O2micro International Ltd (OIIM) 2006 Q2 法說會逐字稿

Good day and thank you for joining us today to discuss O2Micro's earnings for the second quarter of the FY 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 O2Micro's website at www.o2Micro.com.

There will be a replay available through August 9 by calling (888)203-1112, or (719)457-0820, or (080)090-8709. The passcode is 921-3147. Following the presentation by management the conference call will be open for questions and answers as time permits.

At this time I would like to turn the program over to Mitchell Benus . Please go ahead, sir.

Thank you and good afternoon. Welcome to the O2Micro earnings report conference call for Q2 FY 2006. This is Mitchell Benus, Director of Investor Relations.

I would like to begin by reminding listeners that this discussion's 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 F1, form F2 and 20F report and other documents filed with the SEC from time to time. Listeners are referred to the O2Micro earnings press release and 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 for this information.

With us on today's conference call are Perry Kuo, CFO; Jim Keim, Director; and Sterling Du, CEO and Chairman of O2Micro. After the reports, the floor will be open for questions as time permits. Perry Kuo, CFO of O2, will highlight the operating results and projections, followed by Jim Keim, Director. Jim will provide market highlights and comments will be made by Sterling Du, CEO and Chairman. After which we will answer questions.

Now I would like to introduce Perry Kuo, CFO of O2Micro, for a discussion of the revenue, income and financial highlights for the second quarter of fiscal 2006 ended June 30, 2006. Perry?

Thank you and good afternoon, everyone. This is O2Micro's earnings report announcement covering June 2006, ending June 30, 2006. If everyone has a copy of the earnings report press release, I will be brief and report the highlights. First, [inaudible] for second quarter 2006 revenue new for Q2 was $28,029,000, and which represents a decrease of 3.7% from the preceding quarter and an increase of 9.3% from the comparable quarter of the prior year. Net loss for Q2 was $2,512,000, compared to the preceding quarter of income $1,031,000, the net income for the comparable quarter of the prior year was $2,980,000.

If we exclude one time expenses including in house testing staff, $285,000, impairment losses, we see investments. Similarly $756,000 [inaudible] listing $439,000 and the stock compensation expenses $768,000, negation, $3,091,000. The pro forma GAAP net income will be $2,827,000.

Earnings per ADA fully diluted for Q2 ending June 30, 2006, were minus $0.06 for ADA compared to $0.03 for ADA for the preceding quarter. And the $0.07 cents per ADA for the comparable quarter of the prior year. Gross profit margin for Q2 was 55.3% mainly due to product mix and some rolling year rates with new product lines.

R&D expense, excluding stock-based compensation, charge-offs $394,000 for Q2, or $7,757,000 or 27.3% . The higher is a result of hiring R&D engineers and the more recurring engineering for both new products and [inaudible] in the birth of our product line. O2Micro continues to invest in R&D in order to bring momentum to the sales growth in the coming future.

SG&A expense for Q2 including stock compensation charge of $419,000, or $6,392,000 into thousand, not including the IP litigation expense of $3,091,000. The total SG&A expense including the litigation was $9,902,000, or 35% of the revenue. Income tax benefit for Q2 was $161,000. Share repurchases in Q2 were $168,988, for a total of $1,527,252. In Q1 a total of 421,788 have been repurchased to date which is 1.1% of shares outstanding.

Revenue by end market as a percentage of total revenue for Q2 was, consumer, in the range of about low 15% range, computer in the range of low 30% range, industrial and communications, each as more single digit percentage of revenue. Balance shift. Auto-micro hit over $84 million in cash and short term investments. This represents cash and equivalents of ADS of $2.16. In addition auto-micro has no debt. Short term investments or money invested in corporate bonds are at least in AA reg in government bonds of certain developed countries.

Capital expenditures in Q2 was $50,971,000. There were two areas for CapEx in Q2. One is the purchase of [inaudible] and the other one is purchase of land in [inaudible] Taiwan for the global incentive. We expect to improve quality, transparency and [inaudible] with this important investments. The total depreciation expenses in Q2 was $1,000,094. Accounts receivable at the end of Q2 was $15,054,000, or a DSO of 42 days. Given the returned ratio for Q2 were 3.4 compared to 3.5 for the previous quarter and the 3.6 for the comparable quarter of the prior year. Cash flow from operations for Q2 was [inaudible] in the amount, $2,030,000.

