Chingis reported annual revenue of $39.6 million, a net income of $2.6 million. We expect similar numbers for calendar 2012. If all the Chingis shares are tendered, the total acquisition price will be $33.0 million or approximately $16 million net of Chingis' expected cash balance of $17 million at the time of closing.

We currently expect the transaction to close in September of 2012. The acquisition of Chingis will strengthen ISSI's product portfolio by adding another specialty memory technology in expanding the company's future growth opportunities into the $1.2 billion Serial NOR Flash market.

Over the past couple of years many of our automotive industrial customers have requested that we also offer high quality legacy Flash solutions with long-term support like we do for SRAM and DRAM. This acquisition will let us provide that support and meet this demand from customers. We intend to leverage our existing infrastructure, increased scale and lower (inaudible) costs, utilize our foundry relationship to grow Chingis' embedded business and expand the Flash product line based on customers' needs.

The companies share a number of distributor and customer relationships, particularly in Asia. For our target markets, the NOR Flash product line offers many of the same kind of attributes as our specialty memory portfolio, including stable pricing and gross margins plus long product life cycles.

Chingis products are highly complementary to our existing sales channels due to the unique performance and durability characteristics required by our customers' applications. We look forward to expanding our customer relationships and pursuing additional growth opportunities in this exciting new market.

This acquisition does not change our analog strategy as we continue to see opportunities in that segment. However, we believe this is a cost effective way for us to add a complimentary product line to our specialty memory portfolio. John will discuss some of the financial details of our tender offer in his comments.

In summary, we see strong growth opportunities in our target markets for increased design wins and share gains as we continue to introduce SRAM, DRAM and analog products. We believe our focus on high quality specialty products reduces volatility and provides greater potential for growth and revenue and profit, as well as higher more sustainable margins and can be achieved by other similar memory suppliers.

The advantages of our fabless business model, combined with stable end markets and support for our customers' long product life cycles further contributes to opportunity grow revenue and profits in the future and with the addition of NOR Flash we will further strengthen our growth potential.

Let me now turn it over to John to discuss the numbers and I will then provide some closing remarks.

John Cobb

Thank you, Scott. As Scott mentioned, our revenue for the June quarter was $64.8 million, within our guidance range of $63 million to $68 million. SRAM and DRAM revenue was $62.7 million. The analog was $2.1 million. The SRAM and DRAM revenue increased 4% from $60.3 million in the March quarter and decreased 3% for the year ago quarter. We have a book-to-bill ratio of 1.16 in the June quarter compared to 1.08 in the March quarter.

Our revenue in the June by market was 44% automotive, 23% communications, 21% industrial, medical and military, 9% consumer memory, and 3% consumer analog.

Gross margin was 32.9% in the June quarter, which was just below our guidance range of 33% to 35%. This compares to 33.8% in the March quarter and 33.2% in the year ago quarter. Our June 2012 gross margin was just below our guidance range due to an inventory charge resulting from a customer order cancellation.

Operating expenses were $16.1 million the June quarter, below our guidance range of $16.5 million to $17.1 million. This compares to $15.9 million in the March quarter and $15.6 million in the year ago quarter, below our guidance range of $16.5 million to $17.1 million. This compares to $15.9 million in the March quarter and $15.6 million in the year ago quarter.

As we have previously stated, our product mass expense will fluctuate from quarter-to-quarter based on our product development schedules.

GAAP operating income in the June quarter was $5.2 million compared to $5.2 million in the March quarter and $7.5 million in the year ago quarter. Non-GAAP operating income in the June was $6.9 million compared to $6.9 million in the March quarter and $9.1 million in the year ago quarter.

Our non-GAAP figures exclude stock-based compensation and amortization of intangibles related to acquisitions. Interest and other income in the June quarter was a net other income of $400,000 compared to net other expense or $200,000 in the March quarter and net other income of $700,000 in the year ago quarter, which included $300,000 of equity income from an investment in Giantec.

In the June quarter we had GAAP income tax expense of $2.5 million, which represents an effective tax rate of 43.8%. This compares to GAAP income tax expense of $4.1 million with 28% in the March quarter and $90,000 in income tax expense in the same quarter last year.

The 43.8% tax rate in the June quarter reflects an adjustment to the estimated annual effective tax rate of 35% from the 30% we had estimated for the first two quarters of fiscal 2012. The increase in the expected rate is due to a larger portion of our income being generated in higher tax rate jurisdictions.

On a non-GAAP basis, which excludes the non-cash tax expense related to the utilization of previously recorded deferred tax assets, the company had $800,000 in income tax expense in the June quarter or an effective tax rate of 10%. In the March quarter the non-GAAP tax expense was $600,000 and in the year ago quarter, the non-GAAP tax expense was $200,000.

GAAP net income for the quarter was $3.1 million or $0.11 per diluted share. This compares to GAAP net income of $3.6 million or $0.12 per share in the March quarter and GAAP net income of $8.1 million or $0.28 per share in the year ago quarter.

Non-GAAP net income was $6.5 million or $0.22 per share compared to non-GAAP net income of $6.1 million or $0.21 per share in the March quarter and non-GAAP net income of $9.6 or $0.34 per share in the year ago quarter. Please refer to our press release and Form 8-K for a reconciliation of our GAAP and non-GAAP results.

