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Spreadtrum Communications, Inc. (NASDAQ:SPRD)

Q2 2012 Earnings Call

August 9, 2012 9:00 p.m. EDT

Executives

Leo Li – Chairman and CEO

Shannon Gao – CFO

Analysts

Bill Lu – Morgan Stanley

Randy Abrams – Credit Suisse

Mike Walkley – Canaccord Genuity

Dan Heyler – Bank of America Merrill Lynch

Jay Srivatsa – Chardan Capital Markets

Jack Lu – RBS

Eric Chen – Daiwa Capital Markets

Andrew Lu – BarCap Research

Donald Lu – Goldman Sachs

Jessica Chang – Deutsche Bank

Hao Guo – CICC

Operator

Welcome to the Spreadtrum Communications second quarter 2012 results conference call. [Operator Instructions].

Joining the conference today are Dr. Leo Li, Chairman and CEO, and Ms. Shannon Gao, CFO.

Shortly before the start of this call, Spreadtrum issued a press release announcing its second quarter 2012 financial results which is also available along with the quarterly results presentation on the company's IR webpage at ir.spreadtrum.com. This call is also being broadcast live over the internet and will be available on the company's website.

Today's call will include forward-looking statements that include risks and uncertainties that could cause Spreadtrum's actual results to differ materially from management's current expectations. Such forward-looking statements include without limitation statements regarding revenue, cost, profit, competition, customers, products, technologies, partners, business models, M&A and market trends. Spreadtrum encourages you to review the Safe Harbor Statement contained in today's earnings release as well as the risk factors discussed in its Annual Report on Form 20-F filed on April 10, 2012, as well as other documents filed from time to time with the SEC. The company undertakes no obligation to review or update publicly any forward-looking statement to reflect future events or circumstances.

Today's call will include a discussion of certain non-GAAP financial measures. These non-GAAP financial measures should be considered in addition to and not as a substitute for or in isolation from GAAP measures. A reconciliation of the non-GAAP and GAAP reporting for the period discussed can be found in today's earnings release.

All numbers discussed today will be in US dollars unless otherwise noted.

I would now like to turn the call over to Dr. Leo Li. Please go ahead, sir.

Leo Li

Thank you. Welcome, everyone, and thank you for joining us today.

In the second quarter of 2012, we achieved revenue of $173.1 million, which is in line with the guidance we gave previously and 7.5% increase over the first quarter. I am very pleased to update you on the progress we have made with our smartphone products.

This quarter we achieved a strong volume ramp-up of our 1 Ghz TD-SCDMA Edge smartphone chipset, shipping more than 1 million units as expected. Customers such as Huawei, Lenovo, [Pryor], Hisense and others have completed China Mobile's certification test, launched low-cost smartphones based on our products. Many are targeting a new [ratio] price in the range of RMB500 to RMB700, which is making TD-SCDMA smartphone even more affordable and attractive for mass market consumers.

We are seeing very strong demand for our smartphone products and are raising our shipment focus. We now expect to ship more than 10 million smartphone chipsets in the third quarter alone. In the high end of TD-SCDMA market, we expanded our business with the first-tier OEMs, growing shipment of our best-in-class TD-SCDMA-based modems. In our customers, our customers use these modems in very high-end smartphone designs.

Our baseband and RF transceivers are shipping in flagship handsets, that is recently launched, including Samsung's Galaxy S3, HTC One XT and the other devices from first-tier China OEMs.

With the continuing growth in our smartphone chipsets and modem business, we have firmly established our leadership position in TD-SCDMA smartphone market. Our best-in-class modems are designed into top-of-line handsets and our smartphone chipsets are in neighboring 1 Ghz devices at a price of as we low as RMB500.

With this innovation at the low end, we're now seeing consumer preferences shifting rapidly from 3G feature phones to low-cost smartphones. As a result, in the short term of our strong growth in the smartphone segments will occur in tandem with lower shipments on TD feature phones. However, we expect that smartphone units, which carry higher margin and ASP, to continue to grow rapidly in the coming quarters and more than offset this near-term market transition.

Recently, China Mobile has taken steps to speed up TD-SCDMA handset sales in the second half of this year. At a recent conference, China Mobile discussed a plan or plans to increase their investment in TD-SCDMA. In addition, they also encouraged handset makers to sell their TD-SCDMA product through open market with China Mobile providing support with the quality monitoring.

With the China Mobile's handset replacement market now approaching 100 million units per year, this shift in distribution model will make the TD-SCDMA devices even more broadly available and help speed up the 3G adoption in China.

Now, turning briefly to our 2.5G business. Our 40nm baseband and the SC6530 have been well-received by the consumers, by the customers, and it's ramping up nicely. We are now continuing to increase our volumes, in particular in midrange of the market, and expect this trend to continue in the coming quarters. In the next few months we will be introducing our 2.5G products with integrated connectivity. We believe this shift delivers a superior performance and quality at a competitive price. This shift also will help address pricing pressure in the coming quarters.