Human resources. O2Micro now has 863 employees, 52% of which are engineers. This positions us well for new product development and the continuous introduction of new products and [inaudible] in the future.

Now I would on the guidance for Q3, 2006. Auto-micro estimate Q3 revenue compared to Q2 to be up in the range of 7% to 9%. R&D for Q3 will be in the range of 24% to 27%. We expect SG&A without education expense for Q3 to be in the range of 23% to 26%. We expect a key expenses to increase incrementally from Q2 which include IT tech facilities, stock option expenses, 300 to 400,000, the sales infrastructure for retail firewall, 200,000. We comprised in the Q3, 200,000. The tech facilities will enhance our testing capacity and ability in terms of cost and quality. So we expect to have met production in Q4, Q1 2007. We give firewall in specific of the sales infrastructure, application engineer and operational support that the product mature to the market will start to contribute more in our product line. [inaudible] in 2007.

We expect education expense for Q3 to be in the range of $3.8 million to $4.3 million. Stock compensation expenses began in Q1 and we expect the stock compensation expense for Q3 to be in the range of $700,000 to $800,000. A fixed rate of 12% to 14% of pro forma income. Gross profit margin in Q3 is expected to be in the range of 53% to 56%. Many base of the product mix resulting from regaining the market share from [inaudible] . And we speed up the cost on these parts and will see some positive results in the second half next year.

I will now pass the call to Jim Keim, Director.

Thank you, Perry.

First, I'll give a legal update. We see our lead in intellectual property expanding. Few young companies have ever gotten to a point where they have a stronger intellectual property and stronger IT protection program than O2Micro. The expansion of our IP portfolio is evident through our key phase array inverter patents issued in four critical countries that lead the world in TV technology. We are particularly pleased that the phase array patent issued in both Japan and Korea.

These countries have demonstrated LCD TV leadership with key manufacturers including Sharp, Sony, Samsung, and LG Phillips. Patents in some of these leading producing countries are difficult to obtain. It speaks to the quality of our intellectual property. We also have key phase array patents in Taiwan, the key producing country, as well as the United States. Overall our patent portfolio grew from 185 to 200 patents during the quarter. This includes five new inverter patents in the quarter including one in China, one in Japan, two in Taiwan, and one in the United States.

Besides the issue of the patents, our intellectual property also continues to be validated in courts. In recent court actions BiTEK, and two major BiTEK users, Lien Chang and SPI were found to have willfully infringed on our inverter technology in Texas federal court. We are awaiting the court's decision regarding an injunction against infringement of the product and will pursue attorney fees.

This followed an earlier decision of willful infringement by the Texas Federal Court against Taiwan Sumida's use of Monolithic Power Systems product. The court ordered O2Micro $4 million, up to an additional $3 million in attorney's fees. The court also issued a permanent injunction against certain Taiwan Sumida based modules from entering the United States. This award amounts to approximately $1.00 in damages for infringing module plus attorney fees. The award is being appealed.

It also remains to be seen whether Sumida or MPS will pay for this award because MPS filed suit against Sumida -- pardon me, on Sumida in California courts just prior to this trial to invalidate the indemnity agreement for patents with Sumida. Our upcoming trial against Samsung which includes infringement of our phase array patent is scheduled for trial in April. The second trial involving patent infringement filed against Monolithic Power Systems will be heard in California Federal Court. This is the same California federal court that found MPS guilty of trade secret theft and has invalidated two of their inverter patents. We are currently appealing the courts reduction to $2.7 million from the jury award of $12 million. We remain hopeful of receiving the larger award through appeal.

While our heavy investment in patent protection has impacted our short term results due to legal costs, we have successfully defended our intellectual property and are in the process of recapturing costs via judgment and settlement. More importantly by successfully defending our intellectual property, we are obtaining key market wins in achieving better pricing and ASP stability looking forward. We expect legal costs to come down considerably over the coming year as our legal victories are upheld on appeal and as companies settle with us due to our broad legal victory.

We are also hopeful that going forward competitors will be careful not to copy our technology because they know we will aggressively defend it. Although this was considerable pain for shareholders it will ultimately be their gain and we are seeing the benefits of it already and expect to show up and expect that to show up in the numbers in the coming quarters and the coming years. If you have further questions we would be happy to have our legal department speak with you.