On the balance sheet, we ended the quarter with $107.5 million in cash and short-term investments, an increase of $600,000 from March. We generated $2.6 million in cash flow from operations in the June quarter.

Inventory decreased $1.7 million from March. Inventory turns were 3.8 in the June quarter. As Scott mentioned, we have begun purchasing certain end-of-life inventory from one of our foundries. Related to these purchases, we made pre-payments for wafers in the June quarter which reduced our cash flow in the quarter by $5.4 million.

As a result of these continuing end-of-life purchases, we expect our inventory will increase in the September quarter in the range of $12 million to $15 million. We expect to sell this inventory over the next 18 months.

Accounts receivable increased sequentially by $2.9 million. Days still outstanding were 56 days in the June quarter compared to 54 days in March. In the last four quarters, we have generated an aggregate of more than $28 million in cash flow from operations.

At the end of June, we had $3.94 per share in cash and short-term investment. Our total book value per share increased 47% in the last 2 years from $6.28 in June 2010 to $9.24 at the end of June 2012.

Before I discuss our outlooks for the September quarter, I will provide some additional information on the terms and conditions related to our tender offer for Chingis.

We signed a share purchase agreement last week and a tender offering was initiated shortly thereafter. If all the shares are tendered, the aggregate purchase price would be $33 million. We expect that at the time of closing Chingis will have approximately $17 million in cash. Therefore, the net cash purchase price would be approximately $16 million.

Chingis shareholders representing 51% of shares agreed to tender their shares pursuant to the purchase agreement. However, at least 60% of the shares must be tendered for the offer to close. The offering period will last 50 days and as such, assuming all offering conditions are met, we expect the offering to close in mid-September.

While it is our intent to acquire all of the outstanding shares of Chingis, we expect that some shares will not be tendered and a minority interest will remain after the close. Excluding cash on their balance sheet, Chingis had approximately $5 million in net assets at the end of June. As such, we expect to record approximately $11 million in intangible assets and/or good will in the purchase price allocation.

Now let me turn to our guidance for the September quarter. As Scott mentioned, we have seen an overall strengthening of demand as evidenced by the improved book-to-bill ratio and healthy orders at the beginning of the September quarter even though we remain cautious about the continued weakness in the communications and consumer markets.

As such, we expect total revenue to range between $65 million and $71 million. This guidance reflects expectations of SRAM and DRAM revenue between $63 million and $68.5 million and analog revenue between $2 million and $2.5 million.

As a reminder, our guidance excludes any contributions from Chingis since the tender offering not expected to be completed until very late in the quarter.

Gross margin for the September quarter is expected to range between 33% and 34%. We expect DRAM and SRAM pricing to be flat to slightly down sequentially.

Operating expenses are expected to range between $17 million and $17.5 million, as we expect higher product mass expense. We also expect about $200,000 from interest and other income.

We expect our GAAP effective income tax rate will be approximately 35% including non-cash deferred tax expense from the utilization of deferred taxed assets. Excluding the non-cash deferred taxed assets our non-GAAP rate is expected to be 10%.

Taking these factors for the September quarter into account, the company expects GAAP net income to be between $0.10 and $0.16 per diluted share and non-GAAP net income to be between $0.19 and $0.25 per diluted shares.

Now back to Scott for final comments.

Scott Howarth

Thanks, John. Overall, I’m pleased with our progress during the quarter in which we achieved record automotive revenue and strong design-win momentum across our end markets while generating solid margins and cash flow.

We believe our success was a direct result of our high quality special memory focus, expanded product offerings and long-term customer support.

I’m also pleased with our planned acquisition of Chingis Technologies and the addition of NOR Flash to our specialty memory portfolio. With this acquisition, we’ll finally be able to support our customers repeated requests for flash products with long term support.

While we see some short term weakness in certain markets as a result of the on-going macro instability, we believe we are poised for our further revenue growth in future quarters. As the macro (inaudible) economy in our end markets improve, we believe our results will benefit from those added growth opportunities.

We remain focused on successfully executing on our objectives and believe we will continue to gain market share and build an even stronger business in the quarters and years to come.

We’ll take your questions now.

Question-and-Answer Session

Operator

(Operator instructions)

Our first question comes from Jeff Schreiner with Capstone Investments.

Jeffrey Schreiner – Capstone Investments

Yes. Good day gentlemen. Thank you for very much for taking my question.

Scott Howarth

Hi, Jeff.

Jeffrey Schreiner – Capstone Investments

John, to you maybe first. You covered maybe what impacted the sequential decline in gross margin in the June quarter but given the solid guidance you provided in the September quarter, why are you, kind of, pulling the gross margin in a little bit in terms of the range, given you will have that higher revenue base than what we saw in the June quarter.

John Cobb

So, we’re guiding up a little, 33% to 34%. That’s within the range of what we did in the previous two quarters before the June quarter. So if you look at the March quarter and the December. We do expect to move into that range. We are seeing some softness in the communications and consumers sector, but overall, the business is fairly consistent with what we’ve seen throughout the year.