I'd now like to turn the call to Shannon, our CFO, who will give you a more in-depth look of our financial results this quarter. Shannon?

Shannon Gao

Thank you, Leo.

Total revenue in the second quarter increased 7.5% sequentially and 8.1% year over year to $173.1 million, in line with our guidance.

Gross profit for the quarter was $64.2 million, up by $3 million sequentially and down by $3 million year over year. Gross margin was 37.1%, in line with guidance, and down from 38% in the previous quarter and 42% year over year. We believe that our gross margin has now stabilized with the increase in smartphone shipments.

Operating expenses were $40.8 million, up from $35.4 million in the previous quarter and $33.3 million year over year. The sequential increase in operating expenses was due to our continuing investment in research and development for dual-core and quad-core smartphone platforms, as well as WCDMA, LTE and [inaudible] products. In addition, this quarter we recorded a non-recurring cash bonus and share-based compensation on the achievement of a final WCDMA milestone related to the MobilePeak acquisition. This increase was partially offset by recognized government subsidies.

Operating income in the second quarter was $23.4 million, down 9.5% sequentially and 30.9% year over year. Non-GAAP operating income was $32.1 million, up 3.8% sequentially. Operating margin was 13.5%, down from 16.1% last quarter and 21.2% year over year, primarily due to a lower gross margin and the previously discussed increase in operating expenses. Non-GAAP operating margin was 18.5%, 0.7% lower than the previous quarter. GAAP net income in Q2 was $21 million compared to $24.3 million in the previous quarter and $32.5 million in Q2 2011.

Non-GAAP net income was $29.6 million, a sequential increase of 1.2%. Net income per basic and diluted ADS in the quarter were $0.45 and $0.41 respectively compared to a non-GAAP net income per basic and diluted ADS of $0.53 and $0.47 respectively in the first quarter. Non-GAAP net income per diluted ADS for the quarter was $0.58, an increase from $0.57 in the first quarter and a decrease from $0.65 in the second quarter 2011.

Turning to our balance sheet, as of June 30, 2012, we had $161.8 million in cash, cash equivalents and short-term deposits, which is a decrease of $71.3 million from March 31. In the second quarter we generated $16.8 million in the cash from operating activities. In addition to expenditures related to capital equipment, intangible assets, equity investments and our quarterly dividends, we repaid bank loan of approximately $60.9 million, that was still in second quarter.

Inventory, not including deferred costs, as of June 30, 2012 was $98.3 million, an increase from $62.9 million as of March 31, 2012. Inventory days decreased from 71 days in the first quarter to 67 days in Q2. We have increased our inventory to meet the demand for our new 40nm 2.5G feature phone and 1 Ghz smartphone product.

Deferred costs consist of products shipped to customers under our customer acceptance program which -- where the rights and obligations of ownerships have passed to the customers but revenue has not yet been recognized due to pending customer acceptance. We are pulling down the use of this program as of -- as high quality of our products over the last couple of years has helped firmly establish customer confidence. Deferred costs decreased from $55.8 million as of March 31, 2012 to $18.9 million as of June 30, 2012. We expect this balance to continue to decline through the rest of the year as we phase out the program.

In the second quarter, we continue to return capital to shareholders. We declared our fifth quarterly cash dividend and distributed $0.10 per ADS on July 25, 2012.

That completes our financial review. I will now hand the call back to Leo for his additional comments and outlook for the third quarter 2012.

Leo Li

Thank you, Shannon. I'd now like to provide our financial guidance of the third quarter 2012.

In Q3 we expect the revenue to be in the range of $178 million to $186 million, an increase of 2.8% to 7.5% over the second quarter, with a flat gross margin relative to Q2. Our guidance factors seasonal growth and the fast ramp-up of smartphone product shipment, somewhat tempered by the drop in 3G feature phone demand. In our 2.5G business, our growth outlook for Q3, which is a high shipment season, is partly constrained by a shortage of some [inaudible] components.

Looking ahead to the remainder of 2012, we have some exciting product introduction on that. We will be introducing our 1.2 Ghz single-core and dual-core smartphone platforms, our new WCDMA and connectivity products. These products will increase our total addressable market in China and overseas regions and position us for continuing business expansion in 2013.

I thank you for today. And now, Shannon and I will be happy to address any question you may have. Operator?

Question-and-Answer Session

Operator

[Operator Instructions].

Our first question comes from the line of Bill Lu with Morgan Stanley.

Bill Lu – Morgan Stanley

Yeah, hi. Good morning, Bill and Shannon. I just want to look at your guidance maybe a little bit more closely. You're guiding for 3Q growth that is a little bit below what your peers, meaning MediaTek and RDA, are guiding for, and yet you have this deferred line that I think skews things a little bit. If I try to back that out, and you did recognize $37 million in 2Q in deferred costs, it seems like, on a shipment basis, revenue growth is maybe closer to 25%, 30%. Is that the right way to think about it?

