O2micro International Ltd (OIIM) 2004 Q2 法說會逐字稿

Good morning and thank you for joining us today to discuss 02Micro's earnings for the second quarter of fiscal year 2004. If you would like a copy of the press release please call Pamela Campbell at 408-987-5920, Ext. 8095 and we will fax you a copy immediately. It is also posted on 02Micro's website at www.02micro.com. There will be a replay available through August 11 at 1-800-428-6051 and 973-709-2089 with a passcode ID No. of 363006.

Following the presentation by management the conference call will be open for questions and answer as time permits. Gentlemen you may begin.

Thank you. Good afternoon ladies and gentlemen and welcome to the 02Micro first quarter earnings report conference call. My names is Gil Goodrich, Director of Investor Relations, and I would like to remind you of our safe harbor statement, and remind listeners that this discussion of business outlook for 02Micro contains forwarding looking statements. Statements made in this release that are not historical fact are forwarding looking statements within the meaning of the federal securities laws. Actual results may differ materially due to numerous risk factors. Such risk factors are enumerated in the Form F1, Form F3 and 20F reports and other documents filed with the SEC from time to time.

Listeners are referred to the 02Micro press release and the documents filed with the SEC to understand these forwarding looking statements and the associated risk factors. The statements made herein are dated information. With us on today's conference call are Perry Kuo, Chief Financial Officer of 02Micro, Jim Keim, Director and head of Marketing and Sales, and Sterling Du, CEO and Chairman. After the report the floor will be opened for questions as time permits. I would now like to introduce Perry Kuo, the CFO for a discussion of the revenue, income and financial highlights of the second quarter of fiscal year 2004.

Thank you and good afternoon everyone. This is 02Micro's earnings announcement covering Q2 2004 ended June 30, 2004. I will highlight our operating results and projections, and Jim Keim, Director will provide market highlights. Closing comments will be made by Sterling Du, CEO and Chairman of 02Micro. After which we will answer questions.

First I want to emphasize that 02Micro continues to grow and continues to be profitable. During our conference call on May 6, 2004, 02Micro guided for Q2 revenue to be up by high single digit from Q1. Revenue for Q2 was $24.065m. This revenue reflects an increase of 8% from the preceding quarter and an increase of 15% from the comparable quarter of the prior year. Net income for Q2 was $4.148m compared to $4.206m of the preceding quarter, and to $2.439m for the comparable quarter of the prior year. This represents a decrease of 1% from the preceding quarter and an increase of 70% for the comparable quarter of the prior year. Gross profit margin for Q2 was 59.6% compared to 57.7% for the preceding quarter. It was 1.9% increase in one quarter as we continue to get away from low end products. R&D expense for Q2 was $4.681m, an increase of $120,000 from the preceding quarter, or 3%, and a decrease from the comparable quarter of the prior year. The Q2 R&D expense represented 19.5% of revenue. SG&A expense for Q2 was $4.983m compared to $4.259m of the preceding quarter and to $4.319m for the comparable quarter of the prior year. This represented an increase of 13% from the preceding quarter and an increase of 15% from the comparable quarter of the prior year. The Q2 SG&A expense represented 20.7% of revenue. We continue to carefully monitor and control expenses. Net operating income margin for Q2 was 19.4% compared to 17.9% for the preceding quarter and to 12% for the comparable quarter of the prior year.

Income tax for Q2 was $537,000 compared to [$466,000] in the preceding quarter and to $401,000 for the comparable quarter of the prior year. Earnings per share fully diluted for Q2 ending June 30, 2004 were $0.10 per share, compared to $0.10 per share for the preceding quarter and $0.06 per share for the comparable quarter of the prior year.

During the conference call on May 5, 2004, we announced that 02Micro would report a share of revenue by each of its four major and market categories of computer, consumer, industrial and communication. For Q1 we reported computer at just under two-thirds of revenue, consumer at about 30% of revenue, industrial and communications of each a small single digit percentage of the revenue. For Q2 computer was in the low 16% range of revenue, consumer at about one-third of revenue, industrial and communication were each a small single digit percentage of revenue. These are the four end market categories in which 02Micro will participate and grow in the future.