As I mentioned in my comments, our margin was down in the June quarter only because of the charge that we had to take for the order cancellation.

Jeffrey Schreiner – Capstone Investments

Okay. And Scott, coming back to you, you referenced maybe that feature phones had been kind of a drag. We’ve known about that for a few quarters at Syan [sounds like] but there seems to be some chatter of a resurgent in feature phones. And, I was wondering if ISSI had been seeing this trend through Syan and how it may in fact impact the Syan opportunity over the next few quarters?

Scott Howarth

So, it would be interesting to hear who’s commenting in the surge of feature phones. Do you have any specifics on that?

Jeffrey Schreiner – Capstone Investments

I believe Syfer’s talked about an uptick. I’ve seen several articles talking about Asia and other emerging market geographies being people going back to the feature phone as it starts to incorporate touch and other functionality.

Scott Howarth

Okay. Those are trends certainly we have not seen with our China customers. The aspect of the feature phones, is what we’ve seen is the very low end continues to sell. And when I say low end, these are in China, phones that sell for under a 100 RMB. So they’re quite cheap and they won’t add a penny or two even to their bottom cost.

The mid-level feature phones in China in particular, have really been replaced by some of the bigger name smart phones. So basically, the brand feature phones or the higher end feature phone market has been replaced by the smart phones as China Telecom/China Mobile come out with similar to the U.S.

So Chinese citizens can now buy a phone at the same price that they used to pay for a, kind of, a mid-level higher level feature phone, which has really kind of eliminated that middle segment. That’s all the information that I’ve have to have and nobody has described that there’s a resurgent or a new level of feature phones coming back beyond those segments.

Where today, then the other aspect of the China market we’re seeing is the dominance now in the smarthphone market is really by the major players such as, Apple, Samsung. You’re even seeing ZTE, Nokia have really become the bigger players there.

Jeffrey Schreiner – Capstone Investments

Okay. Two more questions from me. I just was wondering if you could maybe quantify the opportunity you’ve now discussed for a quarter or two regarding the exit of Samsung and Hynix within SDRAM and DDR, and what could that mean for ISSI when they do in fact end-of-life those products?

Scott Howarth

Well, it’s a really good question. We don’t have any data to really pinpoint what we think they’re marketshare is. As we have reported before, we think the overall DDR market is about $700 million market.

The percentage they own, we just don’t have any specific details on. Looking at the market, it breaks down into some different pieces. There the SDRAM piece and there is also some of the DDR.

The segments they’ve been in have been more in the consumer electronics areas in very low pricing. So, even though they’re exiting, initially, we saw some designs that were quite challenging on prices for us to be able to achieve, and really not available to us.

What we have seen recently though, particularly in Japan and some of the automotive segments, is new design wins opening up where the prices are in the same range that we would have for automotive support that are looking like they’re very good opportunities to be able to start replacing Samsung and Hynix in those particular markets.

So that’s where we are starting to see a lot of positive opportunity there. Trying to size it at this point is very premature, it’s difficult for us to stay but we are definitely seeing a level of opportunity over this last quarter getting us into some designs that we had not been in in the past. We see quite a bit of potential there.

Jeffrey Schreiner – Capstone Investments

And my final question. I appreciate your time, gentlemen. What’s the current NOR Flash TAM? What end market’s this change is really going to help ISSI do better or incrementally add perhaps some content, and what percentage of that NOR Flash TAM can ISSI expect to participate within?

Scott Howarth

They’re success is predominantly serial NOR Flash. So, I’ll talk to that specific market. The TAM today, 2012 numbers that we’ve seen, is about $1.1billion to $1.2 billion growing to about $1.5 billion over the next 2 to 3 years. So, it is a growing market.

They’re customers are principally in hard disk drive and PC peripheral markets. So these are customers that we have had in the past, they’re presently not customers we’re shipping to but we see opportunity to keep growing there as Chingis invests in additional technology moving to lower geometry.

The additional markets that we see are available to us for Flash that is moving into the industrial and automotive markets. And we’ve already, since we’ve announced it, we’ve had a couple of our automotive customers request samples, even before we’ve closed the deal.

So we’ve had already interest in the devices. And it has been, as I mentioned in the script, a number of different automotive customers in the last year and-a-half keep requesting us to support NOR Flash products, and support for the long term.

We really see this as an opportunity where customers that are requesting it and now we are finally providing a good solution that will meet their needs.

Jeffrey Schreiner – Capstone Investments

Okay. Thank you very much, gentlemen.

Scott Howarth

Great, thanks, Jeff.

John Cobb

Thank you.

Operator

Our next question comes from Daniel Berenbaum with MKM Partners.

Daniel Berenbaum – MKM Partners

Hi guys, good afternoon, thanks for taking the question.

Scott Howarth

Hi, Dan.

Daniel Berenbaum – MKM Partners

Scott, on the revenue guidance, you guys are sort of guiding flat to up, which is generally better than other companies with your type of exposure. How much of that revenue guidance should I think of as being organic and how much should I think of either being from new products, like RLDRAM or from new opportunities like SRAM share gain? Is there a way you can help me think about that?