Now I will move on to a market update. As a significant supplier in the analog market we remain very optimistic about growth in 2006. Our growth in the first half of 2006 was a record being up nearly 17% versus the first half of 2005. Although O2Micro sales results were down 4% sequentially in Q2 this situation was due to inventory corrections related to lower than expected sales at major customers. Taiwan notebook makers reported on June 21 that worldwide notebook sales were expected to fall 10% sequentially in Q2. Corning, the major supplier of LCD glass, reported on July 25 a 14% sequential volume decline in the second quarter LCD glass volume versus Q1. I'd like to highlight that was a volume decline, 14%.

These significant drops in the notebook and LCD display markets attributed to our results despite market share gains we made in notebook in both inverter and e-commerce. Nevertheless we see our core markets being positioned for good growth in the second half of the year. Although the LCD monitor market and notebook market suffered a short term setback in Q2 we see our customers now optimistic that the LCD monitor and notebook market have quickly rebounded and we remain optimistic regarding the LCD TV market. This situation has enhanced with our phase array patents being issued in Japan, Korea, Taiwan and the United States.

We also believe two other factors will enhance our growth as we look to the future. Our expanding R&D efforts with ongoing intellectual property expansion will lead to a more broadly based portfolio of products over the next several years and will moderate the cyclical ups and downs that we have experienced. These products will include battery gauges, wide LED drivers, DC to DC products and VPN firewall. The intellectual property will drive not only growth but profitability. Secondly, we have established major operating activities in China leaving us better positioned for both lower cost production and improved supply support to our major customers most of who base their production in China.

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 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 portable applications. As mentioned earlier, our intellectual property portfolio continues to expand including focus on LED controllers. Intelligent power efforts continue to expand as well. Our patent cool charge product achieved initial design wins at a major OEM and is expected to start shipping later this year.

This patented cool charge product enables higher performance from existing notebooks and helps pave the way for the next-generation of even thinner and lighter notebooks. Our power management units now have mobile design wins with revenue contribution in both Q3 and Q4. Our system DC to DC products continue to win new notebook designs and we expect to increase our market penetration as new products continue to be introduced. Our processor DC to DC are now in the design stage for AMB based platforms.

Intelligent e-commerce has designed a new generation product including PCI express chips that has gained industry acceptance at major notebook OEMs including Dell. We did see revenue gains in the product line in Q2 and expect significant gains based on design wins in Q3 and Q4. The intelligent battery. This product offering incorporates innovative intellectual property to more accurately control charging and discharging of batteries. This is essential in critical applications where safety and accuracy are required. We have achieved initial design wins and expect revenue contribution from this product line in Q4. As mentioned last time our VP and firewall product has past testing at ICSA labs. Our O2Micro product was the first evert to meet all 1.0D's logging requirements without any deficiencies. We are now focusing our effort at sales of this product and do expect 2006 to be a good staging year with meaningful sales.

To summarize, we expect to see significant growth opportunities in the notebook, consumer and industrial business in 2006 as our broad new product lines enjoy a increasing number of design win opportunities.

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

Thank you, Jim.

As our shareholders know, our Company participates in dynamic markets, markets which are reflective of the overall economic health of the world economies. While the recent quarter has shown less than anticipated growth, long-term this market should have renewed growth. Indeed we have begun to see recovery in our market. Second quarter 2006 finished with revenue of $28 million. This was a decrease of 4% from the preceding quarter and an increase of 9% from comparable quarter of the prior year. The last for eight years for the second quarter 2006 fully dilute was $0.06 compared to earnings per ADS of $0.03 in the proceeding quarter and earnings for ADS of $0.07 in a comparable quarter of the preceding year.

A key message today I wish to leave with our shareholder is that we are committed to grow the Company and increase shareholder value. This quarter's market growth has been disappointing and for the first time as a public Company, O2Micro has not recognized a quarterly profit. We commit to improve the financial, visible control of Company spending and to maximize our legal investment return. This renewed commitment including improving the IT area by, one, continued growth IT portfolio; two, recruiting expenses, incurring in defending our portfolio, regenerating growing income and develop product with high entry barriers. As Jim mentioned, our strong market share in the LCD market benefited our second half of this year's business. Our China based foundries will further improve infrastructure.

