ATI Technologies, Inc. F2Q06 (Qtr Ending Feb 28, 2006) Earnings Conference Call Transcript (ATYT)

Mar.30.06 | About: ATI Technologies (ATYT)

ATI Technologies, Inc. (ATYT)

Q2 2006 Earnings Conference Call

March 30, 2006, 8:30 AM

Executives

Janet Craig, Director of Investor Relations

Dave Orton, President and Chief Financial Officer

Patrick Crowley, Senior Vice President, Finance and Chief Financial Officer

Analysts

Randy Abrams, Credit Suisse

Sean Webster, JP Morgan

Chris Casso, Friedman Billings Ramsey

Rick Schaefer, CIBC World Markets

Erna Chunda, Lehman Brothers

Paul Halbold, Deja Bank Securities

Andrew Lee, TD Newcrest

Ben Lynch, Deutsche Bank

Depak Chabra, National Bank Financial

Devon Moodley, Scotia Capital

David Woo, Global Crown Capital

Simona Jenkowsky, (company not mentioned)

David Hodson, Genuity Capital Markets

Brian Alger, Pacific Growth Equities

Dennis Thong, MGI Securities

Jason Qualm, Thomas Weisel Partners

Robert Dennison, UBS

Dale Hog, GMP Securities

Alex Ross, Morningstar

Duncan Stewart, Orion Securities

Patea Chilera, American Technology Research

Janet Craig, Director of Investor Relations

Thanks and good morning. Before I turn the call over to Dave and Patrick, let me remind you that the discussion to follow contains forward-looking statements about ATI’s objectives, strategies, and operating results. These forward-looking statements are based on current expectations entail various risks and uncertainties. Our actual results may materially differ from our expectations if known and unknown risks or uncertainties affect our business or if estimates or assumptions prove inaccurate; therefore, we cannot provide any assurance that forward-looking statements will materialize. Material assumptions that were applied in making these forward-looking statements and material factors that could cause our actual results to differ materially from these forward-looking statements are disclosed in today’s press release. Additional information concerning risks and uncertainties is contained in our filing with Canadian and US security regulatory authority. In particular, in the risk and uncertainties section of our annual information form and our annual MD&A we have seen no obligations, updates, or advising forward-looking statements whether other results of new information in future events or any other reason.

Also, let me remind you that we report in US dollars under Canadian GAAP. In order to ensure that everyone on the call that wishes to ask a question has the opportunity to do so, we are restricting the number of questions each caller may ask to one. At this time, I’ll turn the call over to Dave Orton.

Dave Orton, President and Chief Financial Officer

Good morning, and welcome to ATI’s Q2 and fiscal 2006 conference call. In fiscal Q2 ATI exceeded our revenue guidance, delivering $672 million in sales; a 14% gain quarter-over-quarter and 11% year-over-year. This is almost 10% higher than our previous record revenue. We saw growth in all four major product areas, GPU’s, chipsets, our digital TV business, and handsets. Our chipsets, handhelds, and DTV businesses have now delivered four consecutive quarters of growth. Our Desktop IGP business was up almost 10% sequentially. Our Mobility™ Radeon® GPU’s grew in its seasonally slow quarter. Chipsets are now about 25% of our total sales and Desktop IGP has sold greater than the 50% increase in quarter-over-quarter.

Overall demand for Imageon® media processors was quite strong with a record revenue quarter and shipping almost 25-million units during the Quarter. Our D-TV business set a new record in units and revenues, and we continue to capture numerous design wins in the I D-TV space for late 2006 and 2007. At the center of ATI’s growth and momentum is an unrelenting pursuit to innovate and our ability to drive these technology advances into a top to bottom product stock that delivers real customer value. Just look at the X1000 family to see where ATI is at our best. Innovative technologies like AVEDO and full featured high dynamic range and our ability to translate this innovation into a product that has an incredible customer demand. The X1900 has been a smash success with over 50,000 units shipped in just the first five-weeks and when matched with the new CrossFire™ chipsets the X1900 captures both a single and dual card performance trend.

On January 24, we launched the X1900 with the volume and the channel and many OEM’s like Ether, Alienware, Gateway, and Voodoo shipped immediately as did our add-in partners from Asus, Diamond Multimedia, and Sapphire. The response was and continues to be tremendous as demonstrated by the following quote: “There is little doubt that the X1900 is the most powerful graphics card available on the market today” and that was an (inaudible). The performance and technical superiority of the X1900 is so great that I honestly believe that it actually shocked our competition with both our performance and visual quality. At the heart of the X1900 is the most advanced shared model (inaudible) pixel processing in the industry. In addition, we have designed this product to support up the one gigahertz memories. This combination delivers the fastest GPU on the market and it has quite a bit of head room to spare. If you don’t believe me, just go out and ask the thousands of over clocker enthusiasts who are know clocking to the X1900 for the ultimate visual experience.

With both OEM and SI design winds for our top of the line X1900, we continue to paint the graphics world ruby red. Before I go into details on the rest of our product line, I want to turn it over to Patrick and give you the highlights from Q2.