Scott Howarth

Well, the revenue that you’re seeing at this point, the growth, is really from past design wins. We’re not including anything from Chingis. Certainly, there is new product. I would say some of the newer products that we’ve introduced either in the last one to two years, are a lot of the DDR2 devices really helping drive our growth. As it’s allowed us to get into a lot more designs with our customers.

In terms of SRAM replacement of Samsung, little to none. These are design wins that we have been in in the past and we continue to support. We are now seeing share gain in many situations, as well as the revenue ramp in design wins we’ve gotten into in the past.

Daniel Berenbaum – MKM Partners

Okay. So basically, this is essentially all organic or stuff you’ve been working on. Basically, no RLDRAM and none of the Samsung replacement opportunity.

Scott Howarth

Correct. Exactly.

Daniel Berenbaum – MKM Partners

Okay. Okay. So then, all of that will still be incremental to whatever the core growth rate should be going into fiscal ’13. Is that correct?

Scott Howarth

Correct. We see that more as a ’13 growth opportunity. We mentioned we will start to see a little bit of revenue in RLDRAM too, in the September quarter. We’ll start seeing initial shipments there but it’ll be growing slowly and have a bigger impact in ’13.

Daniel Berenbaum – MKM Partners

So what kind of level should I think about it in September and then how should I think about that opportunity going into fiscal ’13?

Scott Howarth

September will be a few hundred thousand, so it’ll still be a fairly small number. I don’t have a number off the top of my head what we would expect in ’13 yet. We are still trying to get in good sizing from our customers on what they’re demands look like as well.

Daniel Berenbaum – MKM Partners

Okay, fair enough. Now, on Chingis, and I appreciate all the detail that you guys gave but it sounds to me like, even “X” cash, you’re still going to be paying about 8 times trailing earnings for that. Is that… am I doing my math right?

Scott Howarth

Yes. I think it’s a little bit less than 8 time depending on how you take the… The calculation’s what, 2., …

John Cobb

I would say it’s closer to 7 times.

Scott Howarth

Yes, about 7 times.

Daniel Berenbaum – MKM Partners

Okay, so 7 times trailing earnings which is actually a higher multiple than investors are willing to pay for ISSI stock right now. So, can you help me understand what your thought process was on the valuation of that asset? For a relatively small company, it seems to me like a little bit of a rich valuation.

John Cobb

I’ll make comments first. So, if you look at what we’re paying for the revenue, their revenue’s running about $40 million a year. So, on an after cash basis, we’re paying $16 million, so that’s a pretty good price. Their overall financial model is very similar to ours, the margin is around 30, low 30s, operating margin is in high single-digits.

The one place that they’re different is in their tax rate. So they have a higher tax rate than we do. So if you look at their pre-tax numbers, it’s very similar to ours. So obviously, as we combine the two companies, we’ll merge their business with our business and equalize the tax rate.

That’s really the main difference in the model between Chingis and ISSI.

Scott Howarth

The other thing that I would add to it also, Dan, is the strategic benefit we’re really getting out of this with the market opportunity. They have a good embedded business already. I think their revenues have been around $4 million to $5 million, with our foundry relationships I think we can grow that, believe that will have very good margin contribution going forward.

We see that, basically, the combination between our resources there, we think we can definitely start growing into new markets which will then increase the overall earnings potential even faster than they have been in the past.

We really see, kind of, the combination here an opportunity going forward to be quite beneficial. And as John mentioned, on a revenue basis, it’s actually a very, very good valuation overall.

Daniel Berenbaum – MKM Partners

Okay. And then, actually, John, that commentary leads to my next question which is, please remind us gain of how many off balance sheet deferred tax assets and NOLs you have. And if I recall correctly, in Q4 of last year you wrote a bunch of deferred tax assets back onto the balance sheet, would I expect something similar to happen in the current Q4?

John Cobb

I don’t know the exact number. You want the off balance sheet number, correct?

Daniel Berenbaum – MKM Partners

Right. (inaudible)

John Cobb

(inaudible) It’s in the . . .

Daniel Berenbaum – MKM Partners

That could potentially come back on to the balance sheet.

John Cobb

Right. The total amount is $25million to $30 million, however, some of that we’ll probably never recognize. So, just as we did last year, we will do an analysis of the deferred tax assets at the September quarter and we will make another adjustment. And it could be a debit or it could be a credit, we’ll have to go through the analysis and see what it would be. But I would expect that we’ll make some type of an adjustment.

Daniel Berenbaum – MKM Partners

Is there any reason to suspect that it would be a debit given your sustained profitability now?

John Cobb

Probably not, but when you're dealing with tax accounting it can be unpredictable. I would probably expect that it would be a credit, but we'll have to go through the analysis. We have to put together a forecast going out several years and so we'll have to go through that and discuss with it with our auditors and decide what makes sense. In general. I would expect a credit, but it's hard to predict.

Daniel Berenbaum - MKM Partners

Fair enough. Without getting into a further discussion of tax accounting, that's all for me. Thanks very much.

John Cobb

Thank you.

Scott Howarth

Thanks, Dan.

Operator

Our next question comes from Raji Gill with Needham & Company.