Leo Li

On the shipment base, we've -- we saw some increase in 2.5G and also, as I said in my opening statement, there were some component shortage kind of like constrained the increase of the total volume 2.5G. And there's a declining or reducing the demand for feature phones in China market, right? You know the smartphone ramped up pretty nicely. So given that, the combined so-called revenue growth is whatever reported.

Bill Lu – Morgan Stanley

Okay. Leo, what specifically was supply constraint for the 2G product?

Leo Li

Yeah, we -- our customers use two PAs, RFMD and [a multi]. These are two leading companies for PAs, right? I think starting the Q2 and then will go through entire Q3 and maybe cover parts of the -- I don’t know how [powerful] into Q4. There's a switch from our shortage. It's not the PA [inaudible] itself, it's a switch. It's mostly due to the east coast, there are some factory there, SOI, insulator, some kind of a switch, and that's causing problem.

And also in addition, there's a WiFi PA switch, or PA [inaudible] shortage because of the same factor or issue for Skyworks. So, for some of the WiFi customers too. So that's also causing some issues. So that is the one, yeah, main reason.

Bill Lu – Morgan Stanley

Great, thank you. And then my second question is for Shannon. The inventory levels are up 56% quarter on quarter. Can you just explain that?

Shannon Gao

Sure. Seasonality, we always have higher inventory level by end of Q2 because of the second half usually is a hot season for the year and we need to build up some inventory for the ramp-up, especially for the ramp-up of the smartphone in the second quarter and our new 2.5G 40nm feature phone ramp-up.

Bill Lu – Morgan Stanley

But that's quite a big a growth in your guidance, right?

Shannon Gao

Well, we did guide higher. As the volume will ramp up, but, however, the ASP will -- it's declining. That's why the dollar amount for the revenue doesn’t really show that much increase. But we do -- and another reason is we are doing, for 2.5G, it's a transition of the product from old 6610, 6620 to the new products, new 40nm products. So, during the transition period, inventory always higher too.

Bill Lu – Morgan Stanley

Got it. Thank you very much.

Shannon Gao

Thank you.

Operator

Our next question comes from the line of Randy Abrams with Credit Suisse.

Randy Abrams – Credit Suisse

Yes, hi. Good morning. I want to ask a couple of follow-ups on the outlook. I think you mentioned 10 million or more smartphones in third quarter. If you could talk now maybe about the mix between TD and EDGE within that, and if you look at continued momentum as you launch product, expectations for continued growth off of that level for fourth quarter and whether that could help you buck seasonality in fourth quarter?

Leo Li

In the smartphone, I think there's -- I don’t know exactly percentage, but definitely more than 50%, I'm definitely sure of that, will be the TD-SCDMA. In China domestic, we saw now that the TD-SCDMA smartphone is replacing both in the central procurement market and open market replacing so-called 2.5G smartphones. However, for overseas, obviously you know we don't have TD-SCDMA yet, right, so the overseas mostly for 2.5G or 2.75G type of smartphones. But again, I think it's the demand for smartphones in China is much, much stronger than in the so-called emerging markets. Emerging market there is a demand but not as strong as the China domestic. And yes, the TD-SCDMA position themselves -- smartphone position nicely against WCDMA and against the 2.75G products.

Randy Abrams – Credit Suisse

Okay. My second question is on your outlook for TD-SCDMA. I think, one, from just a market perspective, volume, maybe what you expect smartphone and feature phones, and how you expect your market share. And I think you did well on recent tenders, maybe how you expect your product positioning. [Marvel] has been talking about a new platform for early next year and with MediaTek and MStar, how you see your market churn positioning and then overall market.

Leo Li

I feel very confident that the TD overall volume for this year, I think what I said before in the last earnings call, is around 80 million to 90 million total units, both including the so-called central procurement, which you mentioned, and open market, which is the non-mentioned. I think the open market in particular next year, I can see a stronger and stronger demand for TD-SCDMA market in China.

So I certainly know for sure or I think next will be well above 100 million units for the total TD demand. So we at the moment, I think we're about more than 55% market share in TD-SCDMA business. We hope with the technology leadership and also with the business model and then the quality of the products and everything else, we hope that we'll maintain the leadership position in the future.

Operator

Our next question comes from the line of Mike Walkley with Canaccord Genuity.

Mike Walkley – Canaccord Genuity

Great, thank you. A question for Shannon, just the higher stock-based compensation this quarter with MobilePeak. How should we consider sequential growth in your operating expenses for the third quarter?

Shannon Gao

Okay. So this share-based compensation increase in the second quarter is actually a one-time charge and we will -- this is, like we stated, this is -- should be the final milestone that we will pay to the MobilePeak employees based on the acquisition agreement. We are not -- we won't have this kind of charge in the future quarters. However, we will continue to invest in the R&D, especially for the new product development, since we have so many new products, R&D going up, including the WCDMA, dual-core, quad-core smartphone, and connectivity chips. So we need to invest -- continue to invest. So the R&D expenses as a percentage of revenue will keep stable in the third quarter compared to the second quarter, both SG&A expense. So we expect the OpEx will be, as a percentage of revenue, will be stable in Q3.