Patrick Crowley, Senior Vice President, Finance and Chief Financial Officer

Thank you, Dave and good morning everyone. Our revenues that Dave mentioned for the 2nd Quarter of Fiscal 2006 were $672 million dollars. That represents a 14% sequential increase and a new company record in a seasonally down quarter for the industry. So, we are very pleased with top line performance. Revenue growth was driven by all product lines. In terms of revenue split, the PC segment represented $540 million dollars (or 80% of total revenue in the quarter that’s top discreet amounted to less than 40% of company revenues). Chipsets represented almost a quarter of company revenues, and notebook discreet a little less than 20% of company revenues.

Revenue in our Court Desktop Discreet Business grew 10% sequentially on strong ESP improvement despite lower seasonal volumes. Our chipset business on Intel and EMV platforms once again posted record sales, strong growth, and continued margin improvement. Sequential revenue growth was north of 35% for the combined desktop and notebook chipset business, and the desktop to notebook revenue mix was roughly 60/40. The consumer segment which included handheld D-TV NRE and royalty revenues accounted for $132 million dollars or 20% of company revenues in quarter 2. Consumer revenues were up by more than 5% sequentially again in what would normally be considered a seasonally down Quarter. Handheld accounted for more than 10% and D-TV about 5% of consolidated revenues. Royalties from our game consult business which includes royalties from both Microsoft and Nintendo totaled approximately $10 million dollars in the quarter and NRE was less than $10 million dollars in the quarter.

It was another record year for handheld where shipments totaling or approaching 25 million units and revenues up nearly 15% sequentially on continued penetration of the main stream feature phone market. D-TV revenue was up slightly despite seasonality. Moving on to the gross margins, gross margin percent each was 28.2% for the 2nd quarter as compared with 28.7% last quarter. Within the Discreet business we have essentially cleared out the written down legacy product but as a result the discreet margins continued to be impacted in the quarter. Chipset gross margins also continued to improve in the quarter, but as we indicated the growth and relative mix of chipsets contribute to the sequential margin decline. Consumer margins remain steady. Operating expenses at $139 million dollars came in well below guidance due to the timing of our (inaudible) programs as well as reduced advertising and marketing costs and professional fees. When we guided on op-ex last quarter, it looked as though some Q3 programs might be accelerated and possibly land late in Q2 we wanted to be conservative and build this into our guidance for Q2; however, as it turned out this was not the case and these expenses landed in Q3 as originally expected.

Net income for the quarter was $34.1 million dollars or $0.13 per share diluted, adjusted net income which excludes stock option expense, amortization of intangibles and other charges was $44.8 million dollars or $0.17 a share diluted.

Moving now to the balance sheet, we ended the quarter with inventory at $428 million or about 72-days based on Q2 sales. That’s higher than normal and there are essentially three reasons for that and they each represent about a third of the increase. The first is that during the quarter we instituted a change in our sub straight procurement model whereas our assembly and test partners used to purchase and carry sub straights in our behalf. During the quarter we moved to a consignment model which means we are purchasing sub straights directly carrying them in our inventory on our balance sheet and consigning this inventory to our partners. This has allowed us to bring on additional OSET partners quickly while minimizing the impact of supply shortages. We expect to stick with this new procurement model for at least the near term. The second reason for the higher inventory is due to the short term supply shortages of south bridges, which prevented us from shipping a number of completed chipsets prior to quarter-end.

Our north bridges and south bridges are manufactured at different fabs and the different capacities of these fabs can lead to supply imbalances. As a result, we held more north bridges at quarter-end than we would otherwise because we were short south bridges and could not ship as many completed chipsets. Our chipset business remains on a very strong growth track and we have already begun to work down this inventory and will continue to do so as south bridge capacity returns to normal. The third major factor contributing to the increase in inventory was the ramping of new products. We brought in wafers in the latter part of the quarter and simply weren’t able to get sufficient finished product out the door prior to quarter-end. So in summary, the increase in Dave’s sales of inventory is directly attributable to these high moving fresh parts. And I want to make it very clear that the quality of our inventory is very good and I expect demand to remain strong. We see absolutely no problem working through this inventory in the normal course and inventory will be lower at the end of the next quarter.

Our financial position remains strong with cash and investments at quarter-end at $607 million dollars. Last week we announced a renewal of our normal course issuer bid which expires on March, 2007. There were no share repurchases during the previous share buyback plan during Q2. In terms of guidance, we expect Q3 revenues to be between $640 and $680 million dollars, gross margins are expected to be about 30%, based on continued margin improvement in our core desktop business. Operating expenses, including stock option expense, amortization and other charges, but including the impact of foreign exchange are expected to increase between $155 and $160 million dollars. And just a reminder, we did mention at the beginning of this Fiscal Year that the average quarterly op-ex would be between $150 and $155 million per quarter throughout the year and our estimate has not changed and that was based on a $0.80 dollar. We expect foreign exchange to add about $3-4 million dollars to op-ex in each of the third and fourth quarters of this fiscal year relative to the first half and we have locked in the second half of the year at approximately $0.86 to guard against future strength in the Canadian dollar. So from a top line perspective, it was an excellent Quarter and we continue to make solid progress toward our financial and operating objectives of gross margin expansion, improved operational efficiency, and prudent expense management. And I’ll now turn the mic back to Dave.