Balance sheet. 02Micro has over $122m in cash and short term investments. This represents $3.04 per share in cash and equivalents. In addition 02Micro has no debt. Short term investments or money invested in corporate bonds of at least A rating and government bonds of certain developed countries. Accounts receivable at the end of Q2 were $12.361m for a DSO of 46 days. This compares to a DSO of 47 days for the preceding quarter and a DSO of 34 days for Q2 of the prior year. Inventory turns ratio for Q2 was 5.2 compared to 4.6 for the previous quarter and a 2.8 for the comparable quarter of the prior year. Cash flow from operations in Q2 was $4.666m. 02Micro now has 346 employees, 59% of which are engineers. This positions us well for new product development and continues the introduction of new products and more customer design wins in the future.

Guidance for Q3. 02Micro estimates Q3 revenue to be in the range of 1% to 5% sequential growth as we continue to spin away from low end products. The gross profit margin target range of the company's long term financial model is 55% to 60% and we expect gross profit margins to be in the higher end of this range. The R&D expense range of the company's long term financial model is 18% to 23%, and we expect R&D in Q3 to be in about the middle of this range. The SG&A target range of the company's financial model is 13% to 18%. We expect SG&A for Q3 to be a little bit above this range.

I will now pass the call to Jim Keim, Director and he will review the markets and customers.

Thank you Perry. Q2 showed significant improvement in sales of end products for 02Micro, although June was slower than desired, as inventories of some LCD based products [occurred]. We have now experienced several cycles of under-supply of allocation selective LCD panels followed by over-supply. The over-supply leads to a reduction in LCD panel prices, spurring demand and starting another cycle. Although some weakness was evidenced going into July, we do expect price decreases in panels to improve consumption as we move through this quarter into Q4. Notebook sales remain lower than expected and we see no significant uptrend. As you may have noted 02Micro has been expanding margins despite the highly competitive market. One major focus of our company will continue to be receiving value for intellectual property.

The first part of this year has been a significant trend as 02Micro has received some very significant system-oriented patents, including areas where we have not developed product. We will continue to expand our product offerings to take full advantage of these patents and will pursue license agreements where appropriate from systems manufacturers. I will review some of our product introductions that will fuel this growth in the future. At our last meeting 02Micro announced that it had developed video [DJ] products for the use in digital cameras and other video products that enhance operation. Following our first [IC] development, 02Micro is working closely with several manufacturers and we now expect contribution from this product area in the first half of next year. We are continuing to file IP in this area.

02Micro has continued to expand its product offering in intelligent lighting with a focus on the high end through low end consumer products as well as industrial applications. We continue to see major design wins in all areas as we expand our leadership in our popular [Royer Rafter and Phasa Ray] family. We are receiving several major new paths as we continue to announce product expansion in the lighting area that will enhance revenue. We remain very pleased with the continued intellectual property expansion in this area, positioning us for ongoing market leadership.

In the intelligent power area, 02Micro is pleased to have received a key new patent for a remote controlled adapter for RCA topology. This methodology will help solve heat issues and increase power efficiency to simplify charger power topology in notebooks, and can quickly advance pen and light notebook technology. We are already working with several key customers who have leadership in this area. We are also moving forward with Magic Star chargers and DC to DC products offering both new products and new design wins.

Our intelligent battery product activity remains focused on our battery gauge product that lends itself well to applications wherever sophisticated battery management lithium ion cells are required. We are now in the qualification stage for a battery gauge product into a major industrial application. As standard CardBus product has continued to drop in price and will be removed from many systems in the next few years, our intelligent e-commerce group has been refocusing more of our efforts in the security, and also expanding the product line into a new area including VPM firewall. We have operational VPM firewall systems under evaluation at several customers. It's our intention to continue to diversify this product offering as we move forward. I will continue with some general market comments.

