O2micro International Ltd (OIIM) 2006 Q1 法說會逐字稿

Good day and thank you for joining us today to discuss O2Micro's earnings for the first quarter of fiscal year 2006. If you would like a copy of the press release, please call Pamela Campbell at 408-987-5920, extension 8095, and we will fax you a copy immediately. It is also posted on our O2Micro's website at www.o2micro.com. There will be replay available through May 10 by calling 1-888-203-1112 or 1-719-457-0820. The pass code is 234-7111. Following the presentation by management today the conference call will be open for questions and answers as time permits. Gentlemen, you may begin.

Good afternoon. Welcome to the O2Micro earnings report conference call for the first quarter of fiscal year 2006. My name is Mitchell Benus, and I am the Director of Investor Relations. I would like to remind listeners that this discussion of business outlook for O2Micro contains forward-looking statements. Statements made in this release that are not historical facts are forward-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 S1, the Form S3, and 20-F reports, and other documents filed with the SEC from time to time.

Listeners are referred to the O2Micro earnings press release and the documents filed with the SEC to understand these forward-looking statements and the associated risk factors. The statements made herein are dated information. The Company assumes no responsibility to provide updates to this information.

With us today on the conference call are Perry Kuo, CFO of the Company, Jim Keim, Director, and Sterling Du, CEO and Chairman. After the report the floor will be open for questions as time permits. Perry Kuo, CFO O2Micro, will highlight the operating results and projections, followed by Jim Keim, Director. Jim will provide some market highlights. And closing comments will be made by Sterling Du, CEO and Chairman. And then we will take questions.

Now may I introduce Perry Kuo, CFO of O2Micro, for discussions of the revenue income and the financial highlights of the first quarter of fiscal 2006 ending March 31, 2006.

Good afternoon everyone. This is O2Micro's (indiscernible) report announcement targeting Q1 2006 ending March 31, 2006. As everyone has a copy of the earnings report and press release, I will be brief and report the highlights.

Revenue for Q1 was a record high of 29,109,000, which will be then an increase of 1.8% from the preceding quarter, and an increase of 25% from the compatible quarter of the prior year. Net income for Q1 was 1,031,000 compared to the preceding quarter of 226,000. The net income from the comparable quarter of the prior year was 2,089,000.

Earnings per ADS fully diluted for Q1 ended March 31, 2006 was $0.03 per ADS compared to $0.01 per ADS for the preceding quarter, and $0.05 per ADS for the comparable quarter of the prior year.

Gross profit margin for Q1 was 56%. R&D spend for Q1 was 6,788,000, or 23.2%. We will continued to invest in R&D for the future growth of momentum.

SG&A expense for Q1 was 6,223,000, not including the IP litigation expense of $2,261,000. The total SG&A expense, including litigation, was 8,484,000 or 29% of the revenue.

From Q1 the SG&A also included about 400,000 for the start up expense for the in-house testing unit in China. Share repurchases in Q1 were (indiscernible). Revenue by end market as a percentage of the total revenue for Q1 was Consumer in the range of about low 16% range, Computer in the range of low 30% range, Industrial and the Communications each at small single digit percentage of revenue.

Balance sheet. O2Micro has over 99 million in cash and short-term investments. This represents cash and equivalent per share of $2.57. In addition, O2Micro has no debt.

Certain investments were monies invested in corporate bonds of at least A rating and in government bonds of certain developed countries. Accounts receivable at the end of Q1 was 14,217,000 for a DSO of 44 days. Inventory turns ratio for Q1 was 3.5 compared to 2.9 for the previous quarter, and 3.6 for the comparable quarter of the prior year. Cash flow from operations for Q1 was a negative 1,176,000, mainly due to decrease in accrual expenses.

O2Micro now has 733 employees, 61% of which are engineers. These positions us well for new product development and the continuous introduction of new products and more customer design wins in the future.

Guidance for Q2 2006. O2Micro estimates Q2 revenue compared to Q1 to be up in the range of 2% to 6%. The R&D expense range of the Company's financial model is 18% to 23%. And we expect R&D in Q2 to be slightly higher as continuing investment in R&D is vital to the future growth of the Company.