Dave Orton

Thanks, Patrick. As we look into Q3, we are extremely excited about the performance and acceptance of the Imageon® product line and we expect to Q3 to even be stronger than Q2. In other words, we look into the summer Quarters and we continue to see a very strong demand for Imageon®. We are at the cusp of a major inflection point in the handheld market. This true conversion device enjoys the benefits of advanced 3-D gaming, digital television on the handset, and the realization that handheld products can now take on the roll of a multi-mega pixel camera with a flash. ATI’s products are considered within this industry as incredibly customer focused and the premier product line of choice. Our platform approach with a single software stack and product offer ends to meet the most basic to the most advanced phones is making us the media coke processor and IT partner of choice to cell phone manufacturers like Motorola, Ben Q, LG, HTC, and many others that boasts the 3-G and GSM phone markets.

Partnership is the key word here. In non-standardized environments, with long design cycles and rapidly changing technologies we are enabling our customers to stay ahead of the curve. We launched the Imageon® 2380 in Q2 which represents the first complete high fidelity audio and video solution. People are running games with advanced (inaudible) features like fog and shadows and it runs 30 frame-per-second video with the latest industry standard formats. The 2380 is already sampling of many customers and gives our handheld partners a chance to refresh their 2007 product lines to meet what many see as a year of mobile gaming which is already a $2 billion dollar industry.

Likewise, our launch of the single chip DVB-H compliant mobile TV receiver solution in February is hitting the market just as mobile TV is set to explode. Because our media processor is separate from the radio receiver, we are equally at home in 3-G or GSM handsets or any of the other emerging high bandwidth standards. And also look for coming announcements, which will reinforce our reputation as both the technology leader and partner of choice for cell phone (inaudible). Particularly look for things this quarter.

In our chipset business and the Radeon® Express lineup in particular, we have transitioned the business from shipping tens of thousands of units of desktop chipsets to nearly 10 million chipsets in just four quarters. And we have a broad based business with both AMD and Intel Systems in both the OEM and channel segments. And we have great visibility in the quarters to come with design (inaudible) on both the Intel and AMD platforms. They give us our horizon over the 12-months; we’ll see continued demand for the Radeon® Express and we see no slow down in sight. And Intel is also a direct customer with our own motherboard products.

The CrossFire™ Xpress 3200 chipset launched in early March, was met with rabid approval from the enthusiast community and just to give you a quote here’s one, “Radeon® Express 3200 chipset was everything I had hoped for” (inaudible). In the (inaudible) motherboard with the Express 3200 chipset provides the best dual by 16 and video performance that you can currently buy on the market. Launch day - at the launch day, Radeon® partners included A-bit, Asus, DFI, Sapphire, and PC Partner and system integrators quickly signed up and included Alienware, Voodoo, and Monarch. In the momentum in the chipset is the catalyst for revenue and margin growth in Q3, Q4 and beyond.

While the X1900 XTX is our flagship product and the market performance champion, we have the strongest GPU lineup top to bottom, thanks to the entire X1000 family. And also, the success of the X1000 family is the superior image quality. Not only satisfied with faster and faster frame rates as the only major performance, ATI took many of the digital television technologies and weaved these into the X1000 family. And this is brand new to (inaudible), the image enhancement built into every X1000 guarantees users unsuppressed image quality, great video playback, all the standards including the latest from H 264 high definition standards. Another quote from the industry, “Clearly ATI offers the best video support in their latest GPU cards, they dominate the HQV benchmark test and offer the lowest utilization per DVD playback and offers solutions for accelerated H 264 and Divex.” And today we are about 2X performance for even the HQV benchmark and we continue to push that benchmark because we believe that’s going to be a critical part of all graphics in the future.

In the performance segment, the X1800 is taking this crown and our 1600 has insatiable demand in the market and delivers incredible image quality, great game play and it’s at an affordable price and our 1300 continues to be a very strong product in the channel. And back to the 1600, notebook partners like Apple and (inaudible) and others continue to take this product into the market with great success. In closing, as we enter Fiscal 2006, we define five areas of focus. Number one with GPU leadership, ATI delivered top to bottom industry leadership in Q1 and Q2 and we continue to lead with the X1900 XTX. Number two was to drive revenue growth by capturing design and drive in market demand in the channel; and we’ve continued to do that in Q2 and as you understand in our guidance we continue to see momentum for our GPU’s as we enter Q3.

Creative platforms for sustained improvements in our gross margins, number four - operational excellence. In fiscal Q2 we shipped over 55 million units and we look to exceed this number in Q3. And, as the facts are concluded, focus expense management. Coming back to the margins though, ATI is aggressively taking measures and actions to improve gross margins; we made good progress in Q1 and Q2 but are not satisfied. Plus, we see a path to deliver margins in our target range in the coming quarters. And, if you back out our chipset business ATI’s gross margins would be in our margin model in Q3, but we are not satisfied there.

So, what’s on the horizon? Much the same as we brought in Q1 and Q2; more innovations and technology leadership across the entire product line. We’ll continue to enhance our top to bottom stats given our OEM’s are at (inaudible) partners and our customers (inaudible) even better one stop solutions. We are on the verge of a new era of visual computing as Vista, HD Digital Television, Mogul TV’s, and the next generation of game consoles comes to market. In all of these cases, ATI will be there with what our customers want: the ultimate in visual experience. So stay tuned. At this point I’d like to turn it over to some questions and again one question and then we’ll move on so we give a chance for everybody to ask questions today. Thanks.