Our PCI chip, computer game market chip, continues to gain market shares [inaudible] PCI express chips as it grew to higher percentage revenue of Company. Cool charge technology product, as Jim mentioned, attract top tier customers. We believe it is the trend to use cool charge for better server control for the future notebook computers. Our patent portfolio grew from 185 in Q1 to 200 in Q2 2006. Patent claims grew from 4,733 in Q1 2006, to 5,068 in Q2 2006. Our channel team grew from 388 in Q1 2006 to 491 in Q2 2006. We've been repurchasing shares of O2Micro stock and will continue doing so while incorporating our focus program to improve the shareholder benefit.

Thank you for your listening and your continued support of O2Micro.

Thank you and we will take questions from the audience.

[OPERATOR INSTRUCTIONS] We'll take our first question from Tore Svanberg with Piper Jaffray.

Yes. Good afternoon. A couple of questions, I will start with a question for Jim. Jim, you've mentioned you've seen a recovery especially in monitors and notebooks. Could you elaborate a little bit on that, please?

Yes. We had major customers that did have inventory in place at the end of the quarter. And those inventories are now gone and they are ramping up volumes very quickly and have indicated to us that they will need increasing volumes as they move through Q3. So we have seen a rapid dissipation of the inventory that was in place at the end of the quarter.

Can you also just clarify a little bit more on your internal test operations? How is that going to play out , what type of capacity are we talking about? Timing? Just so we can build our models especially to SG&A and gross margin, can you just help us go through that, please?

Yes -- the progress of the in house testing facilities in China is down to a smoother passing last quarter. We continue to install the equipment and we trend, we hire the people up to a 73 and [inaudible]. We expect to trend more in Q3, Q4 time frame. We will start to have done testing in Q3 and then start to do some a free running in Q4. So up to Q4 we expect to gain 50% of the capacity of the design [inaudible]. And Q4, Q1 time frame we expect to -- in terms of the production. At the beginning the impact of the production probably impacted on the gross margin 0.5% to 1%. But after it reached the cost-effective accretion we allowed up to 85% of the capacity we expect to see the gross margin improvement by 0.5% to 1.5% based on the product mix.

Thanks. On R&D -- you've been spending a lot of last couple of quarters. Obviously, you've been coming out with a lot of new products and have some big design centers around the world. Could you maybe update us on where you expect the R&D to go for the next couple of quarters?

Yes, for the R&D, we have been continuing to invest in R&D area by spending our China and also spending offices in China for the past two to three years. We expect we will get a very good support for this investment by introducing new products designed by the China team and also we continue to receive some post-op programming designed by the China team. I think these designs are very important to the future growth of the O2Micro especially when we put our stories into the China area. We produce it ourselves. We are the global structure with the China story so this is very important. In the Q3 we reached a very high amount.

I think for the future trend, the growth rate of the R&D in terms of the amount would be, will slow down because of the -- we also we are in line with the future market situation and also more of the new product actually a new kind of the mature state. So the expenditure of the R&D I think this will be 15 year more amount depending on the NIE. So I will see the trends of the R&D for the future quarters, the incremental increase amount will be much less as the increase of the sales or the percentage will start to decline.

Great. And finally, Jim, you talk quite a bit about how important you see the right patents were especially being granted in areas like Japan and Korea. Can you just talk a little bit more about why that is important? Because as far as I'm concerned, if your product is superior then that might be enough but maybe I don't understand it. So maybe you can elaborate a little bit on why that is so important.

Well, the phase array patent is a methodology that we develop for higher end televisions that choose typically in the 30-inch area and up in the TVs, that helps improve the quality of the picture. And as we applied for these patents we've had some major users of TV follow our technology while we had others including Samsung, for instance, who decided not to follow our path in technology.

And what has happened now is these patents are being issued around the world not only in the United States but also as I mentioned in Japan, Korea itself, and also Taiwan, which covers both the major producing areas as well as the major shipping areas into which these products go. So it gives us a great deal of strength as we move forward, particularly to get Samsung in the court system or these patents.

Great. I will pass over to somebody else and might come back later. Thanks.

Thank you. We will go next to Quinn Bolton with Needham and Company.

Hi. Thanks. Can you hear me? Great. First of all for Perry, Perry, can you just review the one time charges that you backed out to get to your pro forma number? And then similarly review, it sounded like you have a step up in a number of OpEx categories here in the third quarter. Could you just again review those?