SG&A target range of the Company's financial model is 13% to 18%. We expect SG&A, without litigation expenses, for Q2 to to be in the range of 21% to 22%. This also includes 500 to 750,000 for start up option expenses for the in-house testing unit in China.

Litigation. We expect the litigation expense for Q2 to be in the range of 2 million to 2.5 million. Stock compensation expense for Q2 will be about 750,000. The tax rate is about 12% to 14% of pro forma income.

The gross profit margin, target range of the Company's financial model is 55% to 60%. And we expect gross margins in Q2 to be in the low end of the range of 55% to 60%, as we are experiencing still improvement process with new founding partners. We will expect the operating margins to be leveraged by the increase of sales and a yield improvement in the Q4 2006 timeframe. I will now pass the call to Jim Keim, Director.

First let me address the gross margin issue mentioned by Perry. As part of our production capacity expansion, we are producing products at additional wafer foundries. We did experience mysterious yield issues at one of these foundries that impacted costs in our product line. These yield issues also resulted in the need to pay premium processing fees to meet customer delivery requirements. We understand the issues that caused the problem. While we expect ongoing margin impact in Q2, the situation should normalize by Q3.

While this situation is a current problem, it is important to realize that expansion of our production capacity is critical. Q1 saw industry shortages in silicon as a result of the accelerating solar energy activity. Despite these shortages, we are in a good position to meet our growing customer needs for product in the second half of 2006 and beyond. Besides additional wafer fab capacity, we're preceding with our in-house analog, mixed signal testing facility, which will be operational in early 2007.

Next I will give a brief legal update. Based on our Novembers 17, 2005 Texas federal jury decision of local infringement of one of our United States patents, the Texas court has awarded O2Micro 4 million, and up to an additional 3 million in attorney fees, as determined by the judge. The court also issued a permanent injunction against certain Taiwan (indiscernible) based modules from entering the United States. This award amounts to approximately $1.00 in damages per infringing module, not including attorney fees.

As stated previously, we have already see beneficial effects from this jury verdict. Several companies with whom we have litigation have ongoing settlement discussions with us, and several large users were qualified to start a shipment of our product.

A second trial against Taiwan based semiconductor manufacturer, [iTec], and two Taiwanese are module manufactures using iTec product is scheduled to begin next Monday in Texas. O2Micro will seek a permanent injunction against the infringing of iTec product, as well as attorney fees. We are pleased to note that our patent portfolio continued to expand in this lighting area during the quarter.

Now I will move on to a market update. Despite LCD monitor inventory in early Q1, we did grow our business to a record level in Q1, based upon growth in two of our key markets, notebook and LCD TV. Let me comment briefly on each of our two markets.

We remain very optimistic regarding the LCD TV market. IDC projects growth of 55% from 18 million units to 27 million units in 2006. We feel this LCD growth expectation is conservative, and we expect to see good growth in Q2 and onward. The LCD monitor market should return to normal growth for us in Q2. According to IDC data, the LCD monitor market is expected to grow by over 30%, from 97 million to 127 million units in 2006. We continue to agree with this projection and see reasonable growth in Q2.

IDC projects further that the notebook market will grow by over 20% from 65 million to 78 million units in 2006. However, forecasts from our major customer show weakness in Q2 before resuming good growth in Q3. This includes the push out of several new programs. This will cause our revenues in notebook to be flat in Q2, before resuming good growth in the Q3. We remain pleased with the significant design wins we have made in both e-commerce and power products in notebooks.

I will also comment briefly on our major product lines. Intelligent Lighting continues to expand with new products, design wins in all key markets, and an ever expanding customer base. Besides LCD display, O2Micro has developed a family of high-efficiency LED controllers that are patent pending. These products have already begun to ship in volume for global positioning systems and portable DVD systems. We're also working with leading manufactures for LED notebooks and monitor applications. Our Intelligent Property portfolio continues to expand as well.

Intelligent Power is also experiencing increasing design win activity. Our Cool Charge product which addresses the issues of improving the inherent power limitations inside the notebook, is achieving good industry interest. This patented product enables higher performance from existing notebooks, and helps pave the way for the next generation of even thinner and lighter notebooks. We expect to have first production in the second half of this year.