Question-and-Answer Session

Operator

The first question is from Randy Abrams, Credit Suisse

Randy Abrams

I wanted to follow up on the question of gross margins, beyond the improvement in desktop that gets you back to 30% in May can you talk about the drivers of further margin leverage and how quickly you get back to the old 32-35% gross margin range.

Dave Orton

As we talked, the chipset business is now at 25% of our total business and it’s running in the high teens, mid-high teens. We seek continued progress in our cost of our chipset business, but as we talked about in the fall, they really will require a platform change to the RS 6X family to get the cross structures in line with where we need to price in the market, so progress will be made on the chipset business over the next couple of Quarters, but the big inflection point is around that next generation platform. Now on top of that, we continue to drive yield and cost improvements and our desktop our chipset, I’m sorry our handset and D-TV businesses and expect to see the overall business outside of chipset to continue to improve to the mid-high end of our range because today we are in the we would be in he 34-38 range excluding chipsets. So we expect that to continue to improve up market. On the other will be next, the more we can drive CrossFire™ into the market the more that will improve our chipset business and we continue to see a mix chip, more and more notebook OEM’s are selecting our chipset business as well so that will drive margins further north as well.

Randy Abrams

Ok and maybe a follow-up, I wanted to see if you could talk about the broader PC market selling the Intel (inaudible) that we had, are you seeing any signs of excess notebooks or chipset inventory and maybe talk about what trends you are seeing in the PC market.

Dave Orton

Great, ok and then we will move on, thanks Randy. Yes, there is clearly a dynamic in the channel today in Europe, in particular, that says that the channel/retail market has some excess notebooks. I was just in Europe as well and I think that it is fairly well understood. But it is also viewed to be short-lived. So there’s a still a fair amount of excitement for the overall market, no macro economic concerns for just some channel build up. The second is that most of the channel build up that I think people have talked about in terms of the integrated is in the channel. We are not seeing any of that. If you look at our business, over 90% of our chipset business is OEM based today, desktop and notebook and continues to be very high demand so I think there was some one or two OEM’s in particular that had excess channel inventory but we are not seeing it at all.

Operator

The following question is from Sean Webster, JP Morgan

Sean Webster

Yes, good morning. Could you please give some color on your revenue outlook by segment, what are some of the moving parts driving your range and what do you expect in terms of, I guess, sequential growth by segment?

Dave Orton

So, Patrick and I will team up on this one. So just at a high level, I think as we said the chipset business continues to be very strong and we expect growth there but we are somewhat capped by capacity. Patrick gave you a little bit of color on that we had a fab excursion in our Q2 that caused some shortage at the quarter-end and drove some of the inventory (inaudible). We’ll pull that completely on as we balance back out in Q3. So we expect chipsets to be stronger. The one area is seasonality in the desktop and so Q3 is historically particularly in the channel seasonally down and when you look at the overall macro markets verses calendar Q4, calendar Q2 can be from a seasonal standpoint 60%, 70% of calendar Q4. So, we’ve taken that into consideration but from a market penetration standpoint we still see growth in our desktop business as a percentage of market. And, then Patrick anything else on that.

Patrick Crowley

Yes, I think the other strong, we’re continuing to see growth on the handheld side as well. So I think all of those points are really driving the growth in revenue in this certain quarter.

Dave Orton

And on the chipset side, as we said OEM demand is quite high to the point where even if there’s a little bit of softness, much like the handsets… as Patrick described we’re very tight on .18. So in some ways we are buffered in that area in the sense if the market moves what it would allow us to do is deliver on more of the commitments as we are quite tight on the capacity side. So we feel fairly buffered in our .18 technologies in both handsets and chipsets and then the D-TV business has just been extremely robust in terms of its predictability and we expect to see another record quarter from our D-TV business as well.

Operator

The following question is from Chris Casso, Friedman Billings Ramsey

Chris Casso

Hi thanks, I wonder if you guys can talk a little bit with regard to your OEM penetration, I think with the latest of the product launches last year that’s an area you were under penetrated, if you could talk a little bit about the design cycle, how you guys are positioned now and how that can play out as the next couple of quarters come in.

Dave Orton

So, in particular, you are referring to the desktop design cycle because on the Nappa notebook we were quite strong in terms of the design winds. Our notebook business continues to be, we expect it to be 2/3 above the total market Notebook Discreet. So, the real cycle was the OEM desktop cycle in the fall, and most of that was around the consumer cycle; that tends to be a false spring selection process at least two cycles if not three. So we’ve been lined up very well with the OEM’s for the spring cycle. I think the best is to say stay tuned as the OEM’s announce their products for the spring, there will be some announcements we would expect. The product line is stacked up very well both from a cost structure standpoint and performance standpoint to look at the 1300s and 1600s; and of course the 1900s is extremely well received in the market. But, we did miss the fall cycles for the desktop consumer segment for most of those, although we did announce we just (inaudible) in others for the fall cycle as well.

Operator

The following question is from Rick Schaefer, CIBC World Markets

Rick Schaefer

Good morning, this is actually Dan Morris calling in for Rick, thanks for taking my question. I just wanted to ask you, it sounds like handsets are tracking pretty well I just wanted to find out if there any new design winds that you could talk about and when also (inaudible) Qualcom begins to (inaudible).