Mike Walkley – Canaccord Genuity

Okay. So, stable as a percentage of revenue but with lower stock-based comp as it makes up that total?

Shannon Gao

That's right. Yes. Actually, most of the share-based compensation that we recognized this quarter was offset by the governments subsidies. And so next quarter, we will have less share-based compensation but, however, less government subsidy will be recognized. And the net amount will be flat.

Mike Walkley – Canaccord Genuity

Okay, thanks. One question for Leo. Leo, with the MobilePeak hitting the milestone, can you just update us on your WCDMA progress and how you see the competitive landscape as you're coming to market with that product later in the year?

Leo Li

Sure. Yeah, they're making nice progress there. I think it's mostly [inaudible] type of the milestones for their WCDMA. I think also combine the 40nm technology and some other 2.5G product rolls, EDGE, GPRS and GSM, I think we're making the progress for both modem and smartphone products towards the end of the year. So I think at this moment all the development are on track, so I'm pretty happy.

Operator

Our next question comes from the line of Dan Heyler with Bank of America Merrill Lynch.

Dan Heyler – Bank of America Merrill Lynch

Thanks for taking my question. Good morning, Leo and Shannon. I had a couple of quick ones. First, I wanted to ask Leo on the China Mobile comments that you had made. My understanding is that they're allocating right now somewhere in the range of RMB20 billion and that about 60% of that budget was already spent in the first half of the year. So where do you see those subsidies going for the second half? I think many of the subs at this point may not be willing to use TD unless they get these subsidies.

Leo Li

By the way, there's meeting going on and then they decided that the subsidies already been increased for second half of the year. The reason [they spend] so much subsidies the first half actually because of [selling] smartphones. Smartphone costs much more than the feature phones, right? And then for handset subsidies actually is much higher. However, also the -- it's been increased for the subsidies for second half of the year, that's one. Second, also for the low-end smartphone, in particular [My] platform, is helping China Mobile actually selling with the low subsidies and some [My] customers started very well without subsidies. And also in my opening remarks, there's open market now, actually it's very much encouraged by TD-SCDMA products, low-end smartphones, in particular actually 8810 1 Ghz type of platform of [My chips]. That is going very well, very attractive to the both procurement market and the open market.

Dan Heyler – Bank of America Merrill Lynch

Okay. So you think the subsidies are going to be up half on half for TD, is that what you mean?

Leo Li

Yeah. There'll be newly increased subsidies for China Mobile, yes.

Dan Heyler – Bank of America Merrill Lynch

Okay, great. And then on the -- in terms of your EDGE platform, could you give us a sense, where are you on Android? Are you still using on your smartphone, is it 2.3? And when would you move to 4.0 on that platform?

Leo Li

Yeah. Mostly [My] products are 2.3 at the moment. Actually for the -- for some of the emerging markets, sold, in particular in June, 2.2 as well, or in May, 2.2. And also I have one, at least one or two products passed the China Mobile's acceptance test of 4.0, Android 4.0. So we have 2.2, 2.3 and 4.0 all going out.

Dan Heyler – Bank of America Merrill Lynch

Okay. The 4.0 will be shipping in 3Q or 4Q?

Leo Li

This month.

Dan Heyler – Bank of America Merrill Lynch

Oh, you're shipping now, 2Q. Okay.

And then on, quick one on, for Shannon, on the deferred revenue side, it looks like there was about $37 million roughly of your revenue that was from the deferred. When you look at your third quarter guidance, what should we expect in terms of contribution from the deferred again? Because you mentioned that you want to bring that number down further. So, are you embedding deferred revenue in your guidance? And how much?

Shannon Gao

We, like we said last quarter, we don't have 100% control over this number. However, we, like we stated, we will [back] down the use of this deferred program. So definitely we will have some revenue contributed from the deferred revenue from last quarter. What we do is when each sales contract ends with a certain customer, we will renegotiate with the customer and try to take that away from the sales term. So we will definitely have something, but at this point in time I cannot really tell how much it is.

Dan Heyler – Bank of America Merrill Lynch

Okay. So the thing is you made your guidance maybe natural revenue was a little bit lower than you thought but you were able to make up for that with the deferred. And if everything goes according to plan for the third quarter, there could be upside I guess if you have both deferred and you meet your natural revenue growth, is that right?

Shannon Gao

Right.

Leo Li

No, let me add one more thing to so-called deferred, because this deferred in the past mostly happened in 2.5G in the emerging markets because of the quality concern over our products. Now I think after one or two years, we've proven to the market and the customers now that the quality of our products actually is very good, so that there is no need for so-called this deferred program or quality insurance program, right? So that, you know, the main reason for, yeah.

Dan Heyler – Bank of America Merrill Lynch

Okay, great. I guess, if I can squeeze in one more final quick one, otherwise I'll get back in line, but just on the PA shortages, I'm wondering, are you changing your platform away from RDA into other PA suppliers? Is that part of the reason for the shortages? And if that is the case, how long will it take to bring up the other PA suppliers?