02Micro began as a leading provider of power management products for the notebook market. 02Micro is continuing to focus its effort into power management but in ever-broadening markets. We have now evolved into a leader in the lighting market, and we are continuing to focus on profitable product line expansion in other markets where we can take full advantage of both our systems and integrated circuit intellectual property.

I will now pass the call on to Sterling Du CEO and Chairman for closing remarks.

Thank you Jim. Our second quarter 2004 finished with revenue of $24.1m. It was an increase of 8% from the preceding quarter and a growth of 15% growth over the comparable quarter of the prior year. The EPS for the second quarter of 2004 fully diluted were $0.10 per share, compared to $0.10 per share in the preceding quarter and $0.06 per share in the comparable quarter of the preceding year. As Jim mentioned, Q2 2004 was not yet a recovery quarter for the notebook market. Major company's notebook manufacturing production may grow in the unit numbers but will not grow significantly in revenue from last year. Our growth primarily comes from other sectors than notebook PCs, such as industrial and consumer markets. To continue to diversify into other markets is our strategy and effort. We have started several new projects aiming to bring the Notebook PC accomplishment technologies to other segments. Our video DJ or digital scale camera will be ready for prototype next month. It is one of the most integrated PMU power management units to bring DSE [inaudible] and extended DSE battery life.

We created new topology for the notebook PC battery charger subsystem called remote control adapter RCA, as mentioned by Jim. RCA topology increased power efficiency and it eliminated one power conversion space inside notebook PC, which not only saves DOM cost but removes up to two [inaudible] from the Notebook PC box. However RCA does require new AC adapters. One of the major AC adapters [inaudible] committed [inaudible] pilot project to support 02Micro's patent for RCA topology power systems.

Our intellectual property portfolio continues to grow with a patent grant increasing to 62 from 57 in the preceding quarter and the patent claims increasing to 1,524 from 1,431 in the preceding quarter. And at the same time we also continue to be active in our intellectual property protection program. We grew our engineers in China from 75 in the first quarter to 88 in the second quarter. We also started to [inaudible] a team for project management, quality assurance [inaudible] to expand our strategic relationships with the major suppliers in China. We have seen [inaudible] capacity loosen up, and it is the best time for us to build our long term relationships with foundries, [inaudible] and packaging suppliers. That relationship is very critical for [inaudible] companies during a [tight capacity time]. Thank you for listening to our conference call.

Ladies and gentlemen the floor is open for questions and answers as time permits. Operator can we please receive some questions?

Thank you. The question and answer session will begin at this time. If you are using a speakerphone, please pick up the handset before pressing any numbers. Should you have a question, please press star (1) on your pushbutton telephone. If you wish to withdraw your question, please press star (2). The questions will be taken in the order they are received. Please stand by for your first question. Our first question comes from Tore Svanberg, from Piper Jaffrey, please state your question.

Yes, good afternoon, I had a couple of questions. First of all, maybe for Sterling, you mentioned the VPM Firewall product, could you maybe add a little bit more color on that program, and perhaps also when you expect to see some meaningful revenue there.

O2 Micro VPM Firewall technology was [inaudible], we have accelerated [inaudible] ASIC design, in a bundle with proprietary firmware and a devise driver in a [inaudible]. And work with our affiliate company [inaudible] delivery of customized UNIZ based security [inaudible]. And the [inaudible] of the whole system provide a solution to our customer. Either go to [inaudible] OEM or direct to customer niche. Major VPM Firewall customer [inaudible] in China, we have 3 major security system houses in China, is just finished the first stage evaluation of O2Micro VPM Firewall box. VPM Firewall is not a IC system, it's a whole solution/technology. And we expect the [inaudible] of one of these VPM Firewall box sales by the end of this year. The number of the box is going to be limited and the major OEM or customer base is going to carefully [inaudible] they will continue to purchase for their security [needs]. So VPM Firewall business will be slow growth, but as the nature of this technology, very high entry barrier and it evolve with the ASIC design, the system architect, the firmware of [inaudible] and the knowledge of the interface with the security [OS] and/or partly security OS from a [inaudible] company, or [inaudible] education support and technical support as more in a more different security [inaudible] happen in the Internet. Now this is a different business model, however, every unit could be very expensive and also build up gradually the security confidence of O2 Micro customers as we have been able to do the smartcard or security for many years right now. Thank you.