Dave Orton

I’ll work backwards. With Qualcom I think as people are starting to see that the 7000 series is sampling in the market and we expect to have customer ramps on the 7000 series in the late summer to fall. So we are quite encouraged with the success that Qualcom has seen in that family of products. We did announce additional design winds with LG. So part of what I’d say is stay tuned we’ve got some exciting platform announcements coming, the cycles for many of them will be in the spring, early summer as they line up for the fall cycle. Many of those will be going with new products that we’ve announced as well; the 2380s are a good example of that…our DVB-H technologies as well as the broad line of 2X 5X series that we have in the market today. So I would say stay tuned to that as well.

Operator

The following question is from Erna Chunda, Lehman Brothers

Erna Chunda

Thank you, quickly could you talk a little bit about your share situation in desktop and mobile, I would have thought that with the new product the desktop could actually even grow verses seasonality as you did this Quarter, could you talk a little bit about those situations, thank you.

Dave Orton

Sure, in terms of market share, we are always a little cautious in the sense that we like to let Mercury come out with their numbers. But you are right - we believe that in calendar Q1 we gained shares. We actually expect to continue to do that in calendar Q2. The channel reception for the 1300 and 1600 products and 1900 are quite high. In high-end of the market, we believe we are the only performance high-end product shipping today in volume in the market. The 1600 and 1300 have very good volumes going into the channel and sell-through looks quite encouraging in what is typically a seasonally down quarter. So you are right it is just a seasonality question.

And, the notebook share…again Mercury had us at 76, 78%. We think that is a little bit just dynamics of kind of pre-build/post-build of Nappa, so we expect to stay in the 65-75% range of notebooks. We continue to expect to be there. Overall, and I am going to cautious, is that integrated is really coming to fruition in a notebook market. We saw that in calendar Q4 and we continue to have a very high penetration on notebook chipsets. So when we start to think about notebook penetration we want to really consider and look at both segments not just the discreet, but also the integrated segment. We’re quite excited about that on both the Intel and AMD platforms.

Operator

The following question is from Paul Halbold, Deja Bank Securities

Paul Halbold

Hi, just wondering about the royalty and NRE business in think you had said about $10 million roughly for each any thoughts as to how that’s going to progress in the 3rd Quarter, would it be up and how do you sort of see that going through the rest of the year. Thanks.

Patrick Crowley

Well if you look at what happens on the royalty side, consoled market tends to be somewhat seasonal. So you know this is a difficult one to predict because we are reliant on the shipments by our partners. But I would expect for Q3 that that should be flat with Q2.

Operator

The following question is from Andrew Lee, TD Newcrest

Andrew Lee

Dave, could you talk to the pricing environment for the desktop Discreet market and address whether your (inaudible) leaves you less flexibility verses your competitor please. Thanks.

Dave Orton

Sure. First I want to address the second part of your question. It’s quite interesting as you look competitively are the market the focus on (inaudible). I think if I remember correctly, and you can go back to your notes, in the fall of 2002 I think the same dynamic happened when we came out with our 9700 product line and the market decided to focus on (inaudible). We said – look, (inaudible) isn’t as important at the high-end of the market as performance leadership; and then underneath that (inaudible) is also much more relevant than (inaudible) and product cross structures. But ultimately, it’s value. What’s customer value at the high-end? And we believe that’s really what’s driving the acceptance of the 1900 XTX is our performance leadership and the value that we are providing in a total solution.

Now as you move down into the mainstream, the value mainstream of the product line, I think you’ll find (inaudible) there are fairly similar in cost structures. The advantage we have is time to market. We came to market first with our 9-mm parts; the yields are phenomenal and the cost structure is in the mid stage of production and is much better than early stage ramps of cost. And then you get into the customer acceptance on the 1300 and 1600 market acceptance, because ultimately that’s what matters. So I think from that point the 1300 and 1600 have the advantages of time to market and yields. So we are quite confident in the cost structure of our parts competitively.

And then it comes down to, as you said, overall pricing structure in the market; and we think in general it’s pretty stable. The new products, the 9-mm products in the industry yield quite well, I think the market is looking for particularly as you go back to school it tends to be more of a low-end market, but the spring in retail tend to be quite strong in our Q2 and the enthusiast segment is very strong for us right now with the 1900 XTX.

Operator

The following question is from Ben Lynch, Deutsche Bank

Ben Lynch

Hi this is Penny Lahia for Ben Lynch. Wondering how the availability of the ULI south bridges have been in the market and if you think it is affecting CrossFire™ option and if yes, what can you do about it?

Dave Orton

First, ULI south bridge was primarily a channel product, actually 100% a channel product for us. And as I mentioned earlier, our chipset business is probably less than 10% channel based; the rest is OEM. Now, specifically the CrossFire™ 3200, we have customers that are using our south bridge or the ULI south bridge. There is one large customer, Asus, that uses the ULI south bridge and their supply. My understanding is that it is quite acceptable. And then we have other customers either on the south bridge 450 or actually some ramping today with south bridge 600 as well and CrossFire™ 3200 so we don’t see that as an issue at all.