Leo Li

Yeah. I think this is a decision made by customers, so they wanted to use the high quality and competitive good performance products, not mediocre ones. So they're the one making the choice, either RFMD or [a multi]. But this is very unexpected. Nobody knew that the IBM east coast factory could have this -- I don’t know what the exact problem. I didn't hear earthquake, so, something else going on. So that's causing the PA switch a very big shortage, so the cost issue.

So this is all the customer choice. They want to select quality products. And yeah. So the -- I think Q3, definitely the entire quarter will be impacted. I hope not going too deep in Q4. [inaudible] change the PCB design [inaudible] for other peers anyway.

Operator

Our next question comes from the line of Jay Srivatsa with Chardan Capital Markets.

Jay Srivatsa – Chardan Capital Markets

Thanks for taking my question. Leo, on the 2G side, despite ASP pressure, you appear to be growing your revenues. Give us a sense of what's going on there in terms of growth in emerging markets.

Leo Li

Yeah, the 2G, like I said [inaudible] and I think we have actually taken lead with market share expansion, however, tempered by some of the shortage issues. And in particular, people concerned, okay, in 2.5G domain, that business, is pricing pressures still as strong as before? And my answer to that question also is somewhat moderate or not as strong as Q1 or Q4 last year.

So we just introduced the 40nm 2.5G products to the market. There's echo. Oh my God.

Shannon Gao

Can you hear us?

Leo Li

There's something. Hello? I think there's something with the line. I can hear my own voice. I can't hear anybody on the line at this moment. Hello? Hello?

Operator

Our next question comes from the line of Jack Lu with RBS.

Jack Lu – RBS

Yeah, hi, Leo. One question for you. Can you talk about your 2012 smartphone full-year target? Because I think last call you mentioned a figure of 15 million to 20 million. Now, given that you are shipping more than 10 million alone in Q3, what's your thought on that number for this year?

Leo Li

This is a kind of -- yeah, we usually only predict for the next quarter, which I did, right, around more than 10 million unit smartphones. If you really put me in a corner, so if I have to say anything to that question, I would like to say at least 25 million units for the whole year. So, yeah, it's up number from 10 million to 15 million, what I said in early Q2.

Jack Lu – RBS

Okay. And what will be the expected mix within that 25 million between EDGE and --

Leo Li

That's a very good question. I think it's -- TD-SCDMA will be more than the 2.75G. Remember I said in China, China market, there is a demand actually for TD, not for the 2.75G.

Jack Lu – RBS

Okay. One last question if I may, can you talk about expectations for ASPs going to Q3 for both TD feature phones and smartphone products?

Leo Li

Yeah, feature phones, unfortunately the volume dropped sharply. I mean this is unexpected a little bit. The switching from feature phone to smartphone is so quick. It's quicker than most people expected. But as the pricing there stabilizes, the volume drops very sharply. And at this moment actually for the ASP for smartphones, it's there quite nicely. We -- actually it's not the pricing pressure issue, rather it's a whole [inaudible]. There's a huge demand there. It's just so strong that it really surprised many of us.

Jack Lu – RBS

Is the ASP [inaudible] issue that you just mentioned, is that just for TD or you're talking about EDGE smartphone as well?

Leo Li

I think even for EDGE smartphones, we haven't seen a very strong so-called pricing competition or price competition in that regard. So we're very busy to help customers to ship their products.

Jack Lu – RBS

One last question if I may, the CSR connectivity division just sold to Samsung, now, how would that impact your business going forward, your overall competitiveness?

Leo Li

I know the question. Yeah, the impact will be very minimum because the CSR Bluetooth is not -- no longer actually in the 2.5G market, even last year. So it has a very minimum impact.

As far as the WiFi's are concerned, there's many more WiFi vendors out there providing the solution for the smartphones. So that, yes, short answer is, yes, impact is very minimum.

Jack Lu – RBS

Okay. Thank you.

Operator

Our next question comes from the line of Jay Srivatsa with Chardan Capital Markets.

Jay Srivatsa – Chardan Capital Markets

Thanks for giving me another chance to ask a question. It looks like the previous question was not well-received by the operator.

Leo, in terms of gross margins, it looks like with 3G ramping up, is it fair to expect that your margins have bottomed out, or do you expect further price pressure in the 2G side to take it lower at some point?

Leo Li

I think that like I said in the opening statement, the pricing pressure for 2G is moderate. And then I just said ASP and margin for the smartphone is much nicer, right, and then the combined things that will help incoming quarters to further improve the gross profit margins. So I cannot say if this quarter is totally bottom or not, but I can say the -- with more and more smartphone shipments and with 40nm, the 2.5G products with the new products with the integrated connectivity and others, yeah, I'm confident that will be further improved gross margin in coming quarters.