Review the numbers?

Yes, please.

So the one time expense which would include in house testing in Q2, this is $285,000, and impairment loss, investment based on the accounting rules, this is $756,000, and we had the second deal for the Hong Kong [inaudible] by this introduction in March. This $439,000. And other than this we had nonGAAP expense of which is stock compensation $768,000. And education is a special fee, education is $3,091,000.

Okay. Great. And then just the third quarter step up in OpEx?

For the third quarter, for the incremental, as I mentioned for the tech facility, we are increasing the tech there and also the for the $300,000 to $400,000. And we continue to build up our infrastructure which include sales, sales education and also operations supporting systems for the VPM firewall will continue to [inaudible] for this product. So this will increase by $200,000. And for the subset of a directory comparative in Q3, this will increase by $200,000.

Great. Thank you for reviewing that. Then just a question on the financial model, obviously here in the near term it looks like you guys have been moving away from the longer term model. Gross margins have been on the decline and OpEx as a percent of sales has been growing. Can you just review for us what your long-term model is and give us a timetable of when you think you can hit that target?

We began the market share for the local [inaudible], the use of our whole products or we are, we are up the China [inaudible] and also we move our for Taiwan and look to China base policies. So we expect again to gross margins of the second half of the year. Also the gaining of the market share in notebook and also expect the future growth of the [inaudible] TV. The revenue growth was faster than we expected in the second half next year. So I think that the second half of next year will be, we will respect the year model.

Okay. Great. And then just on the new products, obviously you guys, sound like you got a number of wins for the new products. And I'm just wondering as you go forward and report future quarter results, can you break out or will you start to break out what percent of revenues are coming from say the intelligent battery, the power management, the cool charge, or are you going to continue to just report by end market?

We will continue to report by end market only.

Okay. You think you could give us in the future maybe put all the new products in one bucket and tell us what that bucket is as a percent of sales so we can track the success you've had on the new products? Because it really looks like the new products help diversify the revenue stream and probably helped drive gross margins. So it would be interesting if you could give us some kind of detail on that in future quarters.

We will have to think about that. That's actually a more complex question than you might think because there's constant upgrades going on on the old product set. So there's a lot of thought to give to that.

Okay. And then lastly you'd mentioned the gross margin here in the near terms are sort of depressed because some of the wins in the notebook product and I just wasn't sure, are you referring to regaining market share on the lighting products but you're having to cut price to do that? Or is this the new PCI express e-commerce product starting to ramp? Because I know historically the e-commerce products have been at a lower than corporate average gross margin, I was just wondering if you could give us a little bit more flavor on the gross margin.

Well, actually it's both because first of all the PCI express type product that's gone to the notebook, that type product typically does have a lower margin. But in this particular instance it was also intelligent inverter because the product that we had shipped into the notebook market had not been cost reduced. That is in process and that product is just out of wafer patent now. It probably will not be in Taiwan production until Q1 and that will put us back into a better gross margin position for the invertor product that goes into the notebooks.

Okay. And then just lastly, you mentioned some of the LED wins starting to ramp to production; can you tell us the application? I think you said portable, is that in the handset side of the business, is that for PDAs or other types of hand hell devices?

It's in a variety of products, probably the highest volume at this point is the DVD type products.

Great. Thank you.

Thanks, we will take our next question from Andrew Huang with American Technology Research.

Okay. I just want to do kind of dial in a little more detail on your revenue guidance for the September quarter. I believe your guiding 7% to 9% sequentially. And I was wondering if you could give us an idea for the expectations for what you expect for notebooks, monitors and TVs to get to that guidance?

I think we just mentioned that we continued to gain in the notebook area and we also expect some [inaudible] LCD TV [inaudible] the inventory areas. We don't care to comment on the individual sectors.

But then is it fair to say that you expect growth from all three of those segments for the September quarter?

Yes, yes, we do.

Okay. Thank you.

Thank you. We will go next to Craig Berger with Wedbush Morgan Securities.

Good afternoon. On the VPM Systems, could you again recap your revenue growth expectations? When do you expect revenues to start to come in, who are your customers and what is sort of the magnitude of contribution there? Thanks.

I think this year we're looking for the $1 million or $2 million in revenue. And we are setting up the channel including a system integrater and various integraters. And the next year those channels will be warming up and we will begin to focus and will ship into the major targets which is China, [inaudible], Taiwan and [inaudible] Singapore. And [inaudible] is Asia in between. And next year we are looking at how to grow this business three times which is about $3 million to $4 or $5 million.