Besides Chargers, our computer peripheral DC/DC product continues to win new notebook designs. And we expect to increase our market penetration as new products continue to be introduced. Our processor DC/DC is now in the design stage for AMD-based platforms.

Intelligent e-Commerce has designed a new generation of product, including PCI Express chips that have gained industry acceptance at major notebook OEMs. We did see some revenue gains in the product line in Q1, and expect significant gains based on design wins starting in Q3.

Intelligent Battery. This product offering uses innovative intellectual property to more accurately control charging and discharging batteries. This is essential in critical applications where safety and accuracy are required. While we are working on multiple design projects with customers and expect revenue contribution from this product line in the second half of the year.

Intelligent DJ. We have completed design of a sophisticated power management unit for a leading digital still camera manufacturer. Revenues expected in Q1 2007. We also remain focused on development of handheld communication products requiring advanced single cell battery power management.

As mentioned last time, our VPN firewall product has passed testing at ICSA Labs, where the O2Micro product was the first-ever to meet all [1.0 delogging] requirements without any deficiencies. We are now focusing our efforts on sales of this product, and do expect 2006 to be a good staging year with meaningful sales revenue.

To summarize, we now expect to see significant growth opportunities in notebook, consumer and industrial business in 2006, as our broadening product lines are enjoying ever-increasing number of design win opportunities.

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

Our first quarter 2006 finished with a greater high revenue of 29.1 million. It was an increase of 1.8% from the preceding quarter, and an increase of 25% from a comparable quarter of the prior year. The earnings per ADS for the first quarter of 2006 fully diluted was $0.03 compared to $0.01 per ADS in the preceding quarter, and $0.05 per ADS in a comparable quarter of the preceding year.

As Jim mentioned, the Texas court awarded O2Micro, based on a November 17, 2005 patent litigation case. We received US$4 million up to US$7 million, and permanent injunction against Taiwan Sumida. We see increasing design win activities of our CCFL Inverter product line in the market.

LCD TV and the LCD monitors will be driving our continued growth [even] healthy markets and our successful intellectual property protection progress. Our e-commerce product line for the notebook PC market will be another driver which will be flat through Q2, with the PC markets softening, and the renewed strong growth starting from Q3 this year.

Looking forward to 2006 and at the year, let me update new product sales. Every gauge I see have three applications, notebook PC, battery pack, which went well. And we expect to have initial [catalog] in Q3 this year. Industrial applications are on the right track (indiscernible) testing phase. And we expect to have initial production in Q4 this year. And in China, fab resale vendor applications in which our IC samples are in the system level testing.

Battery charger have two generations, conventional charging, which is (indiscernible). We're going to launch a new revision to meet market demand. Our next generation charger, Cool Charge, is getting a lot of interest, as well as design activities.

The DC/DC IC application target two areas, the [ND] new mobile micro microprocessor and computer peripherals DC/DC. Both DC/DC families gained market shares with the design wins. Our WLED controller target portable devices for the panel. We are seeing revenue from many design wins. VPN firewall, as Jim mentioned, successfully got ICSA certification. This is (indiscernible) to generate light revenue this year and targeted to record creasing revenue in 2007.

Building upon (indiscernible) from China University. We grew our engineering staff in China from 225 in the fourth quarter 2005 to 388 in first quarter of 2006. Our test facility projects in China continue to be on the right track with [trial] runs in Q3, and production in Q1 2007. It will further improve our quality assurance, [ER] rates, and the logistic efficiency.

Our intellectual property portfolio continues to grow, with a patent grant including 284 is up March 31, 2006 from 133 in the preceding quarter. [Patent claims] increased to 4,733 from 3,501 in the preceding quarter. Thank you for listening to our conference call today.

Ladies and gentlemen, the conference call is open for questions and answers as time permits. Operator, will you please take the first question?

(OPERATOR INSTRUCTIONS). Tore Svanberg from Piper Jaffray.

A couple of questions. First of all just clarification. The $400,000 you had in SG&A, was that tied to stock option expenses for your test facility in China?

Yes. This is the start up expenses for the in-house testing facility in China.

Okay, very well. Also, it seems like your notebook business is going to be flattish in the June quarter. Do you really view that now as the bottom for that business as you have some -- it looks like you had some new products ramping for the second half?