Jay Srivatsa – Chardan Capital Markets

All right. In terms of the 3G market itself, how do you expect the order activity to come between the tender offers that are coming from China Mobile versus the open market, meaning, are you expecting more volume from the open market relative to the tender offer, and how do you expect that to play out as you look ahead to the rest of the year and also 2013?

Leo Li

This is a very good question. As we speak, I have customers shipping their smartphones to the open market already. So this is unheard of even last year. Last year, if you had asked me the same question, I'd say, hey, it's 100% controlled by the central procurement type of deal. Now actually, already third quarter, we started shipping. The reason for that is you got to be as attractive, high quality and low price type of smartphones. So I can even venture to predict that the second half of next year open market shipments will be higher volume than the central procurement.

Jay Srivatsa – Chardan Capital Markets

Thank you much.

Operator

Our next question comes from the line of Eric Chen with Daiwa.

Eric Chen – Daiwa Capital Markets

Hello? Hi, Leo, this is Eric. My first question, could you give us the idea, I mean in terms of your Q3 revenue guidance and on your assumption and how many revenue came from 2G and how many revenue came from smartphone? And also by the way, how about ASP in the 2G and in the 3G, roughly idea?

Leo Li

I think we're just ramping up for smartphones, right? And then like I mentioned, the 2.5 -- no, no -- the TD feature phones, the volume dropped fairly sharply. And so the contribution for the 3G, or the TD rather, actually percentage even lower, maybe 20% to 30% instead of 30% to 40% previous quarters. And I expected the ASP obviously for 3G smartphones much higher than the 2.5G, this is for sure. We, I guess, answer to this question, moving forward in the coming quarters, we're going to see improved ASP and gross profit margin with a better mix of the products. Remember, down the quarters, the volume of the smartphone units will be higher and higher.

Eric Chen – Daiwa Capital Markets

Okay. So, Leo, you talked about the 20% to 30% of the total revenue from TD for the Q3, and is that right?

Leo Li

Is it Q3 or Q2? Q2 [is average] numbers, so Q3 will be slightly higher.

Eric Chen – Daiwa Capital Markets

Okay. How about the ASP quarter on quarter in Q3? And for the --

Leo Li

-- do I give the very specific numbers of ASP? No. Yes, we don't give the numbers, yes.

Eric Chen – Daiwa Capital Markets

Okay. I saw your 2G ASP in second quarter down close to the 10% quarter on quarter, I'm just wondering [inaudible] for your Q3 as well for your 2G [inaudible] the ASP. So I would like to get the roughly idea in terms of ASP trend.

Leo Li

Okay. I think I answered the question or I stated in my opening statement that the ASP for 2.5G, our pricing pressure is moderate, so the decreasing out also not going to be as strong as Q1 or Q4 last year. So, somewhat moderate. I think the general trend, [unfortunate], for semiconductor business always downwards, right, the pricing pressure, not upwards. Yes. So that we may be some lower a little bit, but not to the extent what we saw in Q1 or Q4 last year.

Operator

Our next question comes from the line of Andrew Lu with BarCap Research.

Andrew Lu – BarCap Research

Thank you, Dr. Li and Shannon. A couple of questions I have here. First, regarding your TD business. You mentioned the smartphone in Q3 will be over 10 million. I think, is that -- can we say that over 80% will be TD?

Leo Li

No, mostly, like I said, someone else asked the same question, for the 10 million smartphone units, actually mostly are TD-SCDMA smartphones.

Andrew Lu – BarCap Research

So, is it over 80% portion will be TD, right? Will be TD smart, will be TD smart.

Leo Li

No, I didn't say 80%. You're the one who said 80%. But I'd say the majority, more than 50% are -- yeah.

Andrew Lu – BarCap Research

Okay. Thank you. But, it's the TD smartphones you have a high ASP and we have a strong growth in Q3, but combined with the TD feature phone, declined. Why do you still expect the Q3 revenue contribution from TD will be lower than the Q2? So which means the total revenue from feature phone, the decline will be larger than smartphone?

Leo Li

No, I did not say Q3's TD contribution will be lower than the Q2 contribution. I think maybe there's some -- I didn't say that. I think the contrary is true, that Q3 TD contribution will be higher than the contribution in Q2.

Andrew Lu – BarCap Research

Okay. So, TD contribution in Q3, the growth rate on the TD revenue including feature, including smart, in Q3, will be higher than your average guidance 3% to 7%, can we say that?

Leo Li

I think it's a little bit too specific. Shannon say that yes. If she thinks it's yes, it must be yes.

Andrew Lu – BarCap Research

Thank you. Earlier you also mentioned WCDMA smartphone solution will be introduced next year. Did you say Q1 next year?

Leo Li

Actually we will try to introduce production small customers first. You know that, right? With big customers, takes longer time. So, Q1, maybe it could be the right time, and then Q2, something, yes.

Operator

Our next question comes from the line of Donald Lu with Goldman Sachs.

Donald Lu – Goldman Sachs

Good morning. Leo, can you give us more color on how can China Mobile help the open market? By open market, I mean mobile probably is not going to subsidize, but can mobile help with distribution or marketing or anything like that?