And we also use this two years to practice our supply chain and we are also seeing those systems in [inaudible] however we do have our own to do it in securities operations and we do have our own accessory based on our assets. And we would like to practice those and we continue to get more certification and secure the reputation as we are in the high-end market of this market -- of the security market. And the customer base several countries we mentioned that including some government in school sand hospitals and those already have one or two machines, some people are using it for many months and some only six months. And we will give us more confidence in getting to more so-called relationship base and customer base. So we treat it with patience and are optimistic for this in the future.

Great. And then on the TV lighting side can you remind us who your top customers are there?

We've certainly announced in the past we've been a leading supplier with Sharp and LG and it's no secret we filed litigation on Samsung and Sony. So basically that gives you an idea of the flavor of the TV position.

So Sharp and LG are the two largest in the TV lighting?

Yes, that's safe to say.

Great. And then I think to Quinn's question, you guys are investing a lot in R&D growing it much faster in the top line and I think it's difficult to track sort of the progress on when some of those investments may turn into revenues. So I mean I think you guys intend to ramp up your R&D further next quarter; do you have any visibility into R&D spending beyond that or should we continue to sort of model that stuff up and to the right?

Regarding the R&D in the Q3, Q4 time frame and beyond, the amount of the R&D will be at the high-end of the growth of the R&D percentage will be slower than the previous quarter. And I think it's still too early to quantify for Q4 or Q1. that's because we continue conduct cost programs. So we will continue to save some -- but the growth in the revenue I start to see the growth rate in the R&D will be much lower than the growth rate in the revenue.

And then just lastly I noticed you included Q2 test start up charges as a pro forma item. Is that correct?

Q2? Q2? The test? Again? The Q2 for the in house testing start is $285,000?

Yes. My question is, is that really a pro forma item? I mean production charges, is that even setting up production?

This is for the one time expense.

Okay. Great. Thank you.

We will take our next question from Paul [Shook] with Paul [Shook] Associates.

Hello. My question I think is somewhat an add on to Tore's and that is, we get all the time patents granted to O2Micro, we seem to be very significant patents both in themselves and as blocking patents. But there never seems to be any revenue attached to them. I've never seen a Company your size that has so much intellectual property that's been recognized without a concomitant revenues and earnings. Could you explain that a little bit?

Well, first of all let me say that we have been given court awards but you have to understand that we do not receive that money until the cases have been through the appellate system, because these cases are almost always appealed. So the length of time it takes us to receive that money is the length of time it takes to go through the appellate system. So in the cases that have been heard to date we would not expect to start receiving money from those until sometime next year after they've been through the appellate system. At that point in time we would certainly be helpful that you will see money come back in.

The other point that I would make is that one of the recent cases which was the BiTEK, Lien Chang, SPI case, we did not seek damages. The reason we didn't -- most of that product went into Samsung. And we will be seeking damages from the end user of the product in that case and clearly BiTEK and the Q modules part were found to willfully have infringed our patents and that will carry through to the system level where we have very significant patents in place that we are going to apply against Samsung. It will not only be the opening ramp protection but also the phase array patents.

So basically we have moved from the IC supplier up to the system level as our patents have become more and more system level patents. But again I want you to understand that we may spend $4 million on the case, get awarded $4 million back, it costs us $4 million up front but we don't see the other money come through until it's been through the appellate division.

Would it be safe to assume that you will see some revenues and earnings from this center sometime next fiscal year?

We would certainly hope so. You can never guarantee what's going to happen in the appellate system but certainly if these awards are upheld we would expect to start collecting money in the 2007 time frame.

Thank you very much.

And also obviously as our patents are held in the court system that does enable some discussions to begin relative to potential settlements and royalties.

Thank you.

We'll go next to Joe [Massaloni] with Amorous Funds.

Hey, guys. Most of my questions have been answered. Can you talk a little bit about your visibility and how linear you see this quarter? Is it pretty back end loaded or is it pretty linear in fashion?