Rajvindra Gill - Needham & Company

Yeah. Thanks and congrats on good results. On the Chingis acquisition, how would you describe the competitive landscape. I know expansion is the predominate player in embedded NOR and there are kind of fewer players. That's a pretty fragmented market, but expansion probably has 40% share.

Can you talk a little bit about how you plan to compete against expansion of some of the other players that are kind of based in Taiwan, like Micronics or Winbond. Any details on that would be helpful.

Scott Howarth

Sure. You really listed the key players right now in the NOR Flash market. Expansion's leader, I think Micronics, too, Winbond's in there, then there might be a couple of other smaller players.

Chingis has actually has very good success being able to complete both performance, as well as cost. A very, very small design parts so they're able to really maintain product margin and continue to compete within the market segments that they're in.

So, we think we'll be able to continue that at the same time and we will start working to qualify various devices for automotive and industrial grade. Those are markets where we think we are already have a competitive advantage given the relationships we have with our customers and that will be a clear opportunity and growth target that we will be going after.

So the combination really of focusing on different markets, as well as continue to focus on just being good lost cost supplier we think we'll be quite competitive. And as I mentioned earlier, the positive thing is the Serial NOR Flash market is actually a growth market, as well. So we're seeing greater penetration of Flash into vehicles, industrial solutions, and even in a variety of different consumer electronics.

Rajvindra Gill - Needham & Company

Are you guys going to be focusing on kind of more of the mid- to high-end storage embedded NOR market like 256 megabytes and above or is this more lower end?

Scott Howarth

This is principally lower end. We will be working it to develop some higher density devices, as well as whether we look and evaluate our customer requirements, particularly automotive industrial, very user, very broad range of memories all the way up to 256 megabit.

Currently, a lot of the devices that Chingis is selling is anywhere 512k up to about 4 megabit, as well as some 8.

Rajvindra Gill - Needham & Company

And what market share did Chingis have and where are they based?

Scott Howarth

They're based in Taiwan, although they have offices here, actually very close to our office in San Jose. They have a number of engineers here. They have engineers in Korea and then Taiwan and even engineers in Shanghai. So they really fit geographically ideally with us.

Their share, I think, would be, especially for the hard disk drive market, is probably... we don't have exact numbers, but I would say somewhere in the probably 10% to 15% range.

Rajvindra Gill - Needham & Company

And the situation that’s going on with the com side, where are you seeing kind of the weakness? Is it more on the wireless infrastructure spending or is it more on enterprise spending on wire line, any clarity there, any particular customers, any particular regions?

Scott Howarth

Overall, it’s still generally weak. On the wire line, there we’re just not seeing any real pickup in business. We’re seeing some customers maybe a little stronger than others, but still nothing significant, no real growth.

On the wireless basis, we’re seeing weaknesses in different areas. The U.S. market, one of our largest customers recently told us U.S. market is showing pickup in base stations, whereas Europe right now is very weak overall, then kind of mixed bag when you look at some of the different Asian countries. India is still stopped as they’re going through a rebidding process after the corruption scandal they had about six months ago.

So, around the globe there are different pockets, but overall there still remains a fairly weak environment.

Rajvindra Gill - Needham & Company

Last question on end vertical, the automotive market, you’re seeing growth there. Maybe describe what’s happening in that market. I know that’s a secular trend that’s happening, but we’ve seen some softness coming from other semiconductor companies exposed to automotive. So, it’s been kind of mixed. Maybe describe what’s happening in that particular market.

Scott Howarth

Overall, I think vehicle growth remains steady for the year. I think U.S. is still heading to about 14 million cars per year. I think Asia is still heading kind of toward numbers consistent with the previous trends. So, really the vehicle sales are not dropping off. Instead, it’s the content per vehicle. When you look at memory and electronics, it continues to grow, and the features that are put into more and more cars.

So, in the past a lot of backup cameras, high definition audio or satellite radio, Wi-Fi, these kind of capabilities were targeting more to the high-end premium cars. You’re now seeing that trickling down into mid-range cars. Even some (inaudible) we see will start going down to even lower end cars. So, that’s created a great opportunity for growth for us in being able to support a lot of those applications.

The second thing is that has been benefiting us, is with the introduction of our DDR2 devices about a year and a half, two years ago. We’ve really been able to then hit these design winds now, and have really started to pick up a lot of share. That really helps right now, in terms of driving our overall revenue. Then, as I mentioned earlier, in Japan for example, where we’ve seen specifically Hynix getting out of some SDRAM and DDR1, that’s opened up opportunities for us to continue to gain share going forward.

Rajvindra Gill - Needham & Company

What makes you confident that you’re going to be able to get back to, on the analog side, the pre-levels, which were probably 4.5 million, 5 million a quarter? You’re doubling. What makes you confident that you can get to that level?

Scott Howarth

Well, the size of the markets are quite large and also growing. So, when you look at really where we play - audio amplifier, we think we have still some very, very competitive devices there, good performance, but lower wattage. Now, we’re developing higher wattage devices, which we’ll be targeting at the automotive market.

Then, on the LED side, we have very good drivers for both high brightness LED, some backlighting capability, and then also for our FX LED, which is more of a decorative type of lighting. We’ve seen design winds in those areas. What we have to keep working toward is getting much higher volume on some of those design winds.