Operator

The following question is from Depak Chabra, National Bank Financial

Depak Chabra

Good morning, I was wondering if you could talk about how the move to 80 nanometers in the coming Quarters will impact the (inaudible) Discreet margin and as well are we completely done the zero margin products from the write-down last summer.

Patrick Crowley

Yes, I’ll talk the latter part, I think, Depak, when you look at the, we were running through and clearing out some inventory that we have written-down to net realizable value and that’s pretty well done, I don’t think you’ll see a lot of that in the 3rd Quarter.

Dave Orton

And then with regard to the 80 nanometer, we are actually beginning to roll out production of 80 nanometer today in the low-end of our line there was a press release out on that as well from one of our fab partners I saw and it’s going quite well and I think as many I’ve seen the 1980s in general have very good deals and 80 is a half note step so it’s not really quite the same as the full note it’s a little easier transition so that’s going well for us.

Operator

The following question is from Devon Moodley, Scotia Capital

Devon Moodley

Hi Dave, I was just wondering if you can comment on what your expectations were with respect to the Vista’s impact on the PC market; what you thought about that delay announcement. Does that change your view on sort of your expectations for the PC consumer split for the company going forward?

Dave Orton

It’s a good question, and I think everyone is scratching their head a little bit on what’s going to happen; primarily in calendar Q4 with the holiday season. Now, Vista is primarily an OEM play out of the shoot. The channel does not adopt the new (inaudible) nearly as quickly as the OEM’s do. They’ll build it right out of the shoot and I think in the past when we were doing August, September launch, October systems would go out with the new operating system we saw that with XP. So with the January push out, again at the corporate level I don’t think you’ll see any impact at all. On the consumer level it’s really hard to say at this point. I’ll be curious as to whether or not he OEM’s look to do some sort of upgrade opportunities or something there so…it’s really for certain segments. The enthusiast segment, I don’t think they are going to care. They are going to take whatever is the fastest and they are going to go out and now upgrade at some point. So it’s really what I call the mid-range to low-end and that is just from our stand point. You know it is outside of the fiscal year and I think that as our new products come out that will help drive the fall quarter.

I think the other thing in general is as Vista comes out from a gaming stand point; there aren’t really games out there that won’t be for this fall that are (inaudible) based. So we would see minimal impact I think from a general graphics stand point.

Operator

The following question is from David Woo, Global Crown Capital

David Woo

Yes, can you comment a little bit about since you are going to 80 nanometers when does it affect your roll out of the R600 series and with those be on 80 or would they go directly to 65?

Dave Orton

Yes, so 80 for us is more of a cost reduction plan in the current X1000 family; you know it as the R5 series. So 80 provides more of a dyeshrink than it does a performance boost. There is a technology out there called ADHS. And so I think what you’ll find from ATI …we’ll do a combination of some 80, some 65 as we transition through the fall and winter on the R6 family. We won’t be, I wouldn’t look for us to be in 90 in that product, so it’ll be the future process technology notes.

Operator

The following question is from Simona Jenkowsky, (company not mentioned)

Simona Jenkowsky

Hi Dave, thanks for taking my call. I just wanted to follow-up on the road map for reducing the costs in the high-end of your best GPU, recognizing that that is not necessarily the primary factor there but in addition to the cost down shrink to 80 nanometers there’s been some commentary out there that you know you have a whole lot of very cool features in there but maybe they are a bit ahead of the market adoption and maybe you have a bit of a dye size penalty so I guess the questions is do you have any plans kinds of in the near term here in the next two or three Quarters for a more efficient or lean architecture?

Dave Orton

We definitely have plans to come out with new products between now and the end of the calendar year, both in the 5 series and the 6 series. I think again, there what I’d be cautious about is just pure dye size. You have to look at redundancy and repair ability in there as well. And you know, our X1900 XTX is an example as 48 shaders. So we have a lot of effective redundancy in that part. And then the second is, as you mentioned, we do have a clear feature performance advantage in the market; high dynamic range with full (inaudible) is an example of a critical feature, the ability to support 1 gigahertz memories is a critical feature we think looking forward.

So we actually think that the demand for those features is building so we think today we say is probably a mistake to pull those out and instead focus on continuing to bring new features to the market and drive overall demand for the GPU’s than, particularly in the high-end than costing us down and when you look at the cost structures of our mid-range and low-end parts they are very competitive.

Operator

The following question is from David Hodson, Genuity Capital Markets

David Hodson

Thank you very much, thanks for taking my question. My question is on the chipset business and the pace of improvement with the new family that will be coming out mid-year and I’m wondering whether before the end of this calendar year, I guess by your Fiscal Q1 of 2007 if you could reach 25% goal in gross margins for chipsets? Thank you.

Dave Orton

Yes, I think David that’s pretty much outside of where we want to guide today. So we can’t give you more color on that. We do see continued progress in our chipset business. The second is we continue to see improvements in mix to notebook over desktop. So if that shift continues in the direction, I think you would see a possibility for us to approach that number. I don’t think we would actually claim victory until we can get above that number on a consistent basis. And that’s probably I think the best we can give today. Is that fair Patrick?

Patrick Crowley

Yes, I think so, the product will be available as Dave mentioned by late summer and we’ll see how we how it performs in terms of ramping and yields and I think at this point in time we would be speculating you know we have high hopes for it but we’ll wait and see.