Leo Li

Sure. Recently there are high-level executives went to Shenzhen, the headquarter [inaudible] right, several times. And then recent one is a very high level China executive went there, had meetings with -- we don't call them free market or [inaudible] anymore, we call them a small brand, right? And actually the meeting, the result is very encouraging, because down the road, you know that year over year subsidies will be reduced and reduced, not increased and increased. So the China Mobile very much encouraging the vendors and the makers of the handsets to engage with open market. Like I said, someone asked me the question, and then, some of my customers already shipping their products in open market without any subsidies. So this is encouraging.

But I think the reason it has been now, not only encouraged by China Mobile, also because the quality of the products and the price of the smartphones, more importantly, we are facing the major trend that the smartphone is replacing the features phones in big way, in such a big way in China that we very much encourage open market people to engage.

Donald Lu – Goldman Sachs

I mean, how -- I man, can China Mobile really help? Because China Mobile really is the biggest carrier in China, but can -- I mean, let's say, China Unicom and China Mobile all are encouraging open market. I mean --

Leo Li

Remember, China Mobile was not very encouraging, remember. I mean, like last year, it was totally you had to go through, any product go through the central procurement program, passing quality acceptance test and with the subsidies and this and that, and then whatever type of handset has been determined selected by China Mobile. And now actually I think with the leadership change and then with the new kind of a thinking, I think it's really helpful that China Mobile has this open market engagement. So they are encouraging this to -- okay. And also they say that TD-SCDMA over WCDMA, very much over 2.75G for that matter actually is making a lot of sense because, one, it's cheaper than WCDMA; two, you don’t need to pay the royalties to the WCDMA. I like that, obviously many folks, right? So they are cheaper price, high quality, and the networks are much improved, and the products much more varieties and more attractive, and the pricing obviously much more affordable.

Operator

Our next question comes from the line of Jessica Chang with Deutsche Bank.

Jessica Chang – Deutsche Bank

Hi, Leo, Shannon.

Leo Li

Go ahead.

Jessica Chang – Deutsche Bank

Yes. I have a few questions. First question, regarding your gross margin. Given you will have major [inaudible] changes in the third quarter [inaudible] such a robust increase in your smartphone shipments, but how come your gross margin guidance is only flat? And you mentioned you should improving for the second half. Is this guidance a little bit conservative or you feel in the near term there is still pressure across all the product, remains affecting your blended gross margin?

Leo Li

I think, remember, if I have as many TD feature phones as the last year, my guidance would have been actually more -- is a bit better. However, remember that there's a sharp drop of the feature phone or TD feature phone volume, which also carries a high ASP and margin as well. And yes, as you said, we have a nice ramp-up with smartphones, however, with very sharp decrease in TD feature phones.

And then as you know, the ASP for the 2.5G, we are also seeing the big transition, starting in old 2.5G, ramping up new 2.5G, and so on. So the margin also is not as nice as the ones for TD and one for smartphones. So with that mix, I think my prediction still fairly flat.

Jessica Chang – Deutsche Bank

But your smartphone, TD smartphone gross margin label?

Leo Li

Yes. I think I answered the question previous callers, we actually at this moment, not big pricing competition or pressure, rather we are very busy to, you know, help customer to design their products. Because this is relatively new to many of our China customers, because most of them actually are used to producing feature phones, right? Only the big companies are shipping the smartphones. Now, they are also in so-called transitioning period that -- where they have to change the design from feature phones to smartphones, adding the software development, Android-based, this type of a knowledge and this and that. So, yeah, there's a transitional period for them too.

Operator

Our next question comes from the line of Bill Lu with Morgan Stanley.

Bill Lu – Morgan Stanley

Yeah, hi. Just a couple of follow-ups. You're getting ready to introduce your combo chip, which I think you said before is a three-in-one, not a four-in-one combo. Now, in the past I've always heard that GPS is not that critical in China, but it seems like more recently people are telling me GPS is becoming more critical not because of navigation but because for using it for social networking, tagging and things like that. I'm wondering if you agree with that and do you think you need to offer a GPS solution? That's my first question.

Leo Li

Yeah. It's a good question. I think from what we saw, less than 20% of My customers for smartphones need GPS. So, less than -- even the number actually much less than that. So the majority is still three-in-one or call the WiFi, Bluetooth and [FM]. So, those are majority. We have a development for that, hopefully by the end of the year or in Q1 we will have so-called [inaudible] early next year.

But I think -- statement is true that the need is for social networking. However, still added cost and then still complexity of the system and this and that. So the overall, when you're talking about a low-end smartphone, in particular like under RMB1,000 or RMB700 for that matter, right, yeah, need is not quite there.

Bill Lu – Morgan Stanley

So there's no plans to either do a four-in-one combo or to integrate -- or to offer a discrete GPS chip?