Okay, and also a question for Jim. Jim, you mentioned the slowdown in the LCD market due to some oversupply. How long do you think that's going to last? And are you already getting some indications from customers that this might bounce back in the December quarter?

Well, it'll definitely bounce back in the December quarter, we believe because of prices decreases that will naturally occur in the LCD supply. We expect the market to correct itself by the end of this quarter. We're already seeing signs of correction. But in fact there is some oversupply, there's been a lot in the press about panel prices coming down, and I think you will see that as we move through the quarter.

Okay, very well, and just a final question. It looks like the standard CardBus is becoming a smaller and smaller percentage of revenue. Is it less than 5% this quarter?

Yes I think it is less single digits.

Great, thank you.

Thank you. Our next question comes from Quinn Bolton from Needham. Please state your question.

I had a couple of questions, just, first on the notebook market, one of the clock suppliers integrated circuit systems this morning talked about seeing a pretty good recovery at least in terms of their unit shipments in the notebook market. It sounds like you're not seeing a recover. I'm just trying to put these data points together. Is it a difference in terms of revenues? Are you seeing a unit recovery but not a revenue recovery? And if you can give us any sense in terms of how demand is shaping up in the back-to-school season for notebooks, that would be appreciated. And then I've got a couple of follow-ups.

This is Jim Keim, I'll handle that. There has been some recovery, and you're correct, in unit volume that has begun to happen in the notebook space. However, that unit recovery has not been significant, it was significantly below the target number that some of the ODMs had for the July timeframe. There is, however, as Sterling indicated in his message, ongoing price compression in some of these areas, so what you really have going on in the overall notebook market is some unit volume growth, but we don't believe there's any real revenue growth.

Okay. Second question, you talked about the benefit of the gross margin by walking away from some of the lower margin products. Is that mostly the standard CardBus or are there other types of products that you're walking away from that are lower margin?

Standard CardBus is simply one of the major ones we've walked away from. There had been a few other products which we don't necessarily care to name. However, those are products where we have minimal intellectual property or patent protection in those areas. We're very much focused on those areas where we have very strong intellectual property contribution.

Okay, next question. Just can you describe the competition in the lighting market? I know one of your competitors tends to be very vocal about making some share gains there. Any updates?

We don't believe we've seen any share loss. We believe that in key areas of the lighting we've continued to expand our overall market penetration in several ways. The Rafter [ph] family was unique, it was brought out to focus on what it was named after, Royer Rafter [ph], Royer [ph] was a significant portion of the market, and now contributing very significantly to some of our revenue flow with the Rafter [ph], it's taken over many sockets that were previously Royer [ph] old fashioned two-stage type design. We continue to expand our activity at the high end. The one disappointment I think we have seen is not really a market loss, it's been that in some instances the yields for some of the [inaudible] fabs have really prevented the LCD very high end monitor market from expanding at the pace that we had previously expected.

Okay, and then last question. Just for Sterling, can you talk about the synergies if any, you see between the VPM firewall business and the analog mixed signal business? I mean, ultimately do you expect to grow the VPM firewall business to a level where you might be able to spin it off, or divest those assets? Or so you expect that this is going to be a new part of the business model going forward. And if it is going to stay part of the business model, what kind of synergies do you seen between the chip business and the systems business?