So, we definitely are seeing a lot of interest, but the design winds we’re seeing are still in the smaller volume level. We think, as we start to gain a little momentum, those will start to grow for us.

Rajvindra Gill - Needham & Company

Great. Thank you.

Scott Howarth

Great, thank you, Raji.

Operator

(operator instructions) Our next question comes from Richard Shannon with Criag-Hallum.

Richard Shannon - Craig-Hallum Capital

Hey, guys. How are you doing?

Scott Howarth

Good, Richard. How are you?

John Cobb

Hi, Richard.

Richard Shannon - Craig-Hallum Capital

Hey, guys. Yeah. Doing well, thanks. I guess this first question is into your guidance for the September quarry here. I just wanted to understand the puts and takes by vertical markets and I guess maybe by product type as well, specifically how (inaudible) coms and the automotive segments you expect to move in September.

Scott Howarth

So, by segment, what overall we’re expecting is we’d start to see some growth in the industrial and com, but again, we’re fairly, I would say conservative when you look at the numbers, so anywhere from zero to some growth. I think that the area we feel the most confident will grow for us will be the continued automotive growth. Com, if it does start to pick up, then that would start to push our number toward the higher end of the range.

Industrial, we expect will be kind of, again, flattish, maybe small growth. But given a lot of the industrial forces coming out of Europe - and this is typically a weaker quarter for Europe - we’re not expecting a great deal there.

Richard Shannon - Craig-Hallum Capital

Okay. Fair enough. The other follow-up questions, I guess in your automotive markets, I think Raji asked a couple questions. I’m going to ask you a slightly different way here, but your year-in-year growth, you’re pretty strong. I think you mentioned 58% or so. How much of the growth that you’ve seen here in the past year to two is driven by units, unit growth versus ASP growth. I think you specifically referred to some success with your DDR2 products, which I think are higher density.

What does that mean for continued growth here in automotive? Could we still see strong ASP growth or could we see this flatten as it’s more of a unit growth story?

Scott Howarth

I would say it’s been principally a unit growth. When we look at the variety of designs we’re in, we still sell quite a bit of 16 megabit memory into different automotive manufacturers. It’s just a lot of the higher end solutions, where you’re seeing higher end cars now, where it’s getting into multiple radios in the vehicle, Wi-Fi, etc., they’re putting in high performance memory, which is as much as 1 gig, 2 gig, DDR2 today.

So, we think that trend will continue. The next piece we’ll see is the introduction of DDR3 into the vehicle as well, and we’re starting to see those design winds coming. We’ll continue to see this higher density memory continuing with new designs also. But at the same time, we’re still shipping surprisingly a lot of 16, 64 Meg into different automotive applications.

So, I see it really principally more of an overall unit growth that’s driving it. Then, obviously some of the units are at a little bit higher ASP, giving us a little bit of this. But I haven’t done the math to give you exact numbers of one versus the other.

Richard Shannon - Craig-Hallum Capital

Okay. Well, that’s fair enough. Just kind of on the side of the automotive space, Scott, you mentioned some Hynix end of life and some DRAM products at Japanese automotive customers. That’s usually a long qualification cycle. How fast can that actually lead to revenues?

Scott Howarth

Yes, you’re right. I think I’ve commented on this before. One of the automotive manufacturers in the past that we haven’t been able to get into is Toyota. Their qualification cycle through the electronics manufacturer is five years. But recently, we’ve been able to sample some parts and are working toward a design wind that will be inside Toyota.

So, the qualification at this point is being accelerated so that our customer has valid supply and capable supply by the end of the year when Hynix will stop shipping. When push comes to shove, customers need parts, they will accelerate qualification, and we expect we’ll start to see volume picking up by the end of this year when Hynix stops shipping.

Richard Shannon - Craig-Hallum Capital

Okay. Okay, great. Maybe two last questions for me. First of all, within your communications space, you talked about some continuing design wind success and activity with your QDR SRAM products. What’s the timeframe there, and can you elaborate to any kind of customer feedback or kind of customer breadth that you’re seeing with those products?

Scott Howarth

Sure. I won’t go into specific customers, but overall we’ve sampled to quite a few different customers. Many of them are fairly new to us, so they’re getting us into designs that we’ve never been before. Across the telecom space, we really have sampled really to all the major players at this point. It’s a matter of just now going through their qualification timeframe and we think again as Samsung stops shipping that we’ll see revenue growth starting toward the end of the year for those devices.

Richard Shannon - Craig-Hallum Capital

Okay.

Scott Howarth

For some, we’ve already started actually shipping some initial production volume.

Richard Shannon - Craig-Hallum Capital

Okay. When you say meaningful revenues, is that something that can get to $1 million per quarter kind of a level or higher by then?

Scott Howarth

Yes. We think it’ll be higher as we go into 2013.

Richard Shannon - Craig-Hallum Capital

Okay, perfect. My last question, on gross margins, you guys have had a pretty steady performance in that metric over the last several quarters. I know at one point the thought processes was to see gross margins get into the upper half of the 30’s here. I’m kind of wondering, what’s the medium term path to seeing gross margins that get above 35%? Is that still something we should look for and count on, and what’s the path to get there? What things have to happen to make that possible?