Leo Li

Right. My approach actually to -- we have a plan, our new chips are dual-core and quad-core, to integrate the GPS function, at least the baseband part, into our baseband chips, yes.

Bill Lu – Morgan Stanley

I see. Okay, great.

Second question, Leo, you talked about smartphone ASP being pretty stable, which is obviously great to hear. As you get into the WCDMA smartphone market next year, can you talk a little bit about your strategy there and maybe what you think the pricing looks like? Because there's already a couple of pretty entrenched players there.

Leo Li

Right. I think the WCDMA, the total available market I think is pretty big in terms of regions and countries. And I do said that there are already quite a few players now there. However, for us, we developed the 21 HSPA+ type of modem and smartphones. Second, we're also utilizing our platform, the 8810 type of a -- very integrated, very pricing -- cost competitive type of a product to design, and combined with the so-called business model of ours, we are confident that we can compete in that area. So it's a net gain for me anyway, right, because now I'm total zero there, so whatever I come up with, still be very positive to me.

I don’t intend to [inaudible] there, but my intent is through the business model, so-called turnkey solutions, offer an ease-of-use type of a platform and very price competitive. On top of that, high performance. Let me emphasize high-performance type of products, not a mediocre one.

Operator

Our next question comes from the line of Hao Guo with CICC.

Hao Guo – CICC

Good morning, Shannon and Leo. My first question, can you state your TD portfolio in feature phone and smartphone, I mean in terms of revenue and volume part? So what's your constitution from the TD feature phone? Because you said [inaudible] TD feature phone volume drop forecasted.

Second one is, we're interested in this EDGE solution. I agree with you that TD is very important for China Mobile, but for the EDGE solution, I think it's -- if you think about EDGE going to -- maybe the smartphone going to replace the feature phone globally, so the EDGE solution may be kind of shipped internationally, and thinking about you have so many feature phones right now in your portfolio. Is it going to be replaced by EDGE smart on that [inaudible]? So what's your product milestone for the EDGE solution? It looks like MTK is doing very well in this part, so that's the plan on it? Thank you.

Leo Li

Well, to answer your first question first, we do not give very specific ratios or numbers for feature phones. However, I can say that, yeah, there's a sharp decline in numbers of TD feature phones. Yes, we are ramping up from smartphones. Specific numbers we don't give out.

The second question, yes, EDGE type of smartphone is important for emerging markets. What you said is true. However, for their shipments of other company, I think the majority unfortunately is still in China, not in emerging markets. For the emerging markets, take India and Africa for example, I think at this moment the huge majority is still the low-end feature phone, not even middle-end feature phones.

So that I agree with the statement that EDGE smartphones are very much needed for emerging market, and even Qualcomm come up with the so-called platform, that means the rest of the [inaudible]. However, the volume ramp-up may not be as high as people expected. Only in China that the smartphone demand is so strong. There are other countries, I'm talking about emerging countries, there's a demand but not as strong as this. Still majority -- even the economic situation in some of the emerging countries, they're actually deteriorating, it's not improving. In that regard, actually putting pressure to reduce the high-end handsets actually going towards the low end. And then the demand for smartphones is there but not as strong. And then I think it will be -- need maybe a couple of years to see the stronger demand, yeah.

Hao Guo – CICC

Okay, thank you. So if I may, follow up two questions. I heard from the industry that Qualcomm going to launch very low-end 3.5G solution in Q3, maybe Q4. Maybe it's targeting for MTK and for low-end competition. So do you heard about -- something about this? And can you comment on this?

And second one is, I think there's a lot of people talking about Spreadtrum cooperating with Taiwan handset maker on the 2.5G feature phone chipset supplier. So, maybe you can comment on this as well. Thank you.

Leo Li

The first one, I don’t comment on other people's the product introduction. But the thing is I heard a similar type of thing and that means this EDGE smartphone is kind of important. And then as I said, I think most of that type of things being shipped in China, not necessarily shipped in overseas markets. So I think -- but also I said in my opening statement and then in my Q&A that in China I think with the TD-SCDMA, to compete with the 2.5G, 2.75G type of smartphones, at least the TD-SCDMA offers some kind of [inaudible] still offer some kind of better connectivity than 2.75G, compared with WCDMA, yes, it's cheaper and without paying the royalty, right?

So I don’t quite follow the second question. Second question is working with a Taiwanese what?

Shannon Gao

Tier 1.

Leo Li

Tier 1. Oh, HTC. No, that's smartphones, right? 2.5G, I can't comment on that -- 2.5G in Taiwan nowadays, mostly in China.

Operator

At this time we have reached the allotted time for questions. I would now like to turn the call over to management for closing remarks.

Leo Li

Yeah, ladies and gentlemen, let me close by stating, we look forward to continued expansion in our business in smartphones, advanced communication standards and connectivity. Our Android smartphone products are going to ramp up very quickly and introduction of our dual-core platform and our WCDMA connectivity products later this year will position us for revenue growth in 2013. We thank you for your continuing interest and support.

Operator?

Operator

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

Leo Li

Thank you.

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