Yes, the synergies date back to 5 years ago when we initiated a security device which was a smartcard integrated to our standard CardBus. As you just asked, our standard CardBus, the low end, and we work away from that standard CardBus, whether we do continue to provide a SmartCardBus. And the base of the technology would put a smartcard reader into the CardBus and after many years [inaudible] right now you see the major computer [inaudible] company has building, like their computer, every machine from notebook to [inaudible] server using the smartcard reader [in fact]. And that's a security product opening O2 Micro has been focused many years ago. And starting from 2 years ago, we are looking at what is next in terms of security as security is one of the major [inaudible] proprietary security is not something has a standard application, standard architecture. Proprietary, which we like, but mixed signal IC, number 2, starts a major extension for standard CardBus and goes to SmartCardBus, and we utilize those technologies to develop even more complicated VPM firewall as [inaudible] IC inside, made up by the [inaudible] micro, or [inaudible] CPU, and do those security functions, and we have the technology, we have the people and are working ourselves, and [inaudible] the O2 Micro systems model because we prefer high entry barrier. We prefer proprietary environment. We prefer we can file IP protection. So these are the three [guidance] that we continue investment into the security area. So the VPM firewall is the one right now we're providing to the customer, and so from the end product point of view, our VPM firewall is different from the mixed signal IC, but however, in the nature of business, research required a long time, and a long investment, and that is fitting to our company strategy and are most important, and that could be, create something new, technology or architecture to the IP protection. So [inaudible], we also share the same base of, customer base. If you look at the Dell computers, product opening, Dell computer today is smart computing, their computers, and they're providing to solve your application, the after market option, provided by [inaudible] with [inaudible], and the same page, they're providing the security including [inaudible] and also VPM firewall box. So our security market is the uprising market, and the security market is not going to be downturned, and also with the computers, will grow and we'd like to ride this momentum with the market niche.

Just a final question, do you think you'll always do the boxes, or do you think at some point you just do the proprietary ASICS and firmware, and sell that to multiple potential VPM firewall box builders?

Let me answer the question this way. We do have the two business models. One is we [building] the box, another one, what we're building is an add-on card and equip or ASICs and also the firmware and customized operating system of that add-on [box] gets plugged into the [inaudible] server. And that, flexibility to give some of the server builders can engage with us in the business.

Okay, thank you.

Thank you. Our next question comes from Sean Slayton [ph] from S.G. Cowan [ph] please state your question.

Hi guys, good afternoon. Perry, this $5m level for SG&A, that coincides with your guidance for the current quarter. Does that have a lot of legal expenses baked in it or can we say that's going to continue on a forward basis for the next several quarters.

Yes, I think it's [inaudible] like we increased some expenses in the China area to set up our [proprietorship] in Shanghai area. More and more customers are moving out from Taiwan to China. Another part of the increase is due to some of the education programs which have [inaudible] Taiwan and the United States. We have more [inaudible] on the [Chinese coast].

Okay, so it sounds like that's going to hold. And your SG&A model of 13-18%, it doesn't look like it's really achievable here on a go-forward basis, it's going to be something higher than that. For R&D, is R&D flattish on an absolute basis for the nest few quarters?

Sean, maybe also some comments of the [S&A] does not on a [forwarding base] it has happened a couple of quarters and the litigation is up and down. And we do have some litigation spending particularly in last quarter, which is Q2, and maybe as Perry has mentioned maybe Q3 and Q4. We expect our legal goes down in the next Q1. And maybe in the future, that would be like [inaudible] of course we hope the litigation expense will be less and less.

Okay, so maybe we're looking at a peak here in Q3 or Q4 and then it tails down some next year?

Yes.

Can you talk about-without getting too specific, what you know now about the notebook market and the LCD market. Can you talk about what you believe the trajectory of your business in the December quarter is going to be? Meaning, should we consider this similar seasonality to last year where I guess you guys were up on a sequential basis in Q4, about 8%. Can you speak to that and can you also speak to-the notebook market and the LCD market as a function of your guidance. You're assuming-can you talk about-are we soft or in line on notebooks still and are we accelerating through the rest of the year for LCDs? I think that's what I heard but can you speak to that again? Thanks.

There's several questions in there.

Right.