Well, there was some inventory to clear out early in the quarter. We see that inventory having quickly dissipated at most of the major customers and in fact high volume shipments have begun. So once the inventory is cleared I think it's become really quite linear in the sense of when they started going forward with the production but to the extent that there were a couple of weeks that some product didn't ship we have to say it was a little bit back end loaded. Nevertheless I think that inventory has cleared out at this point. Customers are all telling us they have good expectations for Q3 and backlog certainly reflects that.

And what percentage of the quarter is turns would you say?

We don't really announce those numbers.

Okay. Thanks.

[OPERATOR INSTRUCTIONS] We will take a follow up from Tore Svanberg with Piper Jaffray.

Yes, I think you spent about $50, $60 million in Capex this quarter. Can you maybe give us some color on what spending you are expecting next couple of quarters on CapEx?

Yes. In Q3, Q4 we expect to continue to spend up to $8 million mainly for the system.

So the second half will be $8 million?

Second half will be $16 million.

So $8 million each?

$8 million for each quarter.

Okay. And maybe also as a follow-up question, Jim, you talked about the legal. Now since you've won three cases what has been the behavior since then? I'm trying to think about, we quantified it in dollar terms but can you maybe give us some qualitative analysis on how that has changed, how you talk to customers, how you go to market? That would be quite helpful. Thanks.

Well, after winning the Taiwan Sumida case we did begin the shift in the notebook market as we mentioned. We have seen market share gains now in notebook in the inverter area. So there has been impact there already. The later case that we won which was the BiTEK situation which was used more in the monitor and TV area has begun to have some impact on customers in terms of some of their design activity. So we have seen increase in design activity in those areas that typically takes quarters to flow through. Although we can say that we are in discussions with some customers relative to potential settlements of royalties.

So as far as the impact on legal itself, has there been a change there? Do you still expect to file the cases or just how has it impacted your legal strategy in general?

Well, in general I would say that basically we are hopeful at this point of not having to file litigation certainly at the rate we've done over the last several years. We've seen a slowing in that and we think there is less of a tendency to copy O2Micro product at this point in time. So it's been very positive from that point of view.

Great. Thank you very much.

Thank you. We will go next to Robert Gardiner with Wasatch Advisors.

Yes, Jim, if you get an injunction in the Texas case here in the next month, what is the impact in the marketplace to people like Samsung and Sony? That would be my first question.

Well, the impact can be significant if they are continuing to use that product and as we mentioned in some instances without talking about specific customers some of those customers have already begun to move designs to other products to make sure they don't get involved in an injunction.

Did they have other options in O2Micro to go to or can you kind of talk about -- ?

Well, that --

The injunction, is that a windfall for you or is it likely a windfall for other guys like Microsemi?

It's certainly beneficial to us because basically obviously we are the leading holder of patents in this area. We now have well over 40 patents worldwide in the inverter area. I think it's becoming quite wide knowledge that we --

I understand that it's going to be a benefit to you long run but in the short run I presume Samsung and Sony, they have to do something if they want to keep selling TVs and monitors. And so does that mean they are forced to buy your product or can they buy somebody else in the short run while they kind of battle it out with you in the courts and in negotiations?

Well, first of all it's difficult for us to comment on that situation relative to a specific customer. But in general they obviously still use different products where they wouldn't be facing an injunction or they can utilize our product and move forward. As I indicated, I think at this point we are quite pleased with the progress but we can't comment specifically on a customer and what they are doing.

Another question I have, and I know you haven't commented on Q4 but can you make any kind of comment about the December quarter or the momentum building there and the new products and how that might, how we might think about that?

Well, we certainly continue to see design wins as we mentioned with some of our new products and I think what we would say is with those design wins and assuming that the economy continues to move in a positive direction that we would be in a good position in Q4. But it's difficult to comment on the overall economy at this point in time. Certainly from a design win point of view we are pleased with the progress.

My last question is, if you get the costs down with the new foundry partners, if they go according to plan and if the mix kind of shifts back to where you think it normally would be, where do you think gross margins in Q1 can be?

Q1 next year?

Q1 next year, yeah.

I see the -- we expect to go back to the model in the second half next year. So in Q1 next year, there's a mix of the stock option, a mix of of the production of the [inaudible]. So we are in the midst of the legal process of the one. And we continue -- I think in Q1 we start to get some program, but it depends on the timing, the final timing and also the timing of the of the customer. So I would say that the Q1 in the area of the 53%, 55% area. Do you feel a need to say [inaudible].

Okay. Thanks.

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