I think the answer to that is yes, based upon the forecast that we've seen. The customers that make up the majority of the product that we ship have typically very good forecasting systems. And those forecasts are in place for the quarter, and we don't really expect those to change.

Also, on legal, I know it is very difficult to give guidance on the longer term, but based on your numbers in Q2, do you think that would potentially be the high point for the year?

Yes. This is Perry. Based on current cost schedule and our status of the (indiscernible), I believe that Q2 will be the peak for the litigation expenses for the year 2006.

Finally, a question for Sterling. Sterling, if you look at two products [white] LED, and VPN firewall, what are some of the metrics that we should be focused on to really try and understand your success in both markets?

White LED, we see that at the smallest square panel as being quite active. And we are going to see our white LED for those portable device. And if you're asking how do we (indiscernible) those, I think that would be one of area to see whether we continue to dominate the market in the popular small device, which is our current -- mostly is current (indiscernible).

For the VPN firewall, for this year it is going to be light revenue. For 2007, right now it is too early to predict. But we will see this year after we have foundation to clean up more our channel for the system integrator and (indiscernible) vendors. And that could be quite meaningful in 2006.

Quinn Bolton from Needham & Company.

I wanted to just -- a first quickly for Perry, ask about the stock comp. You broke out stock comp it looks like in two areas on the income statement. One, you had your own line item, and then you talked about this other 400,000 in SG&A. Is there a way to sort of in future periods add those together just to make it is very clear what stock comp is? And I guess the other question is why do you report it in two different line items?

Stock compensation?

Yes.

In our stock compensation this is one item, which was 689,000 for Q1. And your question about 400,000?

I don't know if you said it is your difference between stock compensation and stock option expenses, is that the difference?

I'm sorry (indiscernible) are start up -- start up for the new testing facilities.

These are costs related to our new testing facility. They are not stock option -- start up.

So it is 400,000 of expenses included in SG&A associated with the start up of the test facility?

Yes. Sorry. Sorry about it. Yes. This is a onetime expenses for the testing facilities in China.

That number in the second quarter will jump to somewhere between 500,000 and 750,000, but then should decline in the second half of the year as that facility comes online. Is that the right way to think about it?

Yes. Let me give you more color. Thank you for asking about it. In Q3 timeframe it will be in the same amount. And as Perry mentioned that Q2 we are going to have the preproduction. And Q4 -- Q1 we are going to have the full production. We expect that up until the full production we may gain the profit in the gross margin by an increased 150 basis points.

As the test facility comes online?

Yes.

And then moving to gross margin, it looks like you had this yield issue in the first and the second quarter. I was wondering if you could sort of remove, or if there is a way to in remove, the effect of those yield issues? What was the normalized gross margin on your products have been? Would have it has still have been at the high end of your range?

Yes.

And then on the legal front, I was wondering if you could comment. Monolithic Power put out a press release a couple weeks ago saying that they have asked the U.S. Patent Office to reexamine your 129 patents that I know you're involved in multiple lawsuits against. What is sort of the process? How do you defend against the re-examination. What is your strategy there?

Basically what we have commented is that re-examinations are not unusual. They may be really requested by a concerned party. That is a lengthy process that involves the Patent Office. It usually takes years. We are very confident of the way that our patents were executed to begin with, and we really don't have a great deal of concern. As a matter of fact as we mentioned, we have gained additional patent strength in this quarter. Basically we have a very, very broad patent portfolio, not only in the U.S., but elsewhere. So we do not have a great deal of concern over this.

Just then just lastly on the notebook side, it sounds like Sumida -- or you have been qualified at a number of notebook modules suppliers. Can you make comments about your market share, or where you think your margin share is headed as we come into the second half of the year?

It is headed up. We now think we will certainly at this point be the market leader as we go into to Q2 in notebook.

(OPERATOR INSTRUCTIONS). Craig Berger from Wedbush Morgan Securities.

I wanted to ask you about your design win visibility for TVs ramping in the second half. I guess you would already have these designs, but how do you see your CCFL revenues ramping with LCD TVs this year? And how is that market looking right now?

Could you repeat the last part of that? How do we see our revenues in LCD TV?

Yes.