Let me highlight a few comments from my end, it's Jim Keim. There's several things that we find somewhat concerning in the general economy as we move forward. There was some inventory build in certain portions of the supply chain as we've already noted. But beyond that, we have noted some softness in some of the world economies which always does concern us. There's been a lull in the US economy, the China economy has slowed down, in some areas very significantly. Beyond that one of the key factors that we look at is always wafer fab utilization. And wafer fab utilization from some of the wafer fabs, according to information we have, has continued to go down, and that's unusual for a July type timeframe moving into August. And that also represents some of the markets, in fact, are probably going to remain slow. There's simply not silicon being processed at the level to see the type of growth that you would expect this time of year. This is really not a normal seasonal situation. You would expect to see wafer fabs actually very bullish moving into August/September. That's very abnormal from my historic perspective. To answer another part of your question as we move forward, as we've mentioned before, even though there is growth in notebooks in terms of unit volume, the revenue growth from our perspective is almost non-existent, very minimal from our perspective, and we will continue to emphasize products in [inaudible] where in fact we achieve good margins. We have no intent to move away from that marketplace. We are working with suppliers to develop new, more cost effective products to the RCA topology that we' mentioned is an excellent example of that. We have a lot of faith in that for the future. That having been said, the lighting area will continue to move forward, we are in an absolute leadership position from a technology as well as from a supply based point of view, and we will continue to expand that area. I think you will see that area along with some industrial areas continue to expand more rapidly on the growth curve than you would on the notebook space for O2Micro.

Okay. I think that correlates with what we're hearing regarding some of the enthusiasm actually for your stock, if I could to speak to that for a second. LCD TVs, I think it's encouraging that you have a larger percentage of your revenue base is LCD, but can you give us any more-can you put any more meat on the bone regarding your opportunities in LCD TV and maybe if you can hazard a guess regarding when you think the unit volume for LCD TV, and if you could speak to the sizes, the relative sizes as well, maybe 32" and above, 32" and below, where your near term opportunities are there. Thanks.

(Interference on line)

Hello?

Yeah, I'm still here.

I'll try to speak over the buzzing sound that we're hearing periodically. We're obviously very much focused on LCD TV, the larger the better. We have very significant strength both in terms of intellectual property as well as in terms of product in this area. We are working with major LCD manufacturers worldwide and previously announced we're already shipping product into some of the world's majors including Sharp. The disappointing thing that we have seen in the LCD TV is there has been difficulty in terms of getting the glass sizes for the next generation into the marketplace with the kind of volume that is significant for the growth. And so some of the companies, and I won't name particular names, but they in fact have had significant problems in terms of bringing their glass facilities up and running to the kind of volume they would like to have. They've also had some significant yield issues and that has kept the pricing in the marketplace high, and has significantly reduced the volume that many of them are projecting. We do have forecasts for many of them, we don't give out specific forecasts for the manufacturers, but nevertheless. LCD TV is a marketplace that after they get through some of these yield issues, will in fact be a very significant marketplace and can have very good opportunity for growth for 02Micro.

Okay, thanks, I'll let somebody else ask some questions.

Thank you. Our next question comes from Andrew Huang [ph] from American Technology Research.

Hi, good afternoon. Just a few questions. First on the sequential improvement in gross margins, you talk a little bit about the product mix helping out with the margins. Can you comment on maybe a bit for ASP on a sequential basis?

Sorry, Andrew, could you repeat the question. We had a hard time hearing it.

Sorry, can you comment on a mix-adjusted ASP, in terms of pricing for your products, quarter-to-quarter?

Andrew, we don't give comments on the ASP product line [inaudible].

Okay. If you look at the 4 product families-hello? If you look at the 4 product families by DJ lighting, power and e-commerce, can you break down revenues by those segments.

We don't break down revenue by internal product line. We don't do that quarterly or annually.

Okay. And then gong forward, what's a good tax rate we could be using?

11%. 11-12%.

11-12%. Great, thank you.

Thank you. Our next question comes again from Quinn Bolton.

I just want to do a quick follow-up. Jim, you talked about seeing a slow down at the foundries and that was one of the reasons why you were concerned about demand. But it would seem to me that if we did have an inventory build, one of the natural things you'd see at this point is folks reducing their wafer starts to try and get that inventory situation under control So I was wondering if you could just come back and say, are there other data points that you're seeing that suggest end demand is actually slower than expected, either in the panel market or in the notebook market, or any of the other end markets that you address. Thanks.