Operator

The following question is from Brian Alger, Pacific Growth Equities

Brian Alger

Good morning guys, nice job. Quick question with regard to visibility, clearly it seems as though your chipset business and D-TV and even handsets are giving you guys a fair amount of insight as to what’s coming around the corner, not just next quarter but even further out. As you look into the second half of this calendar year, how much visibility do you have and how much confidence does that lend you in preparing the overall business going into the tail end of this year despite translations due to things like this and maybe consumer demand.

Dave Orton

It’s a good question on the visibility because at one level the macro field is very positive right now on the back half of the year. You feel it at the OEM’s and the channel; you see it in the retailers. I think there is a lot of excitement around back to school. Many of the OEM’s right now are focused much more on the back to school, the July, August, September build than even the holiday build at this point. So the horizon outside of that I think is always hard. I mean the PC industry is just hard to get a long term view of at a macro level because we’ve seen shifts both up and down in the past. But the near mid-term…I’m going to say through this September time frame there’s a lot of bullishness in the market. Yet, there was some build up at the end of the calendar year and yes, that slowed a little bit in Q1; slowed the Q1 business down. But I think the people are starting to move beyond that. Now in terms of visibility to calendar Q4 and then 2007 that’s just hard; I think we start to then turn toward IDC and other market views of what’s going on out there. And then the other is just the trends. The trends of what’s going on in ISP and then a new technology is shown, Intel is coming out with Conroe. Conroe is going to bring a lot of performance to the market at the high-end and mainstream and we believe that can help fuel the market as well.

Operator

The following question is from Dennis Thong, MGI Securities

Dennis Thong

Hi, thanks for taking my question. Just wondering what you are seeing with the notebook OEM’s in terms of designing I guess for the fall and for Vista, do you see a change in terms of the Discreet verses integrated ground (inaudible)?

Dave Orton

Yes, it’s a good question I think one of the things we all see is with Vista is that there’s going to be a much higher demand on the system for visual capabilities. Vista is going to bring to the market the new DX10 but also the minimum threshold in there around Direct X 9 capabilities. And we talk about Vista readiness, Vista capabilities, the premium logo and the basic logo; I do think that the user experience is going to demand a higher level graphics than we had over the last several years under XP. The notebook itself is a little tricky only in the sense that you are dealing with space and power as well. One of the things that we are very focused on is bringing a low power, low cost discreet solution to the notebook market with Vista and that’s a critical component of our strategy there. So we do believe we could see some shift but ultimately the market will and how they price in position will drive I think the end market mix of discreet and integrated. But as I said before, our integrated products are Vista ready and we’ve got a large number of integrated design winds lined up for that transition as well.

Operator

The following question is from Jason Qualm, Thomas Weisel Partners

Jason Qualm

Yes, good morning. Maybe you could just shed a little more light on some of the things that are going on with the sub straights today did it gate some of your upside this Quarter and then maybe looking forward do you expect the sub straight situation to normalize in the current Quarter with your new sourcing arrangements?

Dave Orton

In terms of Q2, the one area Patrick described was the process excursion on the south bridge that created some bloat in inventory at the end of Q2 and the ability to not get all of that out the door. As Patrick said, that will move through in Q3. At a substrate level, the big transition over the last 6-months has been to let it free mix, and the market has clearly gone too hard to let free. I don’t see it the substrate other than one or two product lines per say; it wasn’t a broad based shortage in Q2. So we cannot sit here and say that that had a big impact. The low-end of the market and our desktop channel business clearly the substrates had some impact there and we’re recovered now as we move into Q3 on that.

Across our product lines we see a couple of things happening, first more capacity is coming online; the second is we’re hitting the slower part of the season so it’s freeing up some flexibility in substrates. The third is, as Patrick described, we brought on some inventory to protect key customers. As they shipped, we bring on additional OSET partners to main continuity and supply. So I think from that standpoint we see Q3 being one of our cleaner sailing quarters operationally from a standpoint of changes whether it’s technology, product, or process changes so quite encouraged by that.

Operator

The following question is from Robert Dennison, UBS

Robert Dennison

Thanks for taking my call, just quickly on the south bridge shortage, I know you guys have spend some time on this, that was purely on the supply side you guys weren’t caught maybe a little wrong footed with more demand for south bridge than you had originally expected?

David Orton

No, I mean the south bridge is not independent of the north bridge and so it’s a chipset sale. So we order both simultaneously. The issue was about a week and a half of supply got lost in the excursion. So they go one-in-one. Clearly in the channel we do have some partners going with (inaudible) if anything that would just drive a few more north bridges. So I lost the other part of that sorry. Sorry, just an additional note there. So I think from that stand point no, there isn’t a demand for south bridges alone, they always go in pairs with north bridges, bottom line.

Patrick Crowley

In fact most customers would not except a north bridge by itself they want to see the set.

Operator

The following question is from Dale Hog, GMP Securities

Dale Hog

Thanks for taking my question. Can you just talk about the transition to the DX10 parts in later in the year, is there going to be a major change in performance of these parts and does this sort of open up performance leadership between you and Invidia or is it more of just a smaller transition in terms of technology?