I think I covered that, perhaps not to the depth of clarity that you understood, but basically we do see LCD TV first of all ramping quickly this year. We're very pleased with the market strength we see in LCD TV. We do have good visibility into design win in LCD TV, and we do see our revenues growing in LCD TV.

Do you have any -- can you tell us some customers that you are shipping your CCFL converter chips into?

I think previously we had mentioned a few customers, including Sharp, who is the market leader. In LCD TV we are the market leader.

Got it. Just with respect to some of the supply tightness you are noting out there. Can you go in and basically give a little color on what you're seeing, and whether or not you're going to be able to meet all your customers' requirements?

We certainly can meet customer requirements. Many of the wafer fabs, however, are basically running at capacity at this point in many of their lines. As I mentioned, some of that relates to solar activity. We had not only made arrangements, but in some cases we had invested in additional wafer fab capacity, and also made very strong management relationships with wafer fabs. So we are in a very good position as far as wafer fab activity is concerned.

I would also mention that when we got into the yield problems that we had in Q1 we were able to recover by getting management support at the wafer fabs to expedite silicon for us. So we did not end up in a shortage situation with customers.

Very well. Just one last question for me. I guess the yield issue is about a 3 to 4 point margin impact. Do you expect similar magnitude impact in Q2 and Q3 or will that improve over time?

Yes, I think we expect a similar impact of the gross margin in Q2 by 3 to 4%. And we expect to improve in Q3 timeframe.

Andrew Huang from American Technology.

I was just wondering if you could first comment on your ASP erosion during the March quarter, and what it is normally, and how it compares in the March quarter.

Basically, when we look at ASPs, we look at ASPs for both existing products, as well as new products as you bring out enhancements to your old products. Basically we did see a significant erosion in ASP in Q1 for products that currently existed. The reason for that is due to lead times at wafer fab, etc. We did not see significant need to move in any of our ASPs in those products. Certainly we are continually enhancing products, bringing out new products into the marketplace that incorporate additional functionality. And we brought out a significant amount of products in the Q4/Q1 timeframe, some of which resulted in some of the yield issues that we had. And so those being new, there really was no ASP erosion.

Got it. Next question is, I think you mentioned a few questions ago that you expect to report Q2 -- you said you would be the, I guess, number one -- you would have the number one market share in notebooks for CCFL inverters. I am just curious, are you seeing any new competitors entering that market for notebooks specifically?

We have not really seen a new name competitor to my knowledge in the notebook space in the last year.

I guess the same question on the LCD TV side.

No, we really see the same names in the marketplace that we have seen over the last year.

Tore Svanberg from Piper Jaffray.

Just two quick ones. First of all, just looking at your R&D the last five or six quarters, Sterling, I assume a lot of that has been going to build out your China infrastructure. How much of that is associated with the revenue you're generating today? Or should I really view that spending to translate to generate revenues in '07 and '08?

So many (indiscernible). You are saying that R&D go to China, and how much revenue relate to China-based R&D activity?

Yes. How much are you experiencing today. And I'm just trying to understand when that R&D is going to translate into revenues?

The R&D by the team was set up in China, most of it is young engineers, without vast experience. We did that in 2001. And our first R&D team in 2001, today the revenue is, I believe, a range of about 20 to 30% related to the China team.

And we hired young engineers. Normally we keep them about at least one to two years before (indiscernible) would be involved with the products. Because the product cycle and also experiencing to be a learning curve. And that would be two or three years’ lead time. So far right now we see 20 to 30%. And we will see the ratio will be increasing in the coming years for the R&D activity from China.

Very good. Also, as I look at the gross margin profile here the next couple of quarter, it looks like it is going to be at the lower end of your range in Q1 and Q2. I think you mentioned an improvement in Q3. Where will that improvement come primarily from? Will it come from a better mix, or will it come from basically solving the yield issue or both?

It will really come from solving the yield issue, which as you are aware when you're dealing with wafer fab material, it takes months to fix and not weeks.

That does conclude our question and answer session, and also our conference call for today. We would like to remind you that a replay is available through May 10 by calling 1-888-203-1112, or you can call 1-719-457-0820. The pass code for the replay is 234-7111. We do appreciate your participation today. And you may now disconnect.