Well, first of all let me speak again about the wafer plan this year. Inventory issues like we mentioned, there was some inventory certainly in the LCD area or certain portions of it, those tend to clear off quite quickly. Those are a matter of weeks or months, and we expect really those issues to be [inaudible] wafer for August, for certain. But here we are in August and wafer fabs are not up to utilization rates that would be expected, some have even indicated [inaudible]. This is product that would normally ship in the 4th quarter. So wafer fab is an indicator of the lead time and some of the demand that obviously some semi-conductor manufacturers are looking at as they move forward for their plans for 4th quarter type shipments. So that is a very strong indicator to us that some markets have been significantly soft. Beyond that, yes we do have other points that we obviously watch. We track forecasts very closely. For instance in notebooks we get all of the ODM forecasts, some of the ODMs were very optimistic going into Q3, Q4. July cooled a lot of that optimism for them. They did not make their targets for July. They're much less optimistic as they look forward. That's a concerning point for us. Also I mentioned the softness of some of the world economies, we do watch economies and the US is showing some signs of slackening, and the China economy is quite weak at this point. So those are all concerning factors for us.

Okay, thank you very much for that clarification.

Thank you. Our next question comes from Sean Connor [ph] from Aragon Global [ph] please state your question.

Hi. I was just wondering if I could ask you, on the LCD side, what exactly, I mean, can you kind of give us some granularity as far as expectation growth for this quarter and next. If I'm guessing, [inaudible] back out if notebooks aren't really growing, I'm guessing the LCDs have got to grow about 10% sequentially, for this quarter?

Well, what we would indicate is that we really have expansion in two areas, certainly the whole lighting area, we're continuing to capture design wins. Yes, we do expect to see ongoing growth in lighting. We also have had new product introductions in some of the areas, including notebooks that will in fact drive some revenue growth.

Okay. All right, thank you so much.

Thank you our next question comes from Brendan Turlong[ph] from Miller Taeback[ph].

I'm sorry, my question's been asked. Thank you.

Thank you our next question comes from Tore Svanberg from Piper Jaffray.

Yeah, I just had some follow ups. So based on your remarks Jim, you do actually expect your notebook business to be off in Q3, you're just being more cautious in the market overall.

Yes, we're being more cautious in the market overall, and obviously wafer fab utilization going down concerns us. That doesn't mean our wafer fab utilization is going down, that's what we're hearing from the wafer fabs themselves that their utilization is going down and this is very abnormal for the August timeframe.

Okay, and also a follow up to Sterling and going back to VPN Firewall. You mentioned this is very strategic to your business model. Could you perhaps talk a little bit on profitability. Is this a type of a business that's going to have a similar margin structure, lower or better?

The margin will be higher than we currently experience, and let me state it this way. VPN firewall is not our only strategic business model or business aspect for in the future, just because it carries on a different energy other than other aspects or [inaudible] we are providing to that customer. Because number one a VPN firewall it comes with a whole [inaudible] of technologies, because if you look at only that aspect and the value is not in that aspect only, the value is in the technology and also the service, to help the enterprise to solve their security problems, which is the area we like very much.

And number two, you don't have the big OEM to dominate all that is going to be, such as Dell or HP or IBM, there is a huge number of the units going to be shipped per quarter, and a limited number is going to be shipping even from the whole worldwide market available. But each one carries a very high price cap, and that price cap could be as high as $10.00 in US dollars, it depends on what kind of features you want to add on. Beyond that I am sold for the customer relationship is very apt to this market for this product, because [inaudible] by any architecture, so you have a [inaudible] to buy the part and anything fitting to the outside is a sale computer maybe inside is computer chips from a different vendor. Now you don't have the so-called loyalty between the end customer and the vendor, which is [inaudible] case, but the VPN firewall, the technology was created and invented by 02Micro ourselves and [inaudible] architecture so if anything 02Micro is going to fix the problem and fix the customer and solve the security issues, and that [inaudible] connection this business is different from the other business that we have with [inaudible] it is not going to be ripe very quickly, but its going to be incremental year by year and it will last many, many years. [Inaudible] once you earn the customer then maybe they will go with you and now easy to [inaudible]. So the approach we are doing is, one we go to ourselves and [inaudible] and we direct go to self selective customer, selective country, we do the market on [inaudible] the current service provider. [Inaudible] and together with technology we ship to them [inaudible] and the computer is boxed and the shipping box under a different name, but however we still put a level three type of support because we are the technology holder so we are the front end, the server company and all our server companies, ODM companies, and then we go out and fix it, so then by that, day by day, month by month, year by year, you can build out the total security confidence in 02Micro and that's sort of the long term strategy we want to engage in.