Scott Howarth

Good question. Our goal is to clearly try to grow our margins. I think in the short-term, we expect to see kind of this mid-30’s margin, probably the next one to two years. Our path to try to get there is certainly we’d like to see our analog revenue coming back, which had a higher margin. We still see some opportunities to grow that. As we get into some more and more higher density, we’re also looking to continue to cost down and move into lower cost solutions, which we think will benefit margins as well.

So, a combination between products, new technologies and expanding into different market segments, see what we're trying to do then to increase margins. The Flash business that we acquired we'd think, again, kind of hits the same margin profile, which is including some imbedded business for them, as well.

Richard Shannon - Craig-Hallum

Okay, guys, thanks for the thought here. I will jump in line.

Scott Howarth

Thanks, Richard.

Operator

We'll take our next question from Chris Sigala with B. Riley.

Chris Sigala - B. Riley & Company

Yeah, hi. Thanks for taking my question. Most of my questions have been asked, but just curious what the QUAD SRAM design activity that you're seeing, maybe you can help us understand or attribute any of that to whether it be GSI's legal battles or Samsung's exit. How much, maybe, of that activity you would attribute to those two phenomena?

Scott Howarth

It's really difficult to pinpoint one versus the other. So the process that our customers have gone through in several situations they just merely said, "Here's one competitor, here's the other competitor, here's the other competitor, show us parts that you have that are equivalent and where we would cross." And in mint situations they'll start sampling and then go through tests of our devices and qualification.

So, it was really impossible for us to tell which is the catalyst. What we've been doing with our customers is say, "Look, we're long-term support. We're stable. We don't have any encumbrances and we're able to support their requirements and we think with our overall strategy, our technology that we have in our position, that we will start gaining share."

Chris Sigala - B. Riley & Company

Okay. Great. John, so in September we're going to see OpEx up a little bit with the product mass (inaudible). I guess my question would be do you expect those costs to be contained within the quarter and then moving into December will move back more towards some of the historical OpEx trends that we're seeing.

John Cobb

The September quarter in terms of mass spending is above average. So if you take the September guidance that we gave, plus the three quarters that we've already completed and just take the average, that's our average rate. So, as I mentioned in the comments, we fluctuate because of the mass expense, some quarters will spend a $.5 million and other quarters over $2 million. So we aren't giving guidance into the December quarter, but I think it's safe to say that September is above average in terms of the ongoing spending.

Chris Sigala - B. Riley & Company

Okay. And then I think associated with that you said you're going to be taking on $10 million to $15 million in inventory. I just want to make sure I heard that correctly.

Scott Howarth

Yes, you heard that correctly.

Chris Sigala - B. Riley & Company

Okay. Thanks. And, then, finally, with the Chingis acquisition closing here, hopefully, in a few months, it looks like you'll still retain over $90 million is cash or so. So just curious, do you remain active on the M&A front and how do you look at some of the capital allocation strategies?

Scott Howarth

Strategy has really not changed, so we're doing everything we can to continue to secure capacity that we need. As I mentioned, we did see some tightness in foundry, as well as backend capacity. So, we may end up making additional investments there to be able to ensure we hit capacity we need. And, then, anything we need to grow our business. We mentioned we are buying a last-time buy of some wafers so that we can support our customers and transition to another foundry. That will cost us a little bit, as I mentioned, $10 million to $15 million.

And, then, we will continue to look at M&A opportunity, as I mentioned, the other one we'd still like to be able to find additional growth opportunities in the analog space, but with Chingis and closing that, we'll want to take some time, six months, potentially longer, so that we can make certain we can integrate (inaudible) and start getting that business headed in the right direction.

Chris Sigala - B. Riley & Company

Okay. Great. Thanks a lot, guys.

Scott Howarth

Great. Thanks, Chris.

Operator

Our next question comes from Jeff Schreiner Capstone Investments.

Jeff Schreiner - Capstone Investments

Hey, guys, just a couple of follow-ups. I wanted to follow up on the commentary about QUAD RAM as shipments and, you know, maybe the overall impact on other vendors. Would it seem likely, given your introduction of product and being able to already ship some volumes, and how do you know there's qualified that you will, in fact, quite possibly be displacing prior incumbents where you didn't necessarily have the product to serve those in the past. Is that how we're going to be looking at this?

Scott Howarth

Well, I think the first incumbent we'll be replacing will be Samsung. So that's a primary focus for customers today is they've got to get, you know, secure supply there. As an incumbent, and as I've said before, we've had a 36 and 72 meg QUAD solution that just weren't competitive in the past, so we did not gain much share.

So, as a new player then we have to prove ourselves and where customers will have half a dozen different designs, they'll qualify us for one and then make certain that our product works and test us and they'll probably do that for the first, anywhere from, 6 to 12 months. So that's going to slow down our ability to grab a lot of share, but we at least see the qualifications occurring and as that occurs and we start making progress with our customers, then we see opportunity to keep growing from there.