David Orton

So Direct X10 is the next major graphics platform transition in our industry and the last one we saw like this was Direct X9 in 2002, so it’s been four years since we’ve seen a major shift in the graphics platform. So, it’s a big transition. We’ve been focused on this for several years and in particular we’ve developed some very unique architectural technologies that we think give us a clear advantage unified shaders is a key one and we’ve developed this in conjunction with the Xbox 360 we’ve validated both the performance and efficiency of that architecture and so we feel very confident directionally with where we are going with our unified shader architectures and how we can drive that top to bottom in the product line.

The second part of the architectural chain is something called advance rendering model. But basically, it’s going to be the first time in the history in graphics architecture that will actually support fine green context switching and that also has significant impact on the overall architecture of the graphics. So we do see it as both a featural and a performance boost in the market and a big transition as well.

Operator

The following question is from Alex Ross, Morningstar

Alex Ross

Good morning, thanks for taking my call. Just a quick question on the accounts receivable; it seems you’ve grown about 30% faster than sales, is there something we should be paying attention to there?

Patrick Crowley

No, Alex, I think receivables are in very good shape and in fact they represent, just the timing of sales in the Quarter, but they are running at about 48-days of sales and we’re seeing no problem there at all.

David Orton

And to add to that, we actually just talked through this with the Board yesterday, we see phenomenal linearity in our business throughout the Quarter. And so one of them is overall revenue growth in the Quarter over Q1, but in terms of other than the south bridge question we just talked about the Quarter was extremely linear for us.

Operator

The following question is from Duncan Stewart, Orion Securities

Duncan Stewart

Hi, I want just a clarification on this south bridge, this has nothing whatsoever to do of course with the recent purchase of ULI or does that have any change in the dynamics of the overall industry which would have caused the south bridge issue, and then the other thing is I believe you said chipsets were close to $10 million dollars, was that for the first, you know was that just in this Quarter?

David Orton

Sorry, Duncan, on the first part I’m getting lost on some of the notes here sorry. Why don’t you just…

Patrick Crowley

I think his question was on the south bridge does that have anything to do with ULI and the quick answer is no, it has nothing to do with ULI.

Janet Craig

He was concerned with quantity capacity.

David Orton

Oh, sorry that was not capacity in terms of quantity, sorry I had a note here in front of me and I was looking at these things and said no, no we don’t have $18 million. Yes, so basically if you step back our north bridges are at 110 nanometer our south bridges are in 180 nanometer and the 180 capacity in the industry is fairly constrained right now. A combination of handsets, wireless technology, Bluetooth® technology, and our south bridge, so we are running our handsets and chipsets as well as important as micron. And so we are running very tight in general on south bridge capacity and so we were running tight and linear and then we ended up with the fab excursion in late December early January, so we took about a week and a half hit in that supply. A week and a half does not sound like a lot but when you are doing on the order of 10 million chipsets a Quarter that’s almost a million units and so that’s the scramble that we went through in our Fiscal Q2 was to recover from that. Our fab partners responded great, but given the linearity in the tightness of back-end you can’t all of a sudden put twice as much through as the back-end even though the fab was able to deliver it. So we are working through that and we are quite encouraged that we’ll catch up here actually over the next two weeks.

Second part of your question, Duncan, your gone, sorry they cut you off. So thanks, thanks a lot.

Operator

The following question is from Patea Chilera, American Technology Research

Patea Chilera

Yes, good morning. Can you talk about the handheld visibility that you have of the design wind momentum that you have is it mostly from 3G or non-3G can you give us some insight on what’s happening there?

David Orton

Yes, so today the market in general is moving towards 3G, but it’s not completely flipped over. Now, we have an application basically a media co-processor so we are actually transparent, I shouldn’t say transparent, we are indifferent as to whether we hook into a 3G or a 2½G band cell phone. The (inaudible) process on the backside of the bass band. Now, featurally we believe 3G instruction is the right way to go, the band wind lines up well with the features that we bring to the market whether it is our DVB-H technology, interactive 3-D gaming on handsets, and then the ability to really do a higher resolution video and camera and then move those across the line. But in terms of the actual platforms themselves we’re independent of that.

We are continuing to gain more and more momentum as OEM’s ramp 3G phones, but today it’s a fairly small percentage of our total volume, again Motorola is our largest customer and they have some 3G but the bulk of their phones today are 2½.

Operator

Thank you this concludes today’s question and answer session, I would like to turn the meeting back over to Mr. Orton.

David Orton

Thanks a lot for everybody’s questions and thanks for your patience and the fact that we wanted to allow more people today to have questions so we cut you off after the first one and I know just a little bit of dynamics but it does give everybody a chance to ask questions so appreciate your time and your patience on this.

Before we sign off today, I think for all of us at ATI we’d like to say thanks and a good-bye to Janet Craig. Janet is heading west to take an opportunity in Vancouver and yes quite often I’d like to can we have the trano team over there because it’s warmer but we wish her the best and we thank her for everything she’s done for ATI over the last five-years. I also want to thank the ATI employees for their efforts in delivering on such a successful Quarter and allowing us to get on track as we move into the back half of the Fiscal Year, and of course our customers for your continued support and demand for our products and we really appreciate that. We look forward to talking to all of you as we report Fiscal Q3 this summer in late June. Thank you very much. Bye.

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