Thanks for that clarification.

Thank you, our next question comes from James Bash [ph] from PAW Partners.

Yeah hi, thanks. Just concerning the notebook OEMs that you said were seeing continued softness into July. Do you have a senses of what geographies they're selling their product into, whether just proportionally one geography or another.

We have some idea of that, but we also have some non-disclosure issues there in terms of some of the information they give us regarding some of the OEMs, we also have some non-disclosure issues with some of the OEMs so I'd prefer not to go into that.

Okay, well I guess what I'm trying to get to, maybe I can try to address it a different way, is whether one geography, let's say North America is actually doing on a relative basis better in terms of Notebook and demand than other geographies like Asia, or whether we're seeing a significant slowdown in Asia versus some of the other geographies. Any type of color surrounding that would be helpful.

We've actually seen Europe be one of the better markets. The US market is satisfactory but certainly not growing significantly from our viewpoint. There has been some slowing in some of the Asian areas.

What do you attribute that to in Asia?

Well, basically as we indicated, in Asia there has been a slowdown in the Chinese economy for one, and that has had some influence in the area.

Thank you.

Thank you our next question comes from Sean Slayton [ph], SG Cowan.

Hi guys, can you tell us what efforts and what success that you've been able to achieve on the lower end notebook side, and what efforts you're making to kind of win incremental business at that end? Thanks.

We have come out with a [inaudible] that address the needs for the low end notebook. Firstly it's not a smart charger, it's dumb charger [inaudible] costs, secondly it is a very easy design and can shorten the design cycle for the OEM designer, and we also come out [inaudible] because of the [inaudible] for the low end notebook design team [inaudible]. Because our product will be [inaudible]. For the low end who tend to use a [inaudible] and another area, or widening area of coverage we are not absent from the low end notebook area, and [inaudible] also the system wide we can achieve [inaudible].

Okay, so you could say that you're having accelerating design wins on Magic Star?

Yes.

Okay, thank you.

Thank you, our last question comes from Andrew Huang at American Technology Research.

Just to follow up on the VPS Firewall business. Did you say that you would expect to get revenues in the first half of 05?

Yes, that's a limited number because the machine is [inaudible] machine and is not going to be quickly to renting out, because [inaudible] production that's for the people [inaudible] buy one machine and they [inaudible], and then buy maybe one each, they're waiting for the IT structure enterprise to expanding and then next time they buy a few more, so that isn't going to be too quick.

Okay, and you know with this new product is it going to require any kind of incremental RSD or SG&A relative to prior levels.

The R&D for developing this technology so far has been quite little because our team right now is working on the next generation which [inaudible] new portable so there's not so much of the R&D for this prototype but we do going to have some of application, fee application engineer also [inaudible] also R&D and those applications then we need to [inaudible] for certain areas [inaudible] and that would be an incremental R&D expenses. Also the fee application [inaudible].

Are the FAEs included in R&D or SG&A?

SG&A, and the sales is under SG&A.

Thank you.

Thank you gentlemen. There are no further questions in queue.

Okay, very good thank you for attending the Q2 02Micro earnings conference call. We look forward to talking with you again next quarter. Ladies and gentlemen a replay of this call will be available approximately one hour from now. To access this rebroadcast you may dial in to 1-800-428-6051 or 973-709-2089, with passcode ID number of 363006. Thank you all for participating and have a nice day. All parties may now disconnect.