Jeff Schreiner - Capstone Investments

Okay. And, then, you see good kind of book-to bills in both the March quarter and what you've reported in June. Can you just help us understand, of the current backlog that you have, what percentage of that is likely to ship in September?

Scott Howarth

The current backlog. Do you know . . .

Jeff Schreiner - Capstone Investments

I assume you have some backlog given the book-to-bill ratios.

John Cobb

Yeah, about three-fourths of it. Obviously, the deeper we get into the quarter, the higher the percent that's for future quarters.

Jeff Schreiner - Capstone Investments

Yeah, you'll start working towards the December quarter at some point then. Right, John?

John Cobb

Right.

Jeff Schreiner - Capstone Investments

Okay. And final question from me. Sometimes I guess I sound like a broken record, but investors are (inaudible) at this point to pay even book value given the metrics you've given us today for ISSI's shares. Has management looked or revisited at the potential consideration of return of capital to investors in the form of either share buy-backs or dividends, as many growth-oriented tech companies have begun to gravitate towards?

Scott Howarth

Yeah. We constantly evaluate that and every quarter the board authorizes us to buy back shares and they set the price at which we would be buying. So that always is something that we've had on agenda for the past. As we're making this acquisition, we're having to buy some inventory. We'll have a board meeting soon and we'll discuss it again whether we think it makes sense to this environment or if the board wishes to wait a quarter or two. As long we continue to generate the cash that we will, then that is part of our overall cash strategy, as well.

Jeff Schreiner - Capstone Investments

Okay. Thank you, gentlemen, for your time.

Scott Howarth

Great. Thanks, Jeff.

Operator

Our next question comes from Daniel Berenbaum with MKM Partners.

Daniel Berenbaum – MKM Partners

Hi, guys. Just a follow-up. There's a lot of litigation going on in your space on some of your competitors. Can you just remind us where that stands and how that impacts you?

John Cobb

So, I think you're referring to the litigation between Cyprus and GSI?

Daniel Berenbaum – MKM Partners

Yes, exactly.

John Cobb

So, that is ongoing. As you know, there's ITT action that Cyprus brought against GSI. It was supposed to have a ruling this month, but it was announced, I think last week, that it was being delayed three months. So we won't get that ruling, I guess, until October. And, then, as a part of that, there's also just a lawsuit by Cyprus against GSI for patent infringement, which I haven't followed closely, but those things usually take a couple of years. Cyprus, I'm sorry, GSI has a counter suit against Cyprus for a trade infringement and that's progressing also in the courts.

As Scott mentioned, because of this litigation that's creating some opportunities with customers who are concerned, if GSI were to lose, then they would not be able to use the GSI product. So it's creating some opportunities for us and it's just an ongoing. We had thought we were going to have the ITT ruling this month, which would add some clarity, but, as I said, it appears that it's not going to happen until October now.

Daniel Berenbaum – MKM Partners

So, you're still viewing that more as an opportunity than a threat? There's no sort of collateral damage to you from that?

Scott Howarth

Correct.

John Cobb

Yeah.

Daniel Berenbaum – MKM Partners

Okay. Great. Thank you.

Scott Howarth

Thanks, Dan.

Operator

Our next question comes from Raji Gill [Author ID1: at Wed Jul 25 18:54:00 2012

]with Needham and Company[Author ID1: at Wed Jul 25 18:54:00 2012

].

Rajvindra Gill - Needham & Company

[Author ID1: at Wed Jul 25 18:54:00 2012

]

Yeah, any thoughts on the pending acquisition of Cyprus with [Ram Chun]. Any thoughts on non-volatile memory space?

Scott Howarth

It is a space that we continue to watch. We getting into some non-volatile with Flash, but we see that as a very nichey market and fairly limited in terms of it's overall opportunity. We've looked at F-RAM, (inaudible) even and continue to kind of watch some of the R-RAM requirements. They're all fairly high cost solutions. We don't see any yet that are mainstream. So, it's just a space that we haven't been as interested in pursuing yet. But it's space that we continue to watch to see if we have enough customer interest that might make it interesting to us.

Rajvindra Gill - Needham & Company

And the reason why I ask is that you've clearly decided to go after, expand into the embedded NOR market. So, therefore, expanding kind of your memory focus on that particular area. I'm just wondering what the though process was to go after embedded NOR versus the other memory areas? Was it a higher margin profile? Was it stable customer bases? The embedded NOR is not a huge growth market, but it is more stable, which has similar characteristics of the SRAM markets.

Scott Howarth

Correct. The embedded NOR market is quite a stable market and its essentially pure margin, which is one of the reasons we're interested in it. We think Chingis has good technology in the embedded space and a combination of fabless relationships that we have coupled with their technology, we think we can grow that. It's not going to be significant growth. Our goal would be to double it from here and continue to try to get some growth, but it is a slower growth market and something we see there's clearly opportunity for another player to continue to support that market.

Rajvindra Gill - Needham & Company

Wonderful. Thank you.

Scott Howarth

Great. Thank you.

Operator

It appears there are no further questions at this time. I'd like to turn the conference back to our speakers for any additional or closing remarks.

Scott Howarth

Thank you for participating in this call. Hope you all have a very good evening.

Operator

That concludes today's conference. Thank you for your